Reinsurance Flashcards
What are some benefits of purchasing reinsurance?
- Expand insurer’s capacity
- share large risks with other insurers
- spread the risk of potential catastrophes and stabilize underwriting results
- finance expanding volume by sharing the financial burden of reserves
- withdraw from a line or class of business
- reduce net liability to amounts appropriate for insurer’s financial resources
62R - pg3 paragraph3
What terms must a treaty include in order to classify as reinsurance?
- The agreement must contain an acceptable insolvency clause
- Recoveries due must be available without delay for payments made by the ceding entity
- There can be no guarantee of profit, directly or indirectly to either party
- the agreement must provide for reports of premiums and losses and payment of losses no less than quarterly, unless no activity.
- agreement must include a proper reinsurance intermediary clause stating that the credit risk for the intermediary will be carried by the reinsurer
- for certified reinsurers, the agreement must include a proper funding clause
- for retroactive reinsurance agreements additional conditions:
- consideration to be paid by the ceding entity for the retroactive reinsurance must be a sum certain stated in the agreement
- direct or indirect compensation to the ceding entity or reinsurer is prohibited
- any provision for subsequent adjustment on the basis of actual experience in regard to policy obligations transferred is prohibited, less it is for the ceding to participate in the reinsurer’s ultimate profit
- a retroactive reinsurance agreement shall not be canceled or rescinded without the approval of the commissioner of the domiciliary state of the ceding
62R pgs4-5 paragraph 8
What is the essential ingredient of a reinsurance contract?
The transfer of risk; the undertaking by the reinsurer to indemnify the ceding entity
62R pg5 paragraph 10
What does insurance risk involve?
Uncertainties about both:
* the ultimate amount of net cash flows from premiums, commissions, claims, and claims settlement expenses (underwriting risk), and * the timing of the receipt and payment of those cash flows (timing risk)
If both of these types of risk are not present, then insurance risk has not been transferred.
62R pg6 paragraph 11
Freihaut pg4
What sort of reinsurance contract features must be examined in the assessment as to whether an agreement provides for the transfer of risk?
features that limit the amount of insurance risk to which the reinsurer is subject:
* experience refunds * cancellation provisions/automatic commutation clauses * adjustable features * additions of profitable lines of business to the reinsurance contract * loss ratio cap
and features that delay the timely reimbursement of claims by the reinsurer
* payment schedules * accumulating retentions from multiple years
62R pg6 paragraph12
2014Spring Q27d
FAS 944 pg8 paragraph 15-40
What are the requirements for a treaty to qualify as providing indemnification of the ceding entity against loss or liability relating to insurance risk?
- The reinsurer assumes significant insurance risk under the reinsured portions of the underlying insurance agreements; and
- It is reasonably possible that the reinsurer may realize a significant loss from the transaction.
62R pg6 paragraph13
Freihaut pg3
Both GAAP and SAP accounting standards specifically required that it be reasonably possible that the reinsurer may realize a significant loss from the transaction, except in cases where the reinsurer meets the “substantially all” requirement. Why is there such an exception?
The “substantially all” exception is meant to allow companies to acquire qualifying reinsurance on inherently profitable books of business where it may not be reasonably possible that the reinsurer will realize a significant loss.
Freihaut pg4
What are some examples of reinsurance treaty types that could qualify as reinsurance under the “substantially all” exception?
straight quota shares (100% QS), individual risk contracts with no loss ratio caps or other risk limiting features, CAT XOLs with 100% of layer assumed by reinsurer
Freihaut pg4
2015Spring Q25b
Ultimately, who at the ceding company is responsible for deciding whether a treaty counts as reinsurance?
The CEO and CFO of the ceding company confirm which treaties are reinsurance in the “Reinsurance Attestation Supplement”
Technically, this document should include evaluation for treaties where the risk transfer is not reasonably self-evident
Freihaut pg3 and pg5
What are two tests used to assess the transfer of risk in a reinsurance contract?
the 10-10 rule; the reinsurer must have a 10% or greater chance of realizing a 10% or greater loss
Expected Reinsurer Deficit (ERD); the probability of a NPV loss times the average severity of loss given that there is a loss must be greater than 1%.
