ILA-LPM D

Question 1

What is the main goal of in-force management?

Answer 1

• get more profit out of in-force business (don’t just try to sell more business)

Question 2

List 6 levers for effective in-force management

Answer 2

1. Steering liability portfolios to support strategic ambitions and financial targets
2. Improving persistency
3. Improving claims management
4. Adjusting asset management subject to regulatory constraints and risk appetite
5. Optimizing capital
6. Increasing operational efficiency (reducing costs)

Question 3

List the 8 steps for applying a holistic in-force steering framework

Answer 3

1. Set financial targets
2. Determine constraints
3. Project future market conditions
4. Identify opportunities and rank by attractiveness
5. Specify target liability portfolio
6. Manage asset portfolio
7. Optimize capital structure
8. Verify that constraints are met

Question 4

Describe ways that insurers can re-design products and develop services to manage in-force blocks

Answer 4

• Align product strategy to cope with changing market conditions
  
  • Lower/abolish guaranteed benefits
  • Shift interest rate and market risks to policyholders with unit-linked products
  • Reprice biometric risks (mortality)
• Prepare for rising interest rates (shock lapses)
• Develop new services to improve consumer value (e.g. wearables)

Question 5

Define cross-selling and up-selling and list their benefits and challenges

Answer 5

• Cross-selling – selling a new product to an existing customer
• Up-selling – upgrading an existing customer’s product
• Benefits:
  
  1. Cross/up-sell when policyholder reports a claim
  2. Reduce costs/prices by targeting good risks
  3. Diversify underwriting risks
• Challenges: fragmented IT, silos, insufficient demographic info

Question 6

List 3 solutions for reducing the risk in unprofitable blocks of business

Answer 6

1. Adjust non-guaranteed elements (dividends, crediting rates, premiums)
2. Exchange/conversion programs
3. Buyout programs (buy back unprofitable products)

Question 7

List 4 options for dealing with unprofitable or non-core run-off business

Answer 7

1. Retain and run off to expiry
2. Outsource to a third-party administrator (TPA)
3. Reinsure with maintained or outsourced administration
4. Sell block

Also, try to recall or list out pros and cons of each of these!

Question 8

Describe 5 methods for improving persistency on in-force blocks

Answer 8

1. Response levers: premium holidays, discounts, exchanges
2. Gradual transitions to ART for term business
3. Behavioral economics: understand consumers’ evolving needs
4. Predictive analytics is promising for the future
5. Increase customer engagement (mobile, social media, etc.)

Question 9

List at least 4 methods for improving claims management

Answer 9

1. Increasing process efficiency with automation
2. Enhancing claims experience: easy, effective, and timely
3. Improving fraud prevention and detection: notifications, training
4. Claims analytics improvements: easier data collection and predictive modeling
5. Health recovery and job reintegration: LTC/disability claimants
6. Nudging health-related behaviors: text reminders, behavioral economics

Question 10

List ways that insurers can adjust asset management for in-force blocks

Answer 10

• Improve asset-liability duration match
• Hedge investment risks with derivatives
• Invest in higher-yielding assets
  
  • Alternative investments (private equity, hedge funds)
  • Less liquid asset classes (RE, infrastructure, CMTGs)
  • Lower-rated bonds (BBB corporates, etc.)

Question 11

List 2 ways that insurers can optimize capital on in-force blocks

Answer 11

1. Stabilizing Cash Flows and Earnings
2. Freeing Up Trapped Capital

Question 12

Describe ways that insurers can optimize capital on in-force blocks

• Stabilizing Cash Flows and Earnings

Answer 12

• Transferring mortality/morbidity risks – reinsurance, cat bonds
• Reinsure longevity risk on life annuities
• Transferring lapse risk – VIF solutions, non-proportional lapse risk reinsurance

Question 13

Describe ways that insurers can optimize capital on in-force blocks

• Freeing Up Trapped Capital

Answer 13

• XXX/AXXX excess reserve financing
• Monetize VIF or sell block

Question 14

Describe ways that insurers can increase operational efficiency for in-force blocks

Answer 14

• Modernize the IT landscape
  
  • Overhaul IT core system
  • Increase process automation
  • AI solutions: product design, customer relations
• Possible ways of optimizing operations
  
  • Outsourcing
  • Transferring operations to lower cost offshore captives or reinsurers

Question 15

List the 3 sources of mortality volatility

Answer 15

1. Trend risk
2. Basis risk
3. Long-term underwriting risk

Question 16

Describe the 3 sources of mortality volatility:

• Trend risk

Answer 16

• uncertainty in future mortality improvement driven by 3 factors:
  
  1. Long-term trends (changes in medical practice, society, economy, environment, etc.)
  2. Annual volatility (extreme weather, disease, etc.)
  3. Correlation between long-term and annual trend volatility

Question 17

Describe the 3 sources of mortality volatility:

• Basis risk

Answer 17

• uncertainty in the assumed mortality level
• Higher uncertainty in best estimate = higher basis risk

Question 18

Describe the 3 sources of mortality volatility:

• Long-term underwriting risk

Answer 18

• uncertainty in 3 factors:
  
  1. Initial select period
  2. Length of grading off period for preferred or substandard
  3. Ultimate mortality level

Question 19

Formula for the mean cost of mortality volatility using IRR

Answer 19

= Deterministic IRR - Stochastic Mean IRR

*Deterministic does not capture tail asymmetry (overstates expected profits)

Question 20

Formula for the mean cost of mortality volatility using distributable earnings

Answer 20

= Deterministic PV(DistEarn) - Stochastic Mean PV(DistEarn)

*Deterministic does not capture tail asymmetry (overstates expected profits)

Question 21

Describe the importance of stochastic modeling when quantifying a mortality/longevity hedge between a term product and a single premium immediate annuity

Answer 21

• Combined deterministic IRR does not reflect diversification
  
  • ≈ weighted average of term and SPIA IRRs
• Combined stochastic IRR > either standalone IRR
  
  • Reflects mortality/longevity hedge
• Stochastic analysis shows conservatism in deterministic margins
  
  • Can allow insurer to adjust deterministic margins based on risk appetite

Question 22

Describe how to quantify diversification savings with a mortality/longevity hedge

Answer 22

• Diversification Savings =

Combined PVDE - (Standalone Term PVDE + Standalone SPIA PVDE)

• Diversification savings increase near the tail
• Increasing SPIA volume increases diversification savings

Question 23

List 4 common GLWB product designs

Answer 23

1. No Ratchet
2. Lookback Ratchet
3. Remaining WBB Ratchet
4. Performance Bonus

Question 24

Describe common GLWB product designs:

• Performance Bonus:

Answer 24

• WBB decreases with withdrawals but never increases

Question 25

Describe common GLWB product designs: * Remaining WBB Rachet

Answer 25

* Like Lookback, except WBB **decreases** with withdrawals

Question 26

Describe common GLWB product designs: * Lookback Rachet

Answer 26

* WBB = highest AV ⇒ allows W^guar_t to increase

Question 27

Describe common GLWB product designs: * No Rachet

Answer 27

* WBB and W_t^guar are constant all years

Question 28

Describe the 4 possible transitions each anniversary when modeling a VA GLWB

Answer 28

1. **Death ⇒ contract terminates** 2. **Alive, but no withdrawal** 3. **Alive and makes a withdrawal W_t \<= W^guar-_t** * Reduce AV by withdrawal for all designs * No Ratchet and Lookback: withdrawal has no impact on WBB * Remaining WBB and Performance Bonus: WBB is **_reduced_** by withdrawal 4. **Full surrender ⇒ contract terminates**

Question 29

Compare the 4 GLWB designs in terms of benefit richness

Answer 29

* No Ratchet is the **least rich** * Ratchets and performance bonuses **increase the guarantee value** * Remaining **WBB design is generally the “richest”** of all 4 * Becomes richer than Lookback when withdrawals are taken * Performance Bonus results in **highest early guaranteed withdrawals**

