Ceding companies and reinsurers could be freed from the strictures of current regulations if a new principles-based reserving system is put in place, according to a presentation made by actuaries to state insurance regulators.

Risk transfer would still continue to be captured, but would be reflected in financial statements and models that assess the risks in those statements, explained Sheldon Summers, representing the American Academy of Actuaries, Washington, during the fall meeting of the National Association of Insurance Commissioners, Kansas City, Mo. Summers is also a life actuary with the California insurance department.

Currently, reserving for life reinsurance requires that companies follow the strictures of regulations such as Statement of Statutory Accounting Principles 61 and Appendix A791, Summers explains. Both are part of the NAIC’s Accounting Practices and Procedures Manual.

However, according to a paper presented by the Academy to the Life & Health Actuarial Task Force, with the new PBR approach, “the only questions should be ‘What is indemnified?’ and ‘What’s that worth?’ given statutory stochastic assumptions.”

LHATF adopted a motion to expose the document for comment.

The report says current regulations use a limited number of factors set by law, including mortality and interest rates. And, it explains that a reinsurance reserve credit is taken for the reinsured business even though cash flows under the agreement may behave differently than the reserve assumptions.

Under current rules, Summers said, ceding companies are penalized if they do not meet regulatory requirements. A big part of those requirements, the paper states, is focused on risk transfer. Ceding companies meeting requirements receive 100% credit, while for those companies that do not meet requirements, no credit is allowed.

The use of models to determine reinsurance reserves, the paper states, would include assumptions regarding cash flows expected to be paid from or to reinsurers under reinsurance agreements.

During a discussion among regulators on the issue Amanda Fenwick, a New York regulator, said that regardless of the cash flow represented in any modeling, it will still be necessary to make sure there is risk transfer.

But Tom Campbell, a member of the Academy’s reinsurance work group and a life actuary with Hartford Life, Simsbury, Conn., explained that the new approach would actually discourage not accurately reflecting risk transfer because there would be no benefit reflected on a ceding company’s balance sheet. The cash flow obligation of the cedent to pay the reinsurer will be reflected in the reserve calculation rather than through rules, he added.

Fenwick also noted that it is unclear whether the new approach would properly capture the bifurcation of risks involved in reinsurance transactions.