Section 1103.10  Preamble

 

a)         The  Department of Financial and Professional Regulation-Division of Insurance (Division) recognizes that licensed insurers routinely enter into reinsurance agreements that yield legitimate relief to the ceding insurer from strain to surplus.

 

b)         However, it is improper for a licensed insurer, in the capacity of ceding insurer, to enter into reinsurance agreements, for the principal purpose of producing significant surplus aid for the ceding insurer, typically on a temporary basis, while not transferring all of the significant risks inherent in the business being reinsured.  In substance or effect, the expected potential liability to the ceding insurer remains basically unchanged by the reinsurance transaction, notwithstanding certain risk elements in the reinsurance agreement such as catastrophic mortality or extraordinary survival.  The terms of reinsurance agreements described in Section 1103.30 would violate:

 

1)         Section 133 and 136 of the Illinois Insurance Code (Code) [215 ILCS 5/133 and 136], relating to financial statements that do not properly reflect the financial condition of the ceding insurer;

 

2)         Section 173.2 of the Code [215 ILCS 5/173.2], relating to reinsurance reserve credits, thus resulting in a ceding insurer improperly reducing liabilities or establishing assets for reinsurance ceded; and

 

3)         Section 188 of the Code [215 ILCS 5/800], relating to creating a situation that may be hazardous to policyholders and the people of this State.

 

(Source:  Amended at 30 Ill. Reg. 7766, effective April 6, 2006)

 

Section 1103.20  Scope

 

This Part shall apply to all domestic life, accident and health insurers and to all other licensed life and health insurers who are not subject to the same regulation in their domiciliary state.  This Part shall also apply to licensed property and casualty insurers with respect to their accident and health business.  This Part shall not apply to assumption reinsurance, yearly renewable term reinsurance, or certain nonproportional reinsurance, such as stop loss or catastrophe reinsurance.

 

(Source:  Amended at 30 Ill. Reg. 7766, effective April 6, 2006)

 

Section 1103.25  Definitions

 

Department means the Illinois Department of Financial and Professional Regulation.

 

Director means the Director of the Illinois Department of Financial and Professional Regulation-Division of Insurance.

 

Division means the Department of Financial and Professional Regulation-Division of Insurance.

 

(Source:  Added at 30 Ill. Reg. 7766, effective April 6, 2006)

 

Section 1103.30  Accounting Requirements

 

a)         No insurer subject to this Part shall, for reinsurance ceded, reduce any liability or establish any asset in any financial statement filed with the Division if, by the terms of the reinsurance agreement, in substance or effect, any of the following conditions exist:

 

1)         Renewal expense allowances provided or to be provided to the ceding insurer by the reinsurer in any accounting period are not sufficient to cover anticipated allocable renewal expenses of the ceding insurer on the portion of the business reinsured, unless a liability is established for the present value of the shortfall, using assumptions equal to the applicable statutory reserve bases on the business reinsured.  Those expenses include commissions, premium taxes and direct expenses including but not limited to billing, valuation, claims and maintenance expected by the company at the time the business is reinsured;

 

2)         The ceding insurer can be deprived of surplus or assets at the reinsurer's option or automatically upon the occurrence of some event, such as the insolvency of the ceding insurer, except that termination of the reinsurance agreement by the reinsurer for nonpayment of reinsurance premiums or other amounts due, including but not limited to modified coinsurance reserve adjustments, interest and adjustments on funds withheld, and tax reimbursements, shall not be considered to be a deprivation of surplus;

 

3)         The ceding insurer is required to reimburse the reinsurer for negative experience under the reinsurance agreement, except that neither offsetting experience refunds against current and prior years' losses nor payment by the ceding insurer of an amount equal to the current and prior years' losses under the agreement upon voluntary terminations of in-force reinsurance by ceding insurer shall be considered a reimbursement to the reinsurer for negative experience.  Voluntary termination does not include situations where termination occurs because of unreasonable provisions that allow the reinsurer to reduce its risk under the agreement.  An example of such a provision is the right of the reinsurer to increase reinsurance premiums or risk and expense charges to excessive levels forcing the ceding company to prematurely terminate the reinsurance treaty;

 

4)         The ceding insurer shall, at specific points in time scheduled in the agreement, terminate or automatically recapture all or part of the reinsurance ceded;

 

5)         The reinsurance agreement involves the possible payment by the ceding insurer to the reinsurer of amounts other than from income realized from the reinsured policies.  For example, it is improper for a ceding company to pay reinsurance premiums or other fees or charges to a reinsurer that are greater than the direct premiums collected by the ceding company;

 

6)         The treaty does not transfer all of the significant risk inherent in the business being reinsured. Exhibit A of this Part identifies, for a representative sampling of products or type of business, the risks considered to be significant.  For products not specifically included, the risks determined to be significant shall be consistent with Exhibit A;

 

7)         Requirements concerning credit quality, reinvestment or disintermediation risk.

