LAM10050 - Reinsurance: Accounting for reinsurance arrangements: ‘deposit back’ and ‘funds withheld’

In a quota share arrangement the reinsurer assumes part of the risk and is entitled to a share of the premium and pays a share of claims. The gross premium will be shown in the insurer’s accounts, with the reinsurance shown separately, to arrive at a premium net of reinsurance. There is no contractual relationship between the policyholder and reinsurer, only between the insurer and the reinsurer.

Reinsurance arrangements, which can last for decades in the case of life business, carry a significant credit risk for the primary insurer who is exposed to loss if the counterparty fails to meet its contractual obligations. The reinsurer’s credit rating, which is a measure of financial strength, reflects that credit risk.

One way in which cedants manage credit risk is to enter into arrangements which mean that the insurer retains control over the assets backing the policy described as:

• ‘deposit back’: an amount of assets deposited with the ceding company as collateral to cover the insurance liabilities. That can be substantial where the premium consists of the assets used to back the insurance liabilities.
• ‘funds withheld’: the ceding company withholds the premium due to the reinsurer and holds the assets in a separate account.

Where these arrangements give rise to investment income in the hands of the cedant that has important tax consequences for the operation of I-E because the cedant remains within the I-E charge and there is no need to calculate an imputed return (see LAM10200- LAM10240).

Other arrangements may involve the provision of collateral by the reinsurer to the insurer but these do not have the same tax consequences.

In practice there may not be separate payments of premium, claims and investment return because amounts will be netted off and accounted for periodically by means of a single payment.