Equalisation reserves: classes other than credit business: example
This is a 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 (the proportion of net written premium attributable to risk borne in the financial year) will not normally be the same as the net written premium.
The first stage in calculating the movements in and out of an equalisation reserve at the end of a financial year (see GIM7210) 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 the company writes only two types of business falling within the equalisation reserves business groups GIM7030): marine and aviation (C) and nuclear risks (D). Net written premiums for the year are £67m for marine and aviation and £120m 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||£67m||6%||£4m|
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||£63m|
|95% of net earned premiums||£60m|
|Net claims incurred||£70m|
There is a potential transfer out equal to this excess (£10m), 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||£15m|
|40% of average net written premium over last 5 years||£6m|
The transfer out is therefore £6m, the lesser of the potential transfer out (£10m) and the business group maximum (£6m) for that year.
A transfer out is due if claims exceed 25% of the net earned premium.
|Net earned premium||£120m|
|25% net earned premiums||£30m|
|Net claims incurred||£3m|
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||£6m|
Reserve carried forward
If the equalisation reserve brought forward at the start of the year is £80m, the movements in the equalisation reserve will look like this:
|Transfer out due to abnormal losses||£6m|
|Potential reserve c/f||£168m|
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 for that business. It needs to be calculated now.
Business group maximum reserve level - nuclear risks:
|Average net written premium over last 5 years||£25m|
|600% of average net written premium over last 5 years||£150m|
|Group reserve maximum, marine and aviation||£6m|
|Group reserve maximum, nuclear risks||£150m|
|Aggregate maximum reserve level||£156m|
The reserve carried forward of £168m exceeds the aggregate of the business group maximum levels £156m so an additional transfer out of £12m is required to reduce to the maximum reserve level. 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.
|Transfer out due to abnormal losses||(£6m)|
|Transfer out due to exceeding maximum reserve level||(£12m)|
|Net transfer in of||£76m|
The reserve is carried forward as a single amount covering all business groups. It is not necessary to break down the balance of reserves brought forward into separate business groups. If it were possible, and say the reserve brought forward at the start of the year was made up of £1m from marine & aviation and £79m from nuclear risks, the transfer out for marine and aviation would not be limited to the £5m made up of £1m brought forward plus £4m transferred in. The balance of the reserve may be used even though its origin was nuclear risk business.