Unexpired Coverage vs LRC
What is the difference between unexpired coverage and LRC?
As part of trying to understand unexpired coverage better, I am trying to reconcile the PAA formula for unexpired coverage for insurance contracts issued:
Unexpired coverage for insurance contracts issued (PAA)
= (liability for remaining coverage, excluding the loss component
- unamortized insurance acquisition cash flows
- unamortized reinsurance commission + premiums to be received)
× ELR + costs
LRC excl LC = UEP - Premiums receivable - DAC
Rewording the unexpired coverage formula to have consistent wording we get:
Unexpired coverage = (LRC excl LC + DAC + unamortized reinsurance commission + premiums receivable)* ELR + costs
which can be simplified to
Unexpired Coverage = (UEP + unamortized reinsurance commission)*ELR + costs
Where it starts to get unclear for me is why do we add back in unamortized reinsurance commission? When I think of reinsurance commission it is the commission the reinsurer pays to an insurer for acquiring underlying business. Is my understanding correct? If so, why would we add this in to get unexpired coverage for insurance contracts issued and not reinsurance contracts held?
Comments
When the new MCT paper came out, OSFI were trying to minimize the impact of transitioning to IFRS17 on an insurer's capital position (i.e. they did not want insurers to suffer an adverse movement on their capital simply due to the transition to IFRS17)
The unexpired coverage is basically the net premium liabilities under IFRS4. They just needed to bridge the two concepts together. This means that it is just the net expected losses + costs.
Reinsurance commissions are received fully by the insurer in full and amortized over the life of the contract
You are adding back unamortized reinsurance commissions to get the full gross position of the unearned premium liability, without preemptively reducing the insurer's net liability since those commissions are not yet earned. It's a more conservative approach in calculating the capital required