Odo.FinReg

Question 1

(SAP v GAAP) - objective

Answer 1

SAP: measure ability to pay claims
GAAP: measurement of earnings (FROM PART VI, which ISN’T ON SYLLABUS)

Question 2

(SAP v GAAP) - intended user

Answer 2

SAP: regulators
GAAP: general audience (policyholders, investors, public)

Question 3

(SAP v GAAP) - asset recognition

Answer 3

SAP: asset recognized when expense incurred
GAAP: may defer recognition of asset for asset/revenue matching with expenses (Ex: DPAE)

Question 4

(SAP v GAAP) - treatment of reinsurance in loss reserves

Answer 4

SAP: loss reserves NET of reinsurance
GAAP: loss reserves GROSS of reinsurance

Question 5

(SAP v GAAP) - deferred income taxes

Answer 5

SAP: no, doesn’t defer
GAAP: yes, does defer

Question 6

contrast (liquidation, going-concern)

Answer 6

liquidiation:
- runoff of assets/liabilities
- of interest to REGULATORS (for satisfying policy holder obligations)
going-concern:
- continued normal operations
- of interest to INVESTORS

Question 7

contrast (fair value, historical cost)

Answer 7

fair value:
- value in open market
- more accurate
historical cost:
- original cost MINUS depreciation
- easier to calculate

Question 8

contrast (principle-based, rule-based) accounting system

Answer 8

principles-based:
- accounting approach requiring interpretation to apply
- more flexible
rules-based:
- specific guidance
- easier to apply, but less flexible

Question 9

what is Solvency 2

Answer 9

Solvency 2 is a :
→ principles-based insurance regulatory system
→ for capital levels of insurance companies
→ in the European Union.

Question 10

what are the 3 pillars of Solvency 2

Answer 10

QGT
[1] QUANTITATIVE: sets SCR & MCR (Solvency & Minimum Capital Requirements)
- uses a total balance sheet approach
- SCR is defined as 99.5% VaR (Value at Risk) meaning that the probability of ruin is < 0.5%
[2] GOVERNANCE: supervisory activities (internal control & risk management, supervisory review process)
- requires adequate governance for the functions: ♦ internal audit ♦ actuarial ♦ risk management ♦ compliance
- supervisor identifies high-risk companies and may intervene
- note that companies are required to perform ORSA
[3] TRANSPARENCY: supervisory reporting & public disclosure
- information from pillars 1 & 2 is given to the supervisor & financial markets
- purpose is to increase market discipline because companies know their decisions are public

Question 11

quantitative pillar - what happens if total capital falls below SCR; below MCR

Answer 11

• if total capital < SCR –> regulatory intervention
• if total capital < MCR –> company not permitted to operate

Question 12

quantitative pillar - method for calculating SCR (Solvency Capital Requirements)

Answer 12

SCR is set using a total balance sheet approach
METHODS
- standard/regulator model
- approved internal model (more costly than standard model but gives lower capital requirements)

Question 13

governance pillar - identify CONDITIONS that must be addressed (3)

Answer 13

fitness & propriety, outsourcing, internal control

Question 14

governance pillar - describe FUNCTIONS that must be addressed (4)

Answer 14

airc
- internal audit (annual report to Board of Directors on deficiencies)
- actuarial (reasonability of methods & assumptions)
- risk management (monitor)
- compliance (with law)

Question 15

briefly describe the “Windows & Walls” approach of the U.S. Solvency Modernization Initiative as it applies to Solvency 2

Answer 15

gives windows for state insurance regulators to look into group-wide operations:
→ enhanced communication between state & group regulators
→ enforcement tools if violations occur
but maintains the walls at the statutory legal entity level
→ capital cannot be “shared” between legal entities

Question 16

what is a ‘commutation agreement’ (in the context of reinsurance)

Answer 16

An AGREEMENT between a ceding insurer and the reinsurer that PROVIDES for the valuation, payment, and complete DISCHARGE of ALL OBLIGATIONS between the parties under a particular reinsurance contract
IN PLAIN ENGLISH: the ReInsR gives the ceded claims BACK to the original InsR

Question 17

advantages of (or reasons for) commutation - from reinsurer point-of-view

Answer 17

• increases STABILITY for long-tailed lines
• decreases claims expenses
• decreases U/W leverage
• to exit market quickly

Question 18

advantages of (or reasons for) commutation - from primary insurer point-of-view

Answer 18

• removes reinsurance CREDIT risk
• insurer receives benefit of favorable LOSS development
• decreases EXPENSE costs
• more EFFICIENT clms handling
• receives immediate Cash Flow

Question 19

disadvantages of commutation from primary insurer point-of-view

Answer 19

• risk of adverse development on claims
• CapReq goes up (to support increased liabilities)