Loss Portfolio Transfer: What it is, How it Works, Example

What Is a Loss Portfolio Transfer (LPT)?

A loss portfolio transfer (LPT) is a reinsurance contract in which an insurer cedes policies, often with incurred losses, to a reinsurer. The reinsurer assumes the insurer’s existing and future claim liabilities through the transfer of loss reserves. It is a type of alternative risk financing.

Key Takeaways

• A loss portfolio transfer (LPT) is a reinsurance treaty in which an insurer cedes policies and loss reserves to a reinsurer.
• LPTs allow insurers to remove liabilities from their balance sheets, strengthen them, and transfer risk.
• Reinsurers gain the chance to generate investment income from the transferred reserves, often at a significant profit.

Understanding Loss Portfolio Transfers (LPT)

Insurers use loss portfolio transfers to remove liabilities from their balance sheets, such as transferring risk from a parent to a captive or exiting a line of business. The liabilities may already exist, such as processed but unpaid claims, or may soon appear, such as incurred but not reported (IBNR) claims.

The insurer, also known as the cedent, effectively sells the policies to the reinsurer. In determining the reinsurer’s payment, the time value of money is considered, resulting in the insurer receiving less than the reserves’ dollar amount—and the overall ultimate payout amount.

However, when an insurer uses a loss portfolio transfer, it also transfers timing and investment risks. Investment risk involves the possibility of the reinsurer generating less income if claims are paid faster than expected. If the reinsurer becomes insolvent or fails to fulfill obligations, the insurer remains responsible for policyholder payments.

LPT reinsurers often handle claims to profit from running them for less than book value. By assuming loss reserve assets for less than book value, an LPT enables the ceding entity to make an immediate profit. This allows the ceding company to increase capital resources and reduce regulatory capital requirements.

The transferred liabilities in an LPT may belong to a single class of business, territory, policyholder, or accident year.

Example of a Loss Portfolio Transfer (LPT)

For example, an insurance company sets aside $5 million in reserves to cover liabilities from workers’ compensation policies it underwrites. It enters into a loss portfolio transfer with a reinsurer, who takes over the reserves and is responsible for paying claims. The reinsurer can use the reserves to generate a return greater than the claims it may have to pay.

Why Insurers Use Loss Portfolio Transfers (LPT)

Insurers use loss portfolio transfers to monetize reserves set aside for claim payouts. This is beneficial if the insurer has over-reserved due to actuarial models establishing premiums and reserves that exceed actual loss experience.

Reinsurers assume loss portfolio transfers without underwriting risk and can generate investment income greater than their obligated losses.