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Commutations have been around for years and are still the oldest and most economical way of extinguishing liabilities and achieving finality on a contract or contracts that are old and where the ...

Commutations have been around for years and are still the oldest and most economical way of extinguishing liabilities and achieving finality on a contract or contracts that are old and where the business is no longer written by the company.

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  • Produced by Derek Somers
  • Produced by Derek Somers

Commutations Presentation Commutations Presentation Presentation Transcript

  • DS Global Solutions Limited The Benefits of Commutation December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • Introduction
    • Commutations have been around for years and are still the oldest and most economical way of extinguishing liabilities and achieving finality, on a contract or contracts that are old and where the business is no longer written by the company. Commutation on current contracts, can be issued if there is no benefit in keeping the older years open, as there is very little chance of any future development on these years.
    • The use of commutations has been around for decades, however they became more prevalent during the late 80’s and 90’s, when the spiral market started to go into free fall and reinsurers wanted to cut their losses and cedants were looking to reduce their exposure to bad debt, as more and more companies were identifying their exposure to the Marine and Non-Marine spiral losses. Today, a commutation is seen as a re-underwriting of a risk which was written several years ago.
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • How do commutations work?
    • A commutation is an agreement between two parties, to extinguish their involvement on a contract or contracts whereby the cedant receives a sum of money, in advance of all the liabilities being crystallised into paid claims.
    • There are a number of elements within a commutation. The three main element are, the agreement of paid claims, outstanding losses and the level of IBNR, (Incurred But Not Reported) attributed to the business. In some cases, a cedant may look to include an IBNER, (Incurred But Not Even Reported) or a risk premium, which in effect is a form of IBNER. A risk premium is normally based on the type of risk being commuted.
    • The IBNR, IBNER and Risk Premium, are all based on an estimate of what the potential future liabilities may be, where the assessment of these elements are more judgemental and require professional actuarial input. These elements are more associated with APH type losses, where it is very difficult for the actuary to estimate the potential exposure on this type of business.
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • What are the benefits?
    • There are benefits to both the cedant and the reinsurer in any commutation.
    • The cedant can use commutation as a way of reducing their potential exposure to bad debt and their balance sheet, by commuting with weak security and closing out their legacy business for a cash sum, to be used against future liabilities. Nevertheless, the benefits of commutation to the cedant are attached to the IBNR or IBNER they manage to secure, as it is very important to secure cash settlement that together with investment income, can run off the future liabilities they have assumed. At the time the commutation is concluded, the cedant is in a far better position to assess the potential future liabilities, with the right actuarial support than at the time the risk was written.
    • The benefit to the reinsurer in any commutation, is to extinguish their liabilities for a cash settlement sum. The reinsurer is in a position to reduce their exposure to long tailed liabilities, where the business is continuing to deteriorate and the payment levels are increasing. They are in a better position to establish the IBNR/IBNER levels, than they were when they wrote the business as their actuary should have built an actuarial model to track the development of this type of business. By doing this, they have the opportunity to reduce the exposure to their balance sheet and at the same time increase their credit rating.
    • Therefore, the benefits of commutation can work for both the cedant and the reinsurer assuming their actuarial models are not out of line.
    •  
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • What are the downsides?
    • In simply terms, all of the risk is borne by the cedant, as they are reducing their reinsurance, increasing their retention and exposing their balance sheet to more potential losses. Another possible downside is the IBNR analysis and the value the actuary allocates against the contract. The actuarial analysis can only ever be a snapshot in time, based on the liabilities being commuted and the past development of the contract, together with the market view of the potential development of this type of business, which then produces a projected estimate of future liabilities
    • Another downside is where a reinsurers concludes a commutation and seek to pass on the commutation to their retrocessionaires and recover their share of the commutation. The recovery of commuted outstanding losses and IBNR from a retrocessionaire has yet to be tested in the UK courts. However, a similar issue was tested in the Singapore Courts in 2000, in the case between Overseas Union V Home & Overseas, whereby the Singapore courts ruled that Home & Overseas, were not liable to follow the fortunes of the reinsured (Overseas Union) as the commutation did not constitute a loss settlement under the “follow the fortunes clause” within the contract.
    • The reason the judge in the Singapore court took this view, was because Overseas Union could not demonstrate that the payment made to their cedant was made in a business like manner. Therefore, any reinsurer who enters into a commutation with their cedant, should make sure that the commutation is conducted in a business like manner. Despite this, any reinsurer who enters into a commutation with a cedant is acting on the basis they are un-reinsured, until they process the commutation and bill their reinsurers and wait for their response.
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • What are the downsides?
    • A reinsurer can only pass on the commutation to their retrocessionaire on proportional contracts, as the majority of proportional contracts have a “follow the fortunes” clause. Nevertheless, a retrocessionaire may still challenge the recoverability of commuted balances, despite the fact there is a follow the fortunes clause in the contract. There are several ways to attempt to eradicate the risk of non-recoverability of commutated balances from reinsurers. One way, is to structure the commutation agreement, whereby the cedant continues to process the claims through as paid claims and the reinsurer then bills their retrocessionaire on a paid as paid basis, however you still need to prove that the losses being processed go through the same claims adjusting process as any other loss. Another way is to obtain agreement from your retrocessionaires to support you in the commutation, in advance of concluding the commutation.
    •  
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • What is the future for commutations?
    • Commutation is a specialist process and the expertise needed in this field, is built up over many years and with more and more companies looking for closure of their legacy business, commutation is still one of the most cost effective options in the market today. It provides the reinsurer and cedant with control over their balance sheet. There are many sophisticated finality options that have been presented to the market in the last 10 years and some of these option take many years to achieve finality. Nevertheless, commutation is still an important tool, within any finality business plan.
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • The future of commutation
    • In most cases, negotiating a commutation can become very emotional for both cedant and reinsurer, this is why the use of a commutations specialist is the best option open to both parties. A commutations specialist will remove any emotion from the procedure and his primary objective is to achieve the best outcome for his client and look to protect his client’s balance sheet at all times.
    • A commutations specialist can reduce the amount of time companies spend on commutations by analyse the data provided and identify areas where savings can be achieved. They can review the 3 main areas of commutation being, paid claims, reserves and IBNR and remove any areas of contention. Therefore, the use of a commutations specialist is more cost effective as they will not only achieve savings they will also save man hours for their client.
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com
  • DS Global Solutions Limited
    • Commutations Specialist
    • To learn more about the benefits of using a commutations specialist, please contact:
    • Derek Somers
    • Contact details:-
    • Phone: 07860109985
    • Email: [email_address]
    • Website: www.dsglobalsolutions.com
    December 12, 2009 Produced by Derek Somers www.dsglobalsolutions.com