A. No insurer
subject to this regulation shall, for reinsurance ceded, reduce any liability
or establish any asset in any financial statement filed with the Bureau if, by
the terms of the reinsurance agreement, in substance or effect, any of the
following conditions exist:
(1) Renewal
expense allowances provided or to be provided to the ceding insurer by the
reinsurer in any accounting period, are not sufficient to cover anticipated
renewal expenses of the ceding insurer allocable pursuant to terms of the
agreement on the portion of the business reinsured, unless a liability is
established for the present value of the shortfall (using assumptions equal to
the applicable statutory reserve basis on the business reinsured). Those
expenses include commissions, premium taxes and direct expenses including, but
not limited to, billing, valuation, claims and maintenance costs expected by
the company at the time the business is reinsured;
(2) The ceding insurer can be deprived of
surplus or assets at the reinsurer's option or automatically upon the
occurrence of some event, which includes but is not limited to insolvency of
the ceding insurer, except that termination of the reinsurance agreement by the
reinsurer for nonpayment of reinsurance premiums or other amounts due, such as
modified coinsurance reserve adjustments, interest and adjustments on funds
withheld, and tax reimbursements, shall not be considered to be such a
deprivation of surplus or assets;
(3) The ceding insurer is required to
reimburse the reinsurer for negative experience under the reinsurance
agreement, except that neither offsetting experience refunds against current
and prior years' losses under the agreement nor provisions requiring payment by
the ceding insurer of an amount equal to the current and prior years' losses
under the agreement upon voluntary termination of in-force reinsurance by the
ceding insurer shall be considered such a reimbursement to the reinsurer for
negative experience. Voluntary termination does not include situations where
termination occurs or may be required due to oppressive or arbitrary provisions
which allow the reinsurer to reduce its risk under the agreement. An example of
such a provision is the right of the reinsurer to increase reinsurance premiums
or risk and expense charges to excessive levels forcing the ceding company to
prematurely terminate the reinsurance agreement;
(4) The ceding insurer must, at specific
points in time scheduled in the agreement, terminate or automatically recapture
all or part of the reinsurance ceded;
(5) The reinsurance agreement entails the
possible payment by the ceding insurer to the reinsurer of amounts other than
from income realized from the reinsured policies. It shall be improper for a
ceding company to pay reinsurance premiums, or other fees or charges to a
reinsurer which are greater than the direct premiums collected by the ceding
company;
(6) The agreement does not
transfer all of the significant risk inherent in the business being reinsured.
The following table identifies for a representative sampling of products or
type of business, the risks which are considered to be significant. For
products not specifically included, the risks determined to be significant
shall be consistent with this table.
Risk categories:
(a)
Morbidity
(b) Mortality
(c) Lapse
This is the risk that a policy will voluntarily terminate
prior to the recoupment of a statutory surplus strain experienced at issue of
the policy.
(d) Credit
Quality (C1)
This is the risk that invested assets supporting the
reinsured business will decrease in value. The main hazards are that an asset
will suffer default or that there will be a decrease in earning power of the
asset. It excludes market value declines due to changes in interest
rate.
(e) Reinvestment (C3)
This is the risk that interest rates will fall and funds
reinvested (coupon payments or monies received upon asset maturity or call)
will therefore earn less than expected. If asset durations are less than
liability durations, the mismatch will increase.
(f) Disintermediation (C3)
This is the risk that interest rates rise and policy loans
and surrenders increase or maturing contracts do not renew at anticipated rates
of renewal. If asset durations are greater than the liability durations, the
mismatch will increase. Policyholders will move their funds into new products
offering higher rates. The company may have to sell assets at a loss to provide
for these withdrawals.
(7) The ceding company does not (other than
for the classes of business excepted below), either transfer the underlying
assets to the reinsurer or legally segregate such assets in a trust or escrow
account or otherwise establish a mechanism satisfactory to the Superintendent
which legally segregates, by contract or contract provision, the underlying
assets when the credit quality, reinvestment, or disintermediation risk is
significant for the business reinsured.
