Difference between revisions of "Reinsurance"

From BattleActs
Jump to navigation Jump to search
(BattleTable)
(Background)
Line 150: Line 150:
 
:* [https://www.battleacts6us.ca/pdf/Freihaut.Reins(10-10)_practice_01-04.pdf <span style="color: white; font-size: 12px; background-color: green; border: solid; border-width: 2px; border-radius: 10px; border-color: green; padding: 1px 3px 1px 3px; margin: 0px;">'''''4 practice problems on the 10-10 rule'''''</span>]
 
:* [https://www.battleacts6us.ca/pdf/Freihaut.Reins(10-10)_practice_01-04.pdf <span style="color: white; font-size: 12px; background-color: green; border: solid; border-width: 2px; border-radius: 10px; border-color: green; padding: 1px 3px 1px 3px; margin: 0px;">'''''4 practice problems on the 10-10 rule'''''</span>]
  
You can access the question & answer with the link to the right '''or''' in the next section '''or''' in the mini BattleQuiz. [https://www.battleactsmain.ca/pdf/Exam_(2016_2-Fall)/(2016_2-Fall)_(16).pdf <span style='font-size: 12px; background-color: yellow; border: solid; border-width: 1px; border-radius: 5px; padding: 2px 5px 2px 5px; margin: 5px;'>E</span>] <span style="color: red;">'''(2016.Fall #16a)'''</span>
+
Note that the '10-10 rule' practice problems Alice created involve discounting, but most of the old exam problems on the '10-10 rule' do not have a discounting component.
  
 
[https://www.battleactsmain.ca/FC.php?selectString=**&filter=both&sortOrder=natural&colorFlag=allFlag&colorStatus=allStatus&priority=importance-high&subsetFlag=miniQuiz&prefix=Frei&suffix=RskTrans&section=all&subSection=all&examRep=all&examYear=all&examTerm=all&quizNum=2<span style="font-size: 20px; background-color: aqua; border: solid; border-width: 1px; border-radius: 10px; padding: 2px 10px 2px 10px; margin: 10px;">'''mini BattleQuiz 2]'''</span> <span style="color: red;">'''You must be <u>logged in</u> or this will not work.'''</span>
 
[https://www.battleactsmain.ca/FC.php?selectString=**&filter=both&sortOrder=natural&colorFlag=allFlag&colorStatus=allStatus&priority=importance-high&subsetFlag=miniQuiz&prefix=Frei&suffix=RskTrans&section=all&subSection=all&examRep=all&examYear=all&examTerm=all&quizNum=2<span style="font-size: 20px; background-color: aqua; border: solid; border-width: 1px; border-radius: 10px; padding: 2px 10px 2px 10px; margin: 10px;">'''mini BattleQuiz 2]'''</span> <span style="color: red;">'''You must be <u>logged in</u> or this will not work.'''</span>

Revision as of 21:50, 15 December 2018

  Forum

Pop Quiz

BattleTable

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

  • ERD method for testing risk transfer
  • 10-10 rule for testing risk transfer
  • reinsurance accounting - determining if a contract qualifies
  • discount rate selection considerations
  • practical considerations in risk transfer analysis: parameter selection & risk, pricing assumptions, commutation clause
  • pitfalls in risk transfer analysis: profit commission, reinsurer expenses,... [PRICE – P]
  • general concepts in risk transfer testing: determining most appropriate test, determining whether risk transfer is self-evident
reference part (a) part (b) part (c) part (d)
E (2018.Spring #26) 10-10 rule:
- test risk transfer
'substantially all' rule:
- test risk transfer
ERD method:
- test risk transfer
E (2017.Spring #27) ERD method:
- test risk transfer
pitfalls:
- in risk transfer test
discount rate:
- selection considerations
E (2016.Fall #25) any method:
- test risk transfer
any method:
- test risk transfer
any method:
- test risk transfer
E (2016.Spring #26) 10-10 rule:
- test risk transfer
see Odomirok.19-RBC ERD method:
- test risk transfer
E (2015.Fall #26) self-evident?:
- test risk transfer
reinsurance accounting:
- conditions to qualify
pitfalls:
- in risk transfer test
E (2015.Spring #25) 10-10 rule:
- test risk transfer
ERD method:
- test risk transfer
see Odomirok.19-RBC
E (2014.Spring #27) describe 2 tests:
- for risk transfer
is 1 test better:
- in a certain scenario
required data:
- for risk transfer test
(d) practical considerations in a risk transfer test
(e) reinsurance accounting vs risk transfer
E (2013.Fall #28) ERD method:
- test risk transfer
reinsurance accounting:
- conditions to qualify
practical considerations:
- in risk transfer test
E (2012.Fall #31) Scenario:
- risk transfer concerns
discount rate:
- selection considerations

Full BattleQuiz You must be logged in or this will not work.

