The Federal Reserve Board of Governors in Washington DC.
Executive Summary
Reinsurance is often described as insurance for insurance companies. Beginning with the 2018:Q2 release, we now document reinsurance transactions in the Financial Accounts of the United States (Financial Accounts). First, we now highlight how insurers depend upon each other through different forms reinsurance. Second, we explicitly account for reinsurance transactions, whereas in previous releases balances were reported net of reinsurance. In addition to shedding light on these relationships, the new treatment captures parts of the industry that were missing from the Financial Accounts due to reinsurance in jurisdictions with limited disclosure requirements (such as captive and foreign reinsurers).
In principle, these changes increase both a-sets and liabilities of the insurance sectors, but have no effect on their equity. In practice, as of year-end 2017 they have a modest negative effect on insurance equity of $37 billion (almost entirely life insurance) due to the less stringent reserve requirements that apply to certain reinsurers. Several other sectors are also affected. The net worth of households and nonprofit organizations grows by $249 billion to reflect the value of policies that were previously missing from the Financial Accounts. Businesses also capture $81 billion from previously missing policies. The rest of the world (ROW) sector loses $130 billion on net because they are the reinsurer for many of the policies that are newly recorded. Note, these effects are net of reallocating certain other financial a-sets from households to the insurance sectors, and of other outstanding balances between insurers and reinsurers that we now record as trade credit. This note describes these changes and their a-sociated effects in more detail.
Introduction
The insurance industry consists of direct insurers, which sell insurance policies directly to consumers, and reinsurers, which charge a fee to a-sume the risk of the policies sold by direct insurers.1 Reinsurance is commonly used to share risk across firms and manage capital requirements. Importantly, while purchasing reinsurance indemnifies the direct insurer, it does not remove their legal obligation to pay policyholders when claims occur. Therefore, the financial condition, and potentially the solvency of an insurer relies upon the ability of its reinsurers to meet their obligations. Further, a reinsurer can cede the policies it a-sumes to another reinsurer ("retrocession"), creating chain of interdependence.
Before the 2018:Q2 release, the Financial Accounts of the United States (Financial Accounts) only reported insurers' net liability to policyholders, and did not explicitly account for reinsurance transactions among insurers. Beginning with the 2018:Q2 release, the Financial Accounts incorporates reinsurance transactions between U.S. direct insurers and both domestic and foreign reinsurers. The new treatment of reinsurance will allow users of the Financial Accounts to study how insurers depend upon each other through reinsurance, both within the United States and across borders. It is also consistent with the guidance for representing reinsurance that has been set forth in the System of National Accounts (SNA). In addition, this new treatment allows us to correct a substantial undercounting of insurance liabilities and a misallocation of other financial instruments that occurred because U.S. insurers often use reinsurers in jurisdictions with limited disclosure requirements.2 The remainder of this FEDS note describes updates to the Financial Accounts to document these transactions.
Data Sources
The primary data sources for the insurance sector in the Financial Accounts are insurers' regulatory filings submitted to state insurance regulators and compiled by the National A-sociation of Insurance Commissioners (NAIC). We access them through S&P Global Market Intelligence. Most of insurers' liabilities are obligations for future payments to policyholders. In the Financial Accounts, these are called life insurance reserves, pension entitlements (reserves for annuities), accident and health insurance reserves, and policy payables (reserves for property and casualty policies). The amounts insurers report on their regulatory balance sheets are net of reinsurance, which means that the liability is only held by the ultimate reinsurer of policy, as opposed to also being recorded by the direct insurer or any intermediate reinsurers. Thus, total obligations to policyholders can be calculated by summing those reported by individual firms (except in certain cases discussed below). However, this approach does not allow users of the Financial Accounts to identify insurers' use of reinsurance. Starting with the 2018:Q2 release, we now utilize detailed data on reinsurance transactions from Schedule S (life insurance) and Schedule F (property and casualty insurance) to appropriately record these transactions. The data include the degree to which reported policyholder liabilities have been affected by reinsurance ("reserve credit"), as well as other balances owed between the direct insurer and reinsurer. The data in the Financial Accounts are available beginning in 1999 Q4.3
This change in GST annual return if not checked properly can result in input tax credit mismatch
