Rising Re Disputes May Affect Balance Sheets
We are all aware of the effect of the extended soft market on the direct profitability of insurance companies. Less well-understood is the possible impact of the soft market on the collectibility of reinsurance.
The amount of recoveries due from reinsurers has increased over the past few years. Chart 1 displays the ratio of ceded reserves to gross reserves and ceded reserves as a percentage of surplus for 10 large primary companies. (The 10 insurance companies selected for analysis had the largest ceded premium volume.)
As can be seen from Chart 1, the amount due from reinsurers as a percentage of gross reserves has more than doubled from 1997 to 2002. Although the percentage of recoverables varies dramatically from company to company (ranging from less than 1 percent to almost 50 percent), most companies are expecting more recoveries now than they did a few years ago.
The reinsurance recoverables as a percentage of surplus increased dramatically from 1997 to 2002, with 2002 more than three times the 1997 ratio.
This dramatic increase is a result of the decline in surplus over the last few years due to unprofitable results of the insurance industry in the soft market as well as increased recoveries.
Similar to the ratios of reinsurance recoverables to gross reserves, the reinsurance recoverables as a percentage of surplus varies dramatically from company to company (ranging from 1 percent to over 150 percent).
The collectibility of reinsurance may not significantly affect many companies. However, for a few companies, the amount of reinsurance recoverables is a large percentage of surplus and the collectibility of reinsurance and timing of the collection could significantly affect the financial results of these companies.
Not only has the amount of reinsurance recoverables increased over the past few years, but the amount of reinsurance in dispute has also increased. Chart 2 compares the amounts of reinsurance in dispute to total ceded reserves and surplus for the past three years.
As shown in Chart 2, the amount of reinsurance in dispute (as a percentage of total ceded reserves) has increased from 4.85 percent to 7.03 percent in the past three years, with the most significant increase occurring in 2002. Seven of the 10 companies we examined reveal some reinsurance in dispute. Alleged reasons for disputes may include:
Misrepresentation of business written.
Misrepresentation of terms.
Improper ceding of premium and/or losses.
Changes to business without notification to reinsurers.
It is not surprising that disputes have increased after the end of the soft market. Many insurance companies and reinsurance companies wrote unprofitable business.
Some reinsurance companies have lost large sums of money on certain contracts and believe they were misled. Some primary companies may have reduced rates more than planned, grown dramatically, or have significantly altered their books of business.
Despite the increases in reinsurance recoverables and amount of reinsurance in dispute, there does not appear to be the same trend for losses over 90 days past due or in the provision for uncollectible reinsurance (which are shown in Schedule F penalties). Chart 3 displays the ratio of ceded losses over 90 days past due and the Schedule F penalties for the last six years.
These results imply that although the amount of total dollars in dispute has increased, the reinsurance that is not in dispute is being paid on time, or where needed, is well collateralized.
It should be noted that insurance companies currently record a penalty of 20 percent of the amount of reinsurance in dispute. If those insurance companies are unsuccessful in the disputes, there could be immediate negative financial implications for the companies losing disputes.
It will take some time to fully quantify the effect of the soft market on reinsurance recoverables. However, it appears that disputes are increasing significantly and could have a material effect on some companys balance sheets.
Brian Z. Brown and Lori E. Julga are consulting actuaries for Milliman USA in Milwaukee, Wis.
Reproduced from National Underwriter Edition, July 7, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.
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