1. Risk Transfer - What Changes Are On The Horizon?
23/07/2018
Risk Transfer - What Changes Are On The Horizon?
Panelist: Marc Oberholtzer - PwC
CAS Seminar on Reinsurance
June 6-7, 2005
Bermuda

2. 23/07/2018
Discussion Topics
An Audit Firm Actuary’s Perspective on Evaluating Risk Transfer
Relevant Accounting Guidance
Role of Audit Firm Actuary
Contracts Where Auditors Request Assistance from Audit Firm Actuary
Process used to Evaluate Contracts
Determine Substance of Arrangement
Evaluate Cash Flows/Scenario Testing
Thresholds (e.g., 10/10 rule)
Terms/Conditions Requiring Special Consideration
Possible Changes to Reinsurance Accounting
Activity at the NAIC; Possible Changes for US Statutory Accounting:
Increased Disclosure
Attestations
NY Proposal re: Bifurcation
Activity at the FASB

3. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Current Relevant US Accounting Guidance
US GAAP
FAS 113 – Primary US GAAP guidance on Reinsurance Accounting.
Para 9a – “Transfer of Significant Insurance Risk”
Para 9b – “Reasonable Possibility of Significant Loss”
EITF 93-6 – Multi-Year RRC
Topic D-54 – Reserve Guarantee Accounting
US Statutory
SSAP 62 – Similar Guidance to US GAAP; no D-54 Retroactive Exception

4. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Role of Audit Firm Actuary
The Auditor (i.e., an Accountant) Considers Input from The Audit Firm Actuary in his/her Assessment of Risk Transfer
Such Input Includes:
A View as to the Economic Substance, as Compared to the Contractual Form, of the Arrangement
The Evaluation and Conclusion on Reasonableness of Projected Cash Flows under Contract, Ensuring Appropriate Consideration of Historical Losses, Modeling Assumptions and Contractual Terms
The Evaluation of Related Disclosures as Applicable

5. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Which Contracts Is the Auditor More Likely to Seek the Assistance of the Audit Firm Actuary?
Those with Various Risk Limiting Features. Typically, this includes:
Quota Share Contracts with Corridors and/or Sliding Scale Commissions and Loss Ratio Caps
Aggregate Stop Loss or Loss Ratio Covers with Premium Payments and/or Profit Commissions
Contracts with Experience Accounts or Similar Provisions

6. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Which Contracts Is the Auditor Less Likely to Seek the Assistance of the Audit Firm Actuary?
Those without Significant Various Risk Limiting Features. Typically, this includes:
Most Traditional Excess of Loss Arrangements
Quota Share without Risk Limiting Features
Most Single Year Catastrophe Covers

7. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
The Substance of Arrangement
Identify the Contract or Contracts being evaluated
Obtain and Read Entire Contract and Related Contracts, if any
Substance does not Always Follow Form
Obtain from the Audited Company an Understanding of the Business Purpose and Substance of the Transaction.
Obtain and Review as much Background to the Transaction as Possible
Obtain and Review Underwriting Memo, Accounting Memo Risk and/or Risk Transfer Memo
In unavailable, there might be control implications and an inability for auditor to conclude on risk transfer

8. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Evaluate Company’s Analysis of Cash Flows/Scenario Testing – Subject Losses
Conclude on Reasonableness of Company’s Estimates of Loss Estimates, Payout Patterns, and their Variability over Reasonably Possible Scenarios
Company’s Selected Mean, CV and Distribution of Subject Losses
Based on Company History? Industry Data? Judgment?
Payout Patterns
How Selected?
What is the basis and methodology used to vary the Payout Patterns?

9. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Evaluate The Audited Company’s Analysis of Cash Flows/Scenario Testing – Contractual Terms
Amount and Timing of Additional Premiums, Commissions, or Related Payments
Are all contractual terms considered in the risk transfer calculation?
Interaction of Loss Payments with Experience Accounts and/or Funds Held Accounts, including Interest Credits and Charges
Determine Impact of Commutation Clauses or Related Terms
Obtain Management’s Representation as to its Intentions regarding Such Clauses

10. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Evaluate The Audited Company’s Analysis of Cash Flows/Scenario Testing – Interest Rate used to Calculate Present Value
Conclude on Reasonableness of Company’s Selected Interest Rate Used to Present Value Cash Flows
Ensure that All Cash Flows are Being Present Valued, and at the same Interest Rate
Determine the Expected Timing and Duration of Payments based on Cash Flow Analysis
Compare Risk-Free Rates at Expected Duration with those used in the Risk Transfer Calculation – modify Calculation as needed to reflect a Risk-Free Rate

11. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Common Rule of Thumb – 10/10 Rule
10% chance of a 10% loss (in present value terms)
Calculated from the Assuming Company’s perspective
The present value of net of cash flows for losses and commissions, divided by
The present value of net cash flows for premiums
Appears to be the Industry Standard Regarding the Minimum Threshold for Risk Transfer
A higher standard may be appropriate
There are other considerations
What happens at other scenarios?
What is the maximum loss to the Company?
Does the Company’s suggested accounting reasonably match the substance of the agreement?

