Reinsurance Flashcards
Balance Sheet <—> Schedule F
6 items
Schedule F (Part 3)
- Amount recoverables from reinsurers (assets)
- UEP for ceded reinsurance (parenthetical amount) (liability)
- Ceded reinsurance premiums payable (net) (liability)
- Funds (collateral) held by company under reinsurance treaties (liability)
- Provision for reinsurance (liability)
Schedule F (Part 1)
- Reinsurance payable on paid loss + LAE (liability)
Reinsurance Provision
Definition
Minimum reserve (calculated under SAP) that reflects estimated uncollectible reinsurance recoveries
Which BS Items Change Net vs Gross of Reinsurance
Assets
- Reinsurance recoverable on loss + LAE payment
- Net amount recoverable from reinsurer (used to balance surplus = A - L)
Liability
- Loss & LAE
- Unearned premium
- Ceded reinsurance premiums payable
- Funds (collateral) held by company under reinsurance treaties
- Provision for reinsurance
Schedule F as a Solvency Monitor (Pros/Cons)
And improvements for cons
Strengths
- RP is formulaic - easy to compare across different years and companies
- hard to manipulate because inputs are numbers from financial statements
- RP accounts for reinsurer credit risk with penalties for (unauthorized reinsurer) and (slow-paying reinsurers)
- Shows impact to surplus if reinsurance contracts are canceled
Weaknesses
- RP is formulaic - may mask management’s better informed estimate of collectability risk
- RP penalizes (unauthorized) and (slow-paying) reinsurers regardless of their financial strength
- slow-paying threshold is arbitrary
- In general, doesn’t measure reinsurer’s solvency (true source of uncollectability risk)
Improvements (for monitoring reinsurer credit risk)
- Include management input of uncollectability risk
- Include reinsurer ratings, big factor in credit risk
- Disclose details of reinsurance arrangements.
- Make 20% slow-pay threshold more flexible and account for reasons for slow-pay
Schedule F as a Solvency Monitor
How
- Tracks reinsurance transactions
- Calculates reinsurance provision
- Shows the effect on the insurer’s balance sheet of canceling all reinsurance
- Quality of reinsurance –> risk of uncollectability from reinsurer –> solvency of insurer
Reinsurance Provision (Unauthorized Reinsurers)
= T - C + 20% * (Pn90 + Td)
Terminology:
- T = Total reinsurance recoverable (dispute + non-dispute)
- C = Collateral (letter of credit, ceded balances payable, other amounts due reinsurer)
- Pn90 = Recoverable paid > 90 days
Reinsurance Provision (Authorized Reinsurer)
Check slow paying ratio > 20%
- = Pn90 / (Pn + Recvd)
If slow paying:
- RP = 20% * max (T-C, Pn90 + Pd90)
If not slow paying:
- RP = 20% * (Pn90 + Pd90)
Terminology:
- T = total reinsurance recoverable (dispute + non-dispute)
- C = collateral (letter of credit, ceded balances payable, other amounts due reinsurer)
- Pn90 = recoverable paid > 90 days past due (NOT in dispute)
- Recvd = amount received prior 90 days
Certified Reinsurer
What is it, benefits
- non-US reinsurer domiciled in a NAIC Qualified Jurisdiction
- insurers not penalized as heavily (vs unauthorized reinsurer) –> reinsurance provison is lower
- reinsurer can post collateral of < 100% of its US claims
Regulator Considerations for Certified Reinsurer Application
- jurisdiction of reinsurer
- rating from a rating agency
- regulatory history
- financial position
- capital and surplus
Reasons for Commutation
Reasons, elaborate
Solvency: primary insurer and reinsurer may have concerns with each other’s solvency
- if reinsurer is weak, commutation eliminates credit risk for the insurer
- if insurer is weak, commutation provides immediate cash to the insurer and the reinsurer avoids future issues if insurer does go insolvent
Exit: provides a way for primary insurer and reinsurer to exit a particular market
- for primary insurer, they also have to do a loss portfolio transfer to a 3rd party
Disputes: primary insurer and reinsurer want to end their relationship because of of dispute
- disputes over claim resolution or contract provisions
Reserves: primary insurer and reinsurer have a big difference in estimated reserves
- commutation will leave them both thinking they’re getting a good deal
Loss Triangle Changes After Commutation
Primary and Reinsurer, gross/net/ceded paid/reserves/ult triangles
Primary Insurer
- Gross Paid/Reserves/Ult –> UNCHANGED
- Net Paid (after) = Net Paid (before) - commutation price
- Net Ult (after) = Net Paid (after) + Gross Reserves (before/after)
- Net Ult (after) = Net Ult (before) + Ceded Reserves (before) - commutation price
- Net Reserves (after) = Net Reserves (before) + Ceded Reserves (before) = Gross Reserves (before/after)
- Ceded Reserves (after) –> 0
- Ceded Paid (after) = Ceded Paid (before) + commutation price
- Ceded Ult (after) = Ceded Paid (after)
Reinsurer
- Gross Paid = Ceded Paid (insurer)
- Gross Reserve/Ult = Ceded Reserve/Ult * (1+%) = Gross Reserve/Ult (insurer) * QS * (1+%)
- (1+%) factor b/c reinsurer will have different view on reserves/ult
Change in Taxable Income After Commutation
Primary and Reinsurer
Primary Insurer
- commutation price - ceded reserves (before) * discount rate
Reinsurer
- Gross reserves (before) * discount rate - commutation price
Commutation Price
= reinsurer gross ult loss (after) - reinsurer gross paid loss (before)
= reinsurer gross paid (after) - reinsurer gross paid (before)
Conditions for Reinsurance Contract to Receive (Favorable) Accounting Treatment
Requires that significant insurance risk is assumed by the reinsurer
- Insurance risk must include U/W risk (uncertain if reinsurer will profit or loss)
- Insurance risk must include timing risk (no preset payment schedule in case of loss)
Requires that a significant loss to the reinsurer is reasonably possible
Qualitative Methods for Testing Risk Transfer
Is the transfer of risk self-evident?
