Part 28 (Freihaut & Vendetti) (****) Flashcards
Reinsurance Accounting Principles
Is it good or bad to apply reinsurance accounting to a contract
It is Financially Advantageous for an insurer to apply reinsurance accounting to a contract
To qualify for reinsurance treatment, the insurer needs to demonstrate what
risk transfer
How does applying reinsurance accounting help with the loss reserves
makes the loss reserves net of reinsurance recoverables, which makes it look lower
Two criteria to meet to demonstrate risk transfer
- Reinsurer assumes significant insurance risk
- It is reasonably possible that the reinsurer may realize a significant loss
Insurance risk consists of what
- Underwriting risk (possible to have uw loss or profit)
- Timing risk (timing of losses is not known)
Exception to the reinsurance treatment requirement of reasonably possible that the reinsurer may realize a significant loss
Substantially all requirement
If virtually all of the insurance risk of the reinsured portion of the underlying contracts assumed by reinsurer
Common examples of substantially all requirement
Quota Share (% of prem and loss same, so loss ratio equivalent between companies)
Contracts without risk limiting features
Risk transfer only needs to be tested if what
is not reasonably self evident
What should be kept if risk transfer is not tested
Documentation incase regulators want to see
10-10 Rule
At least a 10% chance of a 10% or greater loss then risk transfer exists
What’s a drawback of 10-10 rule
Only looks at the 10% percentile, and not at the tail. If jumps really late in tail then this won’t be correct in determination
So use the ERD
Expected Reinsurer Deficit (ERD) rule
ERD > 1% then risk transfer exits
Probability (NPV U/W loss to reinsurer) * Avg Severity (U/W loss)
If close to threshold in 10-10 rule and ERD what does this mean
It may just be because of parameters and assumptions, and if tweaked may indicate risk transfer
Pitfalls
- Profit Commission
- Reinsurer Expenses
- Interest rates and Discount factors
- Premiums
- Evaluation date
- Timing of payments
Profit commission pitfalls
- Need to be excluded from the risk transfer analysis
Why does profit commission need to be excluded from the analysis?
Because the risk transfer only focuses on scenarios that would generate a loss to the reinsurer
in this case a profit commission would not be required
How does profit commission still have an impact on risk transfer analysis
It is indirect
Reinsurer may charge higher premium due to the existence of profit commission
this will indicate a lower probability of risk transfer existing
What to do with profit commission if contract doesn’t qualify for risk transfer
Try reducing the profit commission
Reinsurer Expenses Pitfalls
Exclude from risk transfer analysis
Why exclude Reinsurer Expenses in analyzing risk transfer
they do not constitute a cash flow that takes place between ceding company and reinsurer
Interest Rates and Discount Factors Pitfalls
The same discount rate needs to be used in each simulated iteration in risk transfer analysis
Selected interest rate should be “reasonable and appropriate”
Why should the same interest rate and discount factor be used in risk transfer analysis
Interest rate risk should not impact the risk transfer test result
Only UW risk should be considered for risk transfer
How should an interest rate be reasonable and appropriate
Should reflect:
- Expected timing of payments to the reinsurer
- Duration over which the cash flows are expected to be invested by the reinsurer
Premiums Pitfalls
Gross premiums excluding any payments back to the ceding company should be used in risk transfer analysis.
(net out the ceding commissions though)
All fees should be treated as premium
Any contractual features (eg. loss ratio caps and experience adjustments) in risk transfer analysis
need to be applied to the nominal premiums
If premium is depended on future events in risk transfer analysis, what options are there to use
Initial deposit premium: which may under detect the risk transfer
Expected premium: Which may over detect risk transfer
Actual generated premium
Why would we not want to use the Expected premium option for premium depended on future events for risk transfer analysis?
Over detect risk transfer
Evaluation date Pitfall, what does evaluation date impact in risk transfer analysis
- Interest rate
- Losses that are considered
Timing of Payments Pitfall
- Reinsurance contracts that have prescribed payment patterns do not qualify as having risk transfer
- reinsurer needs to make timely reimbursement payments
Consideration of Risk Transfer analysis (Parameter Selection)
Where are these derived/determined
- most parameters can be derived from contract
- parameters not derived from contract need to be determined by modelers
Consideration of Risk Transfer analysis
(Interest Rate)
What interest rate can be used (recommended)
If deviating, what is appropriate
- Can use risk free rate
- If select a different rate, should exceed the risk free rate
Why should an interest rate selected by greater than risk free rate in risk transfer analysis
- very unlikely a lower rate will be reasonable
- lower rate would over detect risk transfer
What are the issues with selecting higher interest rate than risk free equal to the expected yield earned by reinsurer in risk transfer analysis?
- The reinsurer’s yield is not known
- Reinsurer’s yield could impact risk transfer conclusion
Advantage and disadvantage of using yield curve over one yield in risk transfer analysis
- Makes sure risk transfer test more stringent
- However, inconsistent with accounting standards: results in interest rates that vary by scenario
Consideration of Risk Transfer Analysis
(Payment Pattern)
What can be based on
What should the payment pattern be
- Base this on historical experience, and or industry benchmarks
- Payment pattern needs to be reasonable as this impacts risk transfer test
Consideration of Risk Transfer Analysis
(Loss Distribution)
What can loss distribution be based on
- can be based on:
- Previous company experience
- Industry benchmarks
- Pricing Information
- Judgment
- All of the above
Why is selecting a distribution difficult for Loss Distribution when analyzing Risk Transfer
the right tail that what is important for risk transfer testing, but there is not alot of data for the right tail
Consideration of Risk Transfer Analysis
(Parameter Risk)
What does it do
What will happen when considering
- Accounts for the risk that selected parameters are incorrect
- Incorporating this will increase the chance that risk transfer is indicated
What will happen when incorporating Parameter risk
Does this make sense for Risk transfer analysis
Should Risk be incorporated implicitly or explicitly
Increase the chance risk transfer is indicated
Makes sense, as the reinsurer is accepting this risk
Implicitly, even though explicitly is more accurate it is more difficult.
Consideration of Risk Transfer Analysis
(Use of Pricing Assumptions)
what can it be used for
What can it be used to generate
What may influence
What is it often priced based on
- is this conservative from risk transfer standpoint?
- Can be used for small/ immature books
- Can generate assumptions for expected loss, payment patterns, or appropriate risk load.
- Market conditions may influence the outcome of the risk transfer test
- Conservative assumptions, resulting in a higher expected loss projection
- no
Consideration of Risk Transfer Analysis
(Commutation Clause)
What does the commutation requirement affect
If this clause exists, where must it be reflected
How are fees used to prevent the commutation then treated
- Commutation requirements reduce the amount of risk transferred
- Must be reflected in the model if it impacts the cash flow
- Fees are treated as premium
Considerations of Risk Transfer Analysis
Payment Pattern
Loss Distribution
Parameter Risk
Use of Pricing Assumptions
Commutation Clause
