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ILA Track > ILA-LPM D > Flashcards

ILA-LPM D Flashcards

1
Q

What is the main goal of in-force management?

A
  • get more profit out of in-force business (don’t just try to sell more business)
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2
Q

List 6 levers for effective in-force management

A
  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)
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3
Q

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

A
  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
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4
Q

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

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)
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5
Q

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

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
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6
Q

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

A
  1. Adjust non-guaranteed elements (dividends, crediting rates, premiums)
  2. Exchange/conversion programs
  3. Buyout programs (buy back unprofitable products)
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7
Q

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

A
  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!

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8
Q

Describe 5 methods for improving persistency on in-force blocks

A
  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.)
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9
Q

List at least 4 methods for improving claims management

A
  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
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10
Q

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

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.)
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11
Q

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

A
  1. Stabilizing Cash Flows and Earnings
  2. Freeing Up Trapped Capital
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12
Q

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

  • Stabilizing Cash Flows and Earnings
A
  • Transferring mortality/morbidity risks – reinsurance, cat bonds
  • Reinsure longevity risk on life annuities
  • Transferring lapse risk – VIF solutions, non-proportional lapse risk reinsurance
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13
Q

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

  • Freeing Up Trapped Capital
A
  • XXX/AXXX excess reserve financing
  • Monetize VIF or sell block
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14
Q

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

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
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15
Q

List the 3 sources of mortality volatility

A
  1. Trend risk
  2. Basis risk
  3. Long-term underwriting risk
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16
Q

Describe the 3 sources of mortality volatility:

  • Trend risk
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
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17
Q

Describe the 3 sources of mortality volatility:

  • Basis risk
A
  • uncertainty in the assumed mortality level
  • Higher uncertainty in best estimate = higher basis risk
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18
Q

Describe the 3 sources of mortality volatility:

  • Long-term underwriting risk
A
  • uncertainty in 3 factors:
    1. Initial select period
    2. Length of grading off period for preferred or substandard
    3. Ultimate mortality level
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19
Q

Formula for the mean cost of mortality volatility using IRR

A

= Deterministic IRR - Stochastic Mean IRR

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

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20
Q

Formula for the mean cost of mortality volatility using distributable earnings

A

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

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

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21
Q

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

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
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22
Q

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

A
  • Diversification Savings =

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

  • Diversification savings increase near the tail
  • Increasing SPIA volume increases diversification savings
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23
Q

List 4 common GLWB product designs

A
  1. No Ratchet
  2. Lookback Ratchet
  3. Remaining WBB Ratchet
  4. Performance Bonus
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24
Q

Describe common GLWB product designs:

  • Performance Bonus:
A
  • WBB decreases with withdrawals but never increases
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25
Q

Describe common GLWB product designs:

  • Remaining WBB Rachet
A
  • Like Lookback, except WBB decreases with withdrawals
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26
Q

Describe common GLWB product designs:

  • Lookback Rachet
A
  • WBB = highest AV ⇒ allows Wguart to increase
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27
Q

Describe common GLWB product designs:

  • No Rachet
A
  • WBB and Wtguar are constant all years
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28
Q

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

A
  1. Death ⇒ contract terminates
  2. Alive, but no withdrawal
  3. Alive and makes a withdrawal Wt <= Wguar-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
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29
Q

Compare the 4 GLWB designs in terms of benefit richness

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
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30
Q

List 2 financial models of the equity process for VA GLWBs

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

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31
Q

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

A

As option value increases, FGWR decreases

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32
Q

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

  • Impact of volatility
A
  • as σ increases, option value increases, FGWR decreases
  • Ratchet mechanisms are the most sensitive

*Results are similar for Black-Scholes and Heston b

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33
Q

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

  • Impact of surrender rates
A
  • as surrenders decrease, FGWR decreases (more benefits in force)
  • *Results are similar for Black-Scholes and Heston b*
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34
Q