Question 30

List 2 financial models of the equity process for VA GLWBs

Answer 30

* **Black-Scholes** – assumes deterministic (constant) volatility * **Heston** – assumes stochastic volatility * lambda = market price of risk (rises as σ **decreases**) Either can be used for data generation or hedge position calculations

Question 31

What is the key relationship of the **fair guaranteed withdrawal rate?**

Answer 31

As option value **increases**, FGWR **decreases**

Question 32

Describe how each of the following impact the fair guaranteed withdrawal rate: * Impact of volatility

Answer 32

* as σ **increases**, option value **increases**, FGWR **decreases** * Ratchet mechanisms are the most sensitive *\*Results are similar for Black-Scholes and Heston b*

Question 33

Describe how each of the following impact the fair guaranteed withdrawal rate: * Impact of surrender rates

Answer 33

* as surrenders **decrease**, FGWR **decreases** (more benefits in force) * \*Results are similar for Black-Scholes and Heston b*

Question 34

Describe how each of the following impact the fair guaranteed withdrawal rate: * Impact of risk-free rate

Answer 34

* as *r_f***decreases**, option value **increases**, FGWR **decreases** * \*Results are similar for Black-Scholes and Heston b*

Question 35

Describe how each of the following impact the fair guaranteed withdrawal rate: * Product design

Answer 35

* Richer ratchet = lower FGWR * Lowest FGWRs: Remaining WBB and Performance Bonus (very similar) *\*Results are similar for Black-Scholes and Heston b*

Question 36

Describe how the distribution of guaranteed withdrawals and trigger times vary for each of the 4 GLWB designs * No Ratchet

Answer 36

* **No Ratchet**: W^guar- is constant * Greatest probability of no trigger

Question 37

Describe how the distribution of guaranteed withdrawals and trigger times vary for each of the 4 GLWB designs * Lookback

Answer 37

* **Lookback**: W^guar- increases slightly over time * Greater probability of trigger than No Ratchet

Question 38

Describe how the distribution of guaranteed withdrawals and trigger times vary for each of the 4 GLWB designs * Remaining WBB

Answer 38

* **Remaining WBB**: W^guar- increases more than Lookback * Greater probability of trigger than Lookback

Question 39

Describe how the distribution of guaranteed withdrawals and trigger times vary for each of the 4 GLWB designs * Performance Bonus

Answer 39

* **Performance Bonus**: W^guar- peaks early, then decreases * Highest probability of early trigger * Least uncertainty in trigger time (PB erodes AV quickly)

Question 40

Describe the characteristics of the Greeks in a GLWB hedge portfolio * Delta

Answer 40

* **Delta**: _Negative_ – as S_t **increases**, GLWB value **decreases** * No Ratchet delta is highest initially (guarantee doesn’t adjust) * Ratchets have adjusting guarantees (offsets drop in put value when S_t rises)

Question 41

Describe the characteristics of the Greeks in a GLWB hedge portfolio * Rho

Answer 41

* **Rho**: _Negative_ – as interest rate **increases**, GLWB value **decreases**

Question 42

Describe the characteristics of the Greeks in a GLWB hedge portfolio * Vega

Answer 42

* **Vega**: _Positive_ – as σ **increases**, GLWB value **increases** * Very large for Lookback and Remaining WBB compared to others

Question 43

Briefly describe hedging strategies for GLWBs

Answer 43

* The insurer’s **cumulative gain (loss)** at time t is: Hedge Portfolio_t - GLWB Value_t * **Hedge portfolio** = guarantee fees invested in various positions * **Straddle option** = combination of call and put (required to hedge vega)

Question 44

Describe 3 metrics used to assess GLWB hedging effectiveness

Answer 44

1. Expected profit **(higher is better)** 2. CTE of capital required to avoid a loss **(lower is better)** 3. CTE of final loss **(lower is better)**

Question 45

Describe the following related to GLWB hedging: * Riskiest GLWB designs before and after hedging

Answer 45

* **Riskiest products from hedge perspective**: * No hedge: No Ratchet has highest risk * Delta/Vega hedge: Lookback and Remaining WBB are riskiest

Question 46

Describe the following related to GLWB hedging: * Choice of constant or stochastic volatility for hedging

Answer 46

* **Choice of data-generating model is VERY important** * Heston DG model shows much higher risk after delta hedge * Insurer’s risk depends on whether true volatility is deterministic or stochastic

Question 47

Describe the following related to GLWB hedging: * Impact of vega hedging

Answer 47

* **Vega hedging further reduces risk, but. . .** * Also adds complexity: no unique solution exists * Over-hedging is worse than no hedging at all

Question 48

Describe the following related to GLWB hedging: * Impact of delta hedging

Answer 48

* **Any kind of delta hedging greatly reduces risk** * BS and Heston are similar: hedging model choice not that important

Question 49

How could future interest rate changes impact on insurance liabilities?

Answer 49

* **Worst case**: interest rates rise rapidly triggering capital losses and high lapses * **Best case**: interest rates bottom out, then begin rising slowly * Insurers continue to de-risk (lower guarantees) * Increased cost cutting and M&A activity * Search for yield in alternative assets * **Insurer strategies** * Assume policyholders will get more sophisticated (rational) * Stress test

Question 50

How do shifts in interest rates affect UL, SPDAs, and ULSG?

Answer 50

* UL is very stable * SPDA is hurt by extreme shifts (up or down) * ULSG is hurt most by low rates

Question 51

Why is interest rate history before 1980 not useful?

Answer 51

* More activist central bank role beginning in 1980s * Financial markets are more integrated

Question 52

Describe how interest rate history since 1980 has evolved

Answer 52

* **Interest rate levels have fallen to historic lows** * Short- and long-term Treasury yields have fallen to historic lows * Corporate bond yields low despite larger credit spread in financial crisis * Consumer loan rates have followed the same falling pattern * **Inflation has fallen to a stable and “predictable” 2.2%** * Inflation rate = 10-year CMT Rate - 10-Year TIPS Rate * **Yield curve shape remains normal** (positive slope)

Question 53

How could interest rate history be used as a guide to the future?

Answer 53

* **Yields will likely not change** dramatically in the near future * US economic policy is **no longer in a vacuum** * **Inflation** is more stable, predictable * Increased **global harmonization** of financial markets * **Tighter spreads** between US and foreign interest rates * **Exchange rates** are more correlated * Emerging countries are more **harmonized with US** (exception: China) * **The 1994 yield curve’s shape ≈ current shape** * Might mean the **curve would flatten** after a Fed rate hike * Caveat: central banks are more **harmonized** than the 1990s

Question 54

Describe primary forms of fiscal policy, monetary policy, and stimulus

Answer 54

* **Monetary policy** (the Fed) * **Quantitative easing** – reduce interest rates to increase money supply * **Increase interest rates** to dampen growth * **Keynesian fiscal policy** – increases/decreases in **spending** drive economic growth/contraction * **Austerity** – program of **cutting** government spending relative to revenue

Question 55

What is the quantity theory of money?

