# REINSURANCE REGULATION

## Rules Applying to Cession

In any jurisdiction that has introduced a supervisory system for insurance, particularly one that has adopted a "solvency monitoring" approach, special attention must be given to the use of reinsurance and to the identity and financial strength of reinsurance companies receiving business from domestic companies.

When a company has reinsured a significant proportion of its business to a particular reinsurer, its financial strength can be said to depend on the strength of that reinsurer. In some cases, companies cede more than _50%_ of their business to a reinsurer and thus their basic survival depends entirely on the capacity and willingness of the **rein-** surer to honor any claims as they are presented and to do so in a timely fashion. In a number of cases where insurance company failures have occurred in North America, the cause of failure has been traced to unsound reinsurance of the company's business.

Regulators must address the following aspects when considering the soundness of the reinsurance practices adopted by the companies they supervise:

- I . Proportion of business that is retained by the direct writing company. While it is quite appropriate for a company to cede a major portion, even 100% of certain risks that it accepts, the company should retain for its own account a reasonable proportion of its total premium receipts. It is recommended that this minimum retention level be set at 25% or higher.<sup>7</sup> Regulators may choose to allow **new** companies to retain a smaller proportion in the first few years of operation but they should steadily raise the retention to the 25% level. If a company proposes to retain a lesser percentage, it is seeking to operate as a broker and not as an insurer.

2. Proportion of business that is ceded to unlicensed companies. For a variety of reasons, including cost of reinsurance, companies are frequently inclined to cede business to reinsurers that have not chosen to obtain a license to operate in the jurisdiction. The regulator may be faced with a problem in that it may be quite difficult to obtain information concerning the reinsurance company and its financial strength and there may also be a concern over the ability to enforce payment of claims in the event the regulator is obliged to assume control of the licensed direct-writing company. On the other hand, it cannot be presumed that all reinsurance ceded to unlicensed companies is unreliable. In fact, some of the largest and strongest reinsurance companies in the world solicit business actively in many countries where they are not licensed. There may be valid practical impediments to such licensing. The following approaches may be adopted by regulators in respect of cessions to unlicensed reinsurers:

- a) Impose a maximum percentage of total company premiums that may be ceded to unlicensed companies (such as 25%)

- b) Require licensed companies to file with the regulator financial statements and other pertinent information about such unlicensed reinsurers

The regulator could enforce these provisions by refusing to recognize the reinsurance in its calculation for the test of the domestic insurer's capital adequacy for any cessions that exceed the 25% level or whenever the information filed with the regulator fails to demonstrate that the reinsurer has the desired level of financial strength.

3. Dealings with reinsurance brokers. In many cases, companies arrange reinsurance **through** private brokers who act as agents for a reinsurance company or a pool of such companies. Such arrangements can pose problems for the regulator when information regarding the identity and financial strength of the reinsurance companies that will actually be on the risk is lacking. In such cases, the reinsurance may actually be placed outside the country with reinsurers who may not be licensed in the country. In order to deal with such cases, the regulator should require the local company to obtain complete informnation on the reinsurance companies that ultimately wind up on the risk for the business ceded. Subsequently the regulator will deal with the business as noted in points I and 2 above. We have encountered situations where

> 7 Note: Retention rates among the developed countries average in excess of 80%. See _Sigma,_ Economic Study No. _5194,_ Swiss Reinsurance Company.

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