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

  • Impact of risk-free rate
A
  • as rfdecreases, option value increases, FGWR decreases
  • *Results are similar for Black-Scholes and Heston b*
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35
Q

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

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

*Results are similar for Black-Scholes and Heston b

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36
Q

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

  • No Ratchet
A
  • No Ratchet: Wguar- is constant
    • Greatest probability of no trigger
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37
Q

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

  • Lookback
A
  • Lookback: Wguar- increases slightly over time
    • Greater probability of trigger than No Ratchet
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38
Q

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

  • Remaining WBB
A
  • Remaining WBB: Wguar- increases more than Lookback
    • Greater probability of trigger than Lookback
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39
Q

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

  • Performance Bonus
A
  • Performance Bonus: Wguar- peaks early, then decreases
    • Highest probability of early trigger
    • Least uncertainty in trigger time (PB erodes AV quickly)
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40
Q

Describe the characteristics of the Greeks in a GLWB hedge portfolio

  • Delta
A
  • Delta: Negative – as St increases, GLWB value decreases
    • No Ratchet delta is highest initially (guarantee doesn’t adjust)
    • Ratchets have adjusting guarantees (offsets drop in put value when St rises)
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41
Q

Describe the characteristics of the Greeks in a GLWB hedge portfolio

  • Rho
A
  • Rho: Negative – as interest rate increases, GLWB value decreases
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42
Q

Describe the characteristics of the Greeks in a GLWB hedge portfolio

  • Vega
A
  • Vega: Positive – as σ increases, GLWB value increases
    • Very large for Lookback and Remaining WBB compared to others
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43
Q

Briefly describe hedging strategies for GLWBs

A
  • The insurer’s cumulative gain (loss) at time t is:

Hedge Portfoliot - GLWB Valuet

  • Hedge portfolio = guarantee fees invested in various positions
  • Straddle option = combination of call and put (required to hedge vega)
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44
Q

Describe 3 metrics used to assess GLWB hedging effectiveness

A
  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)
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45
Q

Describe the following related to GLWB hedging:

  • Riskiest GLWB designs before and after hedging
A
  • Riskiest products from hedge perspective:
    • No hedge: No Ratchet has highest risk
    • Delta/Vega hedge: Lookback and Remaining WBB are riskiest
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46
Q

Describe the following related to GLWB hedging:

  • Choice of constant or stochastic volatility for hedging
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
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47
Q

Describe the following related to GLWB hedging:

  • Impact of vega hedging
A
  • Vega hedging further reduces risk, but. . .
    • Also adds complexity: no unique solution exists
    • Over-hedging is worse than no hedging at all
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48
Q

Describe the following related to GLWB hedging:

  • Impact of delta hedging
A
  • Any kind of delta hedging greatly reduces risk
    • BS and Heston are similar: hedging model choice not that important
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49
Q

How could future interest rate changes impact on insurance liabilities?

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
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50
Q

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

A
  • UL is very stable
  • SPDA is hurt by extreme shifts (up or down)
  • ULSG is hurt most by low rates
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51
Q

Why is interest rate history before 1980 not useful?

A
  • More activist central bank role beginning in 1980s
  • Financial markets are more integrated
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52
Q

Describe how interest rate history since 1980 has evolved

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)
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53
Q

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

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
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54
Q

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

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
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55
Q

What is the quantity theory of money?

