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FAS 113: Risk Transfer Testing of Reinsurance Contracts Must Include
- 1. Thorough understanding of contract provisions
- 2. Model of the incidence of cash flows between parties
- 3. Single, appropriate discount rate
- 4. Insurance risk only
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VFIC Recommended Risk Transfer Analysis Include
- 1. Risk transfer analysis included a view of the distribution of expected contract losses
- 2. Identication of an appropriate risk metric and threshold values
- 3. Duration-matched or immunized yields as the approprate discount rates
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FAS 113 Requirements of Risk Transfer
- 1. Reinsurer assumes significant insurance risk under the reinsured portions of the underlying reinsurance contracts (underwriting risk and timing risk)
- 2. It is reasonably possible that the reinsurer may realize a significant loss from the transaction
- 3. Expection to 1 & 2: Substantially all the insurance risk relating to the reinsured portions of the underlying insurancecontracts has been assumed by the reinsurer
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10-10 Rule
- 1. Ceding company must demonstrate a value at risk of 10% at the 90th percentile of the distribution of the net present value of underwriting losses on the contract in question
- 2. Problem: Many contracts which a reasonable person would regard as risky do not strictly have a 10% chance of loss 10% of the time (e.g., high level catastrophe programs)
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5 Considerations in Applying VaR Tests
- 1. Risk transfer testing requirements are prospective in nature
- 2. Practitioners must go beyond the mean
- 3. A model of the incidence of cash ows is required
- 4. Discounted cash flow model should suffice
- 5. Remote results can be judged on the basis of closed form distributions of results, simulations, or through scenario testing
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Weakness of Value At Risk (VaR) and Tail Value At Risk (TVaR)
- 1. VaR considers only a single point on the loss distribution
- 2. TVaR ignores losses below VaR and losses above VaR are treated on an expected basis only
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