Answer 55

* changes in the money supply drive price-level changes

Question 56

GDP formula and all pieces

Answer 56

GDP = P x Y = M x V * GDP = the gross domestic product * P = the average price level in the economy * Y = the output level (volume of transactions) * M = the money supply * V = the velocity of money (normally what you solve for)

Question 57

Interpret the velocity of money

Answer 57

* **Economic growth occurs if M increases faster than V** * Inflation Rate + Real Output Growth Rate = Money Supply Growth Rate + Velocity Growth Rate * **BUT**: Current V is **very low** while M is **high** * **Velocity of money is affected by people’s trust** * Velocity falls if people doubt high debts will be repaid * Velocity increases when people lose faith in the entire system

Question 58

Suggest a new paradigm for modeling interest rates

Answer 58

* Modelers should be using negative interest rate scenarios * Will require new tools * **_Use deterministic scenarios that tell a story_** * Facilitates better strategic management decisions * Should incorporate interest rate risk into ORSA

Question 59

Describe the liquidity dilemma faced by insurers

Answer 59

* **Must balance long-term yield with short-term liquidity** * Longer assets have higher yield, but less liquidity * Shorter assets have more liquidity but less yield

Question 60

Define immunization

Answer 60

* **Immunization** – match asset-liability cash flows and/or durations

Question 61

Describe methods used for interest rate immunization * Macaulay duration

Answer 61

* **Macaulay duration** = average time to receive fixed cash flows

Question 62

Describe methods used for interest rate immunization * Modified duration

Answer 62

* **Modified duration** = **% delta** in PV of fixed CFs for a **1% delta** in interest rates

Question 63

Describe methods used for interest rate immunization * Effective duration

Answer 63

* **Effective duration** allows for interest-sensitive cash flows

Question 64

Describe methods used for interest rate immunization * Key rate duration

Answer 64

* **Key rate duration** = sensitivity to change in a single point on the yield curve

Question 65

List 3 forms of reinsurance-related interest rate risk * Coinsurance

Answer 65

* **Coinsurance** – reinsurer may experience run-on-the-bank (increases counterparty risk)

Question 66

List 3 forms of reinsurance-related interest rate risk * Mod-co and FW

Answer 66

* ​**Mod-co and FW** – reinsurer is at risk from direct writer’s investment results

Question 67

List 3 forms of reinsurance-related interest rate risk * ​​Retrocessions

Answer 67

* ​**Retrocessions** – create contagion risk for other reinsurers

Question 68

Describe how life insurance products are affected by interest rate risk * Issues with US statutory accounting

Answer 68

* **Issues with US statutory accounting:** * Minimum **interest rate floor** for valuation * **Book** value-based * Low interest rates have lead to **additional reserves** * **Capital gains/losses** treated different between stat and GAAP

Question 69

Describe how life insurance products are affected by interest rate risk * Cash value

Answer 69

* **Cash value** products have run-on-the-bank risk

Question 70

Describe how life insurance products are affected by interest rate risk * ​ULSG

Answer 70

* **ULSG** profits are highly dependent on interest rates

Question 71

Describe how life insurance products are affected by interest rate risk * UL

Answer 71

* **UL** – investment margins are a significant source of profit * ALM is complex since policyholder AV **does not equal** assets backing product * When interest rates rise, insurers tend to increase the crediting rate slowly

Question 72

Describe how life insurance products are affected by interest rate risk * VUL

Answer 72

* **VUL** – fixed funds have interest rate risk similar to UL

Question 73

Describe how annuity products are affected by interest rate risk: * Indexed annuities

Answer 73

* more attractive when interest rates and equity volatility are low

Question 74

Describe how annuity products are affected by interest rate risk: * VA Guarantees

Answer 74

* Increase in value when: * Interest rates are low * Equity volatility is high

Question 75

Describe how annuity products are affected by interest rate risk: * Payout Annuities

Answer 75

* **Longevity risk** exacerbates risk of low interest rates

Question 76

Describe how annuity products are affected by interest rate risk: * Deferred Annuities

Answer 76

* **SCs and MVAs** reduce interest rate risk * When **SCs expire**, **surrender risk** is much higher * **Older contracts** with high guaranteed rates will persist when interest rates are low * **Disintermediation risk** – high surrenders and capital losses when interest rates spike

Question 77

Describe YRT reinsurance in general

Answer 77

**YRT is used to reinsure mortality or morbidity risk _only_** * **Ceding company pays**: * Reinsurance premium to reinsurer * All policyholder benefits and expenses * **Reinsurer pays** * Reinsured claims to reimburse ceding company * Expense allowance * **Ceding company takes a (small) ceded reserve credit** * = Unearned YRT premium

Question 78

Which types of business is YRT reinsurance good and not good for

Answer 78

* Ideal if primary objective is **mortality/morbidity risk transfer** * Good for **term, WL, and UL (mortality risk)** * Also can be used for **disability, LTCI, and critical illness (morbidity)** * Not good for transfer of lapse or investment risk—**not good for annuities** * Provides relatively little surplus relief compared to coinsurance

Question 79

Describe the calculation of ceded net amount at risk under YRT

Answer 79

* **NAR = Face - Terminal Reserve** (or whatever treaty defines) * Calculated at policy level * _Ignore_ deficiency reserves * YRT Premiums = YRT Rates x Ceded NAR * Ceded DB = Reinsurer’s share of NAR * NAR must be well documented in the treaty * Companies must agree on method * DB used in calculation should = DB paid on death * NAR used should ≈ actual NAR

Question 80

List the 4 YRT retention determination methods

Answer 80

1. Pro Rata 2. Level or Constant Retention 3. Constant Risk Reinsured 4. Formula Retention

Question 81

Decrive the 4 YRT retention determination methods: * Formula Retention

Answer 81

* NAR and retention are determined by initially agreed upon formula

Question 82

Decrive the 4 YRT retention determination methods: * Constant Risk Reinsured

Answer 82

* (rare) * Reinsured amount = constant amount * Retained portion of NAR falls over time

Question 83

Decrive the 4 YRT retention determination methods: * Level or Constant Retention

Answer 83

* Company retains a fixed amount of the NAR * Reinsured portion of NAR falls over time

Question 84

Decrive the 4 YRT retention determination methods: * Pro Rata

Answer 84

* (preferred by most companies) * Constant reinsured % = Original Face Amount Ceded/Total Original Face Amount of Policy * Results in very small reinsurance amounts in later durations

Question 85

Formula for YRT reinsurance premiums

Answer 85

ReinsPrem = YRT Rate x (Ceded NAR/1000) + Cession Fee

Question 86

Components of YRT reinsurance premiums.

Answer 86

* **YRT premium rate** * May have zero first-year premium (**ZFT**) * **Calendar year scales** * Substandard ratings * **Riders** * **Monthly renewable term (MRT) for UL**

Question 87

Describe the calculation of YRT reinsurance premiums: * YRT premium rate

Answer 87

* **YRT premium rate** = multiple of mortality table * Vary by age, duration, sex, underwriting class * Select periods are common (e.g. 15 years)

Question 88

Describe the calculation of YRT reinsurance premiums. * Calendar year scales

Answer 88

* **Calendar year scales** avoid year-end reinsurance reserves

Question 89

Describe the calculation of YRT reinsurance premiums. * Substandard ratings

Answer 89

* Substandard ratings * **Table rating**: increase by multiple (e.g. 150%) * **Flat extra**: may have allowance on extra premium

Question 90

Describe the calculation of YRT reinsurance premiums. * Riders

Answer 90

* **Riders**: accidental death may be reinsured separately, term riders use base

Question 91

Describe the calculation of YRT reinsurance premiums. * ​Monthly renewable term (MRT) for UL

Answer 91

* **Monthly renewable term (MRT) for UL**: YRT done on a monthly basis

Question 92

Describe coinsurance in general

Answer 92

* Reinsurer has a **_proportionate_** share of: * Direct policyholder premium * Direct reserve * All benefits (mortality, morbidity, lapse, surrender, investment)

Question 93

Compare coinsurance to YRT

Answer 93

* **Cedes more premium**, reserves, and benefits * But also means reinsurer must track all these * Coinsurance EAs may be more complicated to track * Can be used for any type of insurance or annuities * Provides more surplus relief than YRT * Passes deficiency reserves to reinsurer as well

Question 94

Coinsurance premium formula

Answer 94

ReinsPrem = (Amount Ceded Per 1000) x (GP Per 1000)

Question 95

List 3 different approaches for banded premiums for coinsurance

Answer 95

1. Simplest approach 2. More equitable 3. Use a single band

Question 96

Describe different approaches for banded premiums for coinsurance * Simplest approach

Answer 96

* **Simplest approach** * Use actual GP for each policy * Use common set of allowances for all bands

