Reinsurance

Question 1

What are the six parts of schedule F?

Answer 1

1 - Assumed Reinsurance (premiums, losses, commissions, collateral)
2 - Premium Portfolio reinsurance (orig and reinsurance premiums)
3 - Ceded Reinsurance (Provision for Rein./RBC)
4 - Issuing or Confirming Banks for Letters of Credit
5 - Interrogatories for Schedule F, part 3 (commisison rates, loss recoverables)
6 - Restatement of Balance Sheet

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Question 2

Identify the groups/categories used in Schedule F, part 1 (row labels)

Answer 2

Affiliated Insurers
* U.S. intercompany pooling
* U.S. non-pool
* other (non U.S.)

Other U.S. Unaffiliated Insurers
Pools & Associations
* mandatory pools
* voluntary pools

Other Non-U.S. Insurers

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Question 3

Describe part 1 of Schedule F

Answer 3

• Provides the total assumed reinsurance balances by reinsured
• Enables an understanding of the risks associated with reinsurance transactions as of the current year.

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Question 4

Describe part 2 of Schedule F

Answer 4

Provides a detailed listing of portfolio reinsurance transactions effected or canceled during the current year
(Portfolio insurance is the transfer of policies-in-force, or the transfer of liabilities remaining on a block of the insurer’s business)

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Question 5

Describe part 3 of Schedule F

Answer 5

• The first 20 columns detail the ceded reinsurance balances
• Columns 21 through 36 calculate credit risk charge on ceded reinsurance
• Columns 37 through 53 provide the aging of ceded reinsurance
• Columns 54 through 69 provide the calculation of the Provision for Reinsurance for Certified Reinsurance
• Columns 70 through 78 provide the Total Provision for Reinsurance (authorized, unauthorized, total)

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Question 6

Describe part 4 of Schedule F

Answer 6

Provides a listing fo the issuing or confirming banks for letters of credit as collateral reported in Schedule F, Part 3, Column 22
Confirming banks are those that provide a guarantee on a letter of credit such that the confirming bank will pay if the original bank issuing the letter of credit does not)

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Question 7

Describe Part 5 of Schedule F

Answer 7

Has 2 tables with interogattories for Part 3

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Question 8

Describe Part 6 of Schedule F

Answer 8

Restates the balance sheet Gross of reinsurance

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Question 9

Define funds held under reinsurance contracts

Answer 9

A portion of premium due to the reinsurer that is witheld by the ceding company to pay claims (Liability for the insurer, asset for the reinsurer)

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Question 10

Define Letter of Credit

Answer 10

A line of credit issued by a bank in favor of a reinsurer if the reinsurer is unable to fulfill its obligations

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Question 11

Define Portfolio Insurance

Answer 11

The transfer of policies in force, or transfer of liabilities remaining on a block of an insurer’s business

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Question 12

Why would an insurer enter into portfolio reinsurance?

Answer 12

• Discontinue a line of business
• Remove risk of the liabilities
• Surplus Relief (in the form of discounted premium)

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Question 13

Identify 3 reasons an insurer would cede a large portion of their business to a reinsurer, besides fronting

Answer 13

• Discontinue a line of business
• Intercompany Cessions to share risk across related companies
• Cession to a regulated pool

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Question 14

Why is schedule F an important tool in monitoring solvency for users of the Annual Statement?

Answer 14

Identifies gross Assumed Losses
Identifies Slow-Paying (Authorized) reinsurers for futhur scrutinty
Measures Significance of reinsurance against surplus
Provides Financial Strength information of reinsureds and reinsurers

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Question 15

What is the purpose of Schedule F Special Codes? What are they?

Answer 15

They Identify relationships of heightened importance to regulators

Special Code 2 Cessions of 75% or more of subject premium (indicator of fronting to avoid regulatory scrutinty)
Special Code 3 Counterparty Reporting Exception for Asbestos and Pollution Contracts
Special Code 4 IBNR Losses on Contracts in force prior to July 1, 1984 Exempt from: Statutory Provision for Unauthorized Reinsurance

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Question 16

What is a Reinsurance Provision?

Answer 16

a minimum reserve (calculated under SAP) that reflects estimated uncollectible reinsurance recoveries

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Question 17

Identify one asset and five liabilities on an insurance company’s balance sheet that comes directly from Schedule F?

