Odomirok.14-F

Reading: Financial Reporting Through the Lens of a Property/Casualty Actuary - Chapter 14 - Schedule F

Author: Kathleen C. Odomirok, FCAS, MAAA, Liam M. McFarlane, FCIA, FCAS, Gareth L. Kennedy, ACAS, MAAA, Justin J. Brenden, FCAS, MAAA, EY

Forum

BA Quick-Summary: Schedule F - Reinsurance Accounting Schedule F details an insurance company's reinsurance transactions, providing information on premiums, losses, and expenses from these transactions. It is essential for assessing loss and loss adjustment expense reserves and reinsurance collectability. The chapter outlines the structure of Schedule F, including its 6 parts, which cover assumed and ceded reinsurance, portfolio reinsurance transactions, and the provision for reinsurance. This provision reflects the minimum reserve for uncollectible reinsurance.

Study Tips

Changes for 2021.Spring:   There were significant changes to the layout of Schedule F.

For candidates who attempted Exam 6 prior to 2021.Spring, Here are a few things to note: (Details are contained in the wiki article.)

• The layout of Schedule F has changed. See the Introduction. There are now 6 parts numbered 1, 2, 3, 4, 5, 6 (versus 9 previously). Part 3 is the most important.
• There was a minor change to the correspondence between the Balance Sheet and Schedule F.
• The calculation of provision for reinsurance is essentially unchanged. The location of the information you need has changed however, most of it being from with Part 3, but the formulas themselves are the same.
• The current version of the Odomirok source text now includes examples of calculation the provision for reinsurance for Certified Reinsurers. This calculation is not new, but the previous version of the source did not contain detailed examples.
• Virtually all of the old exam problems are still relevant, except as they may refer to specific parts of Schedule F, which, as noted above in the first bullet point above, have changed.

For all candidates:

Schedule F is another reading about reinsurance. If you look at the Ranking Table page, you'll see a group of 3 readings in the Top 12 highlighted in orange, that are all about reinsurance. It's a major topic that accounts for almost 15% of the points on the exam, almost as much as the SAO. Of the 3, the Klann.ReinsComm reading is the most heavily tested, but just by a little bit. Each of the 3 accounts for consistently 4-5% of the exam.

There are a few facts to memorize, most (not all) of which are included in quiz #1. There are also 2 important calculation problems you need to learn:

• provision for reinsurance   ← this is the most important topic
• restating the balance sheet to GROSS of reinsurance   ← not tested frequently

There is another less important calculation in Part 5 of Schedule F related to NAIC IRIS Ratio 2 that is worth looking at. It's easy however and you could probably figure it out based on general knowledge anyway. There is also a brief forum discussion on the credit risk charge for ceded reinsurance and special codes in Schedule F, Part 3, Column 5 so give that a quick read.

Estimate study time: several days (not including subsequent study time)

BattleTable

Based on past exams, the main things you need to know (in rough order of importance) are:

• reinsurance provision calculation
• Sched F solvency testing - strengths & weaknesses of using Schedule F for solvency testing
• "Certified" category - benefits to insurers & reinsurers of this special category
• restatement of balance sheet to a gross-of-reinsurance basis
• provision for reinsurance (SAP) versus other measures of reinsurer credit risk:
  • actuary's SAO discussion on reinsurance collectability
  • management's reinsurer credit risk estimate for GAAP accounting

Questions held out from Fall 2019 exam: #15. (Skip these now to have a fresh exam to practice on later. For links to these questions, see Exam Summaries.)