Question 97

Describe different approaches for banded premiums for coinsurance * More equitable

Answer 97

* **More equitable** (and complicated) * Use actual GP for each policy * Vary allowances by band

Question 98

Describe different approaches for banded premiums for coinsurance * Use a single band

Answer 98

* **Use a single band** * Use GP for a specific band regardless of actual band * One set of allowances for all policies

Question 99

Describe variations in coinsurance expense allowances

Answer 99

* **Allowance** = % of ceded premium * **Uniquely developed** for each product * **Varies** by duration, sex, risk class, band, etc. * Based on reinsurer’s profit objectives * **Premium tax methods:** * Most common: reinsurer includes a provision for premium taxes in basic allowance * Reimburse exact amount (challenging) * Pay a fixed amount as a proxy

Question 100

Describe how the following are treated under coinsurance: * Policy fee

Answer 100

* **Policy fee**: may be fully retained by ceding company * Reinsurer may coinsure policy so it can be included in deficiency reserve ## Footnote *\*Substandards and riders treated similarly to YRT approaches*

Question 101

Describe how the following are treated under coinsurance: * Policyholder dividends

Answer 101

* **Policyholder dividends**: Reinsurer may or may not participate * If no participation, creates asset management challenges for ceding company ## Footnote *\*Substandards and riders treated similarly to YRT approaches*

Question 102

Describe how the following are treated under coinsurance: * Policy loans

Answer 102

* **Policy loans**: No participation by reinsurer ever ## Footnote *\*Substandards and riders treated similarly to YRT approaches*

Question 103

Advantages/uses of mod-co compared to regular coinsurance

Answer 103

* Gives ceding company **more control over investments** * Good for **interest-sensitive liabilities** and policyholder dividends * More assets available for **policy loans** * Good when reinsurer is **offshore or unauthorized** * No question about reserve credits

Question 104

Mod-co is just like coinsurance in all ways except...

Answer 104

* Ceding company **retains assets backing ceded reserves** * **No ceded reserve credit** on ceding company’s balance sheet * No **reinsured reserve** on reinsurer’s balance sheet * Reinsurer pays a **mod-co adjustment** to ceding company * Main source of complexity compared to coinsurance

Question 105

Describe the calculation of the mod-co adjustment

Answer 105

**Positive mod-co adjustment** = **payment by reinsurer** **Mod-co adjustment** = Ending ceded stat reserves - Beginning ceded stat reserves - “Interest” on beginning ceded stat reserves

Question 106

Characterize the interest rate in the calculation of the mod-co adjustment

Answer 106

**Mod-co interest rate must be clearly defined in treaty** * Should ensure reinsurer participates in total asset performance * Asset defaults, capital gains/losses, timing risks, investment income * Not a simple interest rate in practice * Governed by NAIC Life & Health Reinsurance Agreements Model Reg

Question 107

What are the goals of advanced uses of reinsurance?

Answer 107

* Primary goals of advanced uses of reinsurance: * Provide surplus relief to ceding company * Reduce transfer of assets between companies

Question 108

What are the primary advantages of advanced uses of reinsurance?

Answer 108

* Advantages of advanced forms for ceding companies: * Allow **ceded reserve credit** for non-admitted reinsurers * Improve **security** of ceded reserve credit * Coordinate **asset management** for asset-sensitive liabilities * **Minimizes capital gains/losses** on assets at inception * Allow **easier recapture** by minimizing capital gains and losses

Question 109

Compare advanced forms of reinsurance in terms of the following: * Complies with state laws?

Answer 109

1. Coins. = Yes 2. Mod-Co = Yes 3. FW-Co = Yes 4. FW-Mod-Co = ?

Question 110

Compare advanced forms of reinsurance in terms of the following: * Establish a FW balance for initial allowance only?

Answer 110

1. Coins. = No 2. Mod-Co = No 3. FW-Co = No 4. FW-Mod-Co = Yes

Question 111

Compare advanced forms of reinsurance in terms of the following: * Establish a FW balance instead of exchanging cash?

Answer 111

1. Coins. = No 2. Mod-Co = No 3. FW-Co = Yes 4. FW-Mod-Co = Yes

Question 112

Compare advanced forms of reinsurance in terms of the following: * Calculate mod-co adjustment

Answer 112

1. Coins. = No 2. Mod-Co = Yes 3. FW-Co = No 4. FW-Mod-Co = Yes

Question 113

Compare advanced forms of reinsurance in terms of the following: * Reinsurer owns performance of assets?

Answer 113

1. Coins. = Yes 2. Mod-Co = No 3. FW-Co = Yes 4. FW-Mod-Co = Yes

Question 114

Compare advanced forms of reinsurance in terms of the following: * Reinsurer holds assets backing ceded reserves?

Answer 114

1. Coins. = Yes 2. Mod-Co = No 3. FW-Co = No 4. FW-Mod-Co = No

Question 115

Compare advanced forms of reinsurance in terms of the following: * Ceding company takes reserve credit?

Answer 115

1. Coins. = Yes 2. Mod-Co = No 3. FW-Co = Yes 4. FW-Mod-Co = No

Question 116

Compare advanced forms of reinsurance in terms of the following: * Reinsurer holds reserve?

Answer 116

1. Coins. = Yes 2. Mod-Co = No 3. FW-Co = Yes 4. FW-Mod-Co = No

Question 117

What is part-co?

Answer 117

a blend of regular coinsurance and mod-co

Question 118

Compare funds withheld coinsurance with regular coinsurance

Answer 118

* **No cash changes hands at inception or renewal years** * **Net cash owed becomes an accounts payable or receivable** * If net cash owed \> 0, company carries an accounts payable liability * Otherwise, company carries an accounts receivable asset * One company’s receivable asset = other company’s payable liability * **Assets stay with ceding company (like mod-co)** * But ceding company shows ceded reserve credit (like regular coinsurance) * FW balance is adjusted to reflect interest on retained assets * Authors include ceded interest in ceded premium

Question 119

Give an alternative, equivalent OSA calculation for FW

Answer 119

OSA_t = OSA_t-1 + CededPrem_t - CededBen_t - CededResIncr_t - ExperienceRefund_t = RiskCharge_t

Question 120

Describe funds withheld mod-co

Answer 120

* **_Tip: just think of it as “allowance retained mod-co”_** * FW-Mod-Co is **identical** to mod-co in every way except: * Reinsurer retains initial allowance * Reinsurer’s initial FW liability = initial allowance * Ceding company’s initial FW asset = initial allowance

Question 121

FW-Mod-Co and state laws

Answer 121

FW-Mod-Co may violate state laws * State laws usually require quarterly settlement of amounts * May be possible to get approval

Question 122

Describe partially modified coinsurance (part-co)

Answer 122

**_Part-co is a blend of regular coinsurance and mod-co_** * **The cash owed by each party cancels out at inception** * Initial coinsurance reserve = initial allowance * Remaining reserves are mod-co reinsured * **Co/mod-co split is adjusted in renewal years to minimize cash flow** * Generally, stat profits reduce the coinsurance portion * Could be designed so coinsurance portion = reinsurer’s outstanding investment

Question 123

Advantages and disadvantages of part-co

Answer 123

* **Main advantages of part-co**: * Designed to eliminate or minimize cash transfer * No FW balance to track * **Disadvantages of part-co**: * Very complicated to administer and understand * Regulators may be concerned about increasing coinsurance portion * Suggests reinsurer isn’t really absorbing losses * Must calculate stat gain twice: preliminary then final

Question 124

Describe an SPV owner

Answer 124

* SPV owner is called the **“sponsor”** * Could be reinsurer, direct insurer, or parent company

Question 125

How do SPV sponsors want to fund redundant reserves?

