Freihaut

Question 1

2 criteria to classify a transaction as having risk transfer

Answer 1

• reinsurer assumes significant insurance risk

- it is reasonably possible that the reinsurer may realize a significant loss

Question 2

Formula for Expected Reinsurer Deficit (ERD)

Answer 2

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

Question 3

Describe why profit commissions need to be excluded from the risk transfer analysis

Answer 3

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

Question 4

Describe why profit commissions can have an indirect impact on risk transfer

Answer 4

The reinsurer may charge a higher premium to account for the fact that profit commissions may need to be paid

Question 5

Describe why reinsurer expenses need to be excluded from the risk transfer analysis

Answer 5

They do not constitute a cash flow that takes place between ceding company & reinsurer

Question 6

How should premium be treated in the risk transfer analysis when it is dependent on future events

Answer 6

• initial deposit premium: intuitive & simple, but does not include future payments, and can therefore be easily manipulated
• expected premium: also intuitive. may over detect risk transfer: in the iterations with the highest losses, the premium should be higher as well
• actual premium: based on the losses simulated

Question 7

2 reasons that the selected interest rate should at least exceed the risk free rate

Answer 7

1. Very unlikely that a lower rate will be reasonable

2. A lower rate would over detect risk transfer

Question 8

2 issues with using a rate higher than risk free if the reinsurer has a higher expected investment yield

Answer 8

1. The reinsurers yield is most likely not known by the ceding company
2. It will generate the situation where risk transfer is more likely to be triggered when dealing with reinsurers with poorer investment yields

Question 9

Why can’t a yield curve be used to discount cash flows in a risk transfer analysis

Answer 9

Not consistent with the accounting standards, as it would produce different interest rates in each iteration of the simulation when the timing of cash flows differed, which is against the standard that interest rates can not vary by scenario

Question 10

What factors can be used to derive the projected loss payment patterns

Answer 10

• previous experience of the ceding insurer
• industry benchmarks
• combination of the two

Question 11

List some factors which the loss distributions can be based on

Answer 11

• previous company experience
• industry benchmarks
• pricing information
• judgment
• all of the above

Question 12

2 ways to reflect parameter risk in the risk transfer analysis

Answer 12

1. Implicitly: via slightly higher expected loss input, or increased expected volatility
2. Explicitly: the parameters would be variable. This is more scientific, but there is more judgment involved