reference	part (a)	part (b)	part (c)	part (d)
E (2018.Fall #15)	reinsurance provision: - calculate	reinsurance provision: - ways to reduce it
E (2018.Spring #9)	define: - reinsurer recoverable	define: - reinsurer payable	define: - reinsurer funds held	define: - reinsurance provision
E (2017.Fall #14)	balance sheet: - restate to gross of reins.	Sched F solvency testing: - strength/weakness
E (2017.Spring #14)	reinsurance provision: - calculate 1	"Certified" category: - benefits	reinsurance provision: - how to improve
E (2016.Fall #13)	reinsurance provision: - calculate	Sched F solvency testing: - strength/weakness
E (2016.Spring #14)	reinsurance provision: - calculate	"Certified" category: - benefits
E (2015.Spring #15)	reinsurance provision: - calculate	reinsurance provision: - how to reduce	SAO reins. collectability: - vs. Sched F provision
E (2013.Fall #16)	SCENARIO: - slow-paying reinsurer?	reinsurance provision: - calculate	reinsurance provision: - calculate (unauthorized re)	Sched F solvency testing: - potential enhancements
E (2012.Fall #19)	reinsurance provision: 2 - calculate	GAAP estimate: - vs. Sched F provision	GAAP estimate: - vs. Sched F provision	Sched F solvency testing: - strength/weakness

¹ The solution in the examiner's report has the wrong formula for the slow-pay ratio. It's missing the term: amounts paid in last 90 days in the denominator. (But the final answer was still correct because that amount was equal to 0 anyway.)

² The examiners' report solution for part (a) either has an error or the formula for the reinsurance provision is out-of-date. See this forum discussion.

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In Plain English!

Introduction

Schedule F is all about reinsurance and has 6 parts as shown in the table a little further down.

• Parts 1, 2, and 4 are not a big deal. We'll discuss them briefly.
• Parts 3 and 6 each have significant calculations and there is a web-based problem for each.
• Part 5 also has a calculation but it's quite easy.

Spend a few minutes skimming these exhibits, taking general note of the information they contain as well as the column headings. You'll become more familiar with them as we work through the calculations later in this wiki article. According to Odomirok:

• Schedule F shows details underlying an insurance company’s reinsurance transactions on prospective contracts that meet the conditions for reinsurance accounting as defined in NAIC.SSAP-62R

Part 3 is the most important part of Schedule F because it shows the calculation of the provision for reinsurance, which is discussed further down in this wiki article. The provision for reinsurance is a liability on the balance sheet. Part 3 also relates to the credit risk portion, R₃, of the RBC calculation but that is discussed in detail in Odomirok.19-RBC.

link	title/topic	information shown (columns)
Schedule F – Part 1	assumed reinsurance	premiums, losses, commissions, collateral
Schedule F – Part 2	premium portfolio reinsurance	premiums (original premiums and reinsurance premiums)
Schedule F – Part 3	ceded reinsurance	provision for reinsurance (78 columns)
Schedule F – Part 4	Issuing or Confirming Banks for Letters of Credit from Schedule F, Part 3	list of confirming banks
Schedule F – Part 5	Interrogatories for Schedule F, Part 3	commission rates, loss recoverables
Schedule F – Part 6	restatement of balance sheet (to identify net credit for reinsurance)	balance sheet information

* These exhibits will be inserted when I receive my copy of the NAIC Annual Statement blanks from the NAIC.

The organization of Schedule F in the 2019 version of Odomirok represents a significant change from the 2014 version, which consisted of 9 parts. (Much of the information is the same but Part 3 was expanded to include the whole reinsurance provision calculation whereas before it was split into separate parts.)

Both Schedule P and Schedule F are important for actuaries. Schedule P shows actuarial triangles, which are central to an actuary's work in determining reserves. Schedule F is also crucial because an insurer's net reserves depend on the amount of reinsurance assumed and/or ceded. But it's also possible that Schedule F plays no role whatsoever. This would be the case if an insurer has no assumed or ceded reinsurance. That probably isn't likely, but it still feels like Schedule F is not as important as Schedule P. Indeed, the examiners seem to feel the same way because Schedule P is consistently more heavily tested than Schedule F.

Question: what general types of information are provided in the Schedule F exhibits (refers to column labels)

• varies by exhibit (see table above)

Question: identify the groups or categories used in Schedule F, Part 1 (refers to row labels)

• affiliated insurers

- U.S. intercompany pooling

- U.S. non-pool

- other (non U.S.)

• other U.S. unaffiliated insurers
• pools & associations

- mandatory pools

- voluntary pools

• other non-U.S. insurers

Schedule F - Parts 1, 2, and 4

The table above says the topic of Schedule F, Part 1 is assumed reinsurance. A slightly more detailed description is:

• Part 1 provides the total assumed reinsurance balances by reinsured.
• Part 1 enables an understanding of the risks associated with assumed reinsurance transactions as of the current year.