Answer 125

* SPV sponsors want to fund redundant reserves **with low-cost capital** * Allows other capital to be used for higher risk (higher returns) * Should emerge from cash flows without additional funding

Question 126

Redundant reserve formula

Answer 126

= Total Stat Reserves – Economic Reserves * Total Stat Reserves = Basic Stat Reserve + Additional XXX Reserves * Economic Reserves = GAAP BenRes - DAC * Should emerge from cash flows without additional funding

Question 127

Total stat reserves formula

Answer 127

= Basic Stat Reserve + Additional XXX Reserves

Question 128

Economic reserve formula

Answer 128

= GAAP BenRes - DAC

Question 129

Characterize SPV investors

Answer 129

* SPV investors want a **low-risk** investment * Low possibility for loss of investment * Willing to accept low return (since low risk) * Investors could be bondholders or a bank issuing an LOC

Question 130

Describe the capital structure of a SPV * “Required Capital”

Answer 130

* **“Required Capital” = capital contributed by sponsor** * Greater of minimum regulatory capital and capital required by investors * May not tie to regulatory or rating agency capital

Question 131

Describe the capital structure of a SPV * Economic Reserves + Required Capital

Answer 131

* **Economic Reserves + Required Capital** * Should fund claims/expenses even under adverse developments * Higher RC = less risk for investors * If RC too high, SPV may not be viable

Question 132

List the steps for structuring an SPV

Answer 132

**1. Sponsor forms captive and contributes RC** **2. If issuing bonds, document the following:** * Restrictions on use of the funds * Delineation between reserve and capital requirements * Investor funds will be used only after reserves and RC * How/when dividends, cash, etc. may be paid to the sponsor * Any experience refunds * Payment of interest on the bonds * Repayment of the initial principal **3. Place funds in the 3 trusts** * Redundant reserve trust * Capital account trust * Economic reserve trust

Question 133

List considerations for SPV investors (list 4)

Answer 133

1. SPVs are **expensive to establish**: requires sufficient volume of business 2. **Bonds** are no longer issued post-crisis 3. Structures usually **include NB** for limited time (e.g. 1 year) 4. SPVs usually cover **limited group of products** (e.g. level term) 5. **Max funding** required for RC and redundant reserves at inception( could have a agreement for more in future) 6. Usually based on some form of **coinsurance** 7. Ceding company must be able to take **ceded reserve credit** (hence trusts) 8. **Assets** will be in SPV for a long time (30+ years) 9. Investor retains **investment income** from assets

Question 134

List advantages of using LOCs for SPVs

Answer 134

* **Only the amount of annual redundancy needs to be funded by the LOC** * **Bank will increase LOC amount each year for a guaranteed fixed charge** * Avoids the need to refinance the LOC * Better than using bonds, which would have to be reissued (refinanced) * **The cost of long-term LOCs has fallen as banks gain comfort**

Question 135

Describe the key parties in an **assumption reinsurance** agreement

Answer 135

* **Transferring insurer** – the original direct insurer being replaced * **Assuming insurer** – the new insurer 100% responsible for all policy obligations

Question 136

Describe the general purpose of an **assumption reinsurance** agreement

Answer 136

* Effectively a sale of 100% of the business * Assuming reinsurer issues a **notice of transfer** and **certificate of assumption** to the policyholder * All **future contact** is between the assuming insurer and the policyholder * Assumption agreements rarely have **recapture provisions** (unlike indemnity)

Question 137

Why do transferring insurers use assumption reinsurance?

Answer 137

1. **Exit** a product line (e.g. to reduce risk or administrative expense) 2. **Sell** problematic blocks to enhance company value for future sale 3. **Raise capital** more easily 4. **Gain/loss** from recognized immediately under US stat, tax, and US GAAP 5. Assumption results in **higher value for transferring** company than indemnity 6. **Rehabilitator** may require assumption for insolvent insurer

Question 138

Why do assuming insurers use assumption reinsurance?

Answer 138

* **Optimize admin capacity**: lower per unit expenses * **Acquire field force or build larger LOB** * **Earn higher return on excess surplus** * May achieve **additional investment return** on transferred assets MTM * May get a very **favorable deal** from a rehabilitator

Question 139

Describe the purpose of the NAIC Assumption Reinsurance Model Act

Answer 139

* Provides guidance for assumption transactions but * **Most states have not adopted** * **Significant variation** in procedures from state to state

Question 140

Key points/requirements of the NAIC Assumption Reinsurance Model Act (high level)

Answer 140

* Policyholder **notification** and **consent** required before assumption can occur * **Certificate of assumption** must be issued to policyholders * State **commissioner approvals** in affected states * **Factors** for commissioners to consider before approving * **Foreign insurers** must file assumption certificate, notice of transfer, and affidavit

Question 141

What's not included in the NAIC Assumption Reinsurance Model Act

Answer 141

* indemnity * M&A * liquidation/rehabilitation * if state guaranty involved

Question 142

What are the Assumption Reinsurance Model Act’s requirements for state insurance commissioners?

Answer 142

* **State commissioner approvals** * Transferring insurer **domicile state** * Assuming insurer **must be licensed** in each state or get commissioners’ approvals

Question 143

Factors for state commissioners to consider from the Assumption Reinsurance Model Act’s requirements

Answer 143

* **Financial condition** of both insurers before and after the transaction * **Competence and integrity** of assuming insurer’s management * Assuming insurer’s **plans to administer** the transferred business * **Fairness** to the policyholders * If **notice of transfer** is clear and adequate

Question 144

What is the Assumption Reinsurance Model Act’s process for policyholder consent?

Answer 144

* **Mail notification** with response card * If no response within **24 months**, issue final notice * If no response, **consent** is deemed * If policyholder **pays premiums** to assuming insurer during time period, consent is deemed

Question 145

List the 4 key steps of the assumption process

Answer 145

1. Establish assumption reinsurance **agreement** 2. Submit and wait for **regulatory approval** 3. Wait for **policyholder consent** 4. **Consenting policyholders’** policies move to assumption agreement **\*Each step is tedious and time consuming!**

Question 146

Decribe the key steps of the assumption process: * Consenting policyholders’ policies move to assumption agreement

Answer 146

* Policyholder begins dealing directly with assuming insurer * Different from indemnity, where policyholder can’t “look” to reinsurer * Non-consenting policies stay with original insurer

Question 147

Decribe the key steps of the assumption process: * Wait for policyholder consent

Answer 147

* Can be specific, implied, or given by a regulator in the event of insolvency * Significant variation by state

Question 148

Decribe the key steps of the assumption process: * Submit and wait for regulatory approval

Answer 148

* Domicile states of transferrer and assuming insurer must approve * Other affected states must approve notice and certificate

Question 149

Decribe the key steps of the assumption process: * Establish assumption reinsurance agreement

Answer 149

* covers the sale or transfer * Lengthy, complicated negotiation * Extensive documentation required

Question 150

List documentation required in the Assumption reinsurance agreement

Answer 150

* **Business transfered** * **Effective date**, subject to approval * **Consideration paid** to assuming insurer (% of reserves) * Initial ceding **commission** (price paid by assuming insurer) * Responsibility for **incurred but not paid** claims * Responsibility for **policy admin and service** after effective date * **Policyholder notification** * **Tax treatment** and reporting responsibility * **Treatment of policies** never assumed

Question 151

List 2 practical methods for dealing with long policyholder consent times

Answer 151

1. Interim indemnity reinsurance 2. Right of assumption agreements

Question 152

Describe interim indemnity reinsurance

Answer 152

* Usually **cede 100%** using coinsurance or mod-co * Assuming insurer assumes responsibility for **policy admin or uses a TPA** * As policyholders consent, move policies **from indemnity to assumption** * Some policies may not consent ⇒ stay with indemnity agreement

Question 153

Describe right of assumption agreements

Answer 153

* Gives reinsurer **right to convert** from indemnity to assumption in the future * Could be a **clause** in a standard indemnity agreement * **Tax implications** should be carefully considered

Question 154

How does assumption reinsurance affect the **transferring** insurer’s **Tax** reporting?