12. Evaluating Risk Transfer – Process
23/07/2018
Evaluating Risk Transfer – Process
Some Terms, Conditions or Circumstances that Require Close Scrutiny
Multi-Year Arrangements
Does Loss Experience under the Contract create Rights for the Assuming Company that need to be considered?
Different Interest Rates; For example, Interest Credit on Funds Held Accounts exceeding the Rate used to Present Value Cash Flows
The Amount that the Interest Credit Exceeds the Rate used to Present Value Cash Flows is Considered Additional Consideration in the Risk Transfer Analysis
Ceding Commission Paid in the Future
The Time Value Benefit to the Ceding Company is Considered to be Additional Consideration in the Risk Transfer Analysis
Maintenance Fees
Expected Amounts Are Present Valued and Considered Additional Consideration in the Risk Transfer Analysis
Commutation Accounts
Can the Assuming Company Reduce its Losses by Exercising a Right to Commute, and is such Right Considered in the Evaluation?

13. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
May 10, 2005 NAIC Meeting – Possible Changes to SSAP 62 for Year-end 2005:
Increased Disclosure for certain reinsurance contracts
Aggregate Stop Loss
Quota Share with Limiting Features
Many others with Certain Terms/Conditions
Attestation from CEO and CFO
No Side deals
Documentation exists Supporting Risk Transfer and the Economic Intent of All Reinsurance contracts
Bifurcation of Certain Contracts
Portions of Certain Contracts where there is more than a 90% Probability that Premiums would be Recovered would be Accounted for as a Deposit

14. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
May 10, 2005 NAIC Meeting – Possible Changes to SSAP 62 for Year-end 2005:
A Significant Expectation of Documentation within the CEO, CFO Attestations
Expectation by Regulators that Documentation Exists Supporting Risk Transfer and the Economic Intent of All Reinsurance Contracts – Regulators View Lack of Such Documentation as Lack of Compliance with SSAP 62 and the corporate recordkeeping requirements of Foreign Corrupt Practices Act of 1977 (as Amended) .
Compliance Would Effectively Require Documentation Contemporaneous with Entering into Transactions

15. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
May 10, 2005 NAIC Meeting – Possible Changes to SSAP 62 for Year-end 2005:
A Significant Proposal – Bifurcation
Certain contracts, including quota share with limits, aggregate stop-loss and retroactive potentially subject to bifurcation
Bifurcation is the separation of a contract into financing and risk transfer components for accounting purposes
Would require actuarial evaluation to estimate/allocate premium and related consideration between the risk transfer and deposit components

16. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
May 10, 2005 NAIC Meeting – Proposed Bifurcation
Possible Benefits
An Ability to Better Match The Accounting with a Contract’s Economics
Would Likely Eliminate the Benefit, and then eventually the Existence, of Those Contracts Viewed as Problematic by Regulators, Rating Agencies and Investors

17. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
May 10, 2005 NAIC Meeting – Proposed Bifurcation
Possible Concerns
Complexity – Bifurcation Could be Very Complicated, in particular for Certain Quota Share Arrangements with Risk Limiting Features
Potential Unintended Consequences
Change in Structure, Pricing of Traditional Market
Bifurcation of Contracts that are not viewed as Problematic or Viewed to have Significant Risk Limiting Features
Differences in Accounting between US SAP, US GAAP and other Accounting Bases

18. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
Other Recent Regulatory Activity
New York – Effective March 2005
For Reinsurance Cessions, NY Insurance Department will Require the CEO of companies to attest that:
There are No Side Agreements
For each Contract, a File exists that Documents the Economic Intent of the Transaction and the Risk Transfer Analysis Evidencing the Proper Accounting Treatment, which is Available for Review.
Massachusetts – Effective May 2005
Insurer's Audit Committee Chair will be Required to:
Sign Off on any Finite Reinsurance Contracts
Certify that there are no Informal or Side Agreements that might affect Transactions

19. Industry Update – Possible Changes
23/07/2018
Industry Update – Possible Changes
Activity at the FASB – Insurance-Risk Transfer Project (April 6, 2005 meeting)
Underlying Purpose - to Improve the Accounting for Insurance and Reinsurance Contracts by More Clearly Defining which Contracts or Portions thereof should be Accounted for as Insurance and which Should be Accounted for as Deposits (financings).
Objectives:
Clarify Transfer of Significant Insurance Risk; Define Insurance Contracts and Codifying related Guidance in current FASB and AICPA literature.
Explore Simple Approaches to Bifurcation