Part 2 on portfolio reinsurance has only a very brief discussion:

• Part 2 provides a detailed listing of portfolio reinsurance transactions effected or canceled during the current year. (The definition of portfolio insurance is given in quiz #1 below.)

Part 4 is for information purposes.

• Part 4 provides a listing of the issuing or confirming banks for letters of credit as collateral reported in Schedule F, Part 3, column 22. (Confirming banks are those that provide a guarantee on a letter of credit such that the confirming bank will pay if the original bank issuing the letter of credit does not.)

Schedule F - Part 3

Part 3 is by far the most extensive and most important exhibit in Schedule F. This is where the provision for reinsurance is calculated and it's organized as follows:

• The first 20 columns detail the ceded reinsurance balances
• Columns 21 through 36 calculate credit risk charge on ceded reinsurance (click link for brief forum discussion on credit risk charge and 'special codes')
• Columns 37 through 53 provide the aging of ceded reinsurance
• Columns 54 through 69 provide the calculation of the Provision for Reinsurance for Certified Reinsurance
• Columns 70 through 78 provide the Total Provision for Reinsurance (authorized, unauthorized and total)

This is a significant reorganization versus the previous version of Schedule F. Based on past exam questions however, what you need to know is how to calculate the provision for reinsurance for authorized, unauthorized (and possibly, although less likely, for certified reinsurers as well.) This calculation is discussed further down in this wiki article.

Odomirok has extremely detailed discussions of individual columns in this 78-column exhibit. My personal feeling is that this is far too detailed for the exam. If you don't feel comfortable skipping those details, I recommend you study everything else first, then refer directly to the Odomirok text. There is no way to convey that information other than to essentially copy from Odomirok directly into wiki article, which is something I didn't want to do. Odomirok explains it perfectly well and it's actually a great working reference for Schedule F.

Schedule F - Parts 5 and 6

• Part 5 has 2 tables with interrogatories for Part 3 and is discussed in detail further down. It has a pretty easy example of calculation problem that deals with surplus relief and NAIC IRIS Ratio 2.

• Part 6 is important and has a more complicated calculation problem which has been asked on prior exams. It deals with restating the balance sheet as if the company did not purchase reinsurance. This is also discussed in detail further down.

The next quiz has roughly 15 facts pulled from Chapter 14 that you should probably know.

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The Balance Sheet and Schedule F

Let's now go a little deeper and see how the Balance Sheet maps to Schedule F. Everything comes from various columns in Part 3 except the liabilities on line 2 which come from Part 1.

assets (the asset side of the balance sheet has 1 line item from Schedule F)

line 16.1: amounts recoverable from reinsurers (from Schedule F, Part 3)

liabilities (the liability side of the balance sheet has 5 line items from Schedule F)

line   2: reinsurance payable on paid losses and loss adjustment expenses (from Schedule F, Part 1)

line   9: unearned premiums for ceded reinsurance (from Schedule F, Part 3)

line 12: ceded reinsurance premiums payable net of ceding commissions (from Schedule F, Part 3)

line 13: funds held by company under reinsurance treaties (from Schedule F, Part 3)

line 16: provision for reinsurance (from Schedule F, Part 3)

There is a very nice table in Odomirok (page 111, table 21) that explains this and you should look at it now:

Balance Sheet  ↔  Schedule F

There was also an exam problem about this but the answer in examiner's report is now outdated. For part (c), the examiner's report accepted only 3 answers for liability items coming directly from Schedule F. The current version of the source text now lists 5 items. (See above.)

E (2019.Fall #15)

The most important term in the Schedule F chapter is provision for reinsurance (also called 'reinsurance provision'). We'll denote this quantity by RP.

Question: define the term reinsurance provision

• the RP is a minimum reserve (calculated under SAP) that reflects estimated uncollectible reinsurance recoveries

2018.Spring #9 (essay)

Let's review an old exam question related to this mapping between the Balance Sheet and Schedule F:

E (2018.Spring #9)

They ask you to define and classify the given financial statement quantities as either assets, liabilities, or income statement items. This is a very typical question from an accounting course and if you've had an accounting course, you'll probably find it easy. Here's how I think about it:

• Money coming in (a receivable or recoverable) is good! A receivable is an asset.
• Money going out (a payable) is bad! A payable is a liability.

