ILA-LPM D Flashcards

Question 1

Q

What is the main goal of in-force management?

Answer

A

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

Question 2

Q

List 6 levers for effective in-force management

Answer

A

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

Question 3

Q

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

Answer

A

Set financial targets
Determine constraints
Project future market conditions
Identify opportunities and rank by attractiveness
Specify target liability portfolio
Manage asset portfolio
Optimize capital structure
Verify that constraints are met

Question 4

Q

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

Answer

A

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

Q

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

Answer

A

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

Q

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

Answer

A

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

Question 7

Q

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

Answer

A

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

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

Question 8

Q

Describe 5 methods for improving persistency on in-force blocks

Answer

A

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

Question 9

Q

List at least 4 methods for improving claims management

Answer

A

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

Question 10

Q

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

Answer

A

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

Q

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

Answer

A

Stabilizing Cash Flows and Earnings
Freeing Up Trapped Capital

Question 12

Q

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

Stabilizing Cash Flows and Earnings

Answer

A

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

Q

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

Freeing Up Trapped Capital

Answer

A

XXX/AXXX excess reserve financing
Monetize VIF or sell block

Question 14

Q

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

Answer

A

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

Q

List the 3 sources of mortality volatility

Answer

A

Trend risk
Basis risk
Long-term underwriting risk

Question 16

Q

Describe the 3 sources of mortality volatility:

Trend risk

Answer

A

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

Q

Describe the 3 sources of mortality volatility:

Basis risk

Answer

A

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

Question 18

Q

Describe the 3 sources of mortality volatility:

Long-term underwriting risk

Answer

A

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

Question 19

Q

Formula for the mean cost of mortality volatility using IRR

Answer

A

= Deterministic IRR - Stochastic Mean IRR

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

Question 20

Q

Formula for the mean cost of mortality volatility using distributable earnings

Answer

A

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

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

Question 21

Q

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

Answer

A

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

Q

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

Answer

A

Diversification Savings =

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

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

Question 23

Q

List 4 common GLWB product designs

Answer

A

No Ratchet
Lookback Ratchet
Remaining WBB Ratchet
Performance Bonus

Question 24

Q

Describe common GLWB product designs:

Performance Bonus:

Answer

A

WBB decreases with withdrawals but never increases

Question 25

Q

Describe common GLWB product designs:

Remaining WBB Rachet

Answer

A

Like Lookback, except WBB decreases with withdrawals

Question 26

Q

Describe common GLWB product designs:

Lookback Rachet

Answer

A

WBB = highest AV ⇒ allows W^guar_t to increase

Question 27

Q

Describe common GLWB product designs:

No Rachet

Answer

A

WBB and W_t^guar are constant all years

Question 28

Q

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

Answer

A

Death ⇒ contract terminates
Alive, but no withdrawal
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
Full surrender ⇒ contract terminates

Question 29

Q

Compare the 4 GLWB designs in terms of benefit richness

Answer

A

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

Q

List 2 financial models of the equity process for VA GLWBs

Answer

A

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

Q

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

Answer

A

As option value increases, FGWR decreases

Question 32

Q

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

Impact of volatility

Answer

A

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

Q

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

Impact of surrender rates

Answer

A

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

Question 34

Q

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

Impact of risk-free rate

Answer

A

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

Question 35

Q

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

Product design

Answer

A

Richer ratchet = lower FGWR
Lowest FGWRs: Remaining WBB and Performance Bonus (very similar)

*Results are similar for Black-Scholes and Heston b

Question 36

Q

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

No Ratchet

Answer

A

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

Question 37

Q

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

Lookback

Answer

A

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

Question 38

Q

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

Remaining WBB

Answer

A

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

Question 39

Q

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

Performance Bonus

Answer

A

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

Question 40

Q

Describe the characteristics of the Greeks in a GLWB hedge portfolio

Delta

Answer

A

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

Q

Describe the characteristics of the Greeks in a GLWB hedge portfolio

Rho

Answer

A

Rho: Negative – as interest rate increases, GLWB value decreases

Question 42

Q

Describe the characteristics of the Greeks in a GLWB hedge portfolio

Vega

Answer

A

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

Question 43

Q

Briefly describe hedging strategies for GLWBs

Answer

A

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

Q

Describe 3 metrics used to assess GLWB hedging effectiveness

Answer

A

Expected profit (higher is better)
CTE of capital required to avoid a loss (lower is better)
CTE of final loss (lower is better)

Question 45

Q

Describe the following related to GLWB hedging:

Riskiest GLWB designs before and after hedging

Answer

A

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

Question 46

Q

Describe the following related to GLWB hedging:

Choice of constant or stochastic volatility for hedging

Answer

A

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

Q

Describe the following related to GLWB hedging:

Impact of vega hedging

Answer

A

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

Question 48

Q

Describe the following related to GLWB hedging:

Impact of delta hedging

Answer

A

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

Question 49

Q

How could future interest rate changes impact on insurance liabilities?

