Freihaut Reinsurance

Question 1

Two conditions for a contract to receive reinsurance accounting treatment

Answer 1

1. Requires that significant insurance risk is assumed by reinsurer
2. Requires that a significant loss to the reinsurer is reasonably possible

Question 2

Two components of insurance risk

Answer 2

1. U/W risk: must be uncertainty in the $-value of loss
2. Timing risk: refers to timing of claims payments - no predetermined payment schedule

Question 3

Implications of insurer’s balance sheet if they can’t use reinsurance accounting

Answer 3

Insurer can’t show reserves as ‘net’ of reinsurance recoverables (no capital credit for having reinsurance)

Question 4

Risk Transfer Testing Methods

Answer 4

1. Is transfer of risk self-evident? (qualitative)
   Maybe reinsurance premium is very low, or potential loss is very high
   Might be characterized as: transaction is done at arms-length, no risk-limiting features
   If there is a predetermined payment pattern or it’s obvious there is no U/W risk, then it’s self-evident that there’s no risk transfer
2. “Substantially all” exception (qualitative)
   IF (significant loss NOT reasonably possible) BUT (reinsurer assumes “substantially all” risk) THEN (risk transfer may still exist)
   Often applies to quota-share contracts with a high % transferred
3. Calculate ERD (quantitative)
   Expected Reinsurer Deficit: ERD = prob(NPV reinsurer loss) x NPV(reinsurer loss) / (reinsurance premium)
   If ERD > 1% then there has been trasnfer of risk
4. 10-10 Rule (quantitative)
   IF reinsurer has >= 10% chance of >= 10% U/W loss THEN the contract has transferred risk

Question 5

Pitfalls in a risk transfer test

Answer 5

PRICE-P
* Profit commission: do NOT include
* Reinsurer expenses: do NOT include
* Interest rate: do NOT vary by scenario; should only consider insurance risk
* Commutation timing: do NOT use prescribed payment patterns; INCLUDE commutation fees
* Evaluation date: test should be based on circumstances at evaluation date
* -
* Premiums: use PV of GROSS premiums; apply adjustments to UNDISCOUNTED premiums

Question 6

Practical considerations in a risk transfer test

Answer 6

parameter(selection, risk).Pr(ass).Comm
* Parameter selection (interest rate, payment pattern, loss distribution)
* Parameter risk
* Pricing assumptions
* Commutation clause