If you've really drilled yourself on the practice template for Layout of Financial Statements from Odomirok.8-9-IS then you'll know how to classify each item. Each is a line item from financial statements as follows:

(i) amounts recoverable from reinsurers ==> asset - line 16.1

(ii) reinsurance payable on paid loss & LAE ==> liability - line 2 (also appears on Schedule F, Part 1, Column 6)

(iii) funds held under reinsurance treaties ==> liability - line 13 (also appears on Schedule F, Part 3, Column 20)

(iv) provision for reinsurance ==> liability - line 16 (also appears on Schedule F, Part 3, Column 78)

Note that the examiner's report accepted an alternate answer for (iii), stating that this item is an asset but the examiner's report is wrong. They are referring to the following similar-sounding balance sheet item:

• Reinsurance: Funds held by or deposited with reinsured companies ==> asset - line 16.2

Also note that none was classified as an income statement item. (That was a red herring.)

2017.Fall #14 (calculation)

This type of problem, restating the balance sheet as if the company had no reinsurance, relates to Schedule F, Part 6

Aside from the reinsurance provision, the other type of Schedule F problem that may come up involves restatement of the balance sheet assuming the company carries no reinsurance:

E (2017.Fall #14)

One of the uses of Schedule F is monitoring the solvency of the insurer by evaluating the credit-worthiness of its reinsurers. But what if the insurer had no reinsurance protection? How would this change its balance sheet? This is shown in Schedule F Part 6. Note the outdated references in this exam problem to Schedule F, Part 9. This information has been moved to Part 6 but the calculations are essentially the same.

Question: which line items on an insurer's balance sheet change if ceded reinsurance contracts are removed

assets: only these 2 line items change

item 3: reinsurance recoverable on loss and loss adjustment expense payment

item 6: net amount recoverable from reinsurers

liabilities: only these 5 line items change

item 8: losses & LAE

item 9: unearned premium

item 12: ceded reinsurance premiums payable

item 13: funds held by company under reinsurance treaties

item 14: provision for reinsurance

• There is a forum thread for this problem that may be helpful.

Note: The statement of the exam problem uses numbers that do not match the numbering on Schedule F Part 6, which might be confusing. Watch out for that. Also, the labeling on Schedule F Part 6 is different from the corresponding items on the balance sheet. For those reasons, you should probably focus on learning the names of the above items rather than their line numbers.

Anyway, you'll see the above items listed with the given information. They also give you a bunch of other stuff that you don't need, including one trick item:

• funds held by OR deposited with reinsured companies

This sounds very much like the line 15 item: funds held by company under reinsurance treaties. One needs an adjustment (line 15) and the other one doesn't. The KEY to remembering which is which is that the one requiring adjustment has the word treaties in it. (The other doesn't)

Question: how do the quantities on an insurer's balance sheet change if ceded reinsurance contracts are removed

Removing the reinsurance contracts means restating the balance sheet to a gross of reinsurance basis. Click the link below for a step-by-step solution:

Schedule F - 2017.Fall #14

Once you understand the above solution, here's a practice problem:

1 practice problem like 2017.Fall #14

The quiz has a similar web-based practice problem.

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Solvency Monitoring with Schedule F

There are several exam problems that discuss the strengths and weaknesses of using Schedule F to monitor the solvency of an insurer (see BattleTable above). Specifically, an insurer wants to assess the likelihood of collecting recoveries from the reinsurer. If the insurer cannot collect then there will be a negative impact on the insurer's surplus and this can impact insurer solvency. Overall however (and these are just my own thoughts) it seems that Schedule F provides only a narrow snapshot of the solvency position of an insurer. There are much more direct ways to monitor solvency than simply focusing on collectability of reinsurance recoveries, examples being the RBC ratio and IRIS ratios.

Anyway, the weaknesses of using Schedule F to monitor insurer solvency are discussed on the last page of chapter 14 in Odomirok. Let's dive right in as there's a pretty good chance a similar question will appear on future exams. Recall the term Reinsurance Provision (or Provision for Reinsurance) is denoted by RP.

