Reinsurance Contracts Held

Study guide: Exam 6C

Reinsurance Contracts Held are the reinsurance an insurer buys, measured under IFRS 17 as a separate asset with its own fulfilment cash flows, risk adjustment and CSM. They are never netted against the underlying insurance contract liabilities, and several measurement rules are deliberately mirror-images of those for contracts issued.

\text{Reinsurance asset} = \text{PV(recoveries)} - \text{PV(ceded premiums)} + \text{RA} + \text{CSM}

• No netting, ever. The balance sheet shows gross Insurance Contract Liabilities and a separate reinsurance asset. The purpose is to make counterparty exposure visible — a heavily reinsured insurer now displays how much of its balance sheet depends on someone else's solvency.
• The risk adjustment has the opposite sign in effect. For contracts issued, the RA increases the liability; for reinsurance held, it represents risk transferred away and therefore increases the asset. Getting this sign wrong is the most common IFRS 17 reinsurance error.
• Non-performance risk is separate and explicit. The reinsurer's credit risk — including disputes and collectability, not only default — reduces the asset, and changes in it go through profit or loss. This is distinct from the risk adjustment.
• The CSM can be a net cost. Reinsurance is usually bought at a price above expected recoveries, so the "profit" on the contract is negative. IFRS 17 nonetheless defers it as a CSM (a net cost of purchasing reinsurance) rather than recognising it immediately — the no day-one loss treatment, the reverse of the onerous rule for contracts issued.
• The loss-recovery component. Where reinsurance covers an onerous group, a loss-recovery component is recognised on the reinsurance asset at the same time as the loss on the underlying group, so the two are matched rather than the loss appearing first.
• PAA eligibility is assessed separately for reinsurance held, and a treaty covering multiple underwriting years or with a long coverage period may need the GMM even where the underlying business uses the PAA.

Measuring the Reinsurance Asset An insurer buys a quota share ceding 30\%. Ceded premium is \$60 million, expected recoveries have a present value of \$52 million, the ceding commission is \$14 million, the risk adjustment on risk transferred is \$3 million, and the allowance for reinsurer non-performance is \$1.2 million.

Measure the asset at initial recognition and state the presentation.

Answer Fulfilment cash flows on the reinsurance held, from the cedant's perspective — recoveries in, ceded premium out, commission in:

\begin{align*}
\text{Net inflows} &= \$52\text{M} + \$14\text{M} - \$60\text{M} \\
&= \$6\text{M}
\end{align*}

Add the risk adjustment for risk transferred (it increases the asset):

\$6\text{M} + \$3\text{M} = \$9\text{M}

Deduct non-performance risk:

\$9\text{M} - \$1.2\text{M} = \$7.8\text{M}

CSM. Since the fulfilment cash flows are favourable to the cedant, a CSM of \$7.8 million is established so that no gain is recognised at inception; the asset carries at \$7.8M net and the CSM releases as coverage is received.

Presentation. The asset appears on its own line — it does not reduce the gross liabilities. If the insurer's gross LIC is \$400 million and the reinsurance share of it is \$120 million, the balance sheet shows \$400 million of liability and a \$120 million-plus asset, not \$280 million net.

Why that matters. The gross-up makes the insurer's dependence on its reinsurers plain: a reader can now see that 30\% of the claim liability is recoverable from third parties, and can ask who they are and how they are rated. Under netting, that exposure was invisible.