Battlecards 37 v 51

annie123

I believe these 2 cards are contradictory. One assumes that reinsurer's expected investment rate is not reasonable to use as the interest rate while the other one assumes it is preferable.

graham

I see what you mean, but here's what's going on:

• The reinsurer's investment return rate shouldn't play any role in determining whether risk transfer has occurred. The determination should be made primarily using insurance considerations, not external economic considerations. This is what BattleCard 37 states.

The reason for this is that an reinsurer with a poor investment strategy (low investment returns) may detect risk transfer where there is none, while an reinsurer with a good investment strategy (high investment returns) may conclude there is no risk transfer when there should be. (The investment returns for the reinsurer with the good strategy would have a better chance of compensating for losses and expenses under the reinsurance contract so it might appear that their potential loss is too low to for risk transfer to exist.)

Later in the source text (page 17, paragraph 2) it is stated that the interest rate used in a risk transfer test should be at least loosely based on the risk-free rate.

• BattleCard 51 asks about possible alternatives to using the risk-free rate. One of the answers is to use the reinsurer's investment return rate, which indeed contradicts what was stated earlier, as you noted in your question. I'm not sure why this topic was raised but there is a brief discussion that follows...

One reason for using the reinsurer's investment return rate is if the risk-free rate is not available, although that is not likely. The risk-free rate is public information so should always be available. Anyway, after some further discussion, the text concludes that using the reinsurer's investment return rate is probably not a great idea, despite the advantage of likely giving a more accurate estimate of the reinsurer's potential loss. It comes down to the idea that the quality of a reinsurer's investment strategy shouldn't affect the conclusion of a risk transfer test.

If this comes up on the exam, I would definitely say that the reinsurer's investment rate should not be used in a risk transfer test. (I suppose there could be exceptions but that would depend very much on the specific situation.)

zachboaz

So, if we are asked for an alternative to the risk-free rate for a RT analysis and an advantage of that, what do you think a sufficient response would be? It sounds like you're saying BattleCard 51 wouldn't get credit on the exam.

Staff - AC

Graham came out a little too strong against reinsurer's investment rate as an alternative. It is discussed as a possible alternative in the text, albeit a suboptimal one, and that should be enough to offer it as an answer to this type of question in the exam.