Freihaut - Risk Transfer Analysis Flashcards
Benefit to cedant when contract qualifies as reinsurance.
The cedant may use reinsurance account treatment on the contract.
Describe 2 conditions for a contract to receive reinsurance account treatment.
- requires that significant insurance risk is assumed by reinsurer (under reinsured portion of contract)
- requires that a significant loss to the reinsurer is reasonably possible
Identify the components of ‘insurance risk’ (conceptual - not specific). (2)
- U/W Risk
- Timing Risk
Identify items requiring the CEO/CFO confirmation regarding transfer of risk. (4)
- that there are no separate ORAL/WRITTEN agreements between the cedant and the reinsurer
- detailed DOCS are available for review WHEN the risk transfer is not self-evident
- SAP (Statutory Account Principles) compliance by the cedant
- appropriate CONTROLS to monitor reinsurance
List 4 methods for assessing the existence of risk transfer and state whether each is qualitative or quantitative.
1) self-evident? - qualitative
2) ‘substantially all’ exception - qualitative
3) ERD rule (Expected Reinsurer Deficit) - quantitative
4) 10-10 rule - quantitative
Describe the ‘self-evident’ method for assessing the existence of risk transfer. (2)
- sometimes risk transfer is so self-evident that no further analysis is needed
- may apply if reinsurance premium is very low or potential loss is very high
Describe the ‘substantially all’ exception method for assessing the existence of risk transfer.
IF a significant loss is NOT reasonably possible, BUT the reinsurer assumes ‘substantially all’ risk, THEN risk transfer may still exist.
What is the reason for the ‘substantially all’ exception method in testing risk transfer?
To maintain access to reinsurance for profitable books of business.
‘Substantially all’ - 2 common examples.
QUOTA SHARE contracts where a high % is ceded.
INDIVIDUAL RISK CONTRACTS without LR caps or other risk limiting features
Describe the ERD (Expected Reinsurer Deficit) method for assessing the existence of risk transfer.
ERD = Prob(NPV loss) * NPV(avg severity of loss as a % of premium)
- if ERD > 1%, then a risk transfer has occured
ERD is basically (freq * severity as a % of premium)
Describe the ‘10-10’ rule for assessing the existence of risk transfer.
IF reinsurer has a 10% chance of suffering a 10% loss, THEN the contract is deemed to have transferred risk.
How is the risk transfer analysis done?
Calculated ERD based on Monte-Carlo Simulation.
Describe the pitfalls in a risk transfer test. (1-3)
i) Profit commission: don’t include
ii) Reinsurer expenses: don’t include
iii) Interest rates: do NOT vary with scenario, should only consider insurance risk (U/W & timing risk)
Describe the pitfalls in a risk transfer test. (4-6)
iv) Commutation timing: no NOT use prescribed payment patterns, DO include commutation fees
v) Evaluation date: risk transfer test should be based on circumstances at evaluation date
vi) Premiums: use PV of GROSS premium, apply premium adjustment to UNDISCOUNTED premiums
Should profit commission be incorporated into risk transfer test?
DO NOT INCORPORATE because the results of the CEDANT should not be included in the risk transfer analysis.
What is the impact of reinsurer’s expenses on ERD?
NO IMPACT: only cash flows between the cedant and the reinsurer should be considered in ERD calculations.
Describe 2 methods for selecting the Interest Rate in a risks transfer test.
- selection should be REASONABLE and APPROPRIATE: risk-free rate with duration MATCHING reinsurer’s cash flows
- reinsurer’s expected investment rate is irrelevant in a risk transfer test
Compare 2 methods for selecting the Interest Rate in a risk transfer test.
- risk-free rate vs expected investment rate: PV(losses) are higher using the risk-free rate since the risk-free rate < expected investment rate
- make existence of risk transfers more likely; i.e.: less conservative
Describe the practical considerations in a risk transfer test. (4)
- parameter selection (interest rate, payment pattern, loss distribution)
- parameter risk
- pricing assumptions
- commutation clause
Why is the risk-free rate the lowest allowed in a risk transfer test?
- if the selection is lower than the risk-free rate -> PV(losses) will be higher -> over-detection of risk transfer
- note: risk-free rate should always be known
Identify an alternative to the risk-free rate in a risk transfer test and identify an advantage.
Reinsurer’s Expected Investment Return
- more reflective of the reinsurer’s operation, SO it is a more accurate prediction on whether there is significant risk of significant loss
Identify a problem with the use of an interest rate greater than the risk-free rate in a risk transfer test.
- the alternative rate may not be available to the ceding company doing the risk transfer test
- result of the risk transfer test should NOT depend on quality of reinsurer’s investment strategy
Describe the implicit & explicit methods for accounting for parameter risk in a risk transfer test.
IMPLICIT: higher expected loss selection & volatility
EXPLICIT: give parameters a probability distribution & incorporate into simulation
Advantage of using pricing assumptions in a risk transfer test, and identify a relevant situation.
FOR small and immature BOOKS of business:
property priced reinsurance agreement likely based on appropriate expected loss, risk load, payment pattern
Disadvantage of using pricing assumptions in a risk transfer test.
- reinsurance pricing assumptions are market driven -> do NOT necessarily reflect true expected loss
- pricing assumptions were derived for a different purpose
Who has the final say in risk transfer test?
CEO or CFO.
- the actuary does an analysis that they use as an input in their final decision
Identify 2 financial and 2 non-financial considerations regarding cash flows in a reinsurance commutation.
FINANCIAL: amount & timing, discount rate, payment pattern
NON-FINANCIAL: court decisions, life expectancy of claimant, quality of reinsurer
