Reinsurance to close
From Wikipedia, the free encyclopedia
Reinsurance to close (RITC) is a business transaction whereby the estimated future liabilities of an insurance company are reinsured into another, in order that the profitability of the former can be finally determined. It is most closely associated with the Lloyd's of London insurance market that comprises numerous competing "syndicates", and in order to close each accounting year and declare a profit or loss, each syndicate annually "reinsures to close" its books. In most cases, the liabilities are simply reinsured into the subsequent accounting year of the same syndicate, however, in some circumstances the RITC may be made to a different syndicate or even to a company outside of the Lloyd's market.
At Lloyd's, traditionally each year of each syndicate is a separate enterprise, and the profitability of each year is determined essentially by payments for known liabilities (claims) and money reserved for unknown liabilities that may emerge in the future on claims that have been incurred but not reported (IBNR). The estimation of the quantity of IBNR is difficult and can be inaccurate.
Capital providers typically "joined" their syndicate for one calendar year only, and at the end of the year the syndicate as an ongoing trading entity was effectively disbanded. However, usually the syndicate re-formed for the next calendar year with more or less the same capital membership. In this way, a syndicate could have a continuous existence for many years, but each year was accounted for separately.[1] Since some claims can take time to be reported and then paid, the profitability of each syndicate took time to realise. The practice at Lloyd's was to wait three years from the beginning of the year in which the business was written before "closing" the year and declaring a result. For example, for the 1984 year a syndicate would ordinarily declare its result at 31 December 1986. The syndicate's 1984 members would therefore be paid any profit during 1987 (in proportion to their share of the total capacity of the syndicate); conversely, they would have to reimburse the syndicate during 1987 for their share of any 1984 loss.
For the estimated future claims liabilities, the syndicate bought an RITC; the premium for the reinsurance was equal to the amount of the reserve. In other words, rather than placing the reserve in a bank to earn interest, the syndicate transferred its liabilities for future claims to a reinsurer, thus allowing the year to be closed and the profit or loss to be declared. For example, the members of syndicate number '1' in 1984 reinsured the future liabilities of the members of syndicate '1' in 1985. The membership might be the same, or it might have changed.