A
  • changes in the money supply drive price-level changes
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56
Q

GDP formula and all pieces

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)
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57
Q

Interpret the velocity of money

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
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58
Q

Suggest a new paradigm for modeling interest rates

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
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59
Q

Describe the liquidity dilemma faced by insurers

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
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60
Q

Define immunization

A
  • Immunization – match asset-liability cash flows and/or durations
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61
Q

Describe methods used for interest rate immunization

  • Macaulay duration
A
  • Macaulay duration = average time to receive fixed cash flows
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62
Q

Describe methods used for interest rate immunization

  • Modified duration
A
  • Modified duration = % delta in PV of fixed CFs for a 1% delta in interest rates
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63
Q

Describe methods used for interest rate immunization

  • Effective duration
A
  • Effective duration allows for interest-sensitive cash flows
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64
Q

Describe methods used for interest rate immunization

  • Key rate duration
A
  • Key rate duration = sensitivity to change in a single point on the yield curve
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65
Q

List 3 forms of reinsurance-related interest rate risk

  • Coinsurance
A
  • Coinsurance – reinsurer may experience run-on-the-bank (increases counterparty risk)
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66
Q

List 3 forms of reinsurance-related interest rate risk

  • Mod-co and FW
A
  • ​Mod-co and FW – reinsurer is at risk from direct writer’s investment results
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67
Q

List 3 forms of reinsurance-related interest rate risk

  • ​​Retrocessions
A
  • ​Retrocessions – create contagion risk for other reinsurers
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68
Q

Describe how life insurance products are affected by interest rate risk

  • Issues with US statutory accounting
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
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69
Q

Describe how life insurance products are affected by interest rate risk

  • Cash value
A
  • Cash value products have run-on-the-bank risk
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70
Q

Describe how life insurance products are affected by interest rate risk

  • ​ULSG
A
  • ULSG profits are highly dependent on interest rates
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71
Q

Describe how life insurance products are affected by interest rate risk

  • UL
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
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72
Q

Describe how life insurance products are affected by interest rate risk

  • VUL
A
  • VUL – fixed funds have interest rate risk similar to UL
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73
Q

Describe how annuity products are affected by interest rate risk:

  • Indexed annuities
A
  • more attractive when interest rates and equity volatility are low
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74
Q

Describe how annuity products are affected by interest rate risk:

  • VA Guarantees
A
  • Increase in value when:
    • Interest rates are low
    • Equity volatility is high
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75
Q

Describe how annuity products are affected by interest rate risk:

  • Payout Annuities
A
  • Longevity risk exacerbates risk of low interest rates
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76
Q

Describe how annuity products are affected by interest rate risk:

  • Deferred Annuities
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
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77
Q

Describe YRT reinsurance in general

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
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78
Q

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

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
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79
Q

Describe the calculation of ceded net amount at risk under YRT

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
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80
Q

List the 4 YRT retention determination methods

A
  1. Pro Rata
  2. Level or Constant Retention
  3. Constant Risk Reinsured
  4. Formula Retention
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81
Q

Decrive the 4 YRT retention determination methods:

  • Formula Retention
A
  • NAR and retention are determined by initially agreed upon formula
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82
Q

Decrive the 4 YRT retention determination methods:

  • Constant Risk Reinsured
A
  • (rare)
  • Reinsured amount = constant amount
  • Retained portion of NAR falls over time
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83
Q

Decrive the 4 YRT retention determination methods:

  • Level or Constant Retention
A
  • Company retains a fixed amount of the NAR
  • Reinsured portion of NAR falls over time
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84
Q

Decrive the 4 YRT retention determination methods:

  • Pro Rata
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
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85
Q

Formula for YRT reinsurance premiums

A

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

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86
Q

Components of YRT reinsurance premiums.

A
  • YRT premium rate
  • May have zero first-year premium (ZFT)
  • Calendar year scales
  • Substandard ratings
  • Riders
  • Monthly renewable term (MRT) for UL
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87
Q

Describe the calculation of YRT reinsurance premiums:

  • YRT premium rate
A
  • YRT premium rate = multiple of mortality table
    • Vary by age, duration, sex, underwriting class
    • Select periods are common (e.g. 15 years)
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88
Q

Describe the calculation of YRT reinsurance premiums.

  • Calendar year scales
A
  • Calendar year scales avoid year-end reinsurance reserves
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89
Q

Describe the calculation of YRT reinsurance premiums.