Answer 17

Asset:
* Reinsurance Recoverable on Paid Loss & LAE

Liabilities:
* Reinsurance Payable on Paid Loss (when assuming reinsurance)
* Unearned Premium for Ceded Reinsurance
* Ceded Reinsurance Premiums Payable
* Funds held under Reinsurance Treaties
* Reinsurance Provision

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Question 18

How can Schedule F be used to monitor the solvency of an insurer?

Answer 18

• Schedule F tracks reinsurance transactions, calculates a reinsurance provision, and shows the effect on the insurer’s balance sheet of cancelling all reinsurance contracts.
• Quality of reinsurance impacts risks of uncollectibility from reinsurer, which impacts solvency of the insurer
• (Schedule F only provides a narrow scope of solvency, because there are many other risks factors besides reinsurance)

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Question 19

What are strengths and weaknesses with using Schedule F as a solvency monitoring tool?

Answer 19

Strengths:
* RP is formulaic - easy to compare across years & companies
* RP is formulaic - hard to manipulate because inputs are numbers from financial statements
* RP accounts for reinsurer credit risk with penalties for unauthorized reinsurers (often foreign)
* RP accounts for reinsurer credit risk with penalties for slow-paying reinsurers
* Schedule F shows impact to surplus if reinsurance contracts are canceled

Weaknesses:
* RP is formulaic - may mask management’s better informed estimate of collectability risk
* RP is formulaic - but no statistical basis for formula - may not represent true collectability risk
* RP penalizes unauthorized reinsurers regardless of their financial strength
* RP penalizes slow-paying reinsurers regardless of their financial strength and slow-payer threshold is arbitrary
* In General: Schedule F doesn’t directly measure reinsurer’s solvency which is the true source of uncollectability risk
* In General: Schedule F doesn’t measure the quality of an insurer’s reinsurance management

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Question 20

How can Schedule F be enhanced to improve its capacity to monitor reinsurer credit risk?

Answer 20

Disclose details of reinsurance arrangements
Include management input of uncollectability risk
Include Reinsurer ratings
Replace 20% slow-pay threshold with a sliding scale and consider reasons for slow-pay

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Question 21

What is an unauthorized reinsurer?

Answer 21

An Unauthorized Reinsurer is one that does business where it is not legally permitted to do so
For Example, a reinsurer authorized to conduct business only in Maine would be unauthorized to sell reinsurance to an insurer in Texas

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Question 22

Formula for Reinsurance Provision for Unauthorized Reinsurers

Answer 22

RP = T - C + 20% x (P(N>90) + T(D))

T = Total Recoverable
C = Collateral (Offsets to RP)
P(N>90) = Recoverable not in dispute 90 days past due
T(D) = Total reinsurance recoverable in dispute

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Question 23

Slow paying ratio for authorized Reinsurers

Answer 23

SPR = P(N>90) / (P(N) + Received in past 90 Days)

P(N>90) = Recoverable not in dispute 90 days past due
P(N) = Total recoverable not in dispute

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Question 24

Formula for Reinsurance Provision for Authorized Reinsurers

Answer 24

If Not Slow-Paying
RP = 20% x (P(N>90) + P(D>90))

If Slow-Paying
RP = 20% x max(T - C, P(N>90) + P(D>90))

P(N>90) = Recoverable not in dispute 90 days past due
P(D>90) = Recoverable in dispute 90 days past due
T = Total Recoverable
C = Collateral

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Question 25

Define 'Certifed Reinsurer'

Answer 25

* non-U.S. reinsurers domiciled in a jurisdiction designated by the NAIC as a Qualified Jurisdiction (i.e., Bermuda, France, Germany, Ireland, Japan, Switzerland and the United Kingdom) * one that would have been categorized as unauthorized prior to 2012 * one that has attained certification from the reporting entity's domiciliary state ## Footnote Odomirok 14

Question 26

What does a regulator consider when evaluating an unauthorized reinsurer's application for certification?

Answer 26

**J**urisdiction of reinsurer **R**ating from a rating agency **R**egulatory History **F**inancial Positioin **C&S** Capital and Surplus ## Footnote Odomirok 14

Question 27

What are the benefits of being certified (for reinsurers)

Answer 27

The Reporting entity is not penalized as heavily (= reinsurance provision is lower) The Reinsurer can post collateral of less than 100% of its U.S. claims ## Footnote Odomirok 14

Question 28

Identify the two portions of the RP for Certifed Reinsurers.

