Current through Register Vol. XLI, No. 38, September 20, 2024
3.1. No
insurer subject to this rule shall, for reinsurance ceded, reduce any liability or
establish any asset in any financial statement filed with the commissioner 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. Table 114-48A 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.
1. The risk categories indicated
in Table 114-48A are as follows.
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 assets will
default or that there will be a decrease in earning power. 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.
g. 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 of
subdivision g of this subsection) 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.
1. Notwithstanding the requirements of subdivision
g of this subsection, 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:
A. Health
insurance - LTC/LTD
B. Traditional
non-par permanent
C. Traditional par
permanent
D. Adjustable premium
permanent
E. Indeterminate premium
permanent
F. Universal life fixed
premium
(no dump-in premiums allowed)
2. The associated formula for determining the
reserve interest rate adjustment must use a formula which reflects the ceding
company's investment earnings and incorporates all realized and unrealized gains and
losses reflected in the statutory statement. The following is an acceptable formula:
Rate ' 2 (I + CG)/X + Y - I - CG
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 accrued 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.
3.2.
Notwithstanding subsection 3.1 of this rule, an insurer subject to this rule may,
with the prior approval of the commissioner, take such reserve credit or establish
such asset as the commissioner may deem consistent with applicable insurance
statutes and rules, including actuarial interpretations or standards adopted by the
commissioner.
3.3. Agreements entered
into after the effective date of this rule 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 rule and any applicable actuarial standards of practice
when determining the proper credit in financial statements filed with the
commissioner. 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 rule.
3.4. Any increase in surplus net of federal income
tax resulting from arrangements described in subsection 3.3 of this rule, 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) and recognition of the surplus increase as income shall be reflected on a
net of tax basis in the "Reinsurance ceded" line as earnings emerge from the
business reinsured.
a. (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.
