A cedant pays $10 million of premium into a contract that caps the reinsurer's worst-case loss at $500,000. Is that reinsurance, or a disguised loan? The answer decides whether the contract gets reinsurance accounting or deposit accounting.
The cedant (ceding company) transfers risk; the reinsurer (assuming company) accepts it. Premium paid to the reinsurer is ceded premium. The reinsurer often returns a ceding commission to reimburse the cedant's acquisition costs. When a reinsurer reinsures its own book, that is retrocession.
KEY: Reinsurance does not extinguish the cedant's obligation to its policyholders. It creates a recoverable asset, not a novation.
Every reinsurance contract mixes an insurance component (genuine risk transfer) and a financing component (a timed exchange of cash). Accounting hinges on which dominates.
DECISION: Both prongs pass (underwriting risk and timing risk are transferred, and the reinsurer can realize a significant present-value loss) -> reinsurance accounting: ceded premium, reserve credit, ceding commission through underwriting.
Common mistakes
- Testing only underwriting risk. Transfer requires both underwriting and timing risk; a fixed-payout schedule can kill timing risk.
- Treating 10-10 as authoritative. It is a screen, not a codified standard; a contract can pass transfer through reasoned judgment without hitting exactly 10-10.
- Booking ceded premium before testing transfer. A failed contract yields a deposit, so no ceded premium or reserve credit appears.
Bottom line
- Reinsurance accounting applies only when the contract transfers significant insurance risk; otherwise use deposit accounting.
- Insurance risk has two parts: underwriting risk (uncertain ultimate amount of net cash flows) and timing risk (uncertain timing of those cash flows).
- The reinsurer must assume significant insurance risk AND face a reasonable possibility of a significant loss on the contract.
- The "10-10" screen: a 10% chance of a 10% present-value loss is a common (non-authoritative) rule of thumb for reasonable possibility of significant loss.
Exam shortcut
Run risk transfer as a two-way AND gate: significant insurance risk transferred, and reasonable possibility of significant loss. Fail either and the answer is deposit accounting. When a problem hands you a probability and a percent loss, reach for 10-10 first: is P(loss) ≥ 10% and is the loss ≥ 10% of premium?
The full lesson (about 1,149 words, 8 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- D1
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