Cal. Code Regs. tit. 10 § 2303.11

Current through Register 2024 Notice Reg. No. 45, November 8, 2024

Section 2303.11 - Transfer of Risk - Life and Disability

(a) This section prescribes accounting and other requirements for domestic life and disability insurers and for domestic property and casualty insurers with respect to their disability business. Failure to comply with this section results in a ceding insurer improperly reducing liabilities or establishing assets for reinsurance ceded, and, pursuant to Section 922.3 of the Code, the Commissioner shall not allow credit for such reinsurance.

(b) This section shall not apply to assumption reinsurance, or non-proportional reinsurance such as stop loss or catastrophe reinsurance. Except as provided in the Statutory Accounting Principles ("SSAP") 61 of the NAIC Accounting Guidance, it shall also not apply to yearly renewable term reinsurance ("YRT"), as described in SSAP 61, that provides reserve credit not greater than up to one year's valuation mortality cost.

(c) No insurer shall, for reinsurance ceded, reduce any liability or establish any asset in any statutory financial statement if, by the terms of the reinsurance agreement, in substance or effect, any of the following conditions exist:

1. Renewal expense allowances provided or to be provided to the ceding insurer by the reinsurer in any accounting period are not sufficient to cover anticipated allocable renewal expenses of the ceding insurer on the portion of the business reinsured, unless a liability is established for the present value of the shortfall (using assumptions equal to the applicable statutory reserve basis on the business reinsured). Those expenses include commissions, premium taxes and direct expenses including, but not limited to, billing, valuation, claims and maintenance expected by the company at the time the business is reinsured.

2. The ceding insurer can be deprived of surplus or assets at the reinsurer's option, at a specified time scheduled in the reinsurance agreement, or automatically upon the occurrence of some event, such as the insolvency of the ceding insurer, except that termination of the reinsurance agreement by the reinsurer for nonpayment of reinsurance premiums or other amounts due, such as modified coinsurance reserve adjustments, interest and adjustments on funds withheld, and tax reimbursements, shall not be considered to be such a deprivation of surplus or assets.

3. The ceding insurer is required to reimburse the reinsurer for negative experience under the reinsurance agreement, except that neither offsetting experience refunds against current and prior years' losses under the agreement nor payment by the ceding insurer of an amount equal to the current and prior years' losses under the agreement upon voluntary termination of in force reinsurance by the ceding insurer shall be considered such a reimbursement to the reinsurer for negative experience.

4. The ceding insurer must, at specific points in time scheduled in the agreement or at the reinsurer's option, terminate or automatically recapture all or part of the reinsurance ceded.

5. The reinsurance agreement involves the possible payment by the ceding insurer to the reinsurer of amounts other than from income realized from the reinsured policies. For example, it is improper for a ceding company to pay reinsurance premiums, or other fees or charges to a reinsurer which are greater than the direct premiums collected by the ceding company.

6. The treaty does not transfer all of the significant risks inherent in the business being reinsured. The following table identifies for a representative sampling of products or type of business, the risks which are typically considered to be significant. For products not specifically included, the risks determined to be significant shall be consistent with this table.

Table of Significant Risks

Risk Categories:

i. Morbidity

ii. Mortality

iii. Lapse

This is the risk that a policy will voluntarily terminate prior to the recoupment of a statutory surplus strain experienced at issue of the policy.

iv. Credit Quality

This is the risk that invested assets supporting the reinsured business will decrease in value. The main hazards are that assets will default or that there will be a decrease in earning power. It excludes market value declines due to changes in interest rate.

v. Reinvestment

This is the risk that interest rates will fall and funds reinvested (coupon payments or monies received upon asset maturity or call) will therefore earn less than expected. If asset durations are less than liability durations, the mismatch will increase.

vi. Disintermediation

This is the risk that interest rates rise and policy loans and surrenders increase or maturing contracts do not renew at anticipated rates of renewal. If asset durations are greater than the liability durations, the mismatch will increase. Policyholders will move their funds into new products offering higher rates. The company may have to sell assets at a loss to provide for these withdrawals.