Answer 28

**Collateral Defficiency [RP64(CD)]** = A19(recov) - Cr63(recov) A19(recov) = net amount recoverable from reinsurer Cr63(recov) = credit allowed for net recoverables **Overdue Reinsurance [RP69(OR)]** = min[20% x MAX(PN90 + PD90, F), CR63(recov)] Pd90 = recoverable on Paid loss loss & LAE > 90 days past due in dispute Pn90 = recoverable on Paid loss & LAE > 90 days past due not in dispute F = net unsecured recoverable for slow payers for which credit is permitted Cr63(recov) = (Col 57) + (Col 58) x (Col 61) (Col 57) = Catastrophe Recoverables Qualifying for Collateral Deferral (Whatever the heck that is...we're just going to assume this equals 0!) (Col 58) = Net Recoverables Subject to Collateral Requirements for Full Credit (Col 61) = Percent Credit Allowed on Net Recoverables Subject to Collateral Requirements ## Footnote Odomirok 14

Question 29

Briefly Describe the 2 tables in Schedule F part 5

Answer 29

**Table 1**: * Identifies 5 largest reinsurer commission rates (where ceded premium > $50,000) * The purpose is to identify companies using reinsurance to conceal high operating leverage **Table 2**: * Identifies 5 largest loss recoverables from (Col 15) and whether the reinsurer is affiliated with the reporting entity * The purpose is to assess concentration of insurance risk ## Footnote Odomirok 14

Question 30

Define Commutation

Answer 30

A commutation agreement is 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. ## Footnote Klann

Question 31

Identify reasons for a commutation to occur

Answer 31

**S**olvency - insurer/reinsurer concerned about other's solvency **E**xit - commutation provides a way for the reinsurer (& potentially, eventually, for the primary insurer) to exit a particular market **D**isputes - disagreements between parties over contract provisions **R**eserves - primary/reinsurer potentially disagree about value of reserves (both may think they are getting a good deal under the commutation ## Footnote Klann

Question 32

Why would a commutation occur for only one year? In other words, short commutation

Answer 32

* Cash Infusion * Differences in opinions on reserves * Perhaps older accident year is more stable, primary willing to retain risk * Legal/regulator change * Reduce Credit risk * Trial run for future years * Exit certain markets, territories * Reduce Collateral required * Lower provision for reinsurance ## Footnote Klann

Question 33

Who is the buyer in a reinsurance commutation?

Answer 33

The primary insurer is the buyer because they are receiving the liability back (even though they are receiving money) ## Footnote Klann

Question 34

Loss reserves are generally discounted for {} accounting and undiscounted for {} accounting? {Tax/SAP}

Answer 34

Discounted for Tax purposes, nominal for SAP ## Footnote Klann

Question 35

What are the steps in pricing a commutation?

Answer 35

**E**stimate the claim payments that would be made in the absence of commutations (reins. recov for insurer, loss reserves for reinsurer) **D**iscount the estimates **T**ax effects **U**nique considerations ## Footnote Klann

Question 36

Identify 9 functions of reinsurance

Answer 36

**F**ronting Arrangements **CAT**atastraphe protection **S**urplus relief and capital efficiency **W**ithdrawal from market **I**nternal reinsurance transactions **P**ools - mandatory and voluntary **L**arge Line Capacity **E**nter market and/or UW guidance **S**tabilie Results ## Footnote Cedar

Question 37

Name 2 conditions for a contract to receive reinsurance accounting treatment

Answer 37

* Requires that a significant insurance risk is assumed by reinsurer (under reinsured portion of contract) * requries that a significant loss to the reinsurer is reasonably possible ## Footnote Freihaut

Question 38

Name 2 components of insurance risk

Answer 38

**U/W Risk** - There must be uncertainty in the dollar-value of loss **Timing Risk** - Refers to the timing of claims payments, there should not be any sort of predetermined payment schedule ## Footnote Freihaut

Question 39

What are the implications for an insurer's blance sheet if they cannot use reinsurance accounting (must use deposit accounting)?

Answer 39

The insurer cannot show reserves as 'net' of reinsurance recoverables, they get no capital credit for having reinsurance ## Footnote Freihaut

Question 40

Why is determination of risk transfer important?

