Drafting and reviewing pooled reinsurance collateral arrangements

Reinsurers and cedants enter into collateral arrangements, whether by way of security, a transfer of title or a combination of the two, to cover them against the risk of non-payment following early termination of the reinsurance contract.

Here are some issues to consider when drafting or reviewing pooled reinsurance collateral arrangements.

Documentation

Commonly, at least two types of document are required:

• a master framework reinsurance agreement, to govern the interaction of the multiple transactions. This should incorporate a smooth accession mechanism, to allow further reinsurance treaties to be added in future; and
• for title transfer-based collateral, an embedded master collateral arrangement; and/or
• for security-based collateral, a separate master security agreement and master account control agreement.

Scope

If the arrangement is to cover existing reinsurance agreements, rather than solely new reinsurance agreements, additional scrutiny will be required.

Existing reinsurance agreements should be reviewed for consistency so that any inconsistent provisions or definitions can be identified and amended. For example, termination events – such as insolvency – should be made consistent throughout, to avoid the scenario where only some, but not all, transactions are terminated.

Any existing collateral arrangements are likely to need to be released and replaced with the new master arrangements. There is also the technical legal risk of the one-year insolvency ‘hardening’ period for any security-based collateral starting again.

Counterparty risk

There is an obvious commercial incentive to using collateral arrangements for multiple transactions. However, the parties must be comfortable accepting the resulting increased credit risk to any third party custodian, in contrast to transactions being spread across more than one custodian.

Similarly, if the liabilities that are collateralised across multiple transactions flow in both directions, pooling, when viewed on an individual transaction basis, will result in those liabilities being under- or over-collateralised.

Other commercial considerations

Other commercial considerations include:

• the frequency of collateral calculations and reporting requirements. These will need to be harmonised in line with the new arrangements to avoid collateral management becoming operationally challenging;
• how minimum transfer amounts and other thresholds may change as the volume of assets being collateralised under multiple agreements changes;
• whether different transactions should have different collateral loadings – for example, through the application of different discount factors; and
• whether the ‘haircuts’ or valuation percentages on collateral may need to be amended during the life of the arrangements.

Termination

Additional complexities arise on termination of some, but not all, of the underlying reinsurance transactions.

Explicit parameters should be incorporated into the master framework agreement around the type of collateral that is to be accounted for, realised or returned as part of the termination calculations and processes once a reinsurance transaction within the framework terminates. This will often result in an additional valuation date to enable collateral to be adjusted to reflect the value of the continuing reinsured transactions.