- EQ, hurricane
If (significant loss NOT reasonably possible) but (reinsurer assumes substantially all risk) then (risk transfer may still exist)
- Often used with quota-share with high % transferred
Quantitative Methods for Testing Risk Transfer
If Expected Reinsurer Deficit (ERD) > 1%, then there is a transfer of risk
- =Prob(NPV U/W loss to reinsurer) * NPV(U/W loss) / (Reinsurance Premium)
- = Prob(x) * Severity (x)
10-10 Rule
- Is the probablity that the reinsurer have a 10%+ UW loss ≥ 10%? If so, then there is a transfer of risk
- If reinsurer has ≥ 10% chance of ≥ 10% U/W loss, then there is a transfer of risk
Quantitative Methods for Testing Risk Transfer
If Expected Reinsurer Deficit (ERD) > 1%, then there is a transfer of risk
- =Prob(NPV U/W loss to reinsurer) * NPV(U/W loss) / (Reinsurance Premium)
- = Prob(x) * Severity (x)
10-10 Rule
- Is the probablity that the reinsurer have a 10%+ UW loss ≥ 10%? If so, then there is a transfer of risk
- If reinsurer has ≥ 10% chance of ≥ 10% U/W loss, then there is a transfer of risk
Profit Commissions (Pitfall)
Risk transfer test pitfall
Profit Commission
- payment from reinsurer to insurer when business is profitable (LR below certain %)
- do not include in risk transfer test b/c we only focus on reinsurer loss scenarios
- reinsurer may charge higher premium due to these profit commissions, which lowers probability that risk transfer exists
Premiums, Expenses, Fees
Risk transfer test pitfall
Premiums
- use gross premiums
- consider all cash flows between insurer to reinsurer
- apply (LR caps, experience adjustments) to nominal premiums and then discount to PV
Reinsurer Expenses
- do not include in risk transfer test b/c not a cash flow between insurer and reinsurer
Commutation Fees
- Include in risk transfer test and any other fees that depend on future events
Interest Rate, Evaluation Date
Risk transfer test pitfall
Interest Rate (pitfall) - if modeling/simulation is involved in risk transfer test
- same discount rate should be used in each simulation/scenario b/c interest rate risk/variability should not impact the risk transfer test
- rates should be reasonable & appropriate (AAA recommends risk free rate)
Evaluation Date (pitfall)
- impacts interest rate and which losses to be considered
Parameter Selection
Risk transfer test general considerations, examples
- Examples: interest rate, payment-pattern, loss distribution
- Cash flow simulations for risk transfer test need appropriate parameters
- Parameters not provided by contract should be determined by modelers and should be comfortable with assumptions and justifications (when asked by regulators)
Parameter Selection - Interest Rate
Risk transfer test considerations
Interest Rate Considerations:
- rate selected should be > risk free rate b/c risk free rate is easily achievable
- lower rate –> higher PV(losses) –> over detect risk transfer
- use higher rate (like the reinsurer’s expected yield)?
- insurer likely would not know the reinsurer’s yield
- reinsurer’s higher yield might fail risk transfer test
- use yield curve (varing interest rates by duration)
- makes risk transfer test more strict b/c longer durations –> usually higher rate
- inconsistent with accounting standards b/c interest rates are varying by scenario
Parameter Selection - Payment Pattern & Loss Distribution
Risk transfer test considerations
Payment Pattern Considerations:
- payment patterns should be based on historical experience and/or industry benchmarks
- need to be reasonable b/c this impacts risk transfer test
Loss Distribution Considerations:
- historical experience, industry benchmarks, judgement, all of the above
- most important is the right tail of the distribution (not much data there, could have high loss)
Parameter Risk
Risk transfer test considerations
Parameter Risk Considerations
- risks that selected parameters are incorrect
- accounting for this risk will increase chance that risk transfer exists
- does this make sense? Yes, b/c the reinsurer is accepting this parameter risk
- parameter risk can be express implicitly (indirectly) or explicitly (directly)
- author prefers implicitly b/c of simplicity
Pricing Assumptions & Commutation Clause
Risk transfer test considerations
Pricing Assumptions Considerations:
- use these assumptions to parameterize risk transfer test
- useful for small/immature books b/c less data
- BUT pricing assumptions are market-driven (less competitive market –> higher premium)
- preferable to use reinsurer’s actual data but insurer may not have access
Commutation Clause Considerations:
- commutation must be considered in the risk transfer test if it impacts cash flows
- commutation fee treated as premium
