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Casualty Actuarial Society – Washington, D.C.September 18-19, 2008Ian Sterling, FCAS, MAAA
Risk Transfer – Actuarial Perspective
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Agenda
► FAS 113/SSAP 62► Methods of Testing► Metrics► Next Steps
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Reinsurance Accounting Guidance
► GAAP ► FASB Statement No. 113, Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts
► Statutory► SSAP No. 62, Property and Casualty Reinsurance
► Similar to FAS 113
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► Risk Transfer Conditions:► Paragraph 11 Test:
► The reinsurer assumes “substantially all” of the insurance risk relating to the reinsured portion of the underlying insurance contracts, or
► Paragraph 9 Test: ► (a) The reinsurer assumes “significant” insurance risk under the
reinsured portions of the underlying insurance policies.– Transfer of insurance risk refers to:
Ultimate amount of net cash flows between parties, and Timing of the receipt of cash
► (b) It is “reasonably possible” that the reinsurer may realize a significant loss from the transaction.
► Risk factors do not include recognition of reinsurance costs, investment risk, taxes, or credit risk
Short-Duration Risk Transfer – FAS 113
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► Risk Transfer Conditions:► Indemnification of the entity company against loss or
liability relating to insurance risk in reinsurance requires both of the following:► a. The reinsurer assumes significant risk under the reinsured
portions of the underlying insurance agreements; and► b. It is reasonably possible that the reinsurer may realize a
significant loss from the transaction
SSAP 62
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► Risk Transfer Testing Practice Note► American Academy of Actuaries Committee on
Property and Liability Financial Reporting – November 2005
Reinsurance Attestation Supplement 20-1
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► (1) Reasonably “Self-Evident”► Purpose► Need to Document► Considerations
► Substance of the arrangement► Existence, impact and role of risk-limiting factors► Use of professional judgment
► Contract Terms to make this less likely?
Methods of Testing
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► (1) Reasonably “Self-Evident”► Examples of Safe Harbors:
► A straight QS with no risk-limiting features other than a loss ratio cap with negligible effect on the economics of the transaction
► Single year property cat and casualty clash contracts with little or no risk limiting features apart from a reinstatement premium common to these types of contracts
► Most facultative and treaty per risk excess of loss arrangements with rates on line well below the present value of the limit of coverage, or without aggregate limites, sub-limits, or contingent features
Methods of Testing
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► (1) Reasonably “Self-Evident”► Examples of contracts not reasonably self-evident:
► Aggregate excess of loss contracts► Contracts with experience accounts, experience rating
refunds, or similar provisions, if such provisions have a significant impact on the contract’s economics
► Multiple year contracts► QS contracts with risk limiting features
Methods of Testing
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Methods of Testing
Reasonably Self-Evident
Yes No
Document Risk Transfer Analysis
Scenario Testing Simulation/Modeling Techniques
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► (2) Scenario Testing► Historical results by year► Comparison of All Underwriting Downside Scenarios► Comparison of Cedent and Reinsurer Expected
Underwriting Deficits
Methods of Testing
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► Historical Results by Year
Methods of Testing
AY Loss Ratio Commission
Reinsurer Combined
Ratio InvestmentReinsurer
Result1999 70% 20% 90% 5% 15%2000 65% 20% 85% 5% 20%2001 40% 20% 60% 5% 45%2002 95% 20% 115% 5% -10%2003 55% 20% 75% 5% 30%2004 75% 20% 95% 5% 10%2005 80% 20% 100% 5% 5%2006 120% 20% 140% 5% -35%2007 75% 20% 95% 5% 10%2008 70% 20% 90% 5% 15%
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► Comparison of All U/W Downside Scenarios
Methods of Testing
Loss RatioCedent
Expense Ratio Cedent Margin
Reinsurer Ceding
CommissionReinsurer
Margin30% 20% 50% 40% 30%40% 20% 40% 40% 20%50% 20% 30% 40% 10%60% 20% 20% 30% 10%70% 20% 10% 30% 0%80% 20% 0% 20% 0%90% 20% -10% 20% -10%
100% 20% -20% 20% -20%
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► Comparison of Cedent and Reinsurer Expected Underwriting Deficits (EUD)
Methods of Testing
Breakeven Loss Ratio Prob (Loss) U/W Loss EUD
Cedent 80% 12% 8% 0.960%Reinsurer 80% 11% 9% 0.990%
Difference 0% 1% -1% -0.030%
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► (3) Simulation Testing
► Types of Models► Aggregate Loss Models► Frequency-Severity Models► Combination Models
► Considerations
Methods of Testing
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► Modeling Considerations► Need to model:
► Contract losses► Contingent Premium► Commissions► Other Contract Features► Reinsurance Underwriting Expenses
► Potentially not considered:► Tax impacts
Methods of Testing
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► (1) “10-10” Rule (Value at Risk)► Initial rule of thumb, and still somewhat used today► Definition► Shortcomings► Unintended Consequences
Metrics
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► (2) Tail Value at Risk (TVaR)► Definition► Criteria similar to “10-10” = TVaR > 10% at 10th
percentile► Advantages► Disadvantages► Does this solve the shortcomings of VaR?
Metrics
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► Var and TVaR Example
Metrics
Confidence Level
Percentile
VaR NPV Reinsurer's Profit Ratio
TVaR NPV Reinsurer's Profit Ratio
10% 45.0% 15.0%20% 35.0% 10.0%30% 28.0% 2.0%40% 20.0% 0.0%50% 10.0% -4.0%60% 5.0% -10.0%70% 0.0% -15.0%80% -4.0% -20.0%90% -8.0% -35.0%95% -20% -100%
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► (3) Expected Reinsurer Deficit (ERD)► Definition► How relates to previous methods
► Criteria of ERD > 1% similar to “10-10” (1% = 10% x 10%)► Avg Loss Severity = TVaR at the economic breakeven LR
► Advantages► Does this solve “Shortcoming 2”?► Similar to Financial?
Metrics
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► (4) Other Methods► Other methods:
► 1. Right Tail Deviation (RTD) - Wang► 2. Mean Square Adverse Deviation► 3. Conditional Expected Downside► 4. Some combination of (2) and TVaR
► Advantage► Disadvantage
Metrics
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► Can a bright-line test be used?► Advantage► Disadvantage
► Guides► “10-10”, TVaR, ERD, RTD, etc.
► Methods of Testing Risk Transfer► “Reasonably Self-Evident”, Scenario Testing, Simulation
► Next Steps
Summary