+ - Significant 0 - Insignificant

Risk Category

	i.	*ii.*	*iii.*	*iv.*	v.	*vi.*
Health Insurance -- other than LTC/LTD^*	+	0	+	0	0	0

Health Insurance -- LTC/LTD ^*	+	0	+	+	+	0

Immediate Annuities	0	+	0	+	+	0

Single Premium Deferred Annuities	0	0	+	+	+	+

Flexible Premium Deferred Annuities	0	0	+	+	+	+

Guaranteed Interest Contracts	0	0	0	+	+	+

Other Annuity Deposit Business	0	0	+	+	+	+

Single Premium Whole Life	0	+	+	+	+	+

Traditional Non-Par Permanent	0	+	+	+	+	+

Traditional Non-Par Term	0	+	+	0	0	0

Traditional Par Permanent	0	+	+	+	+	+

Traditional Par Term	0	+	+	0	0	0

Adjustable Premium Permanent	0	+	+	+	+	+

Indeterminate Premium Permanent	0	+	+	+	+	+

Universal Life Flexible Premium	0	+	+	+	+	+

Universal Life Fixed Premium	0	+	+	+	+	+

Universal Life Fixed Premium	0	+	+	+	+	+

(dump-in premiums allowed)
^* LTC = Long Term Care Insurance
LTD = Long Term Disability Insurance

7. The credit quality, reinvestment, or disintermediation risk is significant for the business reinsured and the ceding company does not either transfer the underlying assets to the reinsurer or legally segregate such assets in a trust or escrow account or otherwise establish a mechanism satisfactory to the Commissioner which segregates, by contract or contract provision, the underlying assets. Assets held to secure statement credit for a cession to an unauthorized reinsurer as permitted by Code Section 922.5(a)(1) may not be placed in a trust or escrow account unless (1) the reinsurer is an affiliate of the ceding insurer, or (2) the agreement establishing the escrow or trust account provides that the ceding insurer has the sole right to withdraw assets from the account at any time and without prior notice to the reinsurer. The agreement establishing the escrow or trust account shall be in a form satisfactory to the Commissioner.

A. This paragraph shall not apply to the assets supporting the reserves for the following classes of business:

(i) Health Insurance -- LTC/LTD

(ii) Traditional Non-Par Permanent

(iii) Traditional Par Permanent

(iv) Adjustable Premium Permanent

(v) Indeterminate Premium Permanent

(vi) Universal Life Fixed Premium (no dump-in premiums allowed)

B. When asset segregation is not required, the associated formula for determining the reserve interest rate adjustment shall reflect the ceding company's investment earnings and incorporate all realized and unrealized gains and losses reflected in the statutory statement. The following is an acceptable formula:

Rate =	2 (I + CG)
	X + Y - I - CG

Where:

I	is the net investment income
CG	is capital gains less capital losses
X	is the current year cash and invested assets plus investment income due and accrued less borrowed money
Y	is the same as X but for the prior year

8. Settlements are made less frequently than quarterly or amounts receivable from the reinsurer are not paid in cash within ninety (90) days of the settlement date.

9. The ceding insurer is required to make representations or warranties not reasonably related to the business being reinsured.

10. The ceding insurer is required to make representations or warranties about future performance of the business being reinsured.

11. The reinsurance agreement is entered into for the principal purpose of producing significant surplus aid for the ceding insurer, typically on a temporary basis, while not transferring all of the significant risks inherent in the business reinsured and, in substance or effect, the expected potential liability to the ceding insurer remains basically unchanged.

(d) Notwithstanding subdivision (c) of this section, the Commissioner may allow such reserve credit or establishment of such asset as the Commissioner considers appropriate. Such allowance shall not be deemed approval of the reinsurance treaty nor shall it be considered an indication that reinsurance credit may be allowed for other similar treaties.

