freihaut & SSAP 62R Flashcards
Accounting treatment used if risk transfer occurs
Accounting treatment use if risk transfer does NOT occur
YES risk transer →Reinsurance accounting (rsvs net of reinsurance)
NO risk transfer → Deposit accounting (rsvs are gross of reinsurance)
advantage of reinsurance accounting v.s. deposit accounting
reinsurance: paid loss→income down→TAXES down
deposit: paid loss → no change to income
Define deposit accounting
- premium is NOT income (deposit to surplus)
- paid loss is NOT an expense (return on capital)
- no impact on taxes
- balance sheet is gross of reinsurance
Pick reinsurance or deposit accy
- reinsurer assumes insurance risk (both timing risk & UW risk) & possible significant loss →
- reinsurer has not assumed significant risk→
- reinsurer may not realize significant loss→
- reinsurer assumes significant insurance risk & loss from events that occur after contract date →
- reinsurer assumes significant insurance risk & loss from events that occur prior to contract date →
- reinsurer assumes insurance risk (both timing risk & UW risk) & possible significant loss → reinsurance accy
- reinsurer has not assumed significant risk→deposit accy
- reinsurer may not realize significant loss→deposit accy
- reinsurer assumes significant insurance risk & loss from events that occur after contract date → prospective reinsurance accy
- reinsurer assumes significant insurance risk & loss from events that occur prior to contract date → retroactive reinsurance accy w/ exceptions (run off agreement & novation uses deposit accy?)
Conditions needed to demonstrate risk transfer & use reinsurance accy (2)
- Reinsurer assumes significant insurance risk
- insurance risk = BOTH UW risk &TIMING risk
- UW risk = uncertain IF loss will occur
- Timing risk = uncertain when loss will occur
- Reinsurer reasonably possible to have significant loss
Self-evident (qualitative) risk transfer exists because?
risk transfer is obvious becasuse…
- premium is low
- OR
- potential loss is high
Substantially all exception (qualitative) risk transfer
risk transfer exists if?
example?
why exist?
IF significant loss NOT reasonably possible BUT reinsurer assumes substantially ALL risk
- Quota Share with very high % ceded
- OR
- individual risk contract with loss ratio caps
Exist so profitable books of business can access reinsurance
Expected reinsurance deficit (quantitiaive)
risk transfer exist if
formula
adv (2)
IF ERD >= 1%
ERD = [pr(L) * (pv(L) - P)] / P >= 0.01
- Adv: Risk transfer possible for rare catastrophes (risk transfer is more likely)
- Adv: Allows discounting
10-10 rule (quanitative)
risk transfer exists if
formula
adv (2)
IF reinsurer has at least 10% chance of at least 10% loss
IF {L - P] / P >= 0.10 at least 10% of the time
- Adv: Risk transfer not possible for rare catastrophes (risk transfer is less likely)
- Adv: doesn’t need interest rate b/c doesn’t discount
loss pmt patterns in risk transfer test are based on? (2)
T/F loss pmt patterns should be constant bc no need to account for tail risk
- historical experience of primary
- industry benchmarks
F = pmt pattersn should include variability to account for tail risk bc tail risks matters most to risk transfer tests
loss distributions in risk transfer tests are based on ? (2)
which is best for large company?
which best for small company? why?
historical experience of primary - best for large books due to having lots of data
industry benchmark - best for small book bc no data is available to fit the tail (which drives risk transfer)
Parameter selection (how select)
interest rate
loss distribution
pmt patterns
interest rate – use rf, not investment rate (using discount rate below rf will over detect risk transfer & vice versa)
loss distribution – care about tail more (use historical experience for large book but benchmark for small book)
pmt patterns – care about tail more (use historical experience for large book but benchmark for small book)
what is parmeter risk?
should parameter risk be included in risk transfer tests?
if yes, what are the two ways to include it?
paramter risk = risk that selected model paremeters might be incorrect
yes but only for pmt pattern and loss distribution (not interest rate, nor premium)
implicit - choose higher expected loss selection or expected loss variance
explicit - include probability distribution of parameters = more parameter risk
Parameter risk (how much risk of each parameter?)
loss distribution
pmt pattern
discount rate
premium
- loss distribution - a lot - UW risk - most uncertainty –> selecting higher expected loss over detects risk transfer
- pmt pattern - some - timing risk
- discount rate - NONE - no Timing nor UW risk
- premium - very little
Risk Transfer Test pitfalls PRICE-P
include in risk transfer tests?
why or why not?
