Frei.RskTrans Flashcards
benefit to cedant when contract qualifies as reinsurance
cedant may use reinsurance accounting treatment on the contract
describe 2 conditions for a contract to receive reinsurance accounting treatment / requirements of risk transfer
- significant insurance risk is assumed by reinsurer under the reinsured portion of contract
- a significant loss to the reinsurer is reasonably possible
identify the components of ‘insurance risk’
- uw risk
- timing risk
identify items requiring CEO and CFO confirmation regarding transfer of risk
- there are no separate oral/written agreements between cedant and reinsurer
- detailed docs available for review when risk transfer is not self evident
- SAP (Statutory Accounting Principles) compliance by cedant
- controls
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
- when it is obvious that cedant’s financial interest are protected by the reinsurance contract
- may apply if reinsurance premium is low and/or the potential loss is high
describe the “substantially all” exception method for assessing the existence of risk transfer
if significant loss is not reasonably possible, but reinsurer assumes substantially all risk, then risk transfer may still exist
what is the reason for the substantially all exception in testing risk transfer?
to maintain access to reinsurance for profitable books of business
2 common examples for “substantially all”
- quota share contracts with high % ceded
- individual risk contracts without LR caps, other risk limiting features
describe ERD method for assessing the existence of risk transfer
ERD = P(NPV loss) * NPV(avg severity of loss as a % of premium)
if ERD >1%, then risk transfer has occurred
ERD is basically frequency * 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
if there is a 5% probability of 25% loss, does risk transfer exist?
- by 10 10 rule, no
- by ERD, ERD = 5% * 25% = 1.25% >1%, yes
F2017 Q17
F2016 Q16
steps of analyzing risk transfer
1) understand reinsurance contract terms and conditions
2) determine reporting and premium due dates
3) analysis completed using monte carlo simulation
3) calculate ERD
describe the pitfalls in a risk transfer test
PRICE-P
- Profit Commission (N)
- Reinsurance Expense (N)
- Interest Rate (donot vary with scenario, only consider insurance risk)
- Commutation timing: (donot use prescribed payment pattern)
- Evaluation Date: test based on circumstances at evaluation date
- Premiums: use PV(present value) of gross premiums, apply premium adjustments to undiscounted premiums
should profit commission be incorporated into risk transfer test?
No, because the results of the ceding company should not be considered in the analysis.
The analysis focuses only on the scenarios resulting in a loss for the reinsurer. Profit commissions can affect the economic results of a treaty, usually not triggered during a reinsurer loss.
what is the impact of reinsurer’s expenses on ERD calculation?
No impact, only cash flows between cedant and reinsurer should be considered in ERD calculation
describe 2 methods for selecting interest rate in a risk transfer test
- selection should be reasonable and appropriate: risk free rate with duration matching reinsurer’s cash flow
- reinsurer’s expected investment rate
compare 2 methods for selecting interest rate in a risk transfer test
Risk free rate VS. Expected investment rate
- using the risk free rate -> PV(losses) higher because risk free rate < expected investment return
- PV( losses) higher -> risk transfer test is more likely to pass
describe the practical considerations in a risk transfer test
- 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 selected interest rate < risk free rate, then
- PV (losses) higher
- over detect risk transfer
identify an alternate to the risk-free rate in a rate transfer test and identify an advantage
reinsurer’s expected investment return
- more reflective of reinsurer operations
- more accurate estimate of reinsurer loss
identify a problem with using a interest rate greater than the risk free rate in a risk transfer test
- alternate rate may not be available to ceding company, doing risk transfer test
- result of risk transfer test should not depend on the quality of reinsurer’s investment strategy
describe the implicit and explicit methods for accounting for parameter risk in a risk transfer test
- implicit: higher expected loss selection and volatility
- explicit: give parameters a probability distribution & incorporate this into simulation
advantages of using pricing assumptions in a risk transfer test and identify a relevant situation
- a properly priced reinsurance agreement is based on appropriate expected loss, risk load and payment pattern
- may work well for small or immature book of business
disadvantages of using pricing assumptions in a risk transfer test
- reinsurance pricing assumptions are market driven, so it may not reflect the true expected loss
- pricing assumptions are derived for a different purpose
who has the final say in risk transfer test?
CEO or CFO
identify 2 financial and 2 non-financial considerations regarding cash flows in a reinsurance commutation
financial :
- amount and timing of cash flows
- discount rate applied to cash flows
- payment pattern of cash flows
non-financial:
- court decisions
- life expectancy of claimant
- quality of reinsurer
