Reinsurance Security

Calculation of the Bad Debt Reserve

Allowance for reinsurer bad debt takes the following general approach:

• Allocate the reinsurance IBNR between each of the reinsurers
• Determine the payout of each reinsurer’s outstanding plus this IBNR allocation.
• Assign a probability to each cashflow of not being received.

The IBNR allocation between reinsurers is often pro rata according to the current outstanding recoveries expected from each reinsurer.

Generally the same payout pattern is assumed for every reinsurer (although this payout pattern may vary by class of business or other criteria).

The probabilities used for failure of the reinsurer to meet their obligations are generally based on rating agencies’ grades for that reinsurer. 

For example, a Standard and Poors “A” rating may be interpreted as having a 10-year default rate of 1.9%.  This means that if we own debt in the company, we would expect to receive 98.1% of that debt in 10 years.  We reinterpret this percentage by noting that this is equivalent to independently expecting to receive 99.62% per year, i.e. of having an annual default rate of 0.38%.  This 0.38% may then be applied to the annual cashflows expected for case estimate and IBNR recoveries.

Why do we Consider Reinsurance Security?