China’s new accounting rules call for significant risk transfer testing

Under China’s new accounting rules, the recognition of re/insurance policies is subject to a significant insurance risk transfer test. Policies that cannot pass this test will have to be categorised as financial instruments, which means there will, for example, be no solvency relief for the reinsured.

For primary insurance companies it is therefore crucial that such tests are reasonable and legitimate from both a substance and technical angle, to ensure no negative surprises at financial results time and protect against disruptions to risk management efforts.

Fundamental definitions

While actuaries and CFOs are working on finalising their risk transfer test calculations and methodologies, two fundamental definitions of this test are worth emphasising here:

1)  Insurance Risk

Under a reinsurance contract, underlying insurance claims shall lead to claims recovery from reinsurance companies. Claims movements are required to be interactive and directionally the same. However, claims payments do not need to be identical in amount or timing. Differences  will be reflected in the risk transfer test.

2)  Substance and economic purpose

Each party to a reinsurance contract must have an economic interest when entering the trade with the counterparty. Risk exposure has to be at least one of the major items to be traded if not the only one. Therefore, the ultimate purpose of all related transactions covered by a reinsurance contract has to be rooted in the cession of risk exposures.

Local knowledge

Swiss Re has been testing risk transfer levels of reinsurance policies for decades and enjoys a strong local team of experts on this matter in Beijing. Our solid theoretical knowledge and ample market data is there to support clients and assure the integrity of their (and our) business.

Risk transfer tests are an integral part of Swiss Re’s comprehensive package of reinsurance services offered to client companies in China.

These and other views and solutions were shared at Swiss Re’s 2nd annual China CFO Roundtable, held on 20 April 2010 in Beijing.

Published 18 May 2010

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