Answer 40

* Cannot properly price a reinsurance contract without knowledge of how much risk is taken on * When contract qualifies as reinsurance, cedant may use reinsurance accounting treatment, which is more favorable than deposit accounting ## Footnote Freihaut

Question 41

Name 4 methods of assessing the existence of risk transfer

Answer 41

**Self-Evident** - Qualitative **"Substantially All" Exception** - Qualitative **Calculate Expected Reinsurer Deficit** - Quantitative **10-10 Rule** - Quantitative ## Footnote Freihaut

Question 42

Describe "Self-Evident" Method of testing risk transfer

Answer 42

* Is the transfer of risk self-evident? * Maybe potential loss is obviously very high, such as with hurricanes/earthquakes * Reasonably self-evident characterized as (i) transaction is doen at arms-length, (ii) no risk-limiting features * If payment schedule, then self-evident that no risk transfer ## Footnote Freihaut

Question 43

Describe "Substatially All Exception" Method of testing risk transfer

Answer 43

If significant loss is not reasonably possible but reinsurer assumes substantially all risk, then risk transfer may still exist Often applies to quota-share contracts with a high % transferred or individual risk contracts without LR caps or other risk-limiting features ## Footnote Freihaut

Question 44

Describe Expected Reinsurer Deficit Method of testing risk transfer

Answer 44

ERD = prob(NPV reinsurer loss) x NPV(reinsurer loss)/reinsurance premium * if ERD > 1%, then tehere has been transfer of risk ## Footnote Freihaut

Question 45

Describe 10-10 rule Method of testing risk transfer

Answer 45

If reinsurer has >= 10% chance of >=10% UW loss, then the contract has transferred risk ## Footnote Freihaut

Question 46

What is the reason for the 'substantially all' exception is risk transfer testing? / Identify 2 common examples of the 'substantially all' exception in risk transfer testing

Answer 46

To maintain access to reinsurance for profitable books of business * Quota Share Treaties with high % ceded * Individual Risk contracts with no loss capping features ## Footnote Freihaut

Question 47

Identify the pitfalls in a risk transfer test

Answer 47

**P**rofit commissions **R**einsurer expenses **I**nterest rates **C**ommutation timing **E**valuation date **P**remiums ## Footnote Freihaut

Question 48

Identify considerations in selecting a discount rate for a risk transfer test

Answer 48

* Equal in duration to that of the reinsurer's net cash flows * Risk Free rate as its minimum or floor (if lower, rate may over detect risk, or vice versa) * Should be the same rate for all cash flows * Use of interest rate from US treasure department * Should be reasonable (per SSAP 62) * Should not include non-UW risk (for example, should not incorporate a provision for credit risk,interest rate risk, etc...) ## Footnote Freihaut

Question 49

Why is the evaluation date important in a risk transfer test?

Answer 49

Risk transfer is done at the evaluation date based on circumstances, facts known at the time ## Footnote Freihaut

Question 50

Practical Considerations in a risk transfer test

Answer 50

**P**aramater selection (interest rate, payment-pattern, loss distribution) **P**arameter risk **P**ricing **A**ssumptions **C**ommutation clause ## Footnote Freihaut

Question 51

Under new rules (2020) how must uncollectible reinsurance be established?

Answer 51

They must be established based on anticipated ultimate uncollectible amounts. ## Footnote AAA Uncollectible

Question 52

What are the current (previous?) approaches to determining Uncollectable Reinsurance Reserve?

Answer 52

* Incurred Loss Model - Include only known impairments * Expected Loss Model - Include ultimate of all uncollectable reinsurance ## Footnote AAA Uncollectible

Question 53

What are the primary causes of reinsurance uncollectibility?

Answer 53

* Credit Risk (inability to pay) * *usually due to either impairment or insolvency* * Dispute Risk (unwillingness to pay) * *Could be due to following: * Unique exposures (alien invasion from Mars) * Rare events (squirrel steals your sandwich) * Provisions untested in the courts (future self travels back to dump water on your head) * Circumstance not contemplated by the contract (Worldwide pandemic)* ## Footnote AAA Uncollectible

Question 54

Name some specific situations where contract disputes can occur

Answer 54

* Missing Policies * Late Notice of Claim * Settlements made without first consulting with the reinsurer * Definition of an "Occurence" ## Footnote AAA Uncollectible

Question 55

Does a reinsurer default imply that 100% of the associated reinsurance recoverable should be written off?

Answer 55

No, some reinsurers may partially or fully recover and pay some or all amounts previously in default ## Footnote AAA Uncollectible

Question 56

When would you use incremental default rates rather than cumulative default rates

Answer 56

Use incremental default rates when future ceded balances are projected on a runoff basis ## Footnote AAA Uncollectible

Question 57

How is the cumulative probability of default by rating estimated?