Question: how can Schedule F be used to monitor the solvency of an insurer

• Schedule F tracks reinsurance transactions, calculates a reinsurance provision, and shows the effect on the insurer's balance sheet of canceling all reinsurance contracts.
• quality of reinsurance impacts risk of uncollectability from reinsurer which impacts solvency of the insurer.
• (Note that an insurer faces many risk factors other than reinsurance, so monitoring solvency using only Schedule F is obviously going to have limitations.)

Question: identify strengths & weaknesses with using Schedule F as a solvency monitoring tool

strengths:

• RP is formulaic - easy to compare across years & companies
• RP is formulaic - hard to manipulate because inputs are numbers from financial statements
• RP accounts for reinsurer credit risk with penalties for unauthorized reinsurers (often this means foreign insurers)
• RP accounts for reinsurer credit risk with penalties for slow-paying reinsurers
• Schedule F shows impact to surplus if reinsurance contracts are canceled

weaknesses:

• RP is formulaic - may mask management's better informed estimate of collectability risk
• RP is formulaic - but no statistical basis for formula - may not represent true collectability risk
• RP penalizes unauthorized reinsurers regardless of their financial strength
• RP penalizes slow-paying reinsurers regardless of their financial strength and slow-payer threshold is arbitrary
• In General: Schedule F doesn't directly measure reinsurer's solvency which is the true source of uncollectability risk
• In General: Schedule F doesn't measure the quality of an insurer's reinsurance management

There was a variation on the above question that appeared in 2013.Fall #16. If you understand the weaknesses listed above, you could probably come up with the answer without having memorized it.

Question: how can Schedule F be enhanced to improve its capacity to monitor reinsurer credit risk

disclose details of reinsurance arrangements (Schedule F doesn't measure quality of an insurer's reinsurance)

include management input of uncollectability risk (the formula may miss important risk factors)

include reinsurer ratings (Schedule F doesn't do this even though it is an important risk factor)

replace 20% slow-pay threshold with a sliding scale and consider reasons for slow-pay

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Calculation: Provision for Reinsurance

This type of problem, calculating the provision for reinsurance relates to Schedule F, Part 3 The formula for calculating the provision for unauthorized reinsurance has changed slightly. The the quantities 20% x Pn90 and 20% x Td are no longer capped by C. (This cap rarely applied anyway so the old exam problems are still valid.)

You can see from the BattleTable that the provision for reinsurance is the most frequently asked question on Schedule F. Recall from earlier in this wiki article that (in BattleActs) we denote the provision for reinsurance (or Reinsurance Provision) as RP. And recall the definition:

• RP is a minimum reserve (calculated under SAP) that reflects estimated uncollectible reinsurance recoveries

The first exam problem we'll look at is:

E (2017.Spring #14)

Alice the Actuary always likes to fire up Excel and solve the problem in her own way (using the examiner's report and the source reading for guidance). That way she really understands it. Note that she altered the notation used in the text. If you look on page 131 they use the letters A, B, C, D, E in their formulas, but these letters are not descriptive of the quantities they represent. Good notation encapsulates the concepts. It makes formulas easier to remember and understand. Anyway, here is Alice's solution using more descriptive notation:

Schedule F - 2017.Spring #14

Note 1: In the above file, it is stated that "P" stands for "Paid Recoverable", but it's probably better to describe it as "recoverables on paid losses". There was a forum discussion about it. Note 2: This above question also presents the given information in a slightly ambiguous way. The information shown in these lines overlaps: Recoverable on Paid Loss + LAE > 90 Days Past Due Recoverable on Paid Loss + LAE > 120 Days Past Due That means you really only need the amount "> 90 days" because it automatically includes the amounts "> 120 days". The examiners' report however accepted the interpretation that "> 90 days" really meant "90-120 days", in which case you would have to add it to the amount given for "> 120 days". My solution assumes the literal interpretation that "> 90 days" includes the amount for "> 120 days" so you do not have to add them together.

