A Closer Look at Schedule F: Implications for P&C Insurers

Property and casualty insurance company annual statement filers are required to present assumed and ceded reinsurance activity for the year in schedule F. Insurance regulators use schedule F to identify an insurance company’s exposure to reinsurance and to assess the collectability of amounts recoverable. Schedule F complexity has increased over time to include various categories of reinsurers with different collateral requirements for each category and penalty calculations.

Schedule F Overview

Schedule F helps regulators assess an insurer’s financial stability and risk management practices related to reinsurance. It includes six parts:

• Part 1 – Assumed Reinsurance
• Part 2 – Portfolio Reinsurance
• Part 3 – Ceded Reinsurance
• Part 4 – Issuing or Confirming Banks for Letters of Credit from Schedule F, Part 3
• Part 5 – Interrogatories for Schedule F, Part 3
• Part 6 – restatement of Balance Sheet to Identify Net Credit for Ceded Reinsurance

Four of the six parts of schedule F focus on ceded reinsurance. Since an insurance company is ultimately liable for claims if its reinsurers are unable to pay their portion, it is a central focus area for regulator solvency analysis. 

Schedule F, Part 3

Four categories of reinsurers are included on Schedule F Part 3 and each category has different collateral requirements. Each domiciliary state insurance department determines which category a reinsurer falls into annually. A reinsurer may be certified in one state but not in another state, for example.

A reinsurer could move between categories from one year to the next, triggering a different amount of collateral required for net reinsurance recoverables. When collateral amounts are not sufficient, the insurance company is required to record a provision for reinsurance, or allowance against the net recoverable amount, often referred to as the ‘schedule F penalty.’ Insurance companies should review all of its reinsurers on the domiciliary state insurance department website at least annually to ensure there is sufficient collateral in place.

Schedule F Penalty

An insurance company can use any reinsurer for its coverage needs. However, statutory accounting limits the amount an insurer can report as receivable on certain categories of reinsurers. Penalties apply for both collateral deficiencies and past due receivables. The penalty, or provision for reinsurance, serves to reduce the net recoverable with a corresponding surplus reduction.

Penalty for Collateral Deficiency (Certified and Unauthorized Reinsurers)

Reinsurance collateral may take a variety of forms, including:

• Multiple beneficiary trusts – often used by non-U.S. certified insurers to collateralize more than one U.S. ceding company
• Letters of credit received and held by or on behalf of the ceding insurance entity. Letters of credit must be irrevocable, unconditional and evergreen to qualify and they must also be issued from an NAIC approved financial institution. The NAIC Securities Valuation Office (SVO) publishes a “List of Qualified U.S. Financial Institutions” annually.
• Single beneficiary trusts – Conditions must be met in the Credit for Reinsurance Model Law and Credit for Reinsurance Model Regulation, including approval by the state of domicile and access to the trust fund.

In addition to the collateral above, the ceding insurer’s state of domicile may approve other acceptable forms of collateral. It is the ceding insurer’s responsibility to obtain sufficient collateral and verify annually that it meets the NAIC’s regulatory requirements.

Certified Reinsurers

Reinsurers are required to apply for certification with each state insurance department. The state insurance department will assign the reinsurer a rating based on a variety of factors including submitting financial information for regulator review. The rating corresponds to a required collateral percentage of the ceding insurer’s net recoverable amount. The table below lists the collateral requirement associated with each rating.

If the amount of collateral is deficient, then the ceding insurer must reduce its net recoverable from the reinsurer by an amount proportionate to the deficiency in collateral compared to the required collateral using the financial strength rating scale above.

Putting the math into perspective, a certified reinsurer with a financial strength rating of 3, has a collateral requirement of 20% in the above table. A shortfall of $1 in collateral related to this reinsurer corresponds to a $5 schedule F penalty, which is a magnitude larger than the deficiency itself.

Unauthorized Reinsurers

Unauthorized reinsurers require collateral that covers 100% of the outstanding net recoverable as of year end in order to avoid a penalty. When the net recoverable is greater than the collateralized amount for unauthorized insurers, there is a dollar for dollar penalty to reduce the net recoverable to the collateralized amount.

Ceding insurers may increase collateral coverage after December 31 and before the annual statement is filed to meet collateral requirements.

Penalty for Past Due Reinsurance

The penalty for past due reinsurance is calculated on any past due amounts from authorized, certified, reciprocal jurisdiction and unauthorized reinsurers alike. It is a separate calculation from the penalty for collateral deficiency.

Past due status is required to be calculated according to the contractual terms of the reinsurance agreements. Schedule F instructions further specify what to do when the terms of the reinsurance agreement do not specify a due date. The calculation of the past due penalty is dependent on the financial strength of the reinsurer as well as if the past due receivable is collateralized or not.

While authorized and reciprocal jurisdiction reinsurers are not required to establish collateral to secure their obligations for receivables on the annual statement of a ceding insurer, a penalty may still apply if recoverable amounts are past due from these reinsurers. 

To avoid past due reinsurance penalties, ceding insurers should submit claims timely for reinsurance payment and follow up on amounts until they are paid by the reinsurer.

Debunking Common Misconceptions

Errors in the preparation of Schedule F can result in larger penalty calculations. Three common misconceptions can directly impact the collateral required, and therefore, the penalty calculation on Schedule F:

Misconception #1: An AM Best or other rating agency rating signals the reinsurer is authorized

An insurer or reinsurer may be rated favorably on a source like AM Best but still be certified or unauthorized in certain states. 

Misconception #2: Reinsurer classifications do not change from year to year

Filers sometimes assume that the reinsurer classification does not change from the previous year. States may change the designation of a particular reinsurer so as part of the preparation process, financial reporting teams should verify reinsurers using NAIC and other state department tools.

Misconception #3: A ceding insurer can only include a reinsurer in one of the categories

Achieving certified reinsurer or reciprocal jurisdiction reinsurer status is applicable on a prospective basis as determined by the domiciliary state insurance department. Consequently, it is possible that a ceding insurer has reinsurance balances with the same reinsurer in multiple categories based on the timing of the status change with the domiciliary state insurance department. Also remember that reinsurer rating downgrades apply retrospectively.

Property and casualty filers should begin reviewing reinsurers using their state’s department of insurance resources early in the annual statement process to ensure proper classification and adequate collateral coverage, if needed.

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