Frei.RskTrans& CIA.Reins Flashcards
Why do we care whether risk transfer has taken place?
[1] a reinsurer cannot properly Price a reinsurance contract without knowing how much risk they’ve taken on.
[2] when a contract qualifies as reinsurance, the cedant may use reinsurance Accounting treatment, which is more favorable than the alternative.
describe 2 conditions for a contract to receive reinsurance accounting treatment
[1] Significant insurance risk is assumed by reinsurer (under reinsured portion of contract)
[2] 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 (CEO, CFO) confirmation regarding transfer of risk (4)
- that there are no separate ORAL / WRITTEN agreements between (cedant, Reinsurer)
- detailed DOCS available for review WHEN risk transfer not self-evident
- SAP (Statutory Accounting Principles) compliance by cedant
- controls to monitor the use of reinsurance
identify functions of reins
stabilizing loss experience;
Increase large line capacity;
Provide catastrophe protection;
Provide surplus relief;
Facilitate withdrawal from a market segment;
provide UW guidline
4 methods for assessing the existence of risk transfer and state whether each is qualitative or quantitative
METHOD 1: self-evident?
- qualitative
METHOD 2: “substantially all” exception
qualitative
METHOD 3: ERD rule (Expected Reinsurer Deficit)
quantitative
METHOD 4: 10-10 rule
quantitative
describe the “self-evident” method for assessing the existence of risk transfer
- when it’s 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
Def: It is intuitively obvious that the contract protects the cedant from future events that would adversely impact the financial condition of the ceding company.
It requires that transactions be 1) done at arms length, and 2) there are NO risk limiting clauses.
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)
eg 1) QUOTA SHARE contracts with high % ceded
2) INDIVIDUAL RISK CONTRACTS without (LR caps, other risk limiting features)
what is the reason for the ‘substantially all’ exception in testing risk transfer
to maintain access to reinsurance for profitable books of business
describe the ERD method (Expected Reinsurer Deficit) method for assessing the existence of risk transfer
- ERD = Prob(NPV loss) x NPV(avg severity of loss as a % of premium)
- if ERD > 1% –> Risk transfer has occurred
- ERD is basically (frequency) x (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
describe the pitfalls in a risk transfer test (6)
PRICE – P
[1] Profit commission:
- do NOT include in risk transfer test
[2] Reinsurer expenses:
- do NOT include in risk transfer test
[3] Interest rates:
- do NOT vary with scenario
- should only consider insurance risk (U/W & timing risk)
[4] Commutation timing:
- do NOT use prescribed payment patterns
- DO include commutation fees
[5] Evaluation date:
- risk transfer test should be based on circumstances at evaluation date
[6] Premiums:
- use PV (Present Value) of GROSS premiums
- apply premium adjustments to UNDISCOUNTED premiums
should profit commission be incorporated into risk transfer test
DO NOT INCORPORATE: because results of CEDANT should not be included in risk transfer analysis
what is the impact of reinsurer’s expenses on ERD (Expected Reinsurer Deficit) calc
NO IMPACT: only cash flows between (cedant, reinsurer) should be considered in ERD calculation
describe 2 methods for selecting Interest Rate in a risk transfer test (2)
- selection should be (REASONABLE, APPROPRIATE): risk-free rate with duration MATCHING reinsurer’s cash flows
- reinsurer’s expected investment rate
(strictly speaking, the reinsurer’s investment rate should not be relevant in a risk transfer test)
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. [ this is b/c (risk-free rate) < (expected investment rate) ]
PV(losses) higher → risk transfer test is more likely to pass
describe the practical considerations in a risk transfer test - abbreviated list (4)
[PaPaPrCo]
[1] Parameter Selection: (interest rate, payment pattern, loss distribution)
[2] Parameter Risk
[3] Pricing Assumptions
[4] Commutation Clause
Interest Rate - why is the risk-free rate the lowest allowed in a risk transfer test
if (selected interest rate) < (risk-free rate)
==> PV(losses) higher
==> over-detect risk transfer
Note: risk-free rate should always be known
Interest Rate - identify an alternate to the risk-free in a risk transfer test & identify an advantage
