Commutations are being used, by ceding companies and reinsurers, as a common practice in the reinsurance market, to discharge all the obligations between the parties, under a specific reinsurance contract.
The reinsurance company may by this agreement limits its ongoing exposure in long term contracts where losses are “ongoing and recurring”.
A question involving retrocessionaires may arises, as to whether a commutation agreed between a ceding company and a reinsurer, is binding the retrocessionaires.
I. The commutation agreement may be potentially objected by the retrocessionaires
There is an inherent burden on the retrocedant to prove that the commutation settlement was made upon good faith, and in a businesslike fashion manner.
Since, the said agreement is including more than one claim, the commutation arrangement is by nature exposed to more objections, especially in view that outstanding claims and IBNR (Incurred but not reported losses) are a substantial element of the commutation process.
This is why, a retrocedant should if required be able to justify reasons behind the commutation, especially as to how the calculation was made.
The main argument used by retrocessionaires being that outstanding claims, and IBNR are not losses, as they are not recoverable, and that they can have been artificially considered as losses, for the purpose of the commutation.
II. The courts may recognize “actual valuations” as losses.
Under the precedents of common law, there is no specific court decision stating whether outstanding and IBNR claims may be recoverable, and considered as losses.
There is only one case, Cambridge Re Company, No. 0013734 of 1991 (1992) 2 Lloyd’s Rep, giving a brief guidance, by awarding the fact that “actuarial valuation” may be considered, as a loss settlement.
The said decision favoring a “broad interpretation” of “loss settlement”, which leads to believe that some courts may be inclined to consider the valuations of Outstanding and IBNR claims, as a “loss settlement”.
Despite that there are some potential grounds for retrocessionaires, to object the valuation of a commutation, it is to be believed that courts may be rather inclined to consider the “actuarial valuation” of Outstanding and IBNR claim, as a “loss settlement”, binding the retrocessionaires.