  Forum

In Plain English!

Intro

This is a well-organized paper, and I'd suggest reading Section 1. It's short, but provides a nice introduction. The main question that's addressed is:

How can an actuary determine when risk transfer has (or has not) occurred?

But even before trying to answer that, another reasonable question is:

Why do we care whether risk transfer has taken place?
  • One obvious reason is that a reinsurer cannot properly price a reinsurance contract without knowing how much risk they've taken on.
  • Another reason is that when a contract qualifies as reinsurance, the cedant may use reinsurance accounting treatment, which is more favorable than the alternative (deposit accounting)
Question: identify 2 conditions for a contract to receive reinsurance accounting treatment
  1. requires that significant insurance risk is assumed by reinsurer (under reinsured portion of contract)
  2. requires that a significant loss to the reinsurer is reasonably possible

A related concept concerns the components of insurance risk. It's generally understood that insurance risk must include:

  • U/W risk (there must be uncertainty in the $-value of loss)
  • timing risk (refers to timing of claims payments - there should not be any sort of predetermined payment schedule)

mini BattleQuiz 1 You must be logged in or this will not work.

Risk Transfer Testing

Background

When testing risk transfer, you must assess whether the 2 conditions and 2 components of risk transfer are present. (These were described above.) Below are some specific methods for doing this. (There are other pitfalls and considerations that we'll cover later, but this is a good place to start.)

Method 1: Qualitative
  • Is transfer of risk self-evident? (Maybe the reinsurance premium is very low, or the potential loss is very high, like with hurricanes or earthquakes - either way, it should be obvious that the reinsurer has a significant change of a significant loss.)
  • Sometimes you might see reasonably self-evident characterized as: (i) transaction is done at arms-length, (ii) no risk-limiting features.
  • If there is some sort of predetermined payment pattern or if it's obvious there is no U/W risk, then it is self-evident that there's no risk transfer.
Method 2: Qualitative
  • "Substantially All" exception: IF (significant loss NOT reasonably possible) BUT (reinsurer assumes "substantially all" risk) THEN (risk transfer may still exist)
  • (Often applies to quota-share contracts with a high % transferred)
Method 3: Quantitative
  • Calculate ERD (Expected Reinsurer Deficit): ERD = prob(of NPV reinsurer loss) x NPV(reinsurer loss) / (reinsurance premium)
  • If ERD > 1% then there has been transfer of loss
  • click for ERD Example.
Method 4: Quantitative

Note that the '10-10 rule' practice problems Alice created involve discounting, but most of the old exam problems on the '10-10 rule' do not have a discounting component.

mini BattleQuiz 2 You must be logged in or this will not work.

Example 1

  • Given the following info, explain whether there is risk transfer. Assume there can be at most 1 loss in the coverage period. (An excess-of-loss treaty with $A excess of $B means the reinsurer is liable for loss events falling in the range $B → $B + $A.)
excess of loss treaty $2M excess of $1M
aggregate limit $2M
aggregate deductible $1M
reinsurance premium $1M
  • Let's step through the methods in order:
  • Is risk transfer self-evident?
  • If you have to think about this for more than just a few seconds, then it is not self-evident.
  • (Method 1 inconclusive.)
  • Does the "substantially all" rule apply?
  • No, this doesn't apply either because the maximum reinsurer liability is only $2M, and the deductible and premium together sum to $2M. (It seems closer to "substantially nothing" than substantially all!)
  • (Method 2 inconclusive.)
  • Calculate ERD
  • We don't have any data on frequency and severity, but we can still deduce the ERD from the given info:
  • max loss = 3M THEREFORE max reinsurer payout = 1M (because retention = 1M and deductible = 1M) THEREFORE max reinsurer loss = 1M - (premium of 1M) = 0
  • BINGO! The reinsurer can't lose. Therefore there has been no transfer of risk.
  • (Method 3 provided the answer.)
  • Note: Do you see the reason for assuming there is only 1 loss in the coverage period? If there was a second loss of 3m, the insurer would then suffer a loss of 1m. The reasoning is that for the second 3m loss, 1m is retained by the insured as before, but the aggregate deductible of 1m was reached on the first loss and there's still 1m left in the aggregate limit. So, the insurer would have to pay 1m. The answer to whether there has been true transfer of risk would not be so clear now.