Additional methods: Value at Risk (VaR), Tail Value at Risk (TVaR), Right Tail Deviation (RTD), Risk Coverage Ratio (RCR)
Freihaut pgs5-7
2014Spring Q27a
Describe a situation in which a reinsurance treaty might pass one risk transfer test but not the other.
If the reinsurer is exposed to a high probability of a loss with low severity, the treaty could pass the 1% ERD test but not pass the 10-10 rule.
2014Spring Q27b
What are some monetary elements of reinsurance that are not considered when running a risk transfer analysis?
Reinsurer expenses - this is not a cash flow between the ceding company and the reinsuer; they are not part of the risk assumed by the reinsurer from the ceding company.
Profit commissions - we are only concerned with scenarios resulting in a loss for the reinsurer.
Freihaut pg10,11,12
For a treaty that fails a risk transfer test, what sort of adjustment could be made to the premium which could result in the treaty then meeting risk transfer requirements?
because profit commissions are not considered in risk transfer analysis, the treaty could be manipulated to decrease premium and increase profit commissions.
Freihaut pgs11-12
What are some examples of Reinsurer Expenses that are NOT included in risk transfer analysis?
broker expenses
operating expenses
fees related to letters of credit
taxes
Feihaut pg12
What does SSAP 62R require of the interest rate used in risk transfer analysis?
that the interest rate be constant
that the selection of the interest rate be reasonable and appropriate
62R pg6 paragraph15
Freihaut pg12
Why does SSAP 62R require that the interest rate used in risk transfer testing not vary by scenario?
Risk Transfer should only consider insurance risk.
The possibility of invest income varying from expectations is not an element of insurance risk.
62R pg6 paragraph15
Freihaut pg12
Although the risk free rate is recommended by the AAA Practice Note as a reasonable choice for the discount rate to be used in risk transfer analysis, why is the risk free rate not a conservative choice?
The risk free rate is typically below a reinsurer’s expected investment return, and the risk free rate will result in a higher projected present value of losses.
Freihaut pgs12-13
What is a Reinsurance Commutation agreement?
Reinsurance commutation 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.
Klann pg1
What are some reasons for parties to enter into a commutation?
*Either party may wish to exit a particular line of business.
The reinsurer exits at once by commuting. The primary will first commute and then enter into a loss portfolio transfer to a third party. (Loss portfolio may be easier to transfer without the uncertainty of a reinsurance overlay.)
*Either party may have concerns about one another’s solvency.
If the reinsurer is shaky, commutation eliminates credit risk to the primary insurer. If the primary is shaky, commutation provides an immediate cash infusion and allows the reinsurer to avoid potential future problems with a liquidator who may take over the primary.
*The relationship between the primary insurer and reinsurer may have been frayed over time.
Disputes over claim resolution or contract provisions.
A single negotiation over commutation price and termination of relationship might be favorable to protracted argument over other issues
*Reinsurer and primary may have different ideas about loss development under the underlying policies and each side convinced that it is getting a good deal.
If actuaries for the two parties are setting drastically different loss reserves, an intermediate price might be favorable to both parties.
*The primary insurer might want to reduce provision for reinsurance
Klann pg1
2015Spring Q26
Why is it that the price of a commutation can typically be significantly lower than either party’s booked loss estimate?
Losses are booked on a nominal basis, but valued for purposes of pricing a commutation on a discounted basis.
Discounting can be significant for long-tailed lines and especially for excess of loss reinsurance.
Klann pg2
When solvency is an issue, what factors must the parties to a commutation consider?
the parties must consider the possible distribution of future claims as well as the expected value. The healthy party may be willing to commute at a price which generates a small expected economic loss in return for avoiding the possibility of a major loss if claims prove larger than expected and the counterparty becomes insolvent.
Klann pg2
