risk transfer

Question 2

In order to qualify for reinsurance treatment

Answer 2

the insurer needs to demonstrate risk transfer. This requires: Reinsurer assumes significant insurance risk & It is reasonably possible that the reinsurer may realize a significant loss

Question 3

GAAP & SAP accounting both require to demonstrate risk transfer

Answer 3

-GAAP & SAP accounting both require insurance risk (both underwriting and timing risk) to demonstrate risk transfer. -Contracts that qualify according to GAAP are assumed to qualify according to SAP, and vice versa

Question 4

The reason that the Reinsurance Attestation Supplement used the words “reasonably self-evident”

Answer 4

was to reduce the need to rigorously test each reinsurance contract for risk transfer. However, little guidance was provided as to the definition of “reasonably self-evident”. Different parties have attempted to provide guidance, including a CAS working party, which listed a 1% ERD threshold

Question 5

10-10 rule

Answer 5

• 10-10 rule is a benchmark used in the industry to determine if risk transfer does not exist
• According to the rule, there needs to be at least a 10% chance of a 10% or greater loss (underwriting loss to reinsurer relative to ceded premium).
• The 10-10 rule does have some problems

Question 6

ERD

Answer 6

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

-Risk transfer can be assumed to exist if this is greater than 1% of premium

Question 7

Contract that fails risk transfer tests might qualify for reinsurance accounting

Answer 7

= If it fulfills the substantially all exception, If contract transfers all risk (aka 100% QS) from insurer to reins on a profitable book of business

-This puts the reinsurer in essentially the same position as the ceding company

Question 8

Terms in the contract cause concern from a risk transfer perspective

Answer 8

• loss ratio cap: limits the reinsurer’s underwriting risk, limiting the reinsurance transfer
• automatic commutation clause: this may limit the underwriting or timing risk, thus limiting risk transfer. Underwriting risk is limited because if the contract is commuted, the reinsurer will not be responsible for adverse development in the tail

Question 9

Data Elements to calc ERD

Answer 9

• The discount rate is needed. This is needed to actually discount the losses. The risk‐free rate is recommended
• Premium. This is used to determine if there is a loss to the reinsurer or not
• Payment pattern: would need this to consider the time value of money
• Contractual features which limit loss such as loss retro caps, which would need to factor these in as they may limit loss
• Simulated losses -> estimates frequency and size of loss to reinsurer
• Aggregate loss distribution to determine the probability of achieving a loss

Question 10

Practical considerations when calculating ERD

Answer 10

• Reinsurer expenses need to be excluded from the simulation, as they do not constitute a cash flow that takes place between ceding company & reinsurer
• Profit commissions need to be excluded from the analysis. This is because the risk transfer analysis only focuses on scenarios that would generate a loss to the reinsurer, in which case a profit commission will not be required
• Selection of Payment Patterns: Select the ceding company’s payment pattern carefully because this affects the tail of the distribution
• Loss distribution needs to be considered, especially for reasonable results in the tail
• Interest rate should be reasonable and the same for premiums and losses. Interest rate risk should not be a factor to consider; too low, will overdetect risk transfer
• Parameter Risk: can be accounted for explicitly (distribution around parameter) or implicitly (higher expected loss and standard deviation)
• Commutation Clause: If commutation clause exists, how does this impact reinsurer’s potential loss
• Assumptions from pricing analyses should be used with extreme caution, as pricing analyses focus on the expected value of losses under all scenarios; ERD/risk transfer analyses only focus on the tail of the distribution; these tend to be more conservative and thus overestimate risk transfer in some cases

Question 11

Premium Amounts (if change with contract provisions) could use

Answer 11

a. Initial – can be manipulated easily b. Expected – overstates risk transfer if not adjusted up with losses c. Actual – from simulation. Most difficult and best

Question 12

short duration contract

Answer 12

• Insurance contracts can be classified as short duration or long duration, based on how long they are expected to remain in force
• short: provides protection for a fixed period of short duration, contract allows the insurer to cancel or change the provisions at the end of any contract period