Example 2

  • Given the following info, explain whether there is risk transfer.
quota share % 90%
ceding commission 20%
ERL (expected LR) 40%
reinsurance expenses 5%
  • If you remember that the "substantially all" rule applies to quota-share reinsurance, then you can immediately conclude that there is risk transfer under this contract. (Method 2 provided the answer.)
  • (The text says that the 'substantially all' applies to quota-share with a high percentage transfer, but they don't tell you what 'high' means. Is 80% high enough? 70%?)

Example 3

  • Given the following info, explain whether there is risk transfer.
excess of loss (earthquake) $300M excess of $50M
reinsurance premium $5M
100-year PML $50M
200-year PML $200M
500-year PML $350M
  • This is the easiest of the 3 problems. It's tempting to try to calculate ERD because we're given information about both the frequency and severity, but since it's earthquake reinsurance, there is potential for a catastrophic loss in any year.
  • We can immediately invoke Method 1 to conclude that there is self-evident risk transfer under this contract.

Section 3ab & 4: Pitfalls & Practical Considerations in Reinsurance

The first thing you should do is study the 2 examples in the source reading at the beginning of Section 3.

Contract 1 is an example of a quota-share contract:
  • quota share contract (with profit commission LR @ 66%) and one-for-one profit swing up to 5% below an LR of 66%.
Contract 2 is an example of an excess-of-loss contract:
  • excess-of-loss (with optional commutation after 5 yrs) and swing-rated where provisional the reinsurance premium rate of 8.5% varies between 6%-11% based on LR of 75%

These examples are used to illustrate the pitfalls and practical considerations discussed in this section, but also that if you get another problem like (2016.Fall #16a), you'll be familiar how quota-share, and excess-of-loss reinsurance contracts work. This section is fairly straightforward memorization.

There first list must memorize is:

Question: identify the pitfalls in a risk transfer test [Hint: PRICE – P]
Profit commission
Reinsurer expenses
Interest rates
Commutation timing
Evaluation date
    –
Premiums

See details in mini BattleQuiz.

mini BattleQuiz 3 You must be logged in or this will not work.

There second list must memorize is:

Question: identify the practical considerations in a risk transfer test [Hint: parameter(selection, risk).Pr(ass).Comm]
Parameter selection (interest rate, payment-pattern, loss distribution)
Parameter risk
Pricing assumptions
Commutation clause

See details in mini BattleQuiz.

mini BattleQuiz 4 You must be logged in or this will not work.

Note :There is a lot to memorize in these sections, but it's usually not a high point-value reading, 1.0 - 1.5 points. The broad topic of reinsurance, however, covers 3 readings. (See also CIA.ReIns & BK.ReIns) These 3 readings together account for more than 3.0 points per exam, and you never know where the reinsurance questions are going to come from.

Final Thoughts

There have not been any exam questions that ask you simply to list the 6 pitfalls or 4 practical considerations in risk transfer. I'm a little surprised by that - it seems like a standard type of question. In fact, there haven't been questions of any sort on the pitfalls. (I think it's only a matter of time before one appears.) Rather, old exam questions have focused on the practical considerations.

  • A question asking for the advantages & disadvantages of using pricing assumptions in a risk transfer analysis has appeared twice, both very recently: (2017.Spring #17b), (2015.Fall #15b)
  • The answer is covered in the BattleCards, so I won't reproduce it here.
  • I think the reason this question on pricing assumptions is important is that if you're doing a risk transfer analysis, it's very easy just to ask the pricing department to give you their assumptions. It saves you the trouble of having to make your own assumptions. But if you're going to use someone else's assumptions, you should do so with full knowledge of the advantages & disadvantages.

Full BattleQuiz You must be logged in or this will not work.

BattleCodes

Memorize:


Conceptual:


Calculational:

POP QUIZ ANSWERS