Employers' liability disease reserves after a reinsurance dispute
Meridian Insurance carries £120m of net employers' liability reserves, of which 15% is IBNR. Two disease classes dominate: mesothelioma (long-tail, mostly settled by civil compensation) and noise-induced hearing loss (NIHL). The NIHL book has been hit by a Court of Appeal decision in a comparable jurisdiction that widens the trigger for deafness claims; counsel puts a 60% chance the reasoning is followed in this jurisdiction, adding between £8m and £30m. At the same time, the reinsurer on the 2015–2019 excess-of-loss programme has disputed £18m of recoveries, arguing late notification under the claims cooperation clause. The reserve review central estimate is £22m above held, with a 75% interval of £10m to £48m. The CFO wants to release £10m of 'redundant prudence' to lift the solvency coverage ratio from 138% to 148% ahead of a rating review. The external auditor will sign in six weeks.
1. Should the £10m release proceed? Set out your reasoning and the reserve position you would recommend.
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The release is not supportable. The review says the central estimate is £22m above the held reserves. That means the held reserves are already £22m below the central estimate, before any prudence margin. Releasing a further £10m would make the deficiency £32m. It would raise the solvency ratio from 138% to 148% only by understating liabilities; that is not a valid capital management action.
Check what the 'held' figure contains. If the held reserves include a separate prudence margin that is not in the central estimate, the £22m gap must be reconciled line by line. But the wording indicates the opposite: the central estimate is above held. I would ask for the reserve reconciliation: case reserves, IBNR, ULAE, discounting and reinsurance recoveries.
The court ruling. A 60% probability of an £8m–£30m additional cost has an expected value of about 0.6 × £19m = £11.4m, but the distribution is skewed and the downside is £30m. A risk-neutral central estimate would include the expected value; a prudent reserve would hold closer to the upper half. It is not a source of surplus.
The reinsurance dispute. £18m of recoveries is disputed. If the insurer has recognised those recoveries as assets, net reserves are understated if recovery is not probable. If not recognised, the gross liability is higher. Either way, the dispute cannot justify a release.
Recommendation. Do not release. Increase the central estimate by at least £22m, consider a margin for the court ruling and the reinsurance dispute, and report the range £10m–£48m to the board. The solvency ratio should be managed through capital, reinsurance or business actions, not through reserve release.
2. How would you value and present the disputed reinsurance recoveries?
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Legal analysis first. The claims cooperation clause and late notification are contractual. I would obtain counsel's opinion on whether the reinsurer can avoid the £18m, and whether the insurer has a duty to notify. The accounting treatment depends on whether recovery is 'probable' (IFRS) or 'expected' with a counterparty default adjustment (Solvency II).
Quantify the recovery. Build a scenario table:
- Full recovery: £18m asset, net reserves lower.
- 50% recovery: £9m asset.
- No recovery: £0, with a corresponding increase in net liability. Weight by legal probability, but disclose gross and net figures separately.
Counterparty risk. Check the reinsurer's credit rating, collateral, and the presence of a trust fund or letter of credit. If the reinsurer is impaired, apply a default haircut even if the legal case is strong. Under Solvency II, the recoverable should be adjusted for expected default and for the time to recover.
Presentation. Show the balance sheet gross of reinsurance, the reinsurance asset, and net. Show the sensitivity of the solvency ratio to each scenario. Do not net the disputed recovery against the reserve central estimate without disclosure. If the recovery is not recognised, the £10m release is even less defensible: the solvency ratio would fall further.
Recommendation. Recognise only the recovery that is probable after legal advice; hold a provision for the disputed portion; disclose the dispute in the regulatory return and the financial statements.
3. What would you say to the CFO and the external auditor? Include the governance and ethical dimensions.
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Message to the CFO. 'The £10m release would take the reserves £32m below our central estimate. It would improve the ratio today but would create a foreseeable deficiency. If the court ruling goes against us, the ratio would fall well below 138%, not rise to 148%. I cannot support it.'
Show the bridge. Present a table:
- Held reserves: £120m.
- Central estimate: £142m.
- Court ruling expected value: +£11.4m.
- Reinsurance dispute risk: +£0m to +£18m.
- Recommended carried reserves: £150m–£160m.
- Solvency ratio at each level.
To the auditor. Provide the reserve report, the legal opinion, the reinsurance contract, the board paper and the minutes. Explain the judgement on the court ruling and the recovery. If the CFO persists, the actuary should escalate to the Audit Committee and, if necessary, consider the IFoA's whistleblowing guidance. The Actuaries' Code requires integrity and objectivity; signing a reserve release that is not supportable would breach it.
Tone. Be factual and non-confrontational. Offer alternatives: reinsurance commutation, capital raise, or a revised business plan. The CFO may be under rating pressure; the actuary's role is to make the consequences clear, not to block a commercial decision by hiding behind the numbers. Record the advice and any override in writing.