GIM7110 - Equalisation reserves: classes other than credit business: worked example
Transfers in
Transfers out
Reserve carried forward
Net transfer in or out
This is a complete worked example of an equalisation reserve
for an insurer writing insurance falling into two business groups.
Many of the figures are simplified, for example, the amount of the
net earned premium will not normally be the same as the net written
premium.
Transfers in
The first stage in calculating the movements in and out of an
equalisation reserve at the end of a financial year is to quantify
the level of transfers into the reserve, looking at each business
group separately. The transfers in for each business group will be
the set percentage of premiums written for that group. In this
example we assume that the company writes only two types of
business both falling within the equalisation reserves business
groups: marine and aviation and nuclear risks. Net written premiums
for the year are £67k for marine and aviation and £120k
for nuclear risks.
The calculation of transfers in will be made as follows:
| Business Group | Net written premiums | Transfer in % | Transfer into reserve |
| Marine and aviation | £67k | 6% | £4k |
| Nuclear risks | £120k | 75% | £90k |
| Total |
|
| £94k |
Transfers out
The next step is to see if any transfers out of the reserve have
been triggered as a result of poor claims performance in that
financial year. Each business group is looked at separately at this
stage in the computation.
Marine and aviation
| Net earned premium | £63k |
| 95% of net earned premiums | £60k |
| Net claims incurred | £70k |
| Excess | £10k |
There is a potential transfer out equal to this excess (£10K), but this is subject to the business group maximum reserve level for that year. This is calculated as follows:
| Average net written premium over last 5 years | £15k |
| 40% of average net written premium over last 5 years | £6k |
The transfer out is therefore £6k, the lesser of the
potential transfer out (£10k) and the business group maximum
(£6k).
Nuclear risks
A transfer out is due if claims exceed 25% of the net earned
premium.
| Net earned premium | £120k |
| 25% net earned premiums | £30k |
| Net claims incurred | £3k |
There is no excess of claims over the set percentage of premiums
this year, so no transfer out is due.
Total transfers out of the reserve on account of abnormal
losses
| Marine and aviation | £6k |
| Nuclear risk | Nil |
| Total | £6k |
Reserve carried forward
If there was an equalisation reserve brought forward at the start of the year of £80k, the movements in the equalisation reserve will look like this:
| Reserve B/F | £80k |
| Transfer in | £94k |
| Transfer out due to abnormal losses | £6k |
| Potential reserve C/F | £168k |
But this is subject to the aggregate of the maximum reserve
levels for each business group.
The maximum reserve level for marine and aviation was
calculated when transfers out were considered. There was no
need to calculate a reserve maximum for nuclear risk business at
that stage because there was no potential transfer out of the
reserve in respect of that business. It needs to be
calculated now.
Business group maximum reserve level - nuclear risks:
| Average net written premium over last 5 years | £25k |
| 600% of average net written premium over last 5 years | £150k |
| Group reserve maximum, marine and aviation | £6k |
| Group reserve maximum, nuclear risks | £150k |
| Aggregate maximum reserve level | £156K |
The reserve carried forward of £168k is greater than the aggregate of the business group maximum levels so it needs to be limited further. An additional transfer out will be made of £12k so that the reserve carried forward is reduced to equal the maximum reserve level of £156k. This transfer out is not allocated to any particular business group.
Net transfer in or out
The final step is to aggregate the transfers in and out for all business groups to find the net transfer in or out of the reserve.
| Transfers in | £94k |
| Transfer out due to abnormal losses | (£6k) |
| Transfer out due to exceeding maximum reserve level | (£12k) |
| Net transfer in of | £76k |
(The reserve is carried forward as a single amount covering all business groups. It will not usually be possible to break down the balance of reserves brought forward into separate business groups, and even if in this case the reserve brought forward at the start of the year was made up of say £1k from marine & aviation and £79k from nuclear risks, the transfer out for marine and aviation would not be limited to £5k (made up of £1k brought forward plus £4k transferred in). The balance of the reserve may be used even though its origin was nuclear risk business.)
