Reinsurance and other forms of risk transfer: financial reinsurance and alternative risk transfer (ART): loss portfolio transfer
Financial reinsurance can also involve post loss funding, providing what is referred to as retrospective reinsurance cover for claims that have already been incurred at the time when the contract is made.
Perhaps the simplest form of retrospective cover is loss portfolio transfer, which has already been referred to as a form of non-proportional reinsurance at GIM8100. An insurer may estimate that the claims incurred but not yet paid on a particular tranche of its business amount to £12 million, and that the average period of time that will elapse before the outstanding claims are paid will be three years. It might be able to reinsure its liabilities on this portfolio of business for a premium of £10 million or thereabouts. The reinsurer may make a profit or a loss, depending, among other things, on the amount of the claim payments eventually made, their timing, and its ability to earn an investment return on the premium. Whatever happens, however, the present value of the payments that flow back to the insurer will be of the same order of magnitude as the £10 million premium paid. Loss portfolio transfer is a common form of reinsurance, and it may be surprising to see it described as financial reinsurance. But it clearly displays the distinguishing characteristics.