(1) No insurer
subject to this regulation shall, for reinsurance ceded, reduce any liability
or establish any asset in any financial statement filed with the Department if,
by the terms of the reinsurance agreement, in substance or effect, any of the
following conditions exist:
(a) 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
allocable renewal expenses of the ceding insurer 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 expected by the company at the time the business is
reinsured;
(b) The ceding insurer
can be deprived of surplus or assets at the reinsurer's option or automatically
upon the occurrence of some event, such as the 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;
(c) 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 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 because of unreasonable 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 treaty;
(d) The ceding
insurer must, at specific points in time scheduled in the agreement, terminate
or automatically recapture all or part of the reinsurance ceded;
(e) The reinsurance agreement involves the
possible payment by the ceding insurer to the reinsurer of amounts other than
from income realized from the reinsured policies. For example, it is 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;
(f) The treaty 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:
1.
Morbidity
2. Mortality
3. 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.
4. Credit
Quality (C1)
This is the risk that invested assets supporting the
reinsured business will decrease in value. The main hazards are that assets
will default or that there will be a decrease in earning power. It excludes
market value declines due to changes in interest rate.
5. 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.
6. 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.
+ = Significant
0 = Insignificant
RISK CATEGORY
From Subsection (1)(f) above
| PRODUCTS OR TYPE OF
BUSINESS | 1 2 3 4 5 6 |
| Health Insurance - other than
LTC/LTD* | + 0 + 0 0 0 |
| Health Insurance - LTC/LTD* | + 0 + + + 0 |
| Immediate Annuities | 0 + 0 + + 0 |
| Single Premium Deferred
Annuities | 0 0 + + + + |
| Flexible Premium Deferred
Annuities | 0 0 + + + + |
| Guaranteed Interest Contracts | 0 0 0 + + + |
| Other Annuity Deposit Business | 0 0 + + + + |
| Single Premium Whole Life | 0 + + + + + |
| Traditional Non-Par Permanent | 0 + + + + + |
| Traditional Non-Par Term | 0 + + 0 0 0 |
| Traditional Par Permanent | 0 + + + + + |
| Traditional Par Term | 0 + + 0 0 0 |
| Adjustable Premium Permanent | 0 + + + + + |
| Indeterminate Premium Permanent | 0 + + + + + |
| Universal Life Flexible Premium | 0 + + + + + |
| Universal Life Fixed Premium | 0 + + + + + |
| Universal Life Fixes Premium dump-in
premiums allowed | 0 + + + + + |
| * LTC = Long Term Care Insurance |
| LTD = Long Term Disability Insurance |
(g)
1. The
credit quality, reinvestment, or disintermediation risk is significant for the
business reinsured and the ceding company does not (other than for the classes
of business excepted in Paragraph (1)(g)2. 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 commissioner
which legally segregates, by contract or contract provision, the underlying
assets.
2. Notwithstanding the
requirements of Paragraph (1)(g)1., 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)
The associated formula for determining the reserve interest
rate adjustment must use a formula which reflects the ceding company's
investment earning and incorporates all realized and unrealized gains and
losses reflected in the statutory statement. The following is an acceptable
formula:
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Where: I is the net investment income
CG is capital gains less capital losses
X is the current year cash and invested assets plus
investment income due and ac - crued less borrowed money
Y is the same as X but for the prior year
(h) 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.
(i) The ceding insurer is required to make
representations or warranties not reasonably related to the business being
reinsured.
(j) The ceding insurer
is required to make representations or warranties about future performance of
the business being reinsured.
(k)
The reinsurance agreement is entered into for the principal purpose of
producing significant surplus aid for the ceding insurer, typically on a
temporary basis, 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.
(2) Notwithstanding
Paragraph (1), an insurer subject to this regulation may, with the prior
approval of the commissioner, take such reserve credit or establish such asset
as the commissioner may deem consistent with the Insurance Laws, Rules or
Regulations, including actuarial interpretations or standards adopted by the
Department.
(3)
(a) Agreements entered into after the
effective date of this regulation 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 commissioner
within thirty (30) days from its date of execution. Each filing shall include
data detailing the financial impact of the transaction. The ceding insurer's
actuary who signs the financial statement actuarial opinion with respect to
valuation of reserves shall consider this regulation and any applicable
actuarial standards of practice when determining the proper credit in financial
statements filed with the department. The actuary should maintain adequate
documentation and be prepared upon request to describe the actuarial work
performed for inclusion in the financial statements and to demonstrate that
such work conforms to this regulation.
(b) Any increase in surplus net of federal
income tax resulting from arrangements described in Paragraph (3)(a) 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% 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% 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% 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.}