Answer

A

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

Q

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

Answer

A

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

Question 51

Q

Why is interest rate history before 1980 not useful?

Answer

A

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

Question 52

Q

Describe how interest rate history since 1980 has evolved

Answer

A

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

Q

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

Answer

A

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

Q

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

Answer

A

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

Q

What is the quantity theory of money?

Answer

A

changes in the money supply drive price-level changes

Question 56

Q

GDP formula and all pieces

Answer

A

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

Q

Interpret the velocity of money

Answer

A

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

Q

Suggest a new paradigm for modeling interest rates

Answer

A

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

Q

Describe the liquidity dilemma faced by insurers

Answer

A

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

Q

Define immunization

Answer

A

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

Question 61

Q

Describe methods used for interest rate immunization

Macaulay duration

Answer

A

Macaulay duration = average time to receive fixed cash flows

Question 62

Q

Describe methods used for interest rate immunization

Modified duration

Answer

A

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

Question 63

Q

Describe methods used for interest rate immunization

Effective duration

Answer

A

Effective duration allows for interest-sensitive cash flows

Question 64

Q

Describe methods used for interest rate immunization

Key rate duration

Answer

A

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

Answer 65

A

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

Answer 66

A

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

Answer 67

A

Retrocessions – create contagion risk for other reinsurers

Answer 68

A

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

Answer 69

A

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

Answer 70

A

ULSG profits are highly dependent on interest rates

Answer 71

A

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

Answer 72

A

VUL – fixed funds have interest rate risk similar to UL

Answer 73

A

more attractive when interest rates and equity volatility are low

Answer 74

A

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

Answer 75

A

Longevity risk exacerbates risk of low interest rates

Answer 76

A

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

Answer 77

A

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

Answer 78

A

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

Answer 79

A

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

Answer 80

A

Pro Rata
Level or Constant Retention
Constant Risk Reinsured
Formula Retention

Answer 81

A

NAR and retention are determined by initially agreed upon formula

Answer 82

A

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

Answer 83

A

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

Answer 84

A

(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

Answer 85

A

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

Answer 86

A

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

Answer 87

A

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

Answer 88

A

Calendar year scales avoid year-end reinsurance reserves

Answer 89

A

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

Answer 90

A

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

Answer 91

A

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

Answer 92

A

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

Answer 93

A

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

Answer 94

A

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

Answer 95

A

Simplest approach
More equitable
Use a single band

Answer 96

A

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

Answer 97

A

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

Answer 98

A

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

Answer 99

A

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

Answer 100

A

Policy fee: may be fully retained by ceding company
- Reinsurer may coinsure policy so it can be included in deficiency reserve

*Substandards and riders treated similarly to YRT approaches

Answer 101

A

Policyholder dividends: Reinsurer may or may not participate
- If no participation, creates asset management challenges for ceding company

*Substandards and riders treated similarly to YRT approaches

Answer 102

A

Policy loans: No participation by reinsurer ever

*Substandards and riders treated similarly to YRT approaches

Answer 103

A

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

Answer 104

A

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

Answer 105

A

Positive mod-co adjustment = payment by reinsurer

Mod-co adjustment =

Ending ceded stat reserves - Beginning ceded stat reserves - “Interest” on beginning ceded stat reserves

Answer 106

A

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

Answer 107

A

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

Answer 108

A

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

Answer 109

A

Coins. = Yes
Mod-Co = Yes
FW-Co = Yes
FW-Mod-Co = ?

Answer 110

A

Coins. = No
Mod-Co = No
FW-Co = No
FW-Mod-Co = Yes

Answer 111

A

Coins. = No
Mod-Co = No
FW-Co = Yes
FW-Mod-Co = Yes

Answer 112

A

Coins. = No
Mod-Co = Yes
FW-Co = No
FW-Mod-Co = Yes

Answer 113

A

Coins. = Yes
Mod-Co = No
FW-Co = Yes
FW-Mod-Co = Yes

Answer 114

A

Coins. = Yes
Mod-Co = No
FW-Co = No
FW-Mod-Co = No

Answer 115

A

Coins. = Yes
Mod-Co = No
FW-Co = Yes
FW-Mod-Co = No

Answer 116

A

Coins. = Yes
Mod-Co = No
FW-Co = Yes
FW-Mod-Co = No

Answer 117

A

a blend of regular coinsurance and mod-co

Answer 118

A

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

Answer 119

A

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

Answer 120

A

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

Answer 121

A

FW-Mod-Co may violate state laws

State laws usually require quarterly settlement of amounts
May be possible to get approval

