Reinsurance held + onerous
Hi,
I am trying to figure out how it works for reinsurance contracts held that are onerous.
First, my understanding is that when your underlying group is profitable, ceding it to the reinsurer creates a net cost for you (as the insurer on a reinsurance held position). Correct?
From CIA.IFRS17-1 (section 5, source text), it looks like reinsurance held contracts cannot be onerous. This means, they are not immediately recognized as unprofitable. Instead, the CSM can be positive or negative and is recognized as earned.
- From 5.1: "Thus, unlike the CSM for underlying insurance contracts, the CSM on reinsurance contracts held can be positive or negative."
- From 5.3: "The CSM for reinsurance contracts held is determined in the same manner as for insurance (or reinsurance) contracts issued, but the CSM can be positive or negative. According to IFRS 17.68, “reinsurance contracts held cannot be onerous.” Therefore, the cost of reinsurance contracts held is normally recognized over the life of the reinsurance contract."
From CIA.IFRS17-LRC (section 6, source text), the table seems to say if the underlying contract is onerous, then the reinsurance held must be recognized in the financial statement (row 3). Does that mean the reinsurance contract held has net initial gain (recognized with positive CSM while underlying contract has LC)? Similar for row 1 of the table, the non-onerous underlying contract means the reinsurance held contract is at net cost, but does not need to be recognized because underlying contract is profitable?
Section 6.5.1 makes it even more confusing 
... I thought net gain from purchasing reinsurance would lead to negative FCFs, thus positive CSM (they say the opposite)
How do the ARC and loss-recovery component fit in all this?
The wiki does not provide much detail, so I am unsure what to think.
What do you think?
Comments
First, my understanding is that when your underlying group is profitable, ceding it to the reinsurer creates a net cost for you (as the insurer on a reinsurance held position). Right
Does that mean the reinsurance contract held has net initial gain (recognized with positive CSM while underlying contract has LC)?
This is not necessarily true because the contract can be priced such that there is recovery from the reinsurer, but still no gain to the insurer. Think about it this way - Most reinsurance contracts will almost never have a net gain to the insurer. If there was a net gain to the insurer, it would not be written by the reinsurer. Reinsurance is meant to smooth out volatility in results, for a smaller expected return. You wouldn't expect to make a net gain by purchasing insurance right? So why should the insurer expect to make a net gain on purchasing reinsurance.
Now let's start with the table. A group of contracts will be recognized at the earlier of:
For the first two rows in the table in section 6, the contract has not been recognized yet. This answers one of your questions - To even consider recognition of a reinsurance contract held, the underlying must first already be recognized.
In the source: If the amount paid for reinsurance is greater than the inflows expected from the reinsurer plus the risk adjustment, this represents a net cost of purchasing reinsurance and the resulting CSM is booked in an asset position.
lol okay so I know it's going to be super confusing but this paper defines
FCF: Cash in flow - Cash out flow + discounting - RA (page 22)
So..... If your reinsurance produces a net gain, your FCF is positive which means you need a negative CSM to offset. This is why it is important to really understand the FCF and CSM so sign flips won't really matter then
A loss recovery component is the amount of recoveries you expect to receive from the reinsurer and is unrelated to whether the reinsurance contract provides a net gain or net loss.
ARC is just the opposite of LRC. Basically what you are owed in this contract while LRC is what you owe. I don't think you have to go into too much detail about this