- only include cash flows bw primary and reinsurer
- Profit Commission: NO (usually not triggered during loss)
- Reinsurer Expenses: NO (not a cash flow)
- Interest Rates: NO variation (not insurance risk) + use rf w/ duration equal to that of reinsurers net cash flows (not investment rate as investments is not insurance risk)
- Commutations: YES include commutation & maitenance fees (cash flow)
- Evaluation date: test based on inception date unless there is amendment to reinsurance contract
- Premiums: YES include premium fees (cash flow) + use actual discounted gross premiums (gross of commission)
Investment returns
include in risk transer tests?
why or why not?
- No
- Not part of insurance risk (not Timing risk nor UW risk)
Profit commission impact & indirect impact on chance of risk transfer
profit commission defined
Do profit commisions decrease or increase chance of risk transfer? why? (2)
Defined: reinsurer pays primary more if more profitable
- Decrease
- profit commission ↑ —> reinsurer premium ↑ (of reinsurance contract)
- profit carryforwards ↑ (profits carried foward from prior years) → losses ↓
why profit commissions should not be considered in risk transfer analysis?
not usually trigerred during a reinsurer loss
why reinsurer expenses should not be considered in risk transfer analysis?
not cash flows bw primary and reinsuer
why not select interest rate that is lower than risk free rate?
why not select interest rate (i.e. investment rate) that is higher than rf?
lower
- overstates risk transfer
- rf is free to get
higher
- rate is unknown
- will pass risk transfer test simply b/c investment returns are low
recomended discount rate for risk transfer tests? (3) why?
constant rf with duration equal to reinsurer’s cash flows
constant - varying rate would be market risk (not insurance risk)
risk free - don’t want investments impacting the risk transfer test
duration of cash flows - reflect expected timing of pmts
when should Pricing assumptions be used
are pricing assumptinos based on expected loss experience or market’s view of loss experience
small book of business when data is thin
market
use of pricing assumptions in risk transfer
2 risk of using pricing assumptions
pricing uses high expected losses → make profit
vs
risk transfer should use lower expected losses → don’t want to overstate risk transfer
pricing cares about whole loss distribution
vs
risk transfer cares about right tail
use of pricing assumptions in risk transfer tests
- T/F if premium is high then that must indicate the cedants cash flows are more volatile so risk trasnfer exists?
- better to use data underlying the pricing or the pricing derived from the data?
- F - price might be based on market risk.
- risk transfer should be based on expected losses (not market risk)
- if market is overstating the risk (aka higher prices) then pricing assumptions will overstate risk transfer
- better to use the data underlying the pricing
what should the evaluation date be for risk transfer tests
inception date of reinsurance contract
only use renewal date if reinsurance contract was amended
what kind of premium should be used in risk transfer test?
what interest rate to discount premium?
actual gross premiums (including commisions)
discounting: same interest rate as used to discount losses
impact of prescribed pmts in determinig if risk transfer exists
contract with prescribed pmt patterns does not meet risk trasnfer b/c no timing risk
should commuations be included in risk transfer test? why or why not
yes, bc they are cash flows bw primary and reinsurer
include maintenance costs of commutation too
Commutation clause
- commutation fees based on (2)
which has pmt pattern adjustment?
- Mutually agreed value (NO pmt pattern adjustment) vs
- Rules (YES pmt pattern adjustment)
Prospective reinsurance accoutning vs retroactive reinsurance accounting under SAP
prospective reinsurance accy: if claim then reserve up
retroactive accy: if claim then reserve NOT up (contra liability)→L↓+I↑+S↑ (no rsv impact nor SOA opinion impact)
type of accounting used if reinsurance is entered into AFTER policy expiration
4 exceptions
- retroactive reinsurance accounting
- run off agreement – retain liability until date x or policy expire/cancel
- novation – released of all liability
- intercompany reins agreement
- termination of reins treaty
Run-off agreement vs novation
run-off agreement: primary retains liability until x date or policies expire
vs novation: primary released of all liability (both cede 100% of liability to leave LOB)
Run-off provision vs Cut-off provision
- run-off provision: reinsurer has liability until …policies expire/cancel
- cut-off provsion: reinsurer has liability until . ..certain date
