Part 28 (Freihaut & Vendetti) (****)

Question 1

Is it good or bad to apply reinsurance accounting to a contract

Answer 1

It is Financially Advantageous for an insurer to apply reinsurance accounting to a contract

Question 2

To qualify for reinsurance treatment, the insurer needs to demonstrate what

Answer 2

risk transfer

Question 3

How does applying reinsurance accounting help with the loss reserves

Answer 3

makes the loss reserves net of reinsurance recoverables, which makes it look lower

Question 4

Two criteria to meet to demonstrate risk transfer

Answer 4

• Reinsurer assumes significant insurance risk
• It is reasonably possible that the reinsurer may realize a significant loss

Question 5

Insurance risk consists of what

Answer 5

• Underwriting risk (possible to have uw loss or profit)
• Timing risk (timing of losses is not known)

Question 6

Exception to the reinsurance treatment requirement of reasonably possible that the reinsurer may realize a significant loss

Answer 6

Substantially all requirement

If virtually all of the insurance risk of the reinsured portion of the underlying contracts assumed by reinsurer

Question 7

Common examples of substantially all requirement

Answer 7

Quota Share (% of prem and loss same, so loss ratio equivalent between companies)

Contracts without risk limiting features

Question 8

Risk transfer only needs to be tested if what

Answer 8

is not reasonably self evident

Question 9

What should be kept if risk transfer is not tested

Answer 9

Documentation incase regulators want to see

Question 10

10-10 Rule

Answer 10

At least a 10% chance of a 10% or greater loss then risk transfer exists

Question 11

What’s a drawback of 10-10 rule

Answer 11

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

Question 12

Expected Reinsurer Deficit (ERD) rule

Answer 12

ERD > 1% then risk transfer exits

Probability (NPV U/W loss to reinsurer) * Avg Severity (U/W loss)

Question 13

If close to threshold in 10-10 rule and ERD what does this mean

Answer 13

It may just be because of parameters and assumptions, and if tweaked may indicate risk transfer

Question 14

Pitfalls

Answer 14

• Profit Commission
• Reinsurer Expenses
• Interest rates and Discount factors
• Premiums
• Evaluation date
• Timing of payments

Question 15

Profit commission pitfalls

Answer 15

• Need to be excluded from the risk transfer analysis

Question 16

Why does profit commission need to be excluded from the analysis?

Answer 16

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

Question 17

How does profit commission still have an impact on risk transfer analysis

Answer 17

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

Question 18

What to do with profit commission if contract doesn’t qualify for risk transfer

Answer 18

Try reducing the profit commission

Question 19

Reinsurer Expenses Pitfalls

Answer 19

Exclude from risk transfer analysis

Question 20

Why exclude Reinsurer Expenses in analyzing risk transfer

Answer 20

they do not constitute a cash flow that takes place between ceding company and reinsurer

Question 21

Interest Rates and Discount Factors Pitfalls

Answer 21

The same discount rate needs to be used in each simulated iteration in risk transfer analysis

Selected interest rate should be “reasonable and appropriate”

Question 22

Why should the same interest rate and discount factor be used in risk transfer analysis

Answer 22

Interest rate risk should not impact the risk transfer test result

Only UW risk should be considered for risk transfer

Question 23

How should an interest rate be reasonable and appropriate

Answer 23

Should reflect:
- Expected timing of payments to the reinsurer
- Duration over which the cash flows are expected to be invested by the reinsurer

Question 24

Premiums Pitfalls

Answer 24

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

Question 25

Any contractual features (eg. loss ratio caps and experience adjustments) in risk transfer analysis

Answer 25

need to be applied to the nominal premiums

Question 26

If premium is depended on future events in risk transfer analysis, what options are there to use

Answer 26

Initial deposit premium: which may under detect the risk transfer

Expected premium: Which may over detect risk transfer

Actual generated premium

Question 27

Why would we not want to use the Expected premium option for premium depended on future events for risk transfer analysis?

Answer 27

Over detect risk transfer

Question 28

Evaluation date Pitfall, what does evaluation date impact in risk transfer analysis

Answer 28

• Interest rate
• Losses that are considered

Question 29

Timing of Payments Pitfall

Answer 29

• Reinsurance contracts that have prescribed payment patterns do not qualify as having risk transfer
• reinsurer needs to make timely reimbursement payments

Question 30

Consideration of Risk Transfer analysis (Parameter Selection)

Where are these derived/determined

Answer 30

• most parameters can be derived from contract
• parameters not derived from contract need to be determined by modelers

Question 31

Consideration of Risk Transfer analysis
(Interest Rate)

What interest rate can be used (recommended)

If deviating, what is appropriate

Answer 31

• Can use risk free rate
• If select a different rate, should exceed the risk free rate

Question 32

Why should an interest rate selected by greater than risk free rate in risk transfer analysis

Answer 32

• very unlikely a lower rate will be reasonable
• lower rate would over detect risk transfer

Question 33

What are the issues with selecting higher interest rate than risk free equal to the expected yield earned by reinsurer in risk transfer analysis?

Answer 33

• The reinsurer’s yield is not known
• Reinsurer’s yield could impact risk transfer conclusion

Question 34

Advantage and disadvantage of using yield curve over one yield in risk transfer analysis

Answer 34

• Makes sure risk transfer test more stringent
• However, inconsistent with accounting standards: results in interest rates that vary by scenario

Question 35

Consideration of Risk Transfer Analysis
(Payment Pattern)

What can be based on

What should the payment pattern be

Answer 35

• Base this on historical experience, and or industry benchmarks
• Payment pattern needs to be reasonable as this impacts risk transfer test

Question 36

Consideration of Risk Transfer Analysis
(Loss Distribution)

What can loss distribution be based on

Answer 36

• can be based on:
• • Previous company experience
• • Industry benchmarks
• • Pricing Information
• • Judgment
• • All of the above

Question 37

Why is selecting a distribution difficult for Loss Distribution when analyzing Risk Transfer

Answer 37

the right tail that what is important for risk transfer testing, but there is not alot of data for the right tail

Question 38

Consideration of Risk Transfer Analysis
(Parameter Risk)

What does it do

What will happen when considering

Answer 38

• Accounts for the risk that selected parameters are incorrect
• Incorporating this will increase the chance that risk transfer is indicated

Question 39

What will happen when incorporating Parameter risk

Does this make sense for Risk transfer analysis

Should Risk be incorporated implicitly or explicitly

Answer 39

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.

Question 40

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?

Answer 40

• 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

Question 41

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

Answer 41

• 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

Question 42

Considerations of Risk Transfer Analysis

Answer 42

Payment Pattern
Loss Distribution
Parameter Risk
Use of Pricing Assumptions
Commutation Clause