FREI.RSKTRANS

Question 1

describe 2 conditions for a contract to receive reinsurance accounting treatment

Answer 1

• requires that significant insurance risk is assumed by reinsurer (under reinsured portion of contract)
• requires that a significant loss to the reinsurer is reasonably possible

Question 2

list 4 methods for assessing the existence of risk transfer and state whether each is qualitative or quantitative

Answer 2

METHOD 1: self-evident?
- qualitative
METHOD 2: “substantially all” exception
qualitative
METHOD 3: ERD rule (Expected Reinsurer Deficit)
quantitative
METHOD 4: 10-10 rule
quantitative

Question 3

describe the “self-evident” method for assessing the existence of risk transfer

Answer 3

• when it’s obvious that cedant’s financial interest are protected by the reinsurance contract
• may apply if reinsurance premium is low and/or the potential loss is high

Question 4

describe the “substantially all” exception method for assessing the existence of risk transfer

Answer 4

IF (significant loss is NOT reasonably possible) BUT (reinsurer assumes ‘substantially all’ risk) THEN (risk transfer may still exist)

Question 5

‘substantially all’ - 2 common Exs

Answer 5

QUOTA SHARE contracts with high % ceded
INDIVIDUAL RISK CONTRACTS without (LR caps, other risk limiting features)

Question 6

describe the ERD method (Expected Reinsurer Deficit) method for assessing the existence of risk transfer

Answer 6

• ERD = Prob(NPV loss) x NPV(avg severity of loss as a % of premium)
  
  • if ERD > 1% –> Risk transfer has occurred
• ERD is basically (frequency) x (severity as a % of premium)

Question 7

describe the “10-10” rule for assessing the existence of risk transfer

Answer 7

IF reinsurer has a 10% chance of suffering a 10% loss THEN the contract is deemed to have transferred risk

Question 8

describe the pitfalls in a risk transfer test (6)

Answer 8

Profit commission:
- do NOT include in risk transfer test
Reinsurer expenses:
- do NOT include in risk transfer test
Interest rates:
- do NOT vary with scenario
- should only consider insurance risk (U/W & timing risk)
Commutation timing:
- do NOT use prescribed payment patterns
- DO include commutation fees
Evaluation date:
- risk transfer test should be based on circumstances at evaluation date
Premiums:
- use PV (Present Value) of GROSS premiums
- apply premium adjustments to UNDISCOUNTED premiums