(e) Any agreement entered into after the Effective Date of this section which involves the reinsurance of business issued prior to the effective year of the agreement, along with any subsequent amendments thereto, shall be filed by the ceding company with the Commissioner within 30 days from its date of execution if such ceding company is domiciled in this state. Each such filing shall include data detailing the financial impact of the transaction. In the case of an agreement which was entered into prior to the Effective Date of this section but was subsequently amended on or after the Effective Date of this section, such agreement and amendment shall also be filed within 30 days from the date of execution of the amendment if such amendment added business issued prior to the effective year of the amendment and if the ceding company is dom ciled in this state. The requirements of this subdivision are in addition to any other filings required by the Code or this article.

(f) Any increase in surplus net of federal income tax resulting from reinsurance agreements entered into or amended after the Effective Date of this section which involve the reinsurance of business issued prior to the effective date of the agreements shall be identified separately on the insurer's statutory financial statement as a surplus item and recognition of the surplus increase as income shall be reflected on a net of tax basis as earnings emerge from the business reinsured.

For example, on the last day of calendar year N, company XYZ pays a $20 million initial commission and expense allowance to company ABC for reinsuring an existing block of business. Assuming a 34% tax rate, the net increase in surplus at inception is $13.2 million ($20 million - $6.8 million) which is reported on the "Aggregate write-ins for gains and losses in surplus" line in the Capital and Surplus account. $6.8 million (34% of $20 million) is reported as income on the "Commissions and expense allowances on reinsurance ceded" line of the Summary of Operations.

At the end of year N+1 the business has earned $4 million. ABC has paid $.5 million in profit and risk charges in arrears for the year and has received a $1 million experience refund. Company ABC's annual statement would report $1.65 million (66% of ($4 million - $1 million - $.5 million) up to a maximum of $13.2 million) on the "Commissions and expense allowance on reinsurance ceded" line of the Summary of Operations, and -$1.65 million on the "Aggregate write-ins for gains and losses in surplus" line of the Capital and Surplus account. The experience refund would be reported separately as a miscellaneous income item in the Summary of Operations.

(g) The ceding insurer's appointed actuary shall consider this section and any applicable actuarial standards of practice when determining the proper credit to take in financial statements filed with this Department. The appointed actuary shall maintain adequate documentation and be prepared upon request to justify the inclusion of credit in the financial statement.

(h) If a letter of intent precedes the execution of a reinsurance agreement or amendment to a reinsurance agreement, then the agreement or the amendment must be executed within a reasonable period of time, not exceeding ninety (90) days from the execution date of the letter of intent.

(i) No reinsurance agreement or amendment to any agreement may be used to reduce any liability or to establish any asset in any financial statement filed with the Department, unless the agreement, amendment or a binding letter of intent has been duly executed by both parties no later than the "as of date" of the financial statement.

(j) The reinsurance agreement shall expressly state that it constitutes the entire agreement between the parties with respect to the business being reinsured thereunder and that there are no understandings between the parties other than as expressed in the agreement. The entire agreement clause may provide that it shall not be construed to limit the admissibility of evidence regarding the formation, interpretation, purpose or intent of the reinsurance agreement.

(k) In the review of a reinsurance agreement to determine transfer of risk, all contracts between the ceding insurer, its affiliates and the reinsurer may, in the Commissioner's discretion, be reviewed.

(l) A denial of statement credit under this section shall be made in the manner prescribed in Section 2303.18(c) of this article.

Cal. Code Regs. Tit. 10, § 2303.11

1. New section filed 10-24-2006; operative 11-23-2006 (Register 2006, No. 43).
2. Change without regulatory effect amending subsections (a) and (b) filed 3-25-2015 pursuant to section 100, title 1, California Code of Regulations (Register 2015, No. 13).
3. Amendment of subsections (g) and (l) filed 11-27-2017; operative 1-1-2018 (Register 2017, No. 48).

Note: Authority cited: Section 922.8, Insurance Code; CalFarm Insurance Company v. Deukmejian, 48 Cal. 3d 805 (1989); and 20th Century Insurance Company v. Garamendi, 8 Cal. 4th 216 (1994). Reference: Sections 922.3 and 923, Insurance Code.