Once you're worked through the above problem, we'll take a look at a very similar problem:

E (2016.Fall #13)

The way you're given the information is different but it's basically the same as the previous problem. What Alice has done in the following is to fit the given information into the same format as the previous problem. Take a look:

Schedule F - 2016.Fall #13

Notice that in each of the 2 previous problems, the authorized reinsurer is not a slow-payer. In this next exam problem, the reinsurer is a slow-payer and the formula for the reinsurance provision is slightly different. Here's the problem:

E (2016.Spring #14)

And below is the solution. Note that we have again fit the given information into the format of the first problem in this section.

Schedule F - 2016.Spring #14

A final point that deserves mention (although you probably already noticed it yourself) is that the calculation of the reinsurance provision is different depending on whether the reinsurer is authorized or unauthorized.

Question: what is an unauthorized reinsurer

• An unauthorized reinsurer is one that does business where it is not legally permitted to do so.
• An example would be a reinsurer authorized to conduct business only in Maine selling reinsurance to an insurer in Texas.
• From a legal perspective, the insurer in Texas has no reinsurance coverage. The likelihood of not collecting on reinsurance recoverables is much higher, therefore the provision for reinsurance is also much higher.

The idea of an unauthorized reinsurer leads into the next section on Certified Reinsurers. But first, the quiz.

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Calculation: Provision for Reinsurance (Certified Reinsurers)

When I first learned the formulas for calculating the reinsurance provision, I wondered why an insurer would ever place business with an unauthorized reinsurer. As noted in the previous section, the insurer technically has no coverage. In practice, however, even unauthorized reinsurers generally abide by the contract. (If they didn't they would quickly go out of business.) Also, unauthorized reinsurers may offer policies at a lower price to offset the perceived greater risk of uncollectability.

The next thing I wondered was why unauthorized reinsurers didn't just jump through the normal regulatory hoops to become authorized. This isn't discussed in Odomirok, but in 2012 there were changes to the annual statement instructions that addressed the whole issue of unauthorized reinsurance. Recall that the reinsurance provision for unauthorized reinsurance is generally (much) higher than for authorized reinsurers.

Question: identify a criticism of the reinsurance provision with respect to unauthorized reinsurers

• the financial strength of the reinsurer is not considered

This means the reinsurance provision for a financially strong reinsurer would be the same as for a weak reinsurer. To address this, the new category certified reinsurer was introduced in 2012 and is contained in Schedule F, Part 3, columns 54-69.

Question: define 'certified reinsurer'

• non-U.S. reinsurers domiciled in a jurisdiction designated by the NAIC as a Qualified Jurisdiction (i.e., Bermuda, France, Germany, Ireland, Japan, Switzerland and the United Kingdom)
• one that would have been categorized as unauthorized prior to 2012
• one that has attained certification from the reporting entity's domiciliary state

Question: what does a regulator consider when evaluating an unauthorized reinsurer's application for certification

Jurisdiction of reinsurer

Rating from a rating agency

Regulatory history

FinPos (Financial Position)

C & S (Capital & Surplus)

Alice is a Lord of the Rings nerd and since the author of that novel is JRR Tolkien, she remembers this question as the Lord of the Rings question:

• The unauthorized reinsurer has to jump through regulatory hoops or rings in their quest to become certified. (It was a long walk to get that memory trick!)

The last 2 items in the list, FinPos and C & S don't fit into this trick, but they're pretty obvious regulatory considerations. (Frodo for FinPos? Saruman for Surplus?) ← thx GA!

• Another trick to remember C & S is that JRR Tolkien and CS Lewis were friends at Oxford University during the first half of the 20th century. Get more info here.

Since the NAIC went to all the trouble of creating their nifty new model law, there must have been a good reason for it, right? Right! See below:

Question: what are the benefits of a reinsurer being certified

• the reporting entity is not penalized as heavily as for an unauthorized reinsurer so the reinsurance provision is lower (amount depends on the strength of the reinsurer)
• the reinsurer can post collateral of less than 100% of its U.S. claims (varies according to the financial strength of the reinsurer)

Question: identify the 2 components of the reinsurance provision for certified reinsurers

RP⁶⁴(CD): reinsurance provision for collateral deficiency related to certified reinsurers → appears in (Col 64) of Part 3

RP⁶⁹(OR): reinsurance provision for overdue reinsurance related to certified reinsurers → appears in (Col 69) of Part 3

I invented the notation given above because otherwise it's just too hard to keep everything straight in my head. The total reinsurance provision for certified reinsurers is then the sum of these components which we'll denote RP⁷⁷(Cert). It appears in (Col 77) of Schedule F, Part 3.

