Transcript Are You Truly Diversified?

Task Force on the Appropriate
Treatment of Reinsurance
Doug Tozer, Vice-President and Actuary
September 22, 2006
Background
• Late 2004: Media coverage and US investigation
into use of “finite risk” reinsurance (Spitzer, AIG,
HIH……)
• February 2005: OSFI letter to the CIA Re:
Treatment of Reinsurance in Valuation
• Review of SOP’s by PC, CLIFR and PCFRC
• June 2005: Memorandum from PC to all members
on Appropriate Treatment of Reinsurance
Mandate
• Broad mandate to focus on:
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Finite reinsurance
Degree of risk transfer in reinsurance transactions
Side agreements
Stop loss arrangements
Reinsurance counterparty risks
Mandate
• Representatives from all stakeholders groups
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Life and P&C practitioners
Federal and Provincial regulators (OSFI, AMF)
Industry groups (CLHIA, IBC)
Accountants (CICA)
• Deliverables and Timetable
– Develop research paper or educational note
– Consider or suggest potential modifications to the SOPs, if
deemed necessary
– Preliminary draft report was circulated to a focus group in
June
– Draft report to PC this Fall
Paper Outline – Key Sections
• Definitions
• Background
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Overview of reinsurance concepts and terminology
Finite reinsurance
Reinsurance and the actuary
Current reinsurance accounting practice (Canada
and International)
Paper Outline – Key Sections
• The Concept of Risk Transfer
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Key principles of risk transfer
Assessing the “existence” of risk transfer
Assessing the “extent” of risk transfer
Limitations of risk transfer
• Other issues
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Side agreements
Mirroring and Communication
Bifurcation
Reinsurance counter-party risk
Key Principles of Risk Transfer
• Principle #1. There are several approaches that
can be used to assess the existence of risk
transfer
– No single test or rule for each and every type of
contract
– In some contracts it may be obvious that risk
transfer exists in the absence of any specific test
Key Principles of Risk Transfer
• Principle #2. Professional judgment will be
required when assessing the existence of risk
transfer
– Actuaries and/or other relevant professionals
– SOP 2130.02 – “coordinate the valuation with the
insurer’s accounting policy…so that the policy
liabilities…conform to the presentation of the income
statement”
Key Principles of Risk Transfer
• Principle #3. The entire agreement consisting of
the reinsurance contract and all written and verbal
agreements and correspondence must be
considered in assessing the existence of risk
transfer
– Actuaries must make reasonable effort to be
informed of each and every commitment made by
any authorized party
Key Principles of Risk Transfer
• Principle #4. The existence of risk transfer must
be assessed at inception of the contract and every
time a change to the contract that significantly
alters the expected future cash flows of that
contract is made
– Risk transfer does not need to be continually
assessed
– Events occurring during normal operation of the
contract do not trigger reassessment
Assessing Risk Transfer
• Qualitative
– Reasonably self-evident
• Intuitively obvious
• No potential risk limiting features
• Catastrophe covers and specific events (earthquake, terrorism)
• No other tests necessary
• Minimal documentation
– Not reasonably self-evident
• Quantitative analysis impractical
• Substantial documentation
• Quantitative
– Relevant data and computer model available
– Substantial documentation
Risk Limiting Features
• Existence of risk limiting features requires further
analysis
• Some examples include:
– Profit sharing or experience rating provisions
– Retro premium adjustments
– Loss Limits – caps on loss ratio, loss corridor, swing
rate
– Adjustable commission on proportional treaty with or
without credit/debit carry forward
– Side letters and agreements
Other Issues
• Side Agreements
– Can obscure or misrepresent the nature or intention of the
reinsurance contract
– In the extreme, side agreements may negate the risk transfer
– Regulators are not fond of side agreements
• Mirroring and communication between cedant and reinsurer
– Appropriate procedures to confirm similar risk identification
and interpretation
– No mirroring of liability amounts
– Communication between actuaries of ceding companies and
reinsurers to discuss all new material treaty
Other Issues
• Bifurcation or unbundling
– Being discussed in the USA
• Reinsurance counter-party risk
– Under development
Preliminary Conclusions and
Recommendations
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Principles based approach
No one single approach to risk transfer assessment
Consider the entire contract including side agreements
Consider risk limiting features
Mirroring amounts is inappropriate
Communication between ceding company and
reinsurer actuary is important