Answer 57

* A.M. Best Financial Strength ratings and associated probability of impairment * Insurer's history of reinsurer default rates by internal rating * transition matrices ## Footnote AAA Uncollectible

Question 58

How is the Uncollectible Reinsurance Reserve provision for disputes treated in a rating-based method?

Answer 58

Calculate dispute provision by considering any or all of: * Insurer's prior dispute-based reinsurance write-offs * Industry data to the extent available and relevant * Management's judgment ## Footnote AAA Uncollectible

Question 59

How can double-counting be avoided when estimating Uncollectible Reinsurance Reserve?

Answer 59

Apply the URR rating-based method to the reinsurance recoverable net of the calculated dispute provision ## Footnote AAA Uncollectible

Question 60

What are the two methods of estimating URR?

Answer 60

* Rating based (basically calculate expected recoverable by expected default by rating and by year, multiply together) * Experience based (simple: have ratio of all unrecovered over last sever years by total recoverable, multiply by future year; enhanced, add write-offs over time by billing lag year, reinsurance structure (quota, excess of loss, etc...), LOB)) ## Footnote AAA Uncollectible

Question 61

When is it appropriate to use experience-based methods? What are the challenges associated with experience-based URR methods?

Answer 61

Appropriate when an insurer's writeoff history has sufficient credibility * Thin data * Past Uncollectible rates may not be indicative of future uncollectible rates * Experience-based uncollectible rates can be distorted by individual events (commutations, reinsurer insolvency) * (more are listed in the text) ## Footnote AAA Uncollectible

Question 62

Define Prospective Reinsurance Define Retroactive Reinsurance

Answer 62

A reinsurance contract in which coverage is provided for future losses on insurable events A reinsurance contract in which coverage is provided for losses from insurable events that may have occurred in the past ## Footnote SSAP-62R

Question 63

Describe the accounting treatiment of prospective and retroactive reinsurance according to SAP

Answer 63

**Prospective Reinsurance** * If there is a claim then loss reserves increase **Retroactive Reinsurance** * If there is a claim then loss reserves do not increase * the claim amount is recorded as a write-in liability ## Footnote SSAP-62R

Question 64

Define Novation

Answer 64

* A novation is an issuance of a new contract * A novation releases the primary insurer of all liability * A novation may be eligible for reinsurance accounting treatment but not in these situations: (Retroactive reinsurance, novation with an affiliated company) ## Footnote SSAP-62R

Question 65

What is a runoff agreement?

Answer 65

An agreement underwhich an insurer cedes 100% of LOB to a third party and no longer marketing, but still liable if 3rd party defaults (unlike under novation, which liability is completely transferred ## Footnote SSAP-62R

Question 66

Identify items a regulator might consider before approving a reinsurance accounting treatment for a runoff agreement

Answer 66

* Reinsurer is properly licensed * Contract must meet normal risk transfer requirements * Policy limits and coverage don't change * Reinsurere must be rated at least as high as cedant by 2 different rating agencies ## Footnote SSAP-62R

Question 67

Define Financial Guarantee

Answer 67

Non-Cancellable indemnity bond backed by an insurer to guarantee investors that principal and interest payments will be made (in other words, it covers a lender from the liability resulting from the borrower defaulting on a loan) ## Footnote FASB 944

Question 68

What is a retrospectively rated contract?

Answer 68

* a contract where the final premium is based on the loss experience of the policy * includes loss development after expiration * final premium is determined by a formula written into the policy or by law ## Footnote SSAP-66

Question 69

What is a term for a contract that has retrospective features?

Answer 69

Loss Sensitive Contract ## Footnote SSAP-66

Question 70

Are premium adjustments due "to" or "from" insureds considered to be admitted assets?

Answer 70

yes, but with certain exceptions, like if amounts are deemed uncollectible ## Footnote SSAP-66

Question 71

Briefly describe 2 ways of estimating retrospective premium adjustments

Answer 71

[1] apply the historical ratio of (retrospective rated developments)/(earned standard premium) to the premium for the policy being rated [2] for each risk, compare known to anticipated loss development (including IBNR) to estimate return or additional premium earned at that point in time ## Footnote SSAP-66

Question 72

Briefly describe the accounting treatment of "accrued additional" & "accrued return" retrospective premium

Answer 72

accrued additional retrospective premium → record as a receivable → with a corresponding entry in written premium or an adjustment to earned premium accrued return retrospective premium → record as a liability (as a change in unearned premium) → with a corresponding entry in written premium or an adjustment to earned premium (same as for accrued additional premium) ## Footnote SSAP-66