Reinsurance Collectibility Problems Continue

For some of the largest ceding companies, reinsurance collectibility problems continue to be an issue. Although the amount of recoverables is not increasing dramatically, amounts in dispute and the timing of the recoveries are both increasing.

The first table, “Analyzing Trends,” displays the ratio of ceded recoverables-to-gross reserves and ceded recoverables as a percentage of surplus for 10 large primary companies. The 10 companies, which hold total gross reserves of $123 million, were selected based on their ceded premium volume. The ceded recoverables were calculated as ceded paid loss and loss adjustment expenses, case reserves, and incurred-but-not-reported reserves of non-affiliated companies.

As can be seen from the table, the amount of non-affiliated ceded recoverables as a percentage of gross reserves increased by approximately 50 percent from 1998 to 2003. However, over the past three years, the percentages have remained relatively stable. More interesting is the fact that the percentage of recoverables varies dramatically from company to company ranging from 1 percent to 70 percent in 2003.

Reinsurance recoverables as a percentage of surplus have increased even more dramatically from 1998 to 2003 for these selected companies. The percentage in 2003 is almost double the 1998 ratio. This dramatic increase is a result of the decline in surplus over the last few years (caused by the unprofitable results of the insurance industry in the soft market) as well as increased recoveries.

Similar to the ratios of reinsurance recoverables to gross reserves, the reinsurance recoverables as a percentage of surplus varies dramatically from company to company. Here, percentages ranged from less than 2 percent to over 250 percent in 2003. The companies with high ceded percentages had significant fronting operations, where they ceded a high percentage of certain business to captives or third-party reinsurers. These companies appear to be involved in significant reinsurance disputes on certain business segments.

We would note that the 2001 through 2003 ratios in the first table are similar. However, the reserve base and surplus base have grown approximately 30 percent and 20 percent, respectively, over the last two years. The total amount recoverable from unaffiliated reinsurers has also grown, but at a slightly slower pace (17 percent over two years).

Although the amount of reinsurance recoverables as a percentage of gross reserves has remained stable over the recent few years, the amount of reinsurance in dispute has increased. The second table, “Battle Stations,” compares the amounts of reinsurance in dispute to total ceded recoverables and surplus for the past four years.

As shown in the table, the amount of reinsurance in dispute (as a percentage of total ceded recoverables) has increased from 1 percent to 3.6 percent over the past four years, with the most significant increase occurring in 2003. In the past year (2003), the amount in dispute (as a percent of ceded recoverables) more than doubled. This indicated that new disputes are outpacing settlements of older year disputes.

These results are primarily driven by two companies, for which disputed amounts as a percent of ceded reserves increased significantly. (Excluding the two companies, the percentage would have remained the same in 2002 and 2003 at 2 percent, instead of 3.6 percent in 2003 and 1.6 percent in 2002.)

The increase in 2003 may be the result of settlements of large asbestos claims for some primary companies and the uncertainty regarding how to allocate the settlement between the primary company and its reinsurers. Some companies may have already identified all of their reinsurance issues. Other companies, however, continue to have the applicability of their reinsurance questioned, potentially driven by the settlement of a few large, unique claims.

Eight of the 10 companies we have examined have some reinsurance in dispute. Alleged reasons for disputes may include:

• Misrepresentation of business written.
• Misrepresentation of terms.
• Improper ceding of premium and/or losses.
• Changes in or to business without notification to reinsurers.

It is not surprising that disputes have increased after the end of the soft market. Many insurers and reinsurers wrote unprofitable business. Some reinsurers have lost large sums of money on certain contracts and believe that they were misled. Some primary companies may have reduced rates more than planned, grown dramatically, or significantly altered their book of business.

In addition to the increases in the amount of reinsurance in dispute, the losses over 90 days past due have increased substantially in 2003. As noted previously, the increase in the amounts of reinsurance in dispute seems to be driven by a few companies. However, more companies are affected by a slowdown in payments from their reinsurers. Despite, the slowdown in payments, there does not appear to be the same trend in the provision for uncollectible reinsurance (Schedule F penalties).

The third table, “Payments Slow,” displays the ratio of ceded losses over 90 days past due and the Schedule F penalties for the last six years. The table shows that reinsurers paid more slowly in 2003 when compared to 2000-2002. However, the provision for uncollectible reinsurance as a percentage of ceded recoverables is decreasing. This result is somewhat surprising, as we would have expected the percentage to increase.

It should be noted that insurers currently record a penalty of 20 percent of the amount of reinsurance in dispute as part of the Schedule F penalty. If insurers are unsuccessful in the disputes, there could be immediate negative financial implications for the companies losing disputes. (Other components of the Schedule F penalty include a provision for uncollateralized unauthorized reinsurance and a provision for overdue authorized reinsurance.)

It will take some time to fully quantify the effect of the soft market on reinsurance recoverables. However, it appears that disputes are still increasing and reinsurers are paying slower. These reinsurance issues could have a material effect on some companies' future balance sheets.

Brian Z. Brown and Lori E. Julga are consulting actuaries for Milliman USA in Milwaukee, Wis. Both are fellows of the Casualty Actuarial Society and members of the American Academy of Actuaries.

Reproduced from National Underwriter Edition, April 29, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.