If you refer to the actual exhibit, you'll see that what I'm doing is working my way backwards from the final answer RP⁷⁷(Cert). We're now going 1 step further back to get the formulas for each of these components. This exhibit is crazy complicated and there's no way anyone would do this calculation by hand – it would all be programmed into the computer. But we still should have some basic sense for how it's calculated. Unfortunately, there are no old exam problems to look at, unlike for authorized and unauthorized reinsurers, so we have to go back to the actual exhibit to figure it all out. We're not going to go through every detail, but we'll do enough so that you should be able to piece together the solution to any kind of a reasonable exam question.

Question: what are the reinsurance provision formulas for these 2 components

Component 1 formula:

Let A¹⁹(recov)   =   net Amount recoverable from reinsurer (Col 19)

Let Cr⁶³(recov)   =   Credit allowed for net recoverables (Col 63)

RP64(CD)   =   A19(recov) – Cr63(recov)

→ Intuitively, it's simply the shortfall between the amount recoverable and the credit allowed (recall that the reinsurance provision is an estimate of the uncollectible reinsurance)

→ the credit allowed uses the ratio between (collateral provided) and (collateral required)

Here's a quick example to clarify. (We'll assume (Col 57) = 0. This is explained a little further down.)

• Given:

→ A¹⁹(recov) = 150, and the collateral requirement is 30% or 45

→ the reinsurer provides 36 of the required 45 of collateral

• Then:

→ Cr⁶³(recov)   =   150 x 36/45   =   150 x 0.8   =   120

→ RP⁶⁴(CD)   =   150 - 120   =   30

Component 2 formula: Note correction explained below.

P^d₉₀ = recoverable on Paid loss loss & LAE > 90 days past due in dispute   ← (Col 62 45)

Pⁿ₉₀ = recoverable on Paid loss & LAE > 90 days past due not in dispute   ← (Col 65 47)

F = net unsecured recoverable for slow payers for which credit is permitted   ← (Col 68 67)

Correction on March 23, 2023: The column references for Pⁿ₉₀ and P^d₉₀ were inadvertently labelled as columns (62) and (65). This is incorrect - the correct labels are columns (45) and (47). Note that columns (62) and (65) equal 20% times the values of columns (45) and (47). So the original version of the formulas would have multiplied by the 20% factor twice. The same comment applies to the quantity "F". Column (68) equals 20% x column (67) so using column (68) or the quantity F would incorrectly incorporate the 20% factor twice.

RP69(OR)   =   min [ 20% x MAX ( Pn90 + Pd90 , F ) , Cr63(recov) ]

→ Intuitively, this is the estimate of uncollectible overdue amounts from certified reinsurers

Sorry about the slight inconsistency in notation. The superscripts n and d don't refer to the columns where they appear. The component 2 notation is carried over from what I used earlier for authorized and unauthorized reinsurers.

Before getting to the examples, we're going to take 1 more step backwards (sorry!) and see how to calculate Cr⁶³(recov). The formula for this in Part 3, (Col 63) is:

Cr63(recov)   =   (Col 57) + (Col 58) x (Col 61)

• (Col 57) = Catastrophe Recoverables Qualifying for Collateral Deferral (Whatever the heck that is...we're just going to assume this equals 0!)
• (Col 58) = Net Recoverables Subject to Collateral Requirements for Full Credit
• (Col 61) = Percent Credit Allowed on Net Recoverables Subject to Collateral Requirements

→ algebraically, this works out to (collateral provided) / (collateral required)

I'm not even going to make up notation for this because it's getting too confusing. The 2 key things to understand are:

• (Col 58)   =   A¹⁹(recov)   when   (Col 57) = 0
• (Col 61) would be 36/45 = 80% for the earlier example where the reinsurer provided collateral of 36 compared to the collateral requirement of 45

If you stop and think through the arithmetic, you'll see that a high value for (Col 61) is better because it makes Cr⁶³(recov) higher, and that in turn makes RP⁶⁴(CD) lower. In other words, it makes the reinsurance provision for collateral deficiency lower, which is good. Ok, now we can do the example. It's actually very easy once you get past all the notation.

