Sched F - Part 5 Ceding commission concealing high operating leverage
Can you explain what high operating leverage is and why insurers may want to do this?
I followed the example and understood how ceding commission to reinsurer is reduced with a sliding scale commission, I just don't understand the why.
And in part 5 when listing largest ceding commission rates, would you explicitly layout the sliding scale commission if there was one or would simply just put the provisional rate?
Comments
Okay maybe I understand it a little more. Please correct or confirm my thinking.
There may be a sliding scale commission in place that would reduce the actual ceded commission returned to the reinsured if LR was high, which would reduce surplus relief. But if just 35% ceding commission rate was listed in Part 5, it would appear that the reinsured is getting adequate surplus and thus has a usual IRIS 2 ratio. The regulator would have to dig deeper to realize that the sliding scale commission is actually limiting amount of surplus relief in the case of higher LR, resulting in higher IRIS 2 ratio. Not disclosing this sliding scale commission would be the reinsured concealing their high operating leverage since they are trying to appear to have usual IRIS 2 when in reality protection isn't as good as it appears.
Still curious about whether reinsured needs to disclose sliding scale commission if there is one in Part 5.
Thanks!
Your understanding is correct.
Sliding scale is not disclosed in Part 5; only the provisional commission.
Thank you. Where is the sliding scale commission disclosed then. In the Notes to Financial statements under Reinsurance section?
And the wiki says the purpose for disclosing 5 largest commission (provisional) rates is to identify companies using reinsurance to conceal high operating leverage. But how would regulators identify companies with high operating leverage if the sliding scale commission isn't included? By cross checking these rates in Part 5 with sliding scale commission rates listed elsewhere?
The Odomirok example has two parts: first, the one that explains how reinsurance helps the leverage ratio; second, the one that shows how the lowered leverage ratio may be illusory in the case of sliding scale commission being used.
The regulator wants to keep tabs on the highest commission ratios. This gives them a general idea to what extent reinsurance is used to help leverage. This is the main purpose of Part 5. The first part of the example is there to illustrate this phenomenon that the regulator is monitoring.
The second part of the example is not a propos of this main purpose. Odomirok gives it to parenthetically point out that there is a way that the insurer can give the illusion of low leverage using sliding scale commission.
Sliding scale is not currently disclosed in the Annual Statement to my knowledge.
Thanks! That makes sense.
Out of my own curiosity I looked at example Notes to Financial statements and found that under Reinsurance note, Reinsurance Assumed and Ceded, there is an 'Additional or Return commission' section that has place to input sliding scale adjustments.