Gibraltar-based actuarial consulting firm ACTi has issued a paper analysing the usefulness of Adverse Development Cover and Loss Portfolio Transfer reinsurance arrangements in terms of their treatment under Solvency II.
The paper points out that whilst the two covers are usually placed in conjunction with each other, firms working under the Standard Formula for Solvency II would only gain benefit from the LPT element of cover – the protection against volatility afforded by the ADC is not taken into account unless an Internal Model is used. ACTi also point out that stress testing of these arrangements can be challenging, and that a firm risks capital add-ons being imposed by the regulator in the event of incomplete analysis of claims volatility.
This has been a topic discussed by the GIA with the FSC, who have made it clear that they will look very closely at ADC/LPT arrangements, as they have seen some in the market which do not constitute risk transfer, especially where a loss corridor is involved, and where they would therefore impose a capital add-on.
ACTi’s paper can be read here.