TRANSFER OF RISK

Question 1

SECT E: TRANSFER OF RISK

CRITERIA FOR RISK TRANSFER (4)

Answer 1

1. SIGNIFICANT RISK
2. SIGNIFICANT LOSS
3. SUBSTANTIALLY ALL
4. INHERENTLY PROFITABLE
5. CRITERIA A: REINSURER ASSUMES SIGNIFICANT RISK
6. CRITERIA B: REASONABLY POSSIBLE FOR REINSURER TO REALIZE SIGNFICANT LOSS
7. CRITERIA B EXCEPTION: IF CRITERA B NOT MET, RISK TRANSFER EXISTS ONLY IF REINSURER ASSUMED SUBSTANTIALLY ALL OF RISK RELATING TO REINSURED PROTIONS OF UNDERLYING INS AGREEMENTS
8. EXEMPTION TO CRITERIA B EXCEPTION: CONTRACTS THAT REINSURER AN INDIV RISK/BOOK THAT IS INHERENTLY PROFITABLE QUALIFTY AS RISK TRANSFER

Question 2

SECT E: TRANSFER OF RISK

CRITERIA A FOR RISK TRANSFER

Answer 2

CRITERIA A: REINSURER ASSUMES SIGNIFICANT RISK
I. UNCERTAINTY IN TIMING OF LOSS, INCL TIMELY REIMBURSEMENT
II. UNCERTAINTY IN UW RISK (AMOUNT OF LOSS)

Question 3

SECT E: TRANSFER OF RISK

CRITERIA B FOR RISK TRANSFER

Answer 3

CRITERIA B: REASONABLY POSSIBLE FOR REINSURER TO REALIZE SIGNFICANT LOSS
REASONABLY POSSIBLE = PROB OF OUTCOME ≥ 10% > REMOTE
SIGNIFICANT LOSS = PV(ALL CASHFLOWS)/PV(AMTS PD TO REINSURER) ≥ 10% LOSS

Question 4

SECT E: TRANSFER OF RISK

CRITERIA B EXCEPTION FOR RISK TRANSFER

Answer 4

CRITERIA B EXCEPTION: IF CRITERA B NOT MET, RISK TRANSFER EXISTS ONLY IF REINSURER ASSUMED SUBSTANTIALLY ALL OF RISK RELATING TO REINSURED PORTIONS OF INS AGREEMENTS
-> ONLY INSIGNIFICANT RISK RETAINTED BY CEDING ENTITY
(NET CASHFLOWS OF REINSURER) /
(NET CASHFLOWS OF CEDING ENTITY)
-> REINSURER’S ECONOMIC POSITION IS VIRTUALLY EQUIV TO HAVING WRITTEN THE INS CONTRACT DIRECTLY
** IF REINSURER’S ECONOMIC POSITION IS INDETERMINABLE, CONTRACT DOES NOT QUALIFY AS RISK TRANSFERRED UNDER THIS EXCEPTION **

Question 5

SECT E: TRANSFER OF RISK

RISK ATTESTATION SUPPLEMENT (4)

Answer 5

CEO & CFO TO ATTEST VALIDITY OF REINS CONTRACTS
1. NO SEPARATE WRITTEN/ORAL AGREEMENTS
2. WHEN RISK TRANSFER IS NOT SELF-EVIDENT, DOCUMENTATION DETAILING TRANSACTION’S INTENT & EVIDENCING RISK TRANSFER IS AVAILABLE FOR REVIEW
3. REPORTING ENTITY COMPLIES WITH SSAP 62R REQS
4. APPROPRIATE CONTROLS IN PLACE TO MONITOR USE OF REINS

Question 6

SECT E: TRANSFER OF RISK

DETERMINING EXISTENCE OF RISK TRANSFER (2)

Answer 6

1. 10-10 RULE: AT LEAST 10% CHANCE OF AT LEAST 10% REINSURER LOSS
   REINS PROFIT (LOSS) = ∑ NPV (PMTS FROM CEDANT TO REINSURER)
   - ∑ NPV (PMTS FROM REINSURER TO CEDANT)
   PROB [REINSURER LOSS ≥ 10%] ≥ 10%
2. EXPECTED REINSURER DEFICIT (ERD): PROB OF NPV UW LOSS FOR REINSURER MULTIPLIED BY NPV OF AVG SEV OR UW LOSS
   ERD ($) = PROB[REINS NPV LOSS] X NPV[AVG LOSS TO REINSURER]
   ERD (%) = ERD ($)/REINS PREM
   ERD > 1% IS EQUIV TO 10-10 RULE -> 10% LOSS MULTIPLIED BY 10% CHANCE IS 1% ERD

Question 7

SECT E: TRANSFER OF RISK

EXCLUDE FROM RISK TRANSFER ANALYSIS/MODELLING (4)

Answer 7

1. REINSURER EXPENSES – NOT PART OF RISK ASSUMED FROM CEDANT
2. PROFIT COMMISSION – CONSIDER ONLY SCNEARIOS RESULTIN GIN LOSS TO REINSURER (SO NO PROFIT)
3. NON-INSURANCE RISK – CREDIT RISK, CURRENCY RISK, INVESTMENT RISK
4. PRE-DEFINED/PRESCRIBED LOSS PAYMENT SCHEDULE – DOES NOT QUALIFY AS INSURANCE RISK

Question 8

SECT E: TRANSFER OF RISK

INCLUDE IN RISK TRANSFER ANALYSIS/MODELLING (7)

Answer 8

1. CONSTANT DISCOUNT/INTEREST RATE ≥ RISK-FREE RATE FOR PREM & LOSSES
   RISK-FREE RATE COULD RESULT IN OVER-DETECTING RISK TRANSFER
   RATE > RISK-FREE RATE MAY REFLECT RISK TRANSFER DUE TO POOR INVESTMENT STRATEGY (AND NOT ACTUAL RISK TRANSFER)
2. GROSS PREMIUMS – BEFORE CEDING COMMISSION (AND EXCL REINSURER EXPENSES)
3. FEES THAT DEPEND ON FUTURE EVENTS
4. MAINTENACE FEES (TO AVOID EARLY FORCED COMMUTATION) SHOULD BE PART OF PREM
5. COMMUTATION (AND IMPACT ON PMT PATTERN) IF EXPECTED IN THE SCENARIO; COMMUTATIONS RESTRICT AMOUNT OF RISK TRANSFERRED
6. LOSS RATIO CAP – POTENTIAL TO SIGNIFICANTLY AFFECT RISK TRANSFER BUT DOES NOT ALWAYS INDICATE LACK OF RISK TRANSFER
7. SWING RATE – POTENTIAL TO LIMIT RISK TRANSFERRED

Question 9

SECT E: TRANSFER OF RISK

USING REINS PRICING ASSUMPTIONS FOR RISK TRANSFER ANALYSIS (1+/3-)

Answer 9

(+) REINS PRICING IS BASED ON APPROPRAITE EXPECTED LOSS ASSUMPTIONS
(-) RISK TRANSFER SHOULD BE BASED ON EXPECTED LOSS EXPERIENCE (NOT MARKET-DRIVEN ASSUMPTIONS, LIKE IN REINS PRICING)
(-) RISK TRANFER FOCUSSES ON RIGHT TAILOF DISTRIBUTION; REINS PRICING BASED ON ALL POTENTIAL RESULTS
(-) CONSERVATIVE REINS PRICING ASSUMPTIONS => OVER DETECTION OF RISK TRANSFER