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  1. Circumstances rising opportunity for commutation
    • WC where claimant desires cash settlement instead of annuity; discount is larger than time value of money and represents a utility value to the claimant
    • liability claim may be resolved with structured settlement
    • end relationship with a reinsurer
    • companies under supervision, rehabilitation or liquidation can convert non-cash to cash
  2. Claims commutation
    • process where future value of unpaid claim(s) and expenses is current valued, taking into account financial and non-financial aspects, to accelerate payment and close the case
    • entity that has the claims and expense obligation is the commutation seller
  3. Attractions of commutation from the buyer’s viewpoint
    • accelerated settlement of the obligation
    • improved current wealth using perception of cash over non-cash assets
    • cash flow for reinvestment or liquidity to deploy for other purposes 
    • a certain immediate amount is substituted for an uncertain future amount
    • possible administrative cost savings associated with monitoring and collection efforts
    • creating a marginal underwriting loss and a federal income tax marginal adjustment
  4. Attractions of commutation from the seller’s viewpoint
    • accelerated settlement, oftentimes meaning an end of the relationship with buyer
    • improved in perceived wealth when considering financial and non-financial aspect
    • limited attractive cash flow alternatives
    • certain result, not subject to future events such as remediation or retroactive legislation
    • allocated and unallocated loss adjustment administrative expense savings
    • creating a marginal UW gain with a probable adverse current tax consequence
  5. Actuarial consideration for commutation
    • evaluation of unpaid claims and allocated LAE, including ranges
    • estimation of unallocated LAE
    • unanticipated judicial risks
    • LOB specific issues - e.g. WC tabular cases
    • asbestos, environmental, other mass tort or latent liabilities
  6. Ambivalence point
    point estimate monetary figure representing the highest value the seller is willing to pay the buyer, beyond which the economic become unattractive
  7. Canadian calculation
    • tax basis reserve is 95% of min[booked reserve, actuarial discounted reserve incl. PfAD]
    • tax income generated = (actuarial discounted reserve - tax basis reserve) * tax rate
    • X = (X - tax basis reserve) * tax rate + actuarial discounted reserve
  8. U.S. calculation
    • discounted reserve = 5% PV of loss
    • tax basis reserve using IFRS discount factor
    • difference between undiscounted and (2) would unwind over the life of the unpaid AY
    • set up payment pattern of this value
    • 5% PV of (4)
    • times 35% (tax rate)
    • cost not to commute = basis for ambivalence point is (1) - (6)
    • X = (X - (2)) * tax rate + (7)
  9. Comparison to other transactions
    • merger and acquisition: buyer is seeking a high target economic return
    • loss portfolio transfer: price is loaded for risk, production and maintenance costs; policy buyback can be considered a broadly based commutation
    • novation: substitution of a new valid contract between the same or different parties; it extinguishes the old contract
    • rescission: annulling or undoing of a valid contract, with all parties being returned to their original pre-contracting status (unlike commutation)
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