Why do we Consider Reinsurance Security?
The aim of a reserving study is to decide upon an amount that will be held to pay future claims. The amount needed for this will be the gross claims that will be paid out less the reinsurance that will be collected.
Generally speaking, the gross outwards claims are projected and then appropriate recoveries calculated based on the actual reinsurance programme in order to derive this figure.
It is not necessarily the case, however, that an anticipated recovery on a gross claim will in reality be received.
There may be several reasons for this:
• The reinsurer may become insolvent and be unable to pay the claimed recovery
• The reinsurer may contest the claim, resulting in either a settlement at less than 100% of the claimed recovery or a court case that may be lost.
As such it is necessary within the reserve to offset some of the anticipated recoveries. This makes the final reserve net of reinsurance higher than would be expected by simply taking the original expected recoveries from the expected gross payments.
Strictly, the first reason for not receiving the expected recovery is the only reason to do with reinsurer security, since it concerns an inability rather than an unwillingness to pay the claim. This is known as the bad debt reserve. A further reserve may also be necessary to allow for reinsurer unwillingness to pay.
There will be bad debt associated with the reinsurance on current gross case estimates and on current IBNR projections. There will also be bad debt associated with recoveries not yet received on gross payments already made (“reinsurance accruals”). However, the bad debt reserve tends not to include accrual bad debt, since this is accounted for as a bad debt on known debtors rather than as a speculatory provision.
Calculation of Bad Debt Reserve
