Risk Transfer Analysis

Question 1

conditions for a contract to qualify as reinsurance accounting treatment

Answer 1

• reinsurer must assume significant insurance risk: both underwriting risk and timing risk
• it must be reasonably possible that the reinsurer may realize a significant loss

Question 2

exception to requirement that reinsurer must have reasonable chance of significant loss

Answer 2

• if the reinsurer assumes substantially all of the insurance risk, e.g. quota share contracts on a profitable book of business

Question 3

what CEO/CFO must confirm in Reinsurance Attestation Supplement (4)

Answer 3

• there are no separate agreements between reporting entity and assuming entity
• there is is documentation for every reinsurance contract for which risk transfer is not reasonably self-evident
• compliance with SSAP 62R on reinsurance accounting
• controls are in place to monitor use of reinsurance

Question 4

10-10 rule

Answer 4

risk transfer occurs if there is at least a 10% chance of a 10% or greater loss for the reinsurer

Question 5

Expected Reinsurer Deficit (ERD)

Answer 5

probability of NPV underwriting loss for the reinsurer multiplied by NPV of average severity of the underwriting loss; risk transfer threshold is typically 1%

Question 6

why profit commissions generally should not be considered in risk transfer analysis

Answer 6

the analysis focuses on scenarios resulting in a reinsurer loss; however, can still have an indirect impact since profit commission in the contract may result in higher premium

Question 7

why reinsurer expenses should not be considered in risk transfer analysis

Answer 7

they do not represent cash flows between the cedant and the reinsurer

Question 8

what interest rate should be used in risk transfer analysis

Answer 8

constant interest rate should be used across all simulations; risk-free rate with duration of the reinsurer’s net cash flows is recommended

Question 9

what premium should be used in risk transfer analysis

Answer 9

gross premium (excluding any payments back to cedant) modeled for each loss scenario, discounted at same rate as loss payments

Question 10

things to consider in risk transfer analysis

Answer 10

• parameter risk
• interest rate - should be at least risk-free rate
• payment pattern - incorporate volatility if possible
• loss distribution
• reinsurance pricing assumptions may be helpful
• commutation clauses