Buyers of reinsurance need to be wary of PPO capitalisation clauses

Car crash

The increasing use of periodic payment orders (PPOs) to settle large bodily injury claims in the UK is complicating reinsurance buying, according to a new study.

Reinsurance broker Willis Re has released its fifth annual study of the UK motor market, which this year surveyed insurers representing 75% of the UK motor market.

Commenting on the main findings of the report, Willis Re executive director Grange Turner noted that decisions about reinsurance purchasing are becoming increasingly difficult for UK motor insurers to make.

He said: “It used to be the case that a UK motor insurer would simply renew the same programme year after year with the same reinsurers. The increased propensity of PPOs has changed all that.

“The key impact of PPOs for both insurers and reinsurers is that they introduce new elements of uncertainty around how claims have to be reserved: how long the claimant will live; what wage inflation factors will prevail over that time period; and what investment returns can be expected over the same time. Many reinsurers have become increasingly concerned about taking all of these variables on to their own balance sheets.”

Willis Re’s study found that reinsurers reporting results according to US Generally Accepted Accounting Principles pressures on the reserves they set against the long-term risks associated with PPOs, with many of these reinsurers seeking to mitigate this risk by introducing compulsory capitalisation clauses.

Under capitalisation clauses, reinsurers exit the reinsurance policy by paying the insurer protected by the policy a lump sum. This effectively transfers the risk of the PPO claimant living longer than expected back to the insurer from the reinsurer.

Willis Re executive director Catherine Pearson said that while Willis Re is not opposed to capitalisation clauses, having introduced the first compulsory clause to a large programme two years ago, buyers need to make sure they understand them.

Pearson said: “Our concern is that differences in technical points such as what discount rate is being used and how longevity exposure is being assessed can have an enormous impact on how much insurers eventually recover from their reinsurance. We spend a great deal of time explaining to clients the implications of the various capitalisation clauses being proposed by the reinsurance market, and how these differ from a the traditional reinsurance product.”