  • Substandard ratings
A
  • Substandard ratings
    • Table rating: increase by multiple (e.g. 150%)
    • Flat extra: may have allowance on extra premium
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90
Q

Describe the calculation of YRT reinsurance premiums.

  • Riders
A
  • Riders: accidental death may be reinsured separately, term riders use base
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91
Q

Describe the calculation of YRT reinsurance premiums.

  • ​Monthly renewable term (MRT) for UL
A
  • Monthly renewable term (MRT) for UL: YRT done on a monthly basis
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92
Q

Describe coinsurance in general

A
  • Reinsurer has a proportionate share of:
    • Direct policyholder premium
    • Direct reserve
    • All benefits (mortality, morbidity, lapse, surrender, investment)
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93
Q

Compare coinsurance to YRT

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
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94
Q

Coinsurance premium formula

A

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

95
Q

List 3 different approaches for banded premiums for coinsurance

A
  1. Simplest approach
  2. More equitable
  3. Use a single band
96
Q

Describe different approaches for banded premiums for coinsurance

  • Simplest approach
A
  • Simplest approach
    • Use actual GP for each policy
    • Use common set of allowances for all bands
97
Q

Describe different approaches for banded premiums for coinsurance

  • More equitable
A
  • More equitable (and complicated)
    • Use actual GP for each policy
    • Vary allowances by band
98
Q

Describe different approaches for banded premiums for coinsurance

  • Use a single band
A
  • Use a single band
    • Use GP for a specific band regardless of actual band
    • One set of allowances for all policies
99
Q

Describe variations in coinsurance expense allowances

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
100
Q

Describe how the following are treated under coinsurance:

  • Policy fee
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

101
Q

Describe how the following are treated under coinsurance:

  • Policyholder dividends
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

102
Q

Describe how the following are treated under coinsurance:

  • Policy loans
A
  • Policy loans: No participation by reinsurer ever

*Substandards and riders treated similarly to YRT approaches

103
Q

Advantages/uses of mod-co compared to regular coinsurance

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
104
Q

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

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
105
Q

Describe the calculation of the mod-co adjustment

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

106
Q

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

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
107
Q

What are the goals of advanced uses of reinsurance?

A
  • Primary goals of advanced uses of reinsurance:
    • Provide surplus relief to ceding company
    • Reduce transfer of assets between companies
108
Q

What are the primary advantages of advanced uses of reinsurance?

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
109
Q

Compare advanced forms of reinsurance in terms of the following:

  • Complies with state laws?
A
  1. Coins. = Yes
  2. Mod-Co = Yes
  3. FW-Co = Yes
  4. FW-Mod-Co = ?
110
Q

Compare advanced forms of reinsurance in terms of the following:

  • Establish a FW balance for initial allowance only?
A
  1. Coins. = No
  2. Mod-Co = No
  3. FW-Co = No
  4. FW-Mod-Co = Yes
111
Q

Compare advanced forms of reinsurance in terms of the following:

  • Establish a FW balance instead of exchanging cash?
A
  1. Coins. = No
  2. Mod-Co = No
  3. FW-Co = Yes
  4. FW-Mod-Co = Yes
112
Q

Compare advanced forms of reinsurance in terms of the following:

  • Calculate mod-co adjustment
A
  1. Coins. = No
  2. Mod-Co = Yes
  3. FW-Co = No
  4. FW-Mod-Co = Yes
113
Q

Compare advanced forms of reinsurance in terms of the following:

  • Reinsurer owns performance of assets?
A
  1. Coins. = Yes
  2. Mod-Co = No
  3. FW-Co = Yes
  4. FW-Mod-Co = Yes
114
Q

Compare advanced forms of reinsurance in terms of the following:

  • Reinsurer holds assets backing ceded reserves?
A
  1. Coins. = Yes
  2. Mod-Co = No
  3. FW-Co = No
  4. FW-Mod-Co = No
115
Q

Compare advanced forms of reinsurance in terms of the following:

  • Ceding company takes reserve credit?
A
  1. Coins. = Yes
  2. Mod-Co = No
  3. FW-Co = Yes
  4. FW-Mod-Co = No
116
Q

Compare advanced forms of reinsurance in terms of the following:

  • Reinsurer holds reserve?
A
  1. Coins. = Yes
  2. Mod-Co = No
  3. FW-Co = Yes
  4. FW-Mod-Co = No
117
Q

What is part-co?