reinsurer’s Expected Investment Return
==> more reflective of reinsurer operations
==> more accurate estimate of reinsurer loss
Interest Rate - identify a problem with using an interest rate greater than the risk-free rate in a risk transfer test
- alternate rate may not be available to ceding co. doing risk transfer test
- result of risk transfer test should NOT depend on quality of reinsurer’s investment strategy
Parameter Risk - 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 this into simulation
Pricing Assumpions - advantages of using pricing assumptions in a risk transfer test (& identify a relevant situation)
- a properly priced reinsurance agreement is based on appropriate expected loss, risk load, payment pattern
- may work well for small or immature books of business
Pricing Assumpions - disadvantages of using pricing assumptions in a risk transfer test
- reinsurance pricing assumptions are market-driven (may not reflect true expected loss)
- pricing assumptions were derived for a different purpose
who has final say in risk transfer test
CEO or CFO (they rely on the actuary’s analysis as part of their final decision)
identify 2 financial & 2 non-financial considerations regarding cash flows in a reinsurance commutation
FINANCIAL:
- amount & 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
list the key principles of risk transfer assessment (4)
KP1:
- use quantitative and/or qualitative approaches depending on information available
KP2:
- use professional judgment
KP3:
- consider overall agreement (all verbal & non-verbal agreements)
KP4:
- check risk transfer at inception of contract
(& re-check whenever changes affect future cash flows)
in a risk transfer contract, what is included in the ‘overall agreement’
Contract, Amendments, Verbal agreements, Other written docs
when should existence of risk transfer be (re)checked
- at inception
- when contract change significantly alters expected future cash flows
changes to a reinsurance contract that would trigger re-check of risk transfer
revision to premiums or coverage levels OTHER THAN linear increase/decrease of quota share
changes to a reinsurance contract that would NOT trigger re-check of risk transfer
events that are part of the normal course of the contract (Ex: build-up of a Claim Fluctuation Reserve)
what should actuary do PRIOR to re-check of risk transfer
check whether previous reinsurance assessment is still applicable
2 broad categories of risk-limiting contract features
- terms set in advance
- experience-based renewals (EBR)
types of terms-set-in-advance risk limiting features (3)
- ADJUSTABILITY of reinsurace premiums or commissions (Ex: LR caps)
- PRE-SET LIMITS on timing of loss payments from reinsurer to insurer
(Ex: qtrly) - removes timing risk
COUNTERPARTIES ceding back to original cedant
Exs of ‘EBR’ (Experience-Based Renewals) risk limiting features (2)
- future terms BASED ON past experience (& reinsurer guaranteed to recover losses)
- forced renewals if the contract is in deficit (reinsurer is losing money)
describe 3 risk-limiting features of the given contract & 2 that don’t limit risk
risk-limiting features:
1) high retention (10% of limit)
2) swing loss ratio
(LR > 75% ==> ceding companies pays reinsurer ==> reduces risk transfer)
3) automatic commutation after 7 years unless further payment is made to reinsurer
(7 years may not be long enough for liabiity line to fully settle)
Non risk-limiting features: (just list contract features that do NOT limit risk transfer)
1) losses are paid when they occur (so timing risk exists)
2) premium is paid quarterly
define ‘side agreement’
agreement between (cedant,reinsurer) NOT DIRECTLY INCORPORATED into contract - may obscure intent of contract
define ‘mirroring’ + comment
DEFN: cedant & reinsurer carry SIMILAR LIABILITY ESTIMATE for the ceded claims
COMMENT: it is appropriate for cedant & reinsurer actuaries to confer on large losses
considerations in estimating a credit provision for a counter-party (4)
fin-his-ex-DR
1) BEST rating of reinsurer (financial strength)
2) DISPUTES: history of claims disputes
3) EXPERTISE of reinsurer in relevant LOBs
3) DIVERSIFICATION of reinsurer
4) quality of the reinsurer’s retrocession
Bifurcation
Bifurcation involves separating contracts into their basic constituents
Purpose: to identify those portions of contracts that might not have risk transfer element