Notwithstanding the foregoing, the assets supporting the
reserves for the following classes of business and any classes of business
which do not have a significant credit quality, reinvestment or
disintermediation risk may be held by the ceding company without segregation of
such assets:
-- Health Insurance -- LTC/LTD
-- Traditional Non-Par Permanent
-- Traditional Par Permanent
-- Adjustable Premium Permanent
-- Indeterminate Premium Permanent
-- Universal Life Fixed Premium
(no dump-in premiums allowed)
In order for a credit to be allowed, the reinsurance
agreement must provide for a reserve interest rate adjustment when funds held
by the ceding insurer are not segregated. In determining the reserve interest
rate adjustment, the ceding insurer must use a formula which reflects its
investment earnings and incorporates all realized and unrealized gains and
losses reflected in the insurer's annual statutory financial statement. Any
adjustment which produces an additional cost for the reinsurance coverage shall
be recognized as a liability of the insurer. The following is an acceptable
formula:
***** FORMULA HERE *****
Where: I is the net investment income (Exhibit 2, Line 16,
Column 7 Part 1, Line 9, Column 8 for casualty blanks) CG is capital gains less
capital losses (Exhibit 4, Line 10, Column 6 Part 1A, Line 10, Column 7, for
casualty blanks) X is the current year cash and invested assets (Page 2, Line
10A, Column 1) plus investment income due and accrued (Page 2, Line 16, Column
1) less borrowed money (Page 3, Line 22, Column 1) Y is the same as X but for
the prior year
(8)
Settlements are made less frequently than quarterly or payments due from the
reinsurer are not made in cash within ninety (90) days of the settlement
date.
(9) The ceding insurer is
required to make representations or warranties not reasonably related to the
business being reinsured.
(10) The
ceding insurer is required to make representations or warranties about future
performance of the business being reinsured.
(11) The reinsurance agreement is entered
into for the principal purpose of producing significant surplus aid for the
ceding insurer, while not transferring all of the significant risks inherent in
the business reinsured and, in substance or effect, the expected potential
liability to the ceding insurer remains basically unchanged.
B. Notwithstanding Subsection A,
an insurer subject to this rule may, with the prior approval of the
Superintendent, take such reserve credit or establish such asset as the
Superintendent may deem consistent with provisions of 24-A M.R.S.A. or
administrative Rules adopted by the Superintendent.
C.
(1)
Agreements entered into after the effective date of this rule which produce
significant surplus aid and which involve the reinsurance of business issued
prior to the effective date of the agreements, along with any subsequent
amendments thereto, shall be filed by the ceding company with the
Superintendent within thirty (30) days from the date of execution. Each filing
shall include data detailing the financial impact of the transaction. The
actuary who represents the ceding insurer and signs the financial statement
actuarial opinion with respect to the annual valuation of reserves, shall
consider this rule and any applicable actuarial standards of practice in
determining proper credit in financial statements filed with the bureau. The
actuary shall maintain adequate documentation and, upon request, describe and
support the actuarial work performed for inclusion in the financial statement
and demonstrate that such work conforms to provisions of this rule.
(2) Any increase in surplus net of federal
income tax resulting from arrangements described in Subsection C(1) shall be
identified separately on the insurer's statutory financial statement as a
surplus item (aggregate write-ins for gains and losses in surplus in the
Capital and Surplus Account, page 4 of the Annual Statement) and recognition of
the surplus increase as income shall be reflected on a net of tax basis in the
"Reinsurance ceded" line, page 4 of the Annual Statement as earnings emerge
from the business reinsured.
(For example, on the last day of calendar year N, company XYZ
pays a $20 million initial commission and expense allowance to company ABC for
reinsuring an existing block of business.
Assuming a 34 percent tax rate, the net increase in surplus
at inception is $13.2 million ($20 million - $6.8 million) which is reported on
the "Aggregate write-ins for gains and losses in surplus" line in the Capital
and Surplus account. $6.8 million (34 percent of $20 million) is reported as
income on the "Commissions and expense allowances on reinsurance ceded" line of
the Summary of Operations.
At the end of year N+1 the business has earned $4 million.
ABC has paid $.5 million in profit and risk charges in arrears for the year and
has received a $1 million experience refund. Company ABC's annual statement
would report $1.65 million (66 percent of ($4 million - $1 million - $.5
million) up to a maximum of $13.2 million) on the "Commissions and expense
allowance on reinsurance ceded" line of the Summary of Operations, and -$1.65
million on the "Aggregate write-ins for gains and losses in surplus" line of
the Capital and Surplus account. The experience refund would be reported
separately as a miscellaneous income item in the Summary of Operations.)