 

A)        The credit quality, reinvestment or disintermediation risk is significant for the business reinsured and the ceding company does not (other than for the classes of business excepted in subsection (a)(7)(B)) either transfer the underlying assets to the reinsurer or legally segregate such assets in a trust account or escrow account or otherwise establish a mechanism that segregates, by contract or contract provision, the underlying assets.

 

B)        Notwithstanding the requirements of subsection (a)(7)(A), the assets supporting the reserves for the following classes of business and any classes of business that do not have a significant credit quality, reinvestment or disintermediation risk may be held by the ceding company without segregation of those assets; Health Insurance LTC/LTD, Traditional Non-Par Permanent, Traditional Par Permanent, Adjustable Premium Permanent, Indeterminate Premium Permanent, Universal Life Fixed Premium (no dump-in premiums allowed).  The associated formula for determining the reserve interest rate adjustment shall use a formula that reflects the ceding company's investment earnings and incorporates all realized and unrealized gains and losses reflected in the statutory statement.  The following is an acceptable formula:

 

Rate	=	2(I + CG)
		(X + Y - I - CG)

 

i)          I is the net investment income

 

ii)         CG is capital gains less capital losses

 

iii)        X is the current year cash and invested assets plus investment income due and accrued less borrowed money

 

iv)        Y is the same as X but for the prior year;

 

8)         Settlements are made less frequently than quarterly or payments due from the reinsurer are not made in cash within 90 days after the settlement date;

 

9)         The ceding insurer is required to make representations or warranties not reasonably related to the business being reinsured;

 

10)         The ceding insurer is required to make representations or warranties about future performance of the business being reinsured;

 

11)         The amount of the total admitted assets of the ceding insurance company less the amount of all funds withheld by any reinsurer as a result of all reinsurance treaties is less than the total gross amount available to policyholders either through the exercise of policy cash surrender or loan provisions;

 

12)         The reinsurance agreement is entered into for the principal purpose of producing significant surplus aid for the ceding company typically on a temporary basis, while not transferring all of the significant risks inherent in the business reinsured, and the remaining liability to the ceding insurer remains basically unchanged.

 

b)         Requirements for reinsurance of in-force business.

 

1)         Agreements entered into after January 5, 1994, along with any subsequent amendments to those agreements, that involve the reinsurance of business issued prior to the effective date of the agreements or amendments must meet the requirements of Section 174 of the Illinois Insurance Code [215 ILCS 5/174].  Each filing shall include data detailing the financial impact of the transaction.  The ceding insurer's actuary who signs the financial statement actuarial opinion with respect to valuation of reserves shall consider this Part and any applicable actuarial standards of practice when determining the proper credit in financial statements filed with the Division.  The actuary shall maintain documentation and be prepared to describe the actuarial work performed for inclusion in the financial statements and to demonstrate that such work conforms to this Part.

 

2)         As earnings emerge from the business reinsured, any increase in surplus net of federal income tax resulting from arrangements described in subsection (b)(1) shall be identified separately on the insurer's statutory financial statements as a surplus item in the "Change in Surplus as a result of Reinsurance" line for companies filing on the Life, Accident and Health blank and in the "Aggregate write-ins for gains (or losses) in Surplus" line for companies filing on the Property and Casualty blank and Health blank and recognition of the surplus increase as income shall be reflected on a net of tax basis in the "Commissions and Expense allowances on reinsurance ceded" line for companies filing on the Life, Accident and Health blank and in the "Aggregate write-in for miscellaneous income" for companies filing on the Property and Casualty blank.

 

For example, on the last date of calendar year N, company XYZ pays a $20 million initial commission and expense allowance to company ABC for reinsuring an existing block of business.  Assuming a 34% tax rate, the net increase in surplus at inception is $13.2 million ($20 million - $6.8 million) that is reported on the "Change in Surplus as a result of Reinsurance" line of the Summary of Operations.  $6.8 million (34% of $20 million) is reported as income on the "Commissions and Expense allowances on reinsurance ceded" line of the Summary of Operations.  At the end of the year N + 1 the business has earned $4 million.  ABC has paid $.5 million in profit and risk charges in arrears for the year and has received a $1 million experience refund.  Company ABC's annual statement would report $1.65 million (66% of ($4 million - $1 million - $.5 million) up to a maximum of $13.2 million) on the "Commissions and Expense allowances on reinsurance ceded" line of the Summary of Operations, and - $1.65 million on the "Change in Surplus as a result of Reinsurance" line of the Summary of Operations.  The experience refund would be reported separately as an "Aggregate write-in for miscellaneous income" item in the Summary of Operations.

