Treaty capital relief shrinks as the calendar runs down

Under Solvency II, the EU capital rulebook for insurers, a reinsurance contract only earns full credit in the capital requirement if it will still be in force for the next 12 months.

Capital relief is the reduction in the capital an insurer has to hold because part of its risk sits with a reinsurer. The logic behind the 12 month test is easy to follow: protection that is about to lapse cannot be relied on for long.

What Article 209 does to a treaty

That is Article 209 of the Delegated Regulation. Cover with less time left is counted in proportion to the time remaining. On a book whose exposure runs longer than a year, a treaty with six months to go gives about half the relief it gave on the day it incepted, meaning the day it started. The risk it protects has not changed.

Picture a fire extinguisher whose certificate the auditor credits only for the months still printed on it. The extinguisher works as well on the last day as on the first.

Relief as a curve

For a carrier with one annual quota share, a treaty in which the reinsurer takes an agreed percentage of a book, capital relief is a curve. It decays through the year and resets at renewal.

There is a way past it. A documented replacement policy, a written plan to replace cover as it expires, lets shorter cover count in full, and reinsurance used that way needs an initial term of at least three months. Most mid-market cedents, the mid-sized insurers that buy this cover, do not run that machinery. That leaves them with the curve.

The US test

The US test is different. SSAP 62R, the US statutory accounting standard for reinsurance, asks whether the reinsurer takes significant insurance risk with a reasonably possible significant loss. In plain terms, the reinsurer has to carry real risk, and a large loss has to be a realistic outcome for it rather than a remote one.

A contract that fails is booked as a deposit, with no underwriting credit at all. A deposit is accounted for like money placed with the reinsurer, not like insurance.

Extending cover when it is needed

At NextBlock RWA the cession runs into a ring-fenced vault, a dedicated pool kept apart from other assets, with tap-in and tap-out capacity, so cover can be extended when the cedent needs it instead of once a year.

In plain words

The EU rule credits a treaty by the time it has left, so relief fades through the year even though the risk stays put. It resets when the treaty renews. The US test asks a different question: whether real insurance risk moves to the reinsurer at all.

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