Answer 154

* Taxable gain occurs if the MV assets paid by transferring company (net of purchase price) are less than tax reserves released * Otherwise it’s a loss (reduces taxable income)

Question 155

How does assumption reinsurance affect the **transferring** insurer’s **GAAP** reporting?

Answer 155

* Write off DAC and release benefit reserves

Question 156

How does assumption reinsurance affect the **assuming** insurer’s **Tax** reporting?

Answer 156

* Block is treated as the **purchase of an asset** * Any **ceding commission or strain** must be amortized over 180 months * **Tax reserves** are based on the original policy issue dates, not the assumption date

Question 157

How does assumption reinsurance affect the **assuming** insurer’s **GAAP** reporting?

Answer 157

* Treated under **GAAP purchase accounting** so that no gain or loss occurs immediately (gets amortized) * **Initial consideration and allowance** are amortized over future revenues

Question 158

How does assumption reinsurance affect the **assuming** insurer’s **stat** reporting?

Answer 158

* Same reporting as indemnity * Establish **appropriate reserve** for risks assumed * **Initial allowance** is treated as an immediate expense * After the assumption, **amounts received and paid** are treated as direct amounts * Any **gain or loss** is recorded as of the date of the date of the assumption

Question 159

How does assumption reinsurance affect the **transferring** insurer’s **stat** reporting?

Answer 159

* Treated like **policy surrender** * **Policy reserves** are released * **Assets and policy loans** are transferred to assuming insurer

Question 160

What are key provisions of the Insurance Company Act that relate to assumption reinsurance? CANADA

Answer 160

* Governs the **transfer of business and assumption** * **Minister of Finance** must approve if substantially all risks will be transferred (otherwise Superintendent must approve) * Shareholders, members and policyholders are entitled to **vote** through a special resolution * If approved, liabilities transfer to assuming insurer’s books under **Canadian GAAP** * **Relatively simple** compared to US

Question 161

List the ICA’s requirements for the assuming insurers

Answer 161

Can be any of the following. . . * A **federally registered insurance company or society** * A **foreign company** that reinsures the risks in Canada * A **provincial corporation** if the Superintendent has satisfactory arrangements * An **entity authorized to accept risks** that were undertaken outside of Canada by the transferring company

Question 162

List the ICA’s requirements for the transferring insurer

Answer 162

* Publish **notice of the transaction in the Canada Gazette** 30+ days before applying for approval * Make **assumption agreement available** to shareholders, members, and policyholders 30+ days after the publication of the notice * **Copies must be sent** to any shareholders, members, or policyholder that requests in writing * **Superintendent** may ask for a report by an independent actuary before approving * Must send information to the **affected policyholders** regarding the assumption

Question 163

Describe similarities between indemnity and assumption reinsurance from the **reinsurer's** perspective

Answer 163

* Optmize excess admin capacity * Earn higher return on excess surplus * Grow without selling new business

Question 164

Describe similarities between indemnity and assumption reinsurance from the **ceding** company's perspective

Answer 164

* Exit a product line (e.g. to reduce risk or administrative expense) * Sell problematic blocks to enhance company value for future sale * Raise capital without regulator/shareholder approval

Question 165

List situations where indemnity reinsurance would be preferable to assumption reinsurance (from **ceding company** perspective) (list 4)

Answer 165

1. Wants to **continue** LOB and/or field force 2. Fears **reputational risk** of transfer obligations to reinsurer (no disclosure) 3. Wants to **lock in some level of future gains** (not immediately recognized) 4. Desires **recapture** provision 5. **Wants to cede** 6. Wants faster transaction and **immediate cession of risks** * **No waiting** on policyholder consent 7. Wants reinsurer who is **not licensed in all states** with in-force 8. Does not want to **mark transfered assets** to market (avoids capital losses)

Question 166

List key considerations for indemnity surplus relief treaties

Answer 166

**_MOST IMPORTANT:_ All significant risks must transfer to receive reserve credit and/or surplus relief** * Should be designed to be **permanent** * Only the ceding company should have the **option to terminate** * **Recapture provision**: * **Clearly define** in the treaty * Should be for all in-force * Should lower the initial consideration and/or renewal allowances * **Experience refund** provisions are common

Question 167

What are the RBC effects for _indemnity_ reinsurance for: * Mod-co

Answer 167

* Mortality/Morbidity Risks (C-2 transfered): **Proportionate transfer** * Asset Risks (C-1 and C-2 transfered): **Based on mod-co interest rate** * Counterparty Risk (both companies): **More than YRT**

Question 168

What are the RBC effects for _indemnity_ reinsurance for: * Coinsurance

Answer 168

* Mortality/Morbidity Risks (C-2 transfered): **Proportionate transfer** * Asset Risks (C-1 and C-2 transfered): **Proportionate transfer** * Counterparty Risk (both companies): **More than YRT**

Question 169

What are the RBC effects for _indemnity_ reinsurance for: * YRT

Answer 169

* Mortality/Morbidity Risks (C-2 transfered): **Significant (up to 100%)** * Asset Risks (C-1 and C-2 transfered): **No transfer** * Counterparty Risk (both companies): **Some**

Question 170

Compare the risk based capital effects of reinsurance in terms of: * Indemnity vs. assumption reinsurance

Answer 170

**Assumption reinsurance differences**: * Generally reduces ceding company’s capital more than indemnity * _No_ counterparty risk capital requirement

Question 171

What is the key trend in YRT usage

Answer 171

YRT usage **increases** and ceded amounts **increase**

Question 172

Why do ceding companies use YRT reinsurance (4 reasons)

Answer 172

1. Improves **capital position** 2. Increases ceding company’s **competitiveness** 3. Increases **confidence** in ability to pay policyholder dividends 4. Can address **over-retention** issues resulting from M&As

Question 173

List advantages of **YRT** reinsurance

Answer 173

1. Limits reinsurer’s investment and lapse risk 2. Good for reinsurer if it wants to minimize asset management 3. Lower ongoing cost than any form of coinsurance

Question 174

List disadvantages of **YRT** reinsurance

Answer 174

1. Limits potential for surplus relief 2. YRT rates are not guaranteed in the US (may increase)

Question 175

List advantages of **coinsurance**

Answer 175

1. Simplest to administer if a quota share method used 2. Cleanest method from regulatory view point 3. Works with all life and annuity plans * True of all other coinsurance forms too

Question 176

List disadvantages of **coinsurance**

Answer 176

1. **Chief disadvantage: Need to transfer assets** * Capital gains/losses at inception and termination 2. May have to give reinsurer control/veto over dividends / crediting rates 3. Requires reinsurer to assume more investment risk 4. No reserve credit if reinsurer is not admitted * Unless expensive security is provided 5. More counterparty credit risk than YRT

Question 177

List advantages of **mod-co**

Answer 177

1. **Major advantage: No need to liquidate/transfer assets** 2. Good for interest-sensitive products, policyholder dividends, etc. 3. Eliminates reserve credit problem for non-admitted reinsurers 4. Tax-friendly for ceding company and reinsurer 5. Good for reinsurers that don’t want to manage assets 6. Recapture easier 7. Retained assets can used for other purposes

Question 178

List disadvantages of **mod-co**

Answer 178

1. More complicated than regular coinsurance 2. On termination, ceding company may have to transfer assets back 3. May require large initial mod-co adjustment payment by reinsurer 4. Increases reinsurer’s concern over ceding company’s solvency

Question 179

List advantages of **funds withheld coinsurance**

Answer 179

1. Greatly **minimizes cash transfers** (none at inception) 2. Lessens concern over reinsurer’s **solvency** 3. Allows **reserve credit** even if reinsurer is non-admitted 4. Assets can be **managed consistently** with other assets on similar business