Answer 122

A

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

Answer 123

A

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

Answer 124

A

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

Answer 125

A

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

Answer 126

A

= 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

Answer 127

A

= Basic Stat Reserve + Additional XXX Reserves

Answer 128

A

= GAAP BenRes - DAC

Answer 129

A

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

Answer 130

A

“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

Answer 131

A

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

Answer 132

A

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

Answer 133

A

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

Answer 134

A

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

Answer 135

A

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

Answer 136

A

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)

Answer 137

A

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

Answer 138

A

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

Answer 139

A

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

Answer 140

A

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

Answer 141

A

indemnity
M&A
liquidation/rehabilitation
if state guaranty involved

Answer 142

A

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

Answer 143

A

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

Answer 144

A

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

Answer 145

A

Establish assumption reinsurance agreement
Submit and wait for regulatory approval
Wait for policyholder consent
Consenting policyholders’ policies move to assumption agreement

*Each step is tedious and time consuming!

Answer 146

A

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

Answer 147

A

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

Answer 148

A

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

Answer 149

A

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

Answer 150

A

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

Answer 151

A

Interim indemnity reinsurance
Right of assumption agreements

Answer 152

A

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

Answer 153

A

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

Answer 154

A

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)

Answer 155

A

Write off DAC and release benefit reserves

Answer 156

A

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

Answer 157

A

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

Answer 158

A

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

Answer 159

A

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

Answer 160

A

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

Answer 161

A

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

Answer 162

A

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

Answer 163

A

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

Answer 164

A

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

Answer 165

A

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

Answer 166

A

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

Answer 167

A

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

Answer 168

A

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

Answer 169

A

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

Answer 170

A

Assumption reinsurance differences:

Generally reduces ceding company’s capital more than indemnity
No counterparty risk capital requirement

Answer 171

A

YRT usage increases and ceded amounts increase

Answer 172

A

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

Answer 173

A

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

Answer 174

A

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

Answer 175

A

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

Answer 176

A

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

Answer 177

A

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

Answer 178

A

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

Answer 179

A

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

Answer 180

A

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

Answer 181

A

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

Answer 182

A

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

Answer 183

A

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

Answer 184

A

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

Answer 185

A

Use mod-co or FW

Answer 186

A

Use regular coinsurance, possibly mod-co or FW

Answer 187

A

Use any form of coinsurance

Answer 188

A

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

Answer 189

A

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)

Answer 190

A

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

Answer 191

A

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

Answer 192

A

Model Reg denies reserve credit (or asset reduction) if ANY of these exist:

Renewal EA < anticipated allocable renewal expenses
Reinsurer can choose to deprive ceding company of surplus or assets
Ceding company must repay reinsurer for losses
Ceding must recapture or terminate at specific date
Ceding company must pay amounts not realized from reinsured policies
Agreement fails to transfer all significant risk
Credit/disintermediation/reinvestment risk is significant and not transferred
More than 90 days between cash settlement
Ceding company has to make non-reinsurance-related warranties
Ceding company has to guarantee future performance
Main purpose is temporary surplus relief without transferring all significant risks

Answer 193

A

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

Answer 194

A

Morbidity: LTCI only
Mortality: all life products and immediate annuities
Lapse: all life and annuity products except immediate annuities
Credit Quality: all products except non-par term
Reinvestment: all products except non-par term
Disintermediation: all products except non-par term, LTCI, and immediate annuities

Answer 195

A

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

Answer 196

A

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

Answer 197

A

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

Answer 198

A

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

Answer 199

A

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

Answer 200

A

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

Answer 201

A

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

Answer 202

A

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

Answer 203

A

Catastrophe Coverage
Stop Loss
Spread Loss

Answer 204

A

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

Answer 205

A

(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

Answer 206

A

(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

Answer 207

A

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

Answer 208

A

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

Answer 209

A

Maximum Retention of the Ceding Company
Expected Claims of the Covered Business
Attachment Point of the Stop Loss Coverage
Benefit Limits of the Stop Loss Coverage

Answer 210

A

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

Answer 211

A

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

Answer 212

A

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

Answer 213

A

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

Answer 214

A

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)

Answer 215

A

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)

Answer 216

A

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

Answer 217

A

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

Answer 218

A

Structured protection and risk transfer
Corporate-finance driven
Enabling strategy and growth

Answer 219

A

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

Answer 220

A

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

Answer 221

A

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

Answer 222

A

Solutions supporting capital efficiency and relief
Life in-force monetization
Solutions mitigating regulatory changes
Solutions supporting growth plans
Solutions for mutual insurers
Solutions facilitating mergers and acquisitions (M&A)

Answer 223

A

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

Answer 224

A

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

Answer 225

A

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

Answer 226

A

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

Answer 227

A

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

Answer 228

A

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

Answer 229

A

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

Answer 230

A

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

Answer 231

A

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

Answer 232

A

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