13
Apr 2022

What Is a Commutation Agreement in Insurance

A conversion contract is a reinsurance contract in which the reinsurer and the transferring company agree on the conditions under which all the obligations of both parties in the contract are fulfilled. This is an important point that needs to be emphasized; The extent to which internal management resources are used in a switching effort could impact the achievement of long-term objectives. For this reason, companies often tend to use a training session or use outsourced resources and consultants to perform the most important day-to-day activities related to switching. Whatever the motivation, a fundamental fact must be highlighted – conversion is a risky undertaking given the variability inherent in the evolution of loss reserves and the structure of claims reported over time. For example, the switches negotiated in the early 1990s may have been apparently “good” business at the time. However, the current trend of negative losses and environmental development has turned many of these transactions into catastrophic means. Therefore, a basic assumption about switches should be that they are approached with considerable caution and some general skepticism. All actuarial assumptions regarding the evolution of reserves over time should include a reasonable range of possible outcomes so that all parties can fully understand the potential risks. As mentioned earlier, the estimation of IBNR will have a significant impact on the cost of conversion. Industry billing models and its age at conversion have the most direct impact on the estimated IBNR level. It is clear that less mature and/or longer-term companies are likely to have more IBNRs (as a percentage of total damage suffered) and will often rely more on the Bornheutter-Ferguson methodology to estimate reserves for losses. This methodology uses an expected loss rate as well as historical development models (based on actual underlying experience or from similar industry baseline data) to estimate the expected IBNR. More mature and/or shorter lines are likely to have less IBNR (as a percentage of the total loss suffered) and to be more sensitive to methods such as the standard chain conductor development method, which is based either on the actual evolution of the losses incurred or on industry benchmarks.

In this calculation, the assumptions used to determine IBNR reserves, discount losses and tax determination must be examined in detail. An in-depth analysis of switching should include a number of outcomes, as already mentioned with regard to estimates of the evolution of reserves, as well as a thorough examination of possible tax scenarios, including the holding of conferences and the potential impact of alternative minimum tax. Mark Jones is Director of Research and Development and Consulting Actuary at Perr&Knight. Its main task is the development of new products and services for all areas of the company. Mark has extensive experience including pricing, regulatory compliance, competitive analysis, disaster modeling and bookings for most personal and business lines. He also has experience in the development and implementation of predictive models, dynamic financial analysis tools for reinsurance applications, financial forecasting applications for budgeting and retention analysis, rate monitoring tools for most business lines and ad hoc statistical studies for claims investigations, review of premiums and control of claims. Mark`s skills include in-depth knowledge of insurance data systems and business operations, as well as Visual Basic, SQL, R and other software. An additional and potentially important “fold” to a conversion agreement is the existence of contentious claims (or even those that could be subject to arbitration). It is possible to create a conversion agreement that “elaborates” a specific assigned account so that the dispute/resolution process can proceed unhindered. However, it is more desirable to try to solve these problems as part of a global “global” switch, if possible. The main caveat is that the overall economic objectives of the transaction should not be sacrificed in order to reach a single-claim solution.

Negotiating switching agreements can be complicated. Some types of insurance claims are filed long after the breach, as is the case with some types of liability insurance. For example, problems with a building may not occur until years after construction. Depending on the language of the reinsurance contract, the reinsurer may continue to be liable for claims made against the policy taken out by the liability insurer. In other cases, claims may be made decades later. The effects on Appendix P are illustrated below for both parts before and after switching. The assigned loss payments for Fred and the loss payments for Sally will increase by $900 in the conversion. Cedar loss reserves will decrease by $1,000 for Fred and loss reserves by $1,100 for Sally. For Sally, the converted claims are closed claims reflected in Appendix P – Part 5. There will also be tax implications for both parties.

The example given is simplified, but if the parties had several lines of business and the conversion took several years, the cash compensation would be awarded. General considerations Although it seems obvious, it is imperative that all parties mutually agree on a date of entry into force of the conversion, which will serve as the basis for all valuation procedures, including, for example, the present value of the reserves for attributed losses. .

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