Part 28 (Freihaut & Vendetti) (****) Flashcards
Reinsurance Accounting Principles (42 cards)
Is it good or bad to apply reinsurance accounting to a contract
It is Financially Advantageous for an insurer to apply reinsurance accounting to a contract
To qualify for reinsurance treatment, the insurer needs to demonstrate what
risk transfer
How does applying reinsurance accounting help with the loss reserves
makes the loss reserves net of reinsurance recoverables, which makes it look lower
Two criteria to meet to demonstrate risk transfer
- Reinsurer assumes significant insurance risk
- It is reasonably possible that the reinsurer may realize a significant loss
Insurance risk consists of what
- Underwriting risk (possible to have uw loss or profit)
- Timing risk (timing of losses is not known)
Exception to the reinsurance treatment requirement of reasonably possible that the reinsurer may realize a significant loss
Substantially all requirement
If virtually all of the insurance risk of the reinsured portion of the underlying contracts assumed by reinsurer
Common examples of substantially all requirement
Quota Share (% of prem and loss same, so loss ratio equivalent between companies)
Contracts without risk limiting features
Risk transfer only needs to be tested if what
is not reasonably self evident
What should be kept if risk transfer is not tested
Documentation incase regulators want to see
10-10 Rule
At least a 10% chance of a 10% or greater loss then risk transfer exists
What’s a drawback of 10-10 rule
Only looks at the 10% percentile, and not at the tail. If jumps really late in tail then this won’t be correct in determination
So use the ERD
Expected Reinsurer Deficit (ERD) rule
ERD > 1% then risk transfer exits
Probability (NPV U/W loss to reinsurer) * Avg Severity (U/W loss)
If close to threshold in 10-10 rule and ERD what does this mean
It may just be because of parameters and assumptions, and if tweaked may indicate risk transfer
Pitfalls
- Profit Commission
- Reinsurer Expenses
- Interest rates and Discount factors
- Premiums
- Evaluation date
- Timing of payments
Profit commission pitfalls
- Need to be excluded from the risk transfer analysis
Why does profit commission need to be excluded from the analysis?
Because the risk transfer only focuses on scenarios that would generate a loss to the reinsurer
in this case a profit commission would not be required
How does profit commission still have an impact on risk transfer analysis
It is indirect
Reinsurer may charge higher premium due to the existence of profit commission
this will indicate a lower probability of risk transfer existing
What to do with profit commission if contract doesn’t qualify for risk transfer
Try reducing the profit commission
Reinsurer Expenses Pitfalls
Exclude from risk transfer analysis
Why exclude Reinsurer Expenses in analyzing risk transfer
they do not constitute a cash flow that takes place between ceding company and reinsurer
Interest Rates and Discount Factors Pitfalls
The same discount rate needs to be used in each simulated iteration in risk transfer analysis
Selected interest rate should be “reasonable and appropriate”
Why should the same interest rate and discount factor be used in risk transfer analysis
Interest rate risk should not impact the risk transfer test result
Only UW risk should be considered for risk transfer
How should an interest rate be reasonable and appropriate
Should reflect:
- Expected timing of payments to the reinsurer
- Duration over which the cash flows are expected to be invested by the reinsurer
Premiums Pitfalls
Gross premiums excluding any payments back to the ceding company should be used in risk transfer analysis.
(net out the ceding commissions though)
All fees should be treated as premium
