Reinsurance setoff rights and insolvency under Spanish law

A usual query that arises in Spain in almost any single reinsurance transaction or contract where some money is advanced or handed over between the parties is whether it is possible to set-off mutual debts within an insolvency proceedings.

Set-off is an equitable right that allows the parties to a contract to cancel or offset mutual debts to each other by asserting the amounts owed, subtracting one from the other and paying only the balance. In particular, the right of set-off is used in day-to-day business transactions between reinsurers and cedants (reinsured). Balances due to the reinsured for paid losses and earned premiums due from the reinsured to the reinsurer are netted out between the reinsured and the reinsurer through periodic accounting reports.

Besides this net accounting, the right of set-off can be secured as an express contractual right to protect the paying party towards the other party when the latter ceases to pay the amounts due under the reinsurance agreement.

The interest of the parties to set-off amounts arises, for example, in VIF (Value in Force) transactions, which imply monetizing the value in force of an insurer's individual life risk portfolio to allow such insurer to exchange the expectation of future cashflows for an upfront amount of capital. These VIF transactions, quite frequent in Spain during the last crisis, are structured through a reinsurance treaty whereby the cedant cedes the defined book to the reinsurer in exchange of an upfront reinsurance commission reflecting the assessment of the future profits expected to arise from such defined book of business. At the signing date of a VIF, the reinsurer shall pay a (usually) very high reinsurance commission, whereas the cedant pays an initial premium.

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