AAA Uncollectible Reinsurance

Question 1

What are the 2 main causes of reinsurance uncollectibility?

Answer 1

• credit risk (or inability to pay)
• dispute risk (or unwillingness to pay)

Question 2

What are the main causes of an inability to pay?

AAA

Answer 2

• impairment
• insolvency

Question 3

What are the main causes of an unwillingness (dispute risk) to pay?

AAA

Answer 3

• could be due to differing interpretations of the reinsurance contract because such as:
  
  • unique exposures
  • rare/weird events
  • circumstances not contemplate by the contract

The following are some actual examples:
* missing policies, especially if an old contract (asbestos/latent liabilities)
* late notice of claims - ceding company didn’t tell reinsurer within a reasonable period of time
* settlement without consultation - reinsurance contract may require it
* defintion of occurrence, insurer and reinsurer may disagree that a covered event occurred.

Question 4

Why don’t insurers all use the same method to calculate the URR?

Answer 4

• different insurers may have different definitions (or methods) for accounting for write-offs in their system
• write-off histories for different insurers may not be directly comparable.
• Thus, a method used by one insurer may not be appropriate for another insurer

Question 5

What are the 2 methods for calcuating URR?

Answer 5

rating-based method
* uses financial strength ratings of reinsurers as the basis for a URR estimate
* estimates credit-related URR only

experience-based method
* uses historical reinsurance write-offs as the basis for a URR estimate
* estimates both credit-related URR and dispute-related URR

Question 6

How does the rating based method for URR work?

remember credit only

Answer 6

• For each reinsurer rating group determine the expected future ceded billings by year (Matrix A).
• For each reinsurer rating group determine the cumulative default rates by year (Matrix B).
• Multiply Matrix A x Matrix B to get a Matrix of credit rated URR by reinsurer group and year (Matrix C).
• Sum up the values in Matrix C to the total Credit Rated URR

This assumes that a reinsurer stays in the same rating each year

Question 7

How is the cumulative probability of default by rating estimated?

Answer 7

• A.M. Best Financial Strength Ratings and associated probability of impairment
• insurer’s history of reinsurer default rates by internal rating
• transition matrices

Question 8

What is a transition matrix and how is used in the rating based method of URR?

Answer 8

• A transition matrix shows how a reinsuer’s financial rating can change over time.
  
  • A reinsuer with a financial strenth rating of A in Year 1, may keep it’s rating in year 2, but also could drop in rating.
  • This is true of all ratings (can move up or down)
• Can use a transition matrix to determine reinsurer financial rating distribution for each year
• This can be used to calculate the cumulative default probabilities for each year.

Question 9

How does the experience method for URR work?

Answer 9

• Look at the history:
  
  • For each calendar year look companies experience for receivable due and amounts written off.
  • Calculate a write off ratio which is sum of amounts written off divided by amounts receivable due.
• The URR estimate for the current year is Write-Off ratio times amounts receivable due in the year.

Amounts written off may be stated combined (credit and dispute)

Question 10

How can the experience method be enhanced?

Answer 10

Can incorporate elements such as:
* look at write-offs over time by billing lag year (allows for reinsurer deterioration)
* look at write-offs by reinsurance structure (quota share, per-occurrence excess of loss, aggregate excess of loss)
* look at write-offs by line of business

Question 11

What are some of the challenges of the experience based URR Method?

Answer 11

• thin data (an insurer may have little or no historical reinsurance write-offs)
• past uncollectible rates may not be indicative of future uncollectible rates (this is true for any predictive modeling)
• experience-based uncollectible rates can be distorted by individual events (commutations, reinsurer insolvency)

If not enough credibility, use the rating method

Question 12

What is the purpose of the new FASB rules pertaining to URR?

Answer 12

Old: The Incurred loss model considers only known impairments (only incurred, not expected)

The new FASB rules:
* URR reserves must be established based on anticipated ultimate uncollectible amounts (not just incurred)
* Brings FASB more in line with IFRS 17 and Solvency II