Question 180

List disadvantages of **funds withheld coinsurance**

Answer 180

1. More **complicated** than coinsurance and mod-co 2. Regulation may **limit time funds** can remain unpaid 3. More **counterparty risk** for reinsurer 4. Fluctuations in **receivable assets** = earnings volatility 5. **Reserve credit** problem if FW are with the reinsurer 6. Regulators may require **marking assets to market**

Question 181

List advantages of **funds withheld mod-co**

Answer 181

1. Reinsurer does not have to **liquidate/transfer assets** to pay initial allowance 2. Reinsurer has less risk of ceding company **insolvency**

Question 182

List disadvantages of **funds withheld mod-co**

Answer 182

1. **More complicated** than regular coinsurance, mod-co, or FW 2. **Mod-co adjustment** more complicated * **Withheld allowance** requires special adjustment 3. **Deferral of allowance payment** likely violates NAIC Model Life and Health Reinsurance Agreement Regulation

Question 183

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Avoid regulatory concerns

Answer 183

Avoid FW-Mod-Co (and maybe avoid part-co)

Question 184

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Greatly minimize cash flow

Answer 184

Use FW, FW-Mod-Co, or part-co

Question 185

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Use a non-admitted reinsurer

Answer 185

Use mod-co or FW

Question 186

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Simplicity desired

Answer 186

Use regular coinsurance, possibly mod-co or FW

Question 187

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Raise capital, get surplus relief

Answer 187

Use any form of coinsurance

Question 188

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Increase premium competitiveness

Answer 188

Use YRT

Question 189

Recommend a reinsurance method for each of the following (assuming each is the primary reason for using reinsurance) * Significantly reduce mortality risk

Answer 189

Use YRT

Question 190

List treaty terms that were commonly used to reduce risk transfer in the past

Answer 190

1. **Initial ceding commission set too low** compared to expected future earnings 2. **Fixed interest rate mod-co adjustments** 3. **Reinsurer can voluntarily terminate** if ceding company becomes insolvent, etc. 4. **Side agreements** that guarantee ceded business performance 5. **Mandatory recapture** at the reinsurer’s option 6. **Deferred reinsurer payments** for long periods or forever

Question 191

Briefly compare the importance of **reinsurance treaty risk transfer** under each US accounting system

Answer 191

* **US statutory**: risk transfer is defined _strictly by state law_ * No risk transfer = no reserve credit (bad news for ceding company) * Heavy indirect influence on GAAP and tax * **US GAAP**: risk transfer is based on _tests and auditor judgment_ * No risk transfer = must treat as a loan (not beneficial for either party) * **US tax**: main concern is _tax avoidance_ (subject to IRS judgment) * IRS has broad authority to “adjust” tax returns (pay more taxes)

Question 192

Briefly describe how the Life and Health Reinsurance Agreement Model Regulation affects US insurers

Answer 192

* **Purpose**: ensure transfer of all significant risks inherent in reinsured business * Must be adopted by **all US states** * Allows regulators to deny _ceding company’s_ **coinsurance reserve credit** * Outlines **17 product types 6 significant risk categories** * Can influence **GAAP and tax decisions** on risk transfer

Question 193

Briefly describe how the Life and Health Reinsurance Agreement Model Regulation affects US insurers: * Allows regulators to deny **ceding company's** coinsurance reserve credit?

Answer 193

* 11 specific conditions that indicate **insufficient risk transfer** * Various requirements for ceding company * Main focus is surplus relief (does **not** apply to YRT and most non-proportional) * Does **not** directly regulate the reinsurer

Question 194

Review the 11 Model Reg conditions that violate risk transfer (or try to list them if you’re feeling confident!)

Answer 194

**Model Reg _denies_ reserve credit (or asset reduction) if ANY of these exist:** 1. Renewal EA \< anticipated allocable renewal expenses 2. Reinsurer can choose to deprive ceding company of surplus or assets 3. Ceding company must repay reinsurer for losses 4. Ceding must recapture or terminate at specific date 5. Ceding company must pay amounts not realized from reinsured policies 6. Agreement fails to transfer all significant risk 7. Credit/disintermediation/reinvestment risk is significant and not transferred 8. More than 90 days between cash settlement 9. Ceding company has to make non-reinsurance-related warranties 10. Ceding company has to guarantee future performance 11. Main purpose is temporary surplus relief without transferring all significant risks

Question 195

In addition to transferring risk, list at least 3 other requirements the Model Reg has for ceding companies

Answer 195

1. File **in-force agreement and financial impact** with commissioner within 30 days 2. AA must consider the **Model Reg in Actuarial Opinion** 3. **Increases in surplus** are shown on special line in C&S 4. **Final agreement or LOI** must be signed before taking reserve credit 5. Agreement must be in writing and state that it **constitutes the entire contract**

Question 196

List the 6 significant risk categories in the Model Reg and give examples of products in each category

Answer 196

1. **Morbidity**: LTCI only 2. **Mortality**: all life products and immediate annuities 3. **Lapse**: all life and annuity products except immediate annuities 4. **Credit Quality**: all products except non-par term 5. **Reinvestment**: all products except non-par term 6. **Disintermediation**: all products except non-par term, LTCI, and immediate annuities

Question 197

Describe **key reinsurance risk transfer considerations** under US GAAP

Answer 197

1. **Interrelated treaties** for the same business must be evaluated together 2. **Risk transfer** is assessed only at treaty effective date and if/when amended 3. **Provisions that limit insurance risk transfer** or unduly defer reimbursement 4. **FW**: OK as long if no other risk transfer concerns and interest is reasonable 5. Treaty must state **which insurance-related risks** are transferred

Question 198

Describe **key reinsurance risk transfer considerations** under US GAAP * Provisions that limit insurance risk transfer or unduly defer reimbursement

Answer 198

1. **Experience refunds** that result in the reinsurer collecting fees only for financing 2. **Cancellation provisions** that void the reinsurer’s risk 3. **Retroactive adjustments** to premiums or allowances 4. Disproportionate inclusion of **profitable business to offset riskier business** 5. **Delay of timely payments** by the reinsurer

Question 199

Describe the US GAAP rules for risk transfer for short-duration contracts

Answer 199

2 conditions must be met: * **41a test** – reinsurance must be **subject to variability** in **timing and amount** * **41b test** – reinsurer must have **reasonable possibility** of realizing a **significant loss** * Exemption: treaty transfers “substantially all” risk in reinsured business

Question 200

Describe the US GAAP rules for risk transfer for long-duration contracts

Answer 200

* reinsurer must be exposed to a reasonable possibility of a significant loss * **Primary guidance**: if CC’s experience is worse than expected, the reinsurer’s should be, too

Question 201

Describe the IRS’s authority under IRS Code Section 845

Answer 201

* **Gives IRS broad authority if a treaty results in “significant tax avoidance”** * Significant tax avoidance is not defined * Does not require evidence of fraud or intent to avoid taxes * Highly dependent on individual circumstances

Question 202

Describe components of IRS Code Section 845

Answer 202

* **Section 845(a)** – reinsurance between related parties * IRS can **reallocate tax items** between parties, even if no significant tax avoidance * **Best advice**: treaties should be based on “arm’s length” terms * **Section 845(b)** – reinsurance between **non-related parties** * Gives IRS similar authority as 845(a), but not quite as broad

Question 203

Describe **proportional reinsurance**

Answer 203

* Based on a quota share of **individual risks** * Includes YRT and all forms of coinsurance covered in earlier chapters

Question 204

Describe **non-proportional reinsurance**

Answer 204

* Based on actual claims for a **block of policies**, not individual risks * **Not a** **substitute** for proportional reinsurance but can **augment** * **Reduce cost** of proportional reinsurance by increasing individual **retention limits** * **Protect surplus** and earnings form adverse claims fluctuations * Protect against **risk concentrations** * Usually **inexpensive** but often not available in sufficient amounts

Question 205

List 3 non-proportional reinsurance methods

Answer 205

1. Catastrophe Coverage 2. Stop Loss 3. Spread Loss

Question 206

Describe non-proportional reinsurance methods: * Stop Loss

Answer 206

* (rarely used for ILA) * Reinsurer pays all or a share of claims above attachment point * **Key concern**: surplus volatility from claims fluctuations

Question 207

Describe non-proportional reinsurance methods: * Spread Loss

Answer 207

* (almost never used for ILA) * Like stop loss, but ceding company repays the reinsurer with interest * Does not qualify as reinsurance ⇒ **it’s really just a loan**

Question 208

Describe non-proportional reinsurance methods: * Catastrophe Coverage

Answer 208

* (most common of the 3) * Reinsurer pays claims above deductible if multiple claims occur from same covered event * **Key concern**: concentrations in low frequency, high severity risks

Question 209

Describe the characteristics of cat cover

Answer 209

1. Each agreement is **individually negotiated and unique** 2. Premium = rate per million of mean inforce or % of max benefit 3. Only **NAR** is used for premiums and claims 4. **Large deductibles** are common 5. Coverages can be done in **layers**, each with a deductible 6. More useful to **large insurers** with higher exposures to single events

Question 210

What must you specify for cat coverage?