A

a blend of regular coinsurance and mod-co

118
Q

Compare funds withheld coinsurance with regular coinsurance

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
119
Q

Give an alternative, equivalent OSA calculation for FW

A

OSAt = OSAt-1 + CededPremt
- CededBent - CededResIncrt - ExperienceRefundt = RiskCharget

120
Q

Describe funds withheld mod-co

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
121
Q

FW-Mod-Co and state laws

A

FW-Mod-Co may violate state laws

  • State laws usually require quarterly settlement of amounts
  • May be possible to get approval
122
Q

Describe partially modified coinsurance (part-co)

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
123
Q

Advantages and disadvantages of part-co

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
124
Q

Describe an SPV owner

A
  • SPV owner is called the “sponsor”
  • Could be reinsurer, direct insurer, or parent company
125
Q

How do SPV sponsors want to fund redundant reserves?

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
126
Q

Redundant reserve formula

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
127
Q

Total stat reserves formula

A

= Basic Stat Reserve + Additional XXX Reserves

128
Q

Economic reserve formula

A

= GAAP BenRes - DAC

129
Q

Characterize SPV investors

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
130
Q

Describe the capital structure of a SPV

  • “Required Capital”
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
131
Q

Describe the capital structure of a SPV

  • Economic Reserves + Required Capital
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
132
Q

List the steps for structuring an SPV

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
133
Q

List considerations for SPV investors (list 4)

A
  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
134
Q

List advantages of using LOCs for SPVs

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
135
Q

Describe the key parties in an assumption reinsurance agreement

A
  • Transferring insurer – the original direct insurer being replaced
  • Assuming insurer – the new insurer 100% responsible for all policy obligations
136
Q

Describe the general purpose of an assumption reinsurance agreement

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)
137
Q

Why do transferring insurers use assumption reinsurance?

A
  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
138
Q

Why do assuming insurers use assumption reinsurance?

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
139
Q

Describe the purpose of the NAIC Assumption Reinsurance Model Act

A
  • Provides guidance for assumption transactions but
    • Most states have not adopted
    • Significant variation in procedures from state to state
140
Q

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

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
141
Q

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

A
  • indemnity
  • M&A
  • liquidation/rehabilitation
  • if state guaranty involved
142
Q

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

A
  • State commissioner approvals
    • Transferring insurer domicile state
    • Assuming insurer must be licensed in each state or get commissioners’ approvals
143
Q

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

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
144
Q

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

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
145
Q

List the 4 key steps of the assumption process

A
  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!

146
Q

Decribe the key steps of the assumption process:

  • Consenting policyholders’ policies move to assumption agreement
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
147
Q

Decribe the key steps of the assumption process:

  • Wait for policyholder consent
A
  • Can be specific, implied, or given by a regulator in the event of insolvency
  • Significant variation by state
148
Q

Decribe the key steps of the assumption process:

  • Submit and wait for regulatory approval
A
  • Domicile states of transferrer and assuming insurer must approve
  • Other affected states must approve notice and certificate
149
Q

Decribe the key steps of the assumption process:

  • Establish assumption reinsurance agreement
A
  • covers the sale or transfer
  • Lengthy, complicated negotiation
  • Extensive documentation required
150
Q

