Freihaut and Vendetti

Question 1

What are the 2 requirements for a risk transfer to receive Re accounting treatment ?

Answer 1

• Re assumes significant insurance risk under the reinsured portion of the contract
• It is reasonably possible that the Re may realize a significant loss

Question 2

List and describe the components of insurance risk

Answer 2

• Underwriting Risk - Uncertainties around the ultimate amount of net cash flows
• Timing Risk - Timing of the receipt and payment of those cash flows

Question 3

Expected Reinsurer Deficit (ERD) formula

Answer 3

(probability of underwriting loss) x (NPV of average severity of underwriting loss)

Question 4

What is the “substantially all” exemption for a Re contract to be exempt from risk transfer requirements ?

Answer 4

Narrow exemption to “requirement of significant loss” when Re assumes substantially all the insurance risk of reinsured portions of a contract
o Allows Re on inherently profitable business

e.g., Straight QS

Question 5

When is documentation required for risk transfer ?

Answer 5

Required for every Re contract for which risk transfer is not “reasonably self-evident”

Question 6

What is the 10-10 rule ?

Answer 6

Re contract exhibits risk transfer if there is at least a 10% chance of a 10% or greater loss for the Re

Question 7

What is the ERD rule ?

Answer 7

Risk transfer exists if ERD is greater than 1%. CAS does not endorse ERD, but prefers it to the 10-10 rule

Question 8

List methods to measuring if risk transfer exists

Answer 8

• 10-10 Rule
• ERD rule
• VaR
• TVaR
• Right tail deviation (RTD)
• Risk coverage ratio (RCR)

Question 9

Steps to determine if risk transfer is present

Answer 9

1 - Understand the contract’s terms and conditions, especially those affecting the amount of risk transfered
2 - Determine reporting dates and premium due dates

Question 10

Treatment of profit commission in risk transfer analysis

Answer 10

Not considered. May effect economic results and future premium amounts but do not explicitly effect risk transfer

Question 11

Treatment of Re expenses as a common pitfall in risk transfer analysis

Answer 11

Not included. Should only consider cash flows between ceding company and Re

Broker expenses, operating expenses, fees and taxes should bear no impact on the analysis

Question 12

Treatment of Interest Rates for Discount rate as a common pitfall in risk transfer analysis

Answer 12

Should not vary by scenario because risk transfer analysis should only consider insurance risk (not investment, currency, or credit)

Question 13

Treatment of premiums as a common pitfall in risk transfer analysis

Answer 13

Gross premiums. Same interest rate used to discount losses should be applied to calculate the PV

Question 14

Treatment of evaluation date as a common pitfall in risk transfer analysis

Answer 14

Used in selection of interest rate and in determining how much is known about potential losses

Question 15

Treatment of commutation as a common pitfall in risk transfer analysis

Answer 15

Commutation clauses restrict the amount of risk transfer, but may meet risk transfer requirements, but to the extent they affect cash flow between insurer and Re, they must be modeled

Question 16

Treatment of timing risk as a common pitfall in risk transfer analysis

Answer 16

Timing risk requires the Re to make timely reimbursement payments. If there is a prescribed payment pattern, no timing risk and thus not risk transfer

Question 17

Provide the confirmations that the CEO and CFO need to make concerning risk transfer

Answer 17

1 - No separate written or oral agreements between the reporting entity and assuming Re
2 - There is documentation for every Re contract for which risk transfer is not “reasonably self-evident”
3 - Reporting entity complies with all requirements set forth in SSAP62
4 - Appropriate controls are in place to monitor the use of Re

Question 18

What are the common pitfalls in risk transfer analysis ?

Answer 18

1  - Profit Commission
2 - Re expenses
3 - Interest Rates and Discount Rates
4 - Premiums
5 - Evaluation Date
6 - Commutation and Timing of Payments

Question 19

Give 2 examples of features of a Re contract that makes it not “reasonably self-evident” that risk transfer exists.

Answer 19

1 - Presence of a low loss ratio caps (QS Re contract)

2 - Presence of swing-rated premiums (XOL contract)

Question 20

Discuss Parameter Selection as a practical consideration in risk transfer analysis

Answer 20

Any parameter not given by contract must be selected after some reflection

Question 21

Discuss Interest Rates as a practical consideration in risk transfer analysis

Answer 21

Using risk-free rate based upon a duration calculation and expected premium and loss payments is recommended. It is also required that the same rate be used throughout the analysis

Question 22

Discuss Payment Patterns as a practical consideration in risk transfer analysis.

Answer 22

When constant payment patterns are applied to a loss distribution, result will not recognize impact of quicker patterns. This will have significant impact on tails of distribution, which is the portion we are interested in for risk transfer. Variability should be consider

Question 23

Discuss Loss Distribution as a practical consideration in risk transfer analysis.

Answer 23

Having an adequate level of comfort with the tail results produced by the selected distribution is crucial

Question 24

Discuss Parameter Risk as a practical consideration in a risk transfer analysis

Answer 24

• Must not be explicitly shown in a risk transfer analysis

- Recommend documenting the existence of parameter risk and documenting how it could affect the results

Question 25

Discuss Commutation Clause as a practical consideration in risk transfer analysis.

Answer 25

Important to recognize that any commutation requirement does restrict the amount of risk transferred