Answer 210

* Min # of individual claims to trigger (e.g. 5 or more) * Max claims covered * Per life limits

Question 211

List the elements of stop loss coverage

Answer 211

1. **Maximum Retention** of the Ceding Company 2. **Expected Claims** of the Covered Business 3. **Attachment Point** of the Stop Loss Coverage 4. **Benefit Limits** of the Stop Loss Coverage

Question 212

Describe the elements of stop loss coverage: * Benefit Limits of the Stop Loss Coverage

Answer 212

* Max total amount of claims reinsurer will pay * Usually reinsurer pays \< 100% to encourage ceding company to manage claims

Question 213

Describe the elements of stop loss coverage: * Attachment Point of the Stop Loss Coverage

Answer 213

* Like a deductible: reinsurer pays claims in excess of attachment point * Express as % of expected claims * The higher the attachment point, the lower the stop loss premium

Question 214

Describe the elements of stop loss coverage: * Expected Claims of the Covered Business

Answer 214

* Forms the basis for the attachment point * Express relative to ceding company’s experience * Must document exactly which policies are included

Question 215

Describe the elements of stop loss coverage: * Maximum Retention of the Ceding Company

Answer 215

* Defines max amount per life that will be part of the stop loss coverage

Question 216

Why do few insurers purchase stop loss?

Answer 216

* **Few reinsurers _offer_ stop loss** * Correlation risk makes it risky for reinsurers * Most just do it accommodate existing clients * Max coverage is usually **too small** to be of value ñ too little protection * Must be **renegotiated** every year (price and/or coverage could change) * If stop loss claims occur, **premiums will rise** * **Can’t spread** losses or reserves over a number of years * **Administration is difficult** (requires a lot of data)

Question 217

What is spread loss reinsurance?

Answer 217

* **Spread loss is rarely, if ever, used in the US or Canada** * Like stop loss, but ceding company repays claims to reinsurer with interest * **Stat and GAAP accounting view it as a loan**, not reinsurance * Reinsurer’s primary risks are similar to those of a loan: cash flow timing, credit, etc. * If ceding company becomes insolvent, reinsurer does not get repaid * Ceding company **cannot take a stat reserve credit** * US GAAP does not treat it as reinsurance (use deposit accounting)

Question 218

Identify **problems** for non-proportional reinsurance reserving

Answer 218

* **Key problem**: stat and GAAP don’t allow reserve credit * Non-proportional reinsurance **covers events beyond what normal** **reserves cover** * **Possible solution**: set attachment point \< 100% of expected claims * If claims are triggered, ceding company can take credit for expected recoveries

Question 219

Identify **considerations** for non-proportional reinsurance reserving

Answer 219

* Must establish reserve for claims owed (once they are owed) * **US stat accounting** * Can include full premium in earnings or only load above NP * Must **hold surplus** in relation to risk * **US GAAP** * All premiums/claims usually earned/expensed during period of coverage * If only including loading in earnings. . . * Must be able to demonstrate that a **future claim is** **reasonably likely** * Must **release the reserve** over some period of time if claims do not occur

Question 220

List 3 motivations for strategic reinsurance structures

Answer 220

1. Structured protection and risk transfer 2. Corporate-finance driven 3. Enabling strategy and growth

Question 221

Describe 3 motivations for strategic reinsurance structures: * Enabling strategy and growth

Answer 221

* Creates partnership between insurer and reinsurer * Multi-year solutions align reinsurance with the client’s long-term strategic plans

Question 222

Describe 3 motivations for strategic reinsurance structures: * Corporate-finance driven

Answer 222

* Releases trapped or redundant capital and/or increases ROE * Optimizes capital structure to achieve a broader set of financial objectives * Can be substituted for traditional capital * Can reduce insurer’s CoC by reducing volatility

Question 223

Describe 3 motivations for strategic reinsurance structures: * Structured protection and risk transfer

Answer 223

* Increases efficiency of insurance programs * Makes it easier to insure difficult-to-insure risks * Increases capacity for catastrophic risks (most difficult for smaller carriers)

Question 224

List the 6 strategic reinsurance solutions

Answer 224

1. Solutions supporting capital efficiency and relief 2. Life in-force monetization 3. Solutions mitigating regulatory changes 4. Solutions supporting growth plans 5. Solutions for mutual insurers 6. Solutions facilitating mergers and acquisitions (M&A)

Question 225

Describe how strategic reinsurance can be used to for capital efficiency and relief

Answer 225

* Strategic reinsurance can be a better alternative to traditional capital: * Lowers the insurer’s cost of capital * More targeted, flexible, and private * Optimize free cash flow and boost ROE

Question 226

Describe the role of life in-force monetization in strategic reinsurance

Answer 226

* **Reinsurance can be used to monetize embedded profits (VIF)** * Upfront ceding commission = VIF * Use capital for new business * Reduces required capital for the monetized block * Frees up capital and embedded profits in legacy/discontinued LOBs \*Policy admin can also be outsourced to the reinsurer

Question 227

Describe how strategic reinsurance can mitigate regulatory changes

Answer 227

* Reduce risk on non-life lines, making companies more balanced/competitive * Release capital from non-life lines, freeing it up for use in life lines

Question 228

Describe how strategic reinsurance can support growth plans

Answer 228

* Provide upfront funding/capital for new business * Reinsurers can provide underwriting expertise for new products/markets

Question 229

Describe strategic reinsurance solutions for **mutual insurers**

Answer 229

* Reduce capital requirements * Contingent access to capital if threat scenarios emerge * Capital relief for closed participating blocks after demutualization

Question 230

How are mutual companies at a disadvantage to stock companies?

Answer 230

* Can’t issue stock to raise capital * Rely on retained earnings to build surplus * Harder to fund new business, make acquisitions, and compete

Question 231

List 3 ways strategic reinsurance can facilitate M&A

Answer 231

1. Enabling transaction financing and capital efficiency 2. Managing risk and investors’ expectations 3. Strengthen stakeholder confidence by signaling

Question 232

List 3 ways strategic reinsurance can facilitate M&A: * Strengthen stakeholder confidence by signaling

Answer 232

* Confidence that best practices were used in the transaction * Commitment of reinsurer’s backing * Increased confidence in the combined entity’s ability to manage future risks

Question 233

List 3 ways strategic reinsurance can facilitate M&A: * Managing risk and investors’ expectations

Answer 233

* Restructure risks, making seller more attractive to buyers * Reinsure risks the acquiring company does not want to retain * Protect future earnings and dividends from adverse developments * Provide risk management expertise before/after transaction

Question 234

List 3 ways strategic reinsurance can facilitate M&A: * Enabling transaction financing and capital efficiency

Answer 234

* Efficient/flexible capital/reserve relief with no increase in leverage * Can be done before or after acquisition and scaled up later