List documentation required in the Assumption reinsurance agreement

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
151
Q

List 2 practical methods for dealing with long policyholder consent times

A
  1. Interim indemnity reinsurance
  2. Right of assumption agreements
152
Q

Describe interim indemnity reinsurance

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
153
Q

Describe right of assumption agreements

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
154
Q

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

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)
155
Q

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

A
  • Write off DAC and release benefit reserves
156
Q

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

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
157
Q

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

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
158
Q

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

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
159
Q

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

A
  • Treated like policy surrender
  • Policy reserves are released
  • Assets and policy loans are transferred to assuming insurer
160
Q

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

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
161
Q

List the ICA’s requirements for the assuming insurers

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
162
Q

List the ICA’s requirements for the transferring insurer

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
163
Q

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

A
  • Optmize excess admin capacity
  • Earn higher return on excess surplus
  • Grow without selling new business
164
Q

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

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
165
Q

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

A
  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)
166
Q

List key considerations for indemnity surplus relief treaties

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
167
Q

What are the RBC effects for indemnity reinsurance for:

  • Mod-co
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

168
Q

What are the RBC effects for indemnity reinsurance for:

  • Coinsurance
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

169
Q

What are the RBC effects for indemnity reinsurance for:

  • YRT
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

170
Q

Compare the risk based capital effects of reinsurance in terms of:

  • Indemnity vs. assumption reinsurance
A

Assumption reinsurance differences:

  • Generally reduces ceding company’s capital more than indemnity
  • No counterparty risk capital requirement
171
Q

What is the key trend in YRT usage

A

YRT usage increases and ceded amounts increase

172
Q

Why do ceding companies use YRT reinsurance (4 reasons)

A
  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
173
Q

List advantages of YRT reinsurance

A
  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
174
Q

List disadvantages of YRT reinsurance

A
  1. Limits potential for surplus relief
  2. YRT rates are not guaranteed in the US (may increase)
175
Q

List advantages of coinsurance

A
  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
176
Q

List disadvantages of coinsurance

A
  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
177
Q

List advantages of mod-co

A
  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
178
Q

List disadvantages of mod-co

A
  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
179
Q

List advantages of funds withheld coinsurance

A
  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
180
Q

List disadvantages of funds withheld coinsurance

A
  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
181
Q

List advantages of funds withheld mod-co

A
  1. Reinsurer does not have to liquidate/transfer assets to pay initial allowance
  2. Reinsurer has less risk of ceding company insolvency
182
Q

List disadvantages of funds withheld mod-co

A
  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
183
Q

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

  • Avoid regulatory concerns
A

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

184
Q

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

  • Greatly minimize cash flow
A

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

185
Q

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

  • Use a non-admitted reinsurer
A

Use mod-co or FW

186
Q

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

  • Simplicity desired
A

Use regular coinsurance, possibly mod-co or FW

187
Q

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

  • Raise capital, get surplus relief
A

Use any form of coinsurance

188
Q

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

  • Increase premium competitiveness
A

Use YRT

189
Q

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

  • Significantly reduce mortality risk
A

Use YRT

190
Q

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

A
  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
191
Q

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

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)
192
Q

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

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
193
Q

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

  • Allows regulators to deny ceding company’s coinsurance reserve credit?
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
194
Q

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

A

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
195
Q

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

A
  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
196
Q

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

A
  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
197
Q

Describe key reinsurance risk transfer considerations under US GAAP

A
  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
198
Q

Describe key reinsurance risk transfer considerations under US GAAP

  • Provisions that limit insurance risk transfer or unduly defer reimbursement
A
  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
199
Q

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

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
200
Q

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

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
201
Q

Describe the IRS’s authority under IRS Code Section 845

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
202
Q

Describe components of IRS Code Section 845

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
203
Q

Describe proportional reinsurance

A
  • Based on a quota share of individual risks
  • Includes YRT and all forms of coinsurance covered in earlier chapters
204
Q

