How could insurer protect themselves against credit risk?
I understand for collateral how this protects against credit risk since insurer holds an actual security. Could you explain how Holdbacks and Loss Development Factors protects against credit risk? For Holdbacks, is it just protection because the possible payments to insured are delayed? And for Loss Development Factors, is it something to do with premium formula? Thanks!
Comments
Holdbacks and loss development factors are almost always used in incurred retro plans. A holdback provision means either the timing or the size of the retrospective premium adjustments are limited. For example, if at the 18-month adjustment a return of $100,000 is indicated then a holdback may allow the insurer to only return $30,000. By holding onto more of the initial retro premium there is less credit risk because should the 30-month adjustment show a $25,000 increase over the initial premium then the insurer need only request $55,000 instead of $125,000 from the insured.
A holdback can defer all or a portion of the retrospective premium adjustments up to a certain maturity date.
Similarly, retrospective loss development factors stabilize a retro plan by limiting the extremes of the estimated retro premium adjustments.
In both cases we're reducing credit risk through avoiding a large return of premium followed by a large request for more premium the following year.