Reinsurance Side Letter and Risk Transfer on Motor Portfolio
A general insurer enters into a 40% quota share of its motor own-damage and third-party portfolio for 2025-26. The reinsurance agreement includes a 20% profit commission, an experience account, and a commutation clause. A side letter states that the reinsurer will not pay any individual claim above ₹50 crore without prior consent, and the reinsurer may terminate if the portfolio loss ratio exceeds 85%. Gross motor reserves are ₹1,200 crore, ceded reserves are ₹480 crore, and the finance team has taken ₹300 crore of capital relief. The treaty was signed three weeks before the valuation date. The Appointed Actuary is asked to assess whether the arrangement transfers significant insurance risk and how it should be reflected in reserves, capital and disclosures. The CFO is keen to retain the capital relief and has described the side letter as administrative.
1. Assess whether the quota share and side letter transfer significant insurance risk.
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Risk transfer test. A 40% quota share normally transfers a proportional share of insurance risk, but the side letter, termination clause and profit commission can reverse that. The side letter caps the reinsurer's payment at ₹50 crore per claim without consent, so for large motor claims the reinsurer may not bear its proportional share. The 85% loss-ratio termination right lets the reinsurer exit when experience deteriorates. The 20% profit commission and experience account align interests but can also reduce the effective risk transfer. Assessment. These features are not administrative; they are material terms. The actuary should assess whether the reinsurer has accepted significant insurance risk, including frequency and severity, and whether the ceding company retains the ultimate loss. If the side letter is applied in practice, the arrangement may be closer to a financing or deposit arrangement for the capped layer. Conclusion. Significant risk transfer is not automatic; document the analysis and obtain legal and reinsurance confirmation.
2. Explain how the arrangement should affect ceded reserves, capital relief and disclosure.
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Reserves. If significant risk transfer is not established, do not recognise the ₹480 crore ceded reserve as an asset; account for the arrangement as a deposit or financing and show the gross liability. If risk transfer is established, recognise ceded reserves only to the extent recoverable, net of the side-letter cap and counterparty credit. Capital. The ₹300 crore relief should be reduced or removed for the capped layer and for counterparty risk; the regulator may challenge relief that depends on a side letter. Disclosure. Disclose the side letter, termination right, profit commission and experience account, and explain their effect on reserves, capital and risk. Governance. The CFO's label administrative is not determinative; the actuary should obtain the signed treaty, side letter and legal opinion, and document the judgement.