NU Online News Service, Oct. 24, 2003, 12:06 p.m. EDT – Scottish Re Group Ltd., Hamilton, Bermuda, says the discovery of years of underreporting of death claims by a major annuity reinsurance client forced it to take a $12.5 million charge in the third quarter.

Because of the accounting problems and a big increase in claims costs, Scottish Re is reporting $1.6 million in net income for the latest quarter on $135 million in revenue, down from $7 million in net income on $79 million in revenue for the third quarter of 2002.

Scottish Re is a relatively new, rapidly growing life reinsurer. Thanks to its growth, premium revenue reached $93 million, up 68% from the total for the comparable quarter in 2002. Growth and the rebound in world investment markets pushed net investment income to $38 million, from $29 million. But claims expenses and other policy benefit expenses increased 95%, to $69 million.

Scottish Re reports in its third quarter earnings release that, during a routine monthly review of two annuity reinsurance arrangements, which are known as “treaties,” the company “identified inconsistencies in information that was reported by [a] ceding company to Scottish Re for the month ended August 2003.”

When Scottish Re investigated further, it decided that “death claims had been consistently underreported to Scottish Re since the inception of the relationship in early 2000,” the company says.

“We have a 50% quota-sharing relationship with the ceding company, which was reporting to us, effectively, instead of 50% of the claims, 25% of the claims, because of internal issues,” Scottish Re President Scott Willkomm said during a conference call held to discuss the third quarter earnings. “One system had 50%. The system that sent us the settlement statement each month cut the number in half yet again. It sounds stupid, and it is.”

Scottish Re has increased the amortization of deferred acquisition costs on the two annuity reinsurance treaties, and two related treaties, to reflect the effects of the extra death claims on the treaties’ profitability, the company says.

Scottish Re also notes that it is emphasizing traditional, mortality-based reinsurance business and turning away “financial reinsurance” deals that appear to be too risky.

“If you do [financial reinsurance] right, it’s a high-margin business,” Willkomm said during the earnings conference call.

But some of the insurers that were shopping for financial reinsurance for interest-sensitive blocks of business are out of the market now that interest rates have rebounded, and some of the insurers that are still in the market want to use financial reinsurance to back what appear to be aggressively designed products, Willkomm said.