RA - Reinsurance

AndrewLAndrewL
edited September 2023 in CIA.IFRS17-1

Hello @graham, can you please explain the following?

  1. From my understanding, risks are transferred from the insurer to reinsurer. For example, if we had RA=$500 from direct insurance contract and we now buy reinsurance where 50% is ceded, the LIC/LRC will decrease to $250 and the ARC/AIC will increase by $250. This is the amount of Risk adjustment transferred. Can you please confirm.

  2. But how does the release of the RA reduce profit?

  3. Can you please expand on "will be the opposite for RA direct contracts issued"

Comments

  • Staff-T1Staff-T1
    1. No, that is incorrect. LIC and LRC would not decrease as those are measured gross of reinsurance. ARC/AIC net of the risk adjustment will be 250, that is correct. The risk adjustment would be based on the risk appetite of the firm and would increase the ARC/AIC.
    2. Since the RA increases the AIC, a release of Risk Adjustment would reduce the profit
    3. The RA for direct contracts increases the LRC/LIC but would increase profit as it now increases the liability. A decrease in liability would flow into the P&L
  • AndrewLAndrewL

    Thank you very much for your response @Staff-T1.

    I think I do not truly understand what AIC/ARC stands for and how RA work.

    1. From my understanding, AIC and ARC are for reinsurance held. Insurance contracts issued always have LIC and LRC (No AIC/ARC) and reinsurance held always have AIC/ARC but no LIC/LRC. Is that accurate?

    2. AIC is the amount recoverable for LIC and ARC the amount recoverable for LRC. Is that correct?

    3. RA is the compensation required for financial risks. From the primary insurer perspective, it this represent the compensation they require to issuing these contract, why would that increase liability? Should it not be built into premiums? Why does it increase the LRC/LIC.

    4. You said above AIC/ARC net of reinsurance would be 250.Can you please expand on this. What would it be gross of reinsurance.

    Thanks again!

  • Staff-T1Staff-T1
    1. That's correct
    2. Also correct
    3. It reflects the uncertainty in the estimation of the liabilities and would not be built into the premiums. It's more of a pad to protect against adverse development, similar to pfads under IFRS 4. I suggest that you go through the RA paper again as this is a pretty fundamental building block of IFRS-17.
    4. I said it would be net of the risk adjustment, not net of reinsurance. The AIC/ARC is basically the ceded amounts.
  • AndrewLAndrewL
    edited September 2023

    Thanks @Staff-T1

    1. So to reiterate, suppose RA for Non-financial is $1000 and expected loss =$3000
      If we cede 50% of losses, we would cede $1500 of losses and ALSO cede $500 of Risk Adjustment?

    2. Can you also please explain that sentence again "Reinsurance held will increase the ARC and is the opposite of the RA for direct insurance contracts. The release of RA for reinsurance held reduces profit rather than increasing it for insurance contracts issued."

    The only part I understand is that reinsurance increases the ARC. Could you please break down and explain the sentence in further details. There seems to be a lot here!

    1. You also said above "The RA for direct contracts increases the LRC/LIC but would increase profit as it now increases the liability. A decrease in liability would flow into the P&L"

    I agree that RA will increase LRC/LIC. But why does it increase profit? And why did you mention DECREASE in liability after?

    Thanks again for your help!

  • Staff-T1Staff-T1

    1) No, you don't see the RA of the underlying LRC. You would separately calculate a different RA for your ARC which reflects the difference in the capital position of the entity before and after reinsurance

    2) Whoops sorry it is a typo. I meant the RA will increase the ARC for reinsurance held*

    3) Well, say your expected losses are 5000 and RA is 1000. When your coverage is provided, you will now have 5000 in FCF on the LIC side not 6000. The 100 of RA on the LRC side will then go into profit. The RA increases the liability as it increases the LRC

    Lol yeah there is a lot - It's hard to wrap your head around things if you don't actually work on ifrs17

  • AndrewLAndrewL

    Thanks @Staff-T1

    In summary,

    1. I do not understand how you say we do not cede RA of underlying to reinsurance held. Please see below. @graham Do you have any thoughts please?

    1. You are saying that RA for underlying increases Liability through LIC or LRC. Therefore, the release increases profit. For reinsurance held, RA increases asset and therefore the release decrease profit? Can you please explain what release of RA means? From my understanding, it means release=use. As we use asset(ARC/AIC) it goes to expense and decrease profit. If we use liability(LRC/LIC) it flows into Revenue and increases income?
  • Staff-T1Staff-T1

    For the grouping, what it is saying is you estimate ceded as either one of options 2 or 3, and then you separately calculate the RA for that. You do NOT cede the underlying RA directly

    Your RA is somewhat proportional to your ARC/LRC. As you decrease your PV of future cash flows, the RA that needs to be applied on them decreases. This is what is meant by releasing the RA.

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