Sample Question: Reinsurance Provision for Certified Reinsurers
I had a lot of trouble understanding this calculation from just the wiki, so went through the table in Odomirok to try to understand it and strip it down to a reasonable exam-level question.
Suggestions/corrections welcome!
Q1:
Certified Pretty Good is certified at level [blah] with a collateral requirement of 20%. Certified Reinsurers Rule's only ceded reinsurance contract is with CPG and there are currently net recoverables of $5M outstanding, $500,000 of which are more than 90 days overdue. CPG has provided $750,000 in collateral.
There are no recoverables qualified for collateral deferral. [There might be if there's a named hurricane involved? But Odomirok doesn't seem to cover it so it'd be really mean to have an exam question on it.]
a) What is CRR's Provision for Reinsurance Due to Collateral Deficiency on this contract?
b) What is CRR's Provision for Reinsurance Due to Overdue Balances and Amounts in Dispute on this contract assuming that CPG's slow-pay ratio for this contract is <20%?
c) What is CRR's Provision for Reinsurance Due to Overdue Balances and Amounts in Dispute on this contract assuming that CPG's slow-pay ratio for this contract is >20%?
A1:
a) CPG has provided 750,000 of the required 20% x 5=1M in collateral, i.e. 75% of it, thus there is a collateral deficiency provision of 25% x 5M = $1.25M. [There are a number of equivalent ways to get here, but I think I like this one.]
b) As a non-slow-payer, the Provision for Reinsurance Due to Overdue Balances and Amounts in Dispute is 20% of the late recoverables [like for an authorized reinsurer], so $100,000.
[Thus the total provision would be $1.35M. I didn't explicitly note any caps in my answers because they didn't change anything, but basically the provisions can't be negative and the total provision can't exceed the recoverables.]
c) As a slow-payer, the Provision for Reinsurance Due to Overdue Balances and Amounts in Dispute is 20% x max(late recoverables, uncollateralized recoverables) [again like for an authorized reinsurer] and unsurprisingly the latter is much larger so we get 20% x (5M-750k ) = $850,000.
[And again we don't hit any caps.]
Comments
That was a pretty good example. I made a few enhancements to my own example and have linked to your post from the wiki.
Looking over Odomirok one last time I think I over-simplified the answer to c. Apparently it's actually different from the Authorized case and isn't simply the uncollateralized recoverables but instead the uncollateralized recoverables that you got credit for in part a.
So since we got credit for 75% of the 5M the calculation would be 20% of (5M x 75%-750k) = $600,000 (still much larger than the answer to b).
I've attached a workbook that does this a longer way to match the table in Odomirok.
I'm really curious if a calculation on certified insurers will appear on the exam but now that exams aren't published, I won't find out. Based on past exams, the most likely question on certified reinsurers (if there is one at all) is a short answer question that might cover:
There might be a very simple calculation as part of a larger question where you have to calculate and combine the 3 main components of the provision for reinsurance as shown in the table below:
Or you might even be given the provision for certified reinsurers and you would just have to know to include it in the sum when calculating your final answer.
I think you're right about the most likely case, but they've asked people to calculate the Provision for Authorized and Unauthorized before and it's not as if Certified is particularly more difficult if you avoid edge cases. Who knows!
Yup, anything is possible. If you're solid on everything else, you might pick up an extra point or two on the exam by delving into these less likely topics.