 

(Source:  Amended at 30 Ill. Reg. 7766, effective April 6, 2006)

 

Section 1103.40  Written Agreements

 

a)         No reinsurance agreement or amendment to any agreement shall be used to reduce any liability or to establish any asset in any financial statement filed with the Division, unless the agreement or amendment or a binding letter of intent has been duly executed by both parties no later than the "as of date" of the financial statement.

 

b)         In the case of a letter of intent, a reinsurance agreement or an amendment to a reinsurance agreement must be executed within a reasonable period of time, not exceeding 90 days from the execution date of the letter of intent, in order for credit to be granted for the reinsurance ceded.

 

c)         The reinsurance agreement shall contain provisions that:

 

1)         The agreement shall constitute the entire agreement between the parties with respect to the business being reinsured thereunder and that there are no understandings between the parties other than as expressed in the agreement; and

 

2)         Any change or modification to the agreement shall be null and void unless made by amendment to the agreement and signed by both parties.

 

(Source:  Amended at 30 Ill. Reg. 7766, effective April 6, 2006)

 

Section 1103.50  Existing Agreements

 

On or before December 31, 2011, all insurers that are subject to this Part must be able to certify that they have reduced to zero any reserve credits or assets established with respect to reinsurance agreements entered into prior to December 31, 1994 that, under the provisions of this Part, would not be entitled to recognition of the reserve credits or established assets; however, the reinsurance agreements must have been in compliance with the laws and regulations in existence immediately preceding the effective date of this Part (January 5, 1994).

 

(Source:  Old Section repealed at 30 Ill. Reg. 7766, effective April 6, 2006 and new Section added at 35 Ill. Reg. 6182, effective March 28, 2011)

Section 1103.EXHIBIT A   Risk Category

 

Risk Categories:

 

a)         Morbidity

 

b)         Mortality

 

c)         Lapse

This is the risk that a policy will voluntarily terminate prior to the recoupment of a statutory surplus strain experienced at issue of the policy.

 

d)         Credit Quality (C1)

This is the risk that invested assets supporting the reinsured business will decrease in value.  The main hazards are that assets will default or that there will be a decrease in earning power.  It excludes market value declines due to changes in interest rate.

 

e)         Reinvestment (C3)

This is the risk that interest rates will fall and funds reinvested (coupon payments or monies received upon asset maturity or call) will, therefore, earn less than expected.  If asset durations are less than liability durations, the mismatch will increase.

 

f)         Disintermediation (C3)

This is the risk that interest rates rise and policy loans and surrenders increase or maturing contracts do not renew at anticipated rates of renewal.  If asset durations are greater than the liability durations, the mismatch will increase.  Policyholders will move their funds into new products offering higher rates.  The company may have to sell assets at a loss to provide for these withdrawals.

 

Risk Category			a	b	c	d	e	f
Health Insurance – other than LTC/LTD			+	0	+	0	0	0
Health Insurance – LTC/LTD			+	0	+	+	+	0
Immediate Annuities			0	+	0	+	+	0
Single Premium Deferred Annuities			0	0	+	+	+	+
Flexible Premium Deferred Annuities			0	0	+	+	+	+
Guaranteed Interest Contracts			0	0	0	+	+	+
Other Annuity Deposit Business			0	0	+	+	+	+
Single Premium Whole Life			0	+	+	+	+	+
Traditional Non-Par Permanent			0	+	+	+	+	+
Traditional Non-Par Term			0	+	+	0	0	0
Traditional Par Permanent			0	+	+	+	+	+
Traditional Par Term			0	+	+	0	0	0
Adjustable Premium Permanent			0	+	+	+	+	+
Indeterminate Premium Permanent			0	+	+	+	+	+
Universal Life Flexible Premium			0	+	+	+	+	+
Universal Life Fixed Premium			0	+	+	+	+	+
Universal Life Fixed Premium			0	+	+	+	+	+
dump-in premiums allowed
+	=	Significant
0	=	Insignificant
LTC	=	Long-Term Care Insurance
LTD	=	Long-Term Disability Insurance

 

(Source:  Amended at 30 Ill. Reg. 7766, effective April 6, 2006)