Funds withheld

Funds withheld are premiums or reserves owed to the reinsurer that the cedant keeps in its own books rather than remitting, as security for future obligations. They bear interest at a contractual rate and are released as claims settle or the cover runs off. The problem they solve is collateral with no set-up cost: no bank and no trust are needed, since the security follows simply from the money never having left the cedant. The mechanism is old and remains heavily used in life reinsurance and on long-duration treaties. It does move the risk, however: the reinsurer becomes a creditor of the cedant for potentially large sums, and therefore takes on credit and interest rate risk in turn, since the contractual rate credited on funds withheld often diverges from the real yield of the underlying assets. The accounting and prudential treatment of these amounts has been recharacterized where their scale stripped the risk transfer of its economic substance.