Example A: Find the reinsurance provision for collateral deficiency of the given certified reinsurer .

A¹⁹(recov) = 1,000

Net Recoverables Subject to Collateral Requirements for Full Credit (Col 58) = 1,000

Percent Credit Allowed on Net Recoverables Subject to Collateral Requirements (Col 61) = 20%

  Then

RP⁶⁴(CD)   =   A¹⁹(recov) – Cr⁶³(recov)   =   1,000 – 1,000 x 20%   =   800

Example B: Find the reinsurance provision for overdue reinsurance of the given certified reinsurer.

Pⁿ₉₀ = 600

P^d₉₀ = 300

F = 500

Cr⁶³(recov)   =   (amount not subject to collateral requirement) + (collateral provided)   =   0 + 200   =   200  ← from example A

  Then

RP⁶⁹(OR)   =   min [ 20% x MAX ( Pⁿ₉₀ + P^d₉₀ , F ) , Cr⁶³(recov) ]

  =   min [ 20% x MAX ( 600 + 300 , 500 ) , 200 ]

  =   min [ 180 , 200 ]

  =   180

Note: Although not part Example B, if you calculate the value of "Total Collateral Provided" (column 66) you will get a negative value which doesn't make sense. The numbers I selected for this example were not internally consistent, but the formulas are all correct. Click for a forum discussion about this.

Example C: Find the total reinsurance provision for the given certified reinsurer.

This is easy. It's just the sum of the answers to Example A & B:   RP⁷⁷(Cert) = 800 + 180 = 980

PK posted another example in the forum. Thx PK!

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Schedule F - Part 5

Schedule F, Part 5 provides interrogatories for Schedule F, Part 3. It includes 2 tables with more detailed information.

Question: briefly describe the 2 tables in Schedule F Part 5

Table 1:

• identifies 5 largest reinsurer commission rates (where ceded premium ≥ $50,000)
• the purpose is to identify companies using reinsurance to conceal high operating leverage

Table 2:

• identifies 5 largest loss recoverables from (Col 15) and whether the reinsurer is affiliated with the reporting entity
• the purpose is to assess concentration of insurance risk

There's an interesting little example in Odomirok that demonstrates how an insurer can use reinsurance to conceal high operating leverage. Suppose you're given:

• DWP = 150m (Direct Written Premium)
• surplus = 25m
• reinsurance quota-share percentage = 30%
• ceding commission = 35%

→ without reinsurance, the premium-to-surplus ratio is 150m / 25m = 600%. This is the IRIS Ratio 2 and is well above the 300% benchmark.

→ with reinsurance, the premium-to-surplus ratio is reduced as follows:

• NWP = DWP x (1 - qs%) = 150m x 70% = 105m
• growth in surplus = DWP x (ceding percentage) x (ceding commission) = 150m x 30% x 35% = 15.75m

So the new premium-to-surplus ratio = 105m / (25m + 15.75m) = 258%

So far, the insurer has done nothing wrong because one of the valid purposes of reinsurance is to provide surplus relief. The trick that an insurer can use is to put the ceding commission on a sliding scale. The ceding commission in the above example would still start at 35% but would be reduced by 1 percentage point for every percentage point increase in the ceded loss ratio past some specified value, say 65%. If the ceded loss ratio is "bad" then there will be less surplus relief, but this fact is not obvious at contract inception. A regulator would have to dig deeper to see what's going on. From Odomirok:

• If the actual loss ratio turns out to be 80%, then the company will have to return $6.75 million of the original $15.75 million in ceding commission. Instead of receiving 35% of ceded premium in commission, the company (reinsured) will end up getting only 20%. If a 20% fixed commission rate was considered at the onset, the premium-to-surplus ratio would have been 309%, triggering an unusual value for IRIS Ratio 2.

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More Practice

There is no new material here. The quiz just has a few exam problems that weren't covered in previous sections.

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