Describe non-proportional reinsurance

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
205
Q

List 3 non-proportional reinsurance methods

A
  1. Catastrophe Coverage
  2. Stop Loss
  3. Spread Loss
206
Q

Describe non-proportional reinsurance methods:

  • Stop Loss
A
  • (rarely used for ILA)
  • Reinsurer pays all or a share of claims above attachment point
  • Key concern: surplus volatility from claims fluctuations
207
Q

Describe non-proportional reinsurance methods:

  • Spread Loss
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
208
Q

Describe non-proportional reinsurance methods:

  • Catastrophe Coverage
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
209
Q

Describe the characteristics of cat cover

A
  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
210
Q

What must you specify for cat coverage?

A
  • Min # of individual claims to trigger (e.g. 5 or more)
  • Max claims covered
  • Per life limits
211
Q

List the elements of stop loss coverage

A
  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
212
Q

Describe the elements of stop loss coverage:

  • Benefit Limits of the Stop Loss Coverage
A
  • Max total amount of claims reinsurer will pay
  • Usually reinsurer pays < 100% to encourage ceding company to manage claims
213
Q

Describe the elements of stop loss coverage:

  • Attachment Point of the Stop Loss Coverage
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
214
Q

Describe the elements of stop loss coverage:

  • Expected Claims of the Covered Business
A
  • Forms the basis for the attachment point
  • Express relative to ceding company’s experience
  • Must document exactly which policies are included
215
Q

Describe the elements of stop loss coverage:

  • Maximum Retention of the Ceding Company
A
  • Defines max amount per life that will be part of the stop loss coverage
216
Q

Why do few insurers purchase stop loss?

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)
217
Q

What is spread loss reinsurance?

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)
218
Q

Identify problems for non-proportional reinsurance reserving

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
219
Q

Identify considerations for non-proportional reinsurance reserving

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
220
Q

List 3 motivations for strategic reinsurance structures

A
  1. Structured protection and risk transfer
  2. Corporate-finance driven
  3. Enabling strategy and growth
221
Q

Describe 3 motivations for strategic reinsurance structures:

  • Enabling strategy and growth
A
  • Creates partnership between insurer and reinsurer
  • Multi-year solutions align reinsurance with the client’s long-term strategic plans
222
Q

Describe 3 motivations for strategic reinsurance structures:

  • Corporate-finance driven
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
223
Q

Describe 3 motivations for strategic reinsurance structures:

  • Structured protection and risk transfer
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)
224
Q

List the 6 strategic reinsurance solutions

A
  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)
225
Q

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

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
226
Q

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

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

227
Q

Describe how strategic reinsurance can mitigate regulatory changes

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
228
Q

Describe how strategic reinsurance can support growth plans

A
  • Provide upfront funding/capital for new business
  • Reinsurers can provide underwriting expertise for new products/markets
229
Q

Describe strategic reinsurance solutions for mutual insurers

A
  • Reduce capital requirements
  • Contingent access to capital if threat scenarios emerge
  • Capital relief for closed participating blocks after demutualization
230
Q

How are mutual companies at a disadvantage to stock companies?

A
  • Can’t issue stock to raise capital
  • Rely on retained earnings to build surplus
  • Harder to fund new business, make acquisitions, and compete
231
Q

List 3 ways strategic reinsurance can facilitate M&A

A
  1. Enabling transaction financing and capital efficiency
  2. Managing risk and investors’ expectations
  3. Strengthen stakeholder confidence by signaling
232
Q

List 3 ways strategic reinsurance can facilitate M&A:

  • Strengthen stakeholder confidence by signaling
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
233
Q

List 3 ways strategic reinsurance can facilitate M&A:

  • Managing risk and investors’ expectations
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
234
Q

List 3 ways strategic reinsurance can facilitate M&A:

  • Enabling transaction financing and capital efficiency
A
  • Efficient/flexible capital/reserve relief with no increase in leverage
  • Can be done before or after acquisition and scaled up later

ILA Track (5 decks)

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