Odomirok.14-F

Schedule F is another reading about reinsurance. If you look at the BattleBriefings page, you'll see a group of 3, readings highlighted in tan, 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.

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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 collectabiliy
  • management's reinsurer credit risk estimate for GAAP accounting

reference	part (a)	part (b)	part (c)	part (d)
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 re	Sched F solvency testing: - strength/weakness
E (2017.Spring #14)	reinsurance provision: - calculate	"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 enhancments
E (2012.Fall #19)	reinsurance provision: - calculate	GAAP estimate: - vs. Sched F provision	GAAP estimate: - vs. Sched F provision	Sched F solvency testing: - strength/weakness

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In Plain English!

Introduction

Schedule F is all about reinsurance. When I start a new chapter, I like to orient myself by sketching out the chapter contents. According to Odomirok, Schedule F has 8 parts. (Links to Schedule F example exhibits are provided below. Spend a few minutes looking at these exhibits. You'll become more familiar with them as we work through the calculations later in this wiki article.)

link	title/topic 1	information shown
Schedule F – Part 1	assumed reinsurance	premiums, losses, commissions, collateral
Schedule F – Part 2	premium portfolio reinsurance	premiums, losses, commissions, collateral
Schedule F – Part 3	ceded reinsurance	premiums, losses, commissions, collateral
Schedule F – Part 4	ceded reinsurance (aging)	paid loss recoverables by current, 1-29 days,...
Schedule F – Part 5	provision for unauthorized reinsurance	reinsurance provision, recoverables, payables, collateral
Schedule F – Part 6	provision for overdue authorized reinsurance	reinsurance provision, recoverables, payables, collateral
Schedule F – Part 7	provision for overdue reinsurance	reinsurance provision, recoverables, payables, collateral
Schedule F - Part 8: n/a	restatement of balance sheet (to identify net credit for reinsurance)	no example is available for Part 8

¹ The 2014 edition of Odomirok shows 8 parts for Schedule F but the current version of Schedule F has 9 parts. Parts 1-5 are the same for each, but an exhibit for Certified Reinsurers was inserted and labeled as Part 6. That means the original Parts 6-8 are now labeled Parts 7-9, but it isn't necessary to know this for the 2018.Spring exam. Note that the example annual statement for Liberty Mutual uses the new version of Schedule F but Part 6 is blank is Part 9 is missing.

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. affiliated insurers
• pools & associations

- mandatory pools

- voluntary pools

• other non-U.S. insurers

The next quiz has roughly 15 facts that I 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.

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 3 line items from Schedule F)

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

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

line 16: provision for reinsurance (from Schedule F, Part 7)

There is a very nice table in Odomirok (page 110, table 21) that explains this and you should look at it now:

Balance Sheet  ↔  Schedule F

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 (denoted RP in Alice the Actuary's BattleActs notation!)

• 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:

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 an 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 insurers ==> 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 19)

(iv) provision for reinsurance ==> liability - line 16 (also appears on Schedule F, Part 8)

Note that the examiner's report accepted an alternate answer for (iii), stating that this item is an asset but this 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)

After years of asking you to calculate the reinsurance provision, the CAS switched to a new type of problem involving restatement of the balance sheet:

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? Well, this is shown in Part 8, and it's actually pretty easy.

Question: how does an insurer's balance sheet change if ceded reinsurance contracts are removed

assets: only these 2 line items change (line numbers refer to the labels in Schedule F, Part 8)

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

line 6: net amount recoverable from reinsurers

liabilities: only these 5 line items change

line  9: losses & LAE

line 11: unearned premium

line 14: ceded reinsurance premiums payable

line 15: funds held by company under reinsurance treaties

line 17: provision for reinsurance

ASC (Alice's Snarky Comment): The statement of the exam problem uses numbers that do not match the numbering on Schedule F, Part 8, which is totes confusing. Watch out for that. Also, the labeling on Schedule F, Part 8 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 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)

The next obvious question is: how do these items change or in other words how do you restate the balance sheet to a gross of reinsurance basis. Alice has (again) reworked the problem in her own style to make it easier to understand:

Schedule F - 2017.Fall #14

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

1 practice problem like 2017.Fall #14

The mini BattleQuiz has a practice template for this problem for more torture. :-)

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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) 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 20% 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

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. But one of my pet peeves with Odomirok, which is otherwise well-written, is that they don't use good notation. 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. I'm a mathematician so I've learned that good notation is cricuial. Good notation encapsulates the concepts. It makes formulas easier to remember and understand. Anyway, here is Alice's solution using my notation:

Schedule F - 2017.Spring #14

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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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 the different parts of Schedule F were relabeled:

• Parts 1-5 are the same both before and after 2012
• Part 6 is now the exhibit for Certified Reinsurers
• The pre-2012 Parts 6-8 have been relabeled as Parts 7-9

Question: define 'certified reinsurer'

• one that was previously unauthorized
• one that has applied for certification from the reporting entity's domiciliary state
• one that has attained certification

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.

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 less collateral (varies according to the financial strength of the reinsurer)

Important Note: Not all states have adopted this aspect of the new NAIC model law, and Part 6 was not applicable for many companies in 2012. Odomirok did not spend much time on certified reinsurers in the main part of the text but they did provide the formula and an example so it's probably a good idea to learn it. If the examiners want to create a calculation question that hasn't been asked before, this might be a good candidate.

Question: briefly describe the 2 sections in the new Schedule F, Part 6

Section 1: reinsurance provision for collateral deficiency related to certified reinsurers

Section 2: reinsurance provision for overdue reinsurance related to certified reinsurers

Question: what are the reinsurance provision formulas for Sections 1&2 of Schedule F, Part 6

Section 1 formula:

• RP = C^r - C^p   (this is the collateral deficiency)

Section 2 formula:

• RP = min [ 20% x MAX ( Pⁿ₉₀ + P^d , F ) , C^p ]

Notation for Section 1 formula:

C^r = Collateral or credit required

C^p = Collateral or credit permitted

Notation for Section 2 formula:

Pⁿ₉₀ = recoverable on Paid loss & LAE > 90 days past due not in dispute

P^d = recoverable on Paid loss loss & LAE in dispute

F = net unsecured recoverable for slow payers for which credit is permitted

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

T = Total recoverables = 1,000

rating of certified reinsurer = 6 (lowest on a scale of 1-6)

C^r = 100% of T = 1,000

C^p = 750

  Then

RP = C^r - C^p = 1,000 - 750 = 250

Example B: find the reinsurance provision for collateral deficiency of the given certified reinsurer

T = Total recoverables = 1,000

C^r = 80% of T = 1,000 (based on rating of certified reinsurer)

C^p = 500

  Then

RP = C^r - C^p = 800 - 500 = 300

Example C: find the reinsurance provision for overdue reinsurance of the given certified reinsurer

Pⁿ₉₀ = 200

P^d = 100

F = 250

C^p = 500

  Then

RP = min [ 20% x MAX ( Pⁿ₉₀ + P^d , F ) , C^p ]

= min [ 20% x MAX ( 200 + 100 , 250 ) , 500 ]

= min [ 60 , 500 ]

= 60

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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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BattleCodes

Memorize:

Conceptual:

Calculational: