Casualty Actuarial Society – Washington, D.C. September 18-19, 2008 Ian Sterling, FCAS, MAAA Risk Transfer – Actuarial Perspective.

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Presentation transcript:

Casualty Actuarial Society – Washington, D.C. September 18-19, 2008 Ian Sterling, FCAS, MAAA Risk Transfer – Actuarial Perspective

Presentation titlePage 2 Agenda ► FAS 113/SSAP 62 ► Methods of Testing ► Metrics ► Next Steps

Presentation titlePage 3 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

Presentation titlePage 4 ► 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

Presentation titlePage 5 ► 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

Presentation titlePage 6 ► Risk Transfer Testing Practice Note ► American Academy of Actuaries Committee on Property and Liability Financial Reporting – November 2005 Reinsurance Attestation Supplement 20-1

Presentation titlePage 7 ► (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

Presentation titlePage 8 ► (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

Presentation titlePage 9 ► (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

Presentation titlePage 10 Methods of Testing Reasonably Self- Evident Yes Document No Risk Transfer Analysis Scenario Testing Simulation/Modeling Techniques

Presentation titlePage 11 ► (2) Scenario Testing ► Historical results by year ► Comparison of All Underwriting Downside Scenarios ► Comparison of Cedent and Reinsurer Expected Underwriting Deficits Methods of Testing

Presentation titlePage 12 ► Historical Results by Year Methods of Testing

Presentation titlePage 13 ► Comparison of All U/W Downside Scenarios Methods of Testing

Presentation titlePage 14 ► Comparison of Cedent and Reinsurer Expected Underwriting Deficits (EUD) Methods of Testing

Presentation titlePage 15 ► (3) Simulation Testing ► Types of Models ► Aggregate Loss Models ► Frequency-Severity Models ► Combination Models ► Considerations Methods of Testing

Presentation titlePage 16 ► Modeling Considerations ► Need to model: ► Contract losses ► Contingent Premium ► Commissions ► Other Contract Features ► Reinsurance Underwriting Expenses ► Potentially not considered: ► Tax impacts Methods of Testing

Presentation titlePage 17 ► (1) “10-10” Rule (Value at Risk) ► Initial rule of thumb, and still somewhat used today ► Definition ► Shortcomings ► Unintended Consequences Metrics

Presentation titlePage 18 ► (2) Tail Value at Risk (TVaR) ► Definition ► Criteria similar to “10-10” = TVaR > 10% at 10 th percentile ► Advantages ► Disadvantages ► Does this solve the shortcomings of VaR? Metrics

Presentation titlePage 19 ► Var and TVaR Example Metrics

Presentation titlePage 20 ► (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

Presentation titlePage 21 ► (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

Presentation titlePage 22 ► 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