Evaluating an asbestos reinsurance commutation offer

At the central estimate of £200m, the reinsurance recovery is 60% of the layer from £50m to £200m, which is 60% of £150m, or £90m, subject to the treaty limit of £90m. At the low estimate of £140m, the recovery is 60% of £90m, or £54m. At the high estimate of £320m, the recovery is capped at £90m. The expected recovery is therefore somewhere between £54m and £90m, depending on the probability weighting of the range. If the central estimate is reliable, the expected recovery is close to £90m. The offer of £70m is below that central recovery but above the low-end recovery. The timing matters: the recoveries are spread over 15 years, so their present value at a 3% discount rate is lower than £90m. A rough present value of a 15-year run-off at 3% could be around £75m–£80m, depending on the payment pattern. The offer of £70m is therefore at the low end of the risk-adjusted range. The BBB rating adds a credit-risk discount: a default or downgrade could reduce the recovery further. On pure expected value, the offer looks modestly unattractive unless the insurer places significant weight on the low-end scenarios or on credit risk.

Accepting the commutation would remove the reinsurance recoverable of £90m from the balance sheet and replace it with £70m of cash. That is an immediate £20m reduction in own funds before any tax or risk-margin effects. The gross asbestos liabilities would remain, so the net best estimate liability would rise. The SCR could fall because the counterparty risk module would no longer include the reinsurer, and because the uncertainty around recoveries would be removed. The net effect on the solvency ratio depends on whether the fall in own funds is larger or smaller than the fall in the SCR. If the reinsurer is already rated BBB, the counterparty risk charge may be material, so the SCR relief could be meaningful. The accounting treatment depends on the applicable framework: the insurer should derecognise the reinsurance asset, recognise the cash received, and record any difference in profit or loss or as an adjustment to the liability. The board should see a before-and-after solvency ratio, not just the £20m accounting hit. The commutation also changes the future volatility of results: it removes both adverse development risk and recovery risk.

I would not accept the £70m offer immediately. It is below the central expected recovery and below a reasonable risk-adjusted present value once the payment pattern is allowed for. The credit rating downgrade justifies a discount, but not necessarily a £20m discount to the balance-sheet recoverable. The insurer should negotiate, using the central estimate, the payment pattern and the credit risk as evidence. A counter-offer in the region of £80m–£85m would better reflect the expected recovery and the removal of uncertainty. The insurer should also obtain an independent actuarial review of the asbestos reserves and the reinsurance recoverable before agreeing, because the reinsurer may have better information and the offer could be adversely selected. If the reinsurer will not move, acceptance may still be justified if the insurer's solvency ratio is under pressure, if the counterparty risk is unacceptable, or if the board wants to eliminate tail volatility. Any acceptance should be disclosed clearly, with the rationale and the financial effect, and should be approved at board level rather than treated as a routine claims settlement.