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🛡️ Adverse development cover (ADC) is a reinsurance contract that protects an insurer against the possibility that its existing loss reserves for claims already incurred will prove insufficient over time. Unlike traditional reinsurance that covers future losses, an ADC specifically addresses reserves that have already been established — stepping in when actual claim payments exceed the level the insurer originally anticipated. It is a form of retroactive reinsurance, meaning it covers liabilities from events that have already occurred but whose ultimate cost remains uncertain.

⚙️ Under a typical ADC arrangement, the ceding insurer selects a specific block of business or accident year and sets an attachment point — a dollar threshold above its carried reserves. If cumulative claim payments on that portfolio breach the attachment point, the reinsurer begins reimbursing the cedent up to a predetermined limit. The premium for this protection reflects the reinsurer's assessment of how likely and how severely reserves may deteriorate, informed by actuarial analysis and independent reserve studies. The contract may also include provisions governing how claims are administered and reported during the coverage period.

📊 ADCs play a critical role in stabilizing an insurer's financial position, particularly during mergers and acquisitions, corporate restructurings, or when an insurer is exiting a line of business with long-tail liability exposure. By capping downside reserve risk, the cover gives management, investors, and regulators greater confidence in the company's balance sheet. For acquirers purchasing a book of business, an ADC can make a transaction viable by ring-fencing legacy uncertainty. Rating agencies also view well-structured ADCs favorably, as they reduce earnings volatility and demonstrate prudent risk management.

Related concepts

• Definition:Loss portfolio transfer (LPT)
• Definition:Retroactive reinsurance
• Definition:Loss reserve
• Definition:Run-off
• Definition:Incurred but not reported (IBNR)
• Definition:Reserve redundancy