The Actuary's Role in Transfer Pricing

When related parties enter into cross border intercompany reinsurance, most countries require that the intercompany pricing be consistent with an “arm’s-length standard”. An arm’s-length standard is an internationally accepted concept that the price of a transaction needs to be reasonably consistent with what would have been negotiated between unrelated parties. In the U.S., regulations governing the intercompany prices are in the Internal Revenue Code (“IRC”) Section 482 and Treasury Regulations promulgated thereunder. The analysis and documentation surrounding these regulations is referred to as transfer pricing analysis. Actuaries often play a key role in creating transfer pricing documentation since it requires an in depth knowledge of reinsurance pricing and a fundamental understanding of the reinsurance market. In this paper, we will provide an overview of transfer pricing regulations and acceptable documentation. Further, we will explore and demonstrate the methods that are commonly used to support the pricing of such transactions, which include Return on Economic Capital, Market Based, Expected Profits, Rate-on-Line and Contract Comparison. We will also give practical examples and provide considerations for the actuary performing these analyses.

Keywords. Reinsurance, Transfer Pricing, Tax