ARM 56 – Risk Financing Exam Review Session RIMS 2014 – Denver, CO

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Recording of this session via any media type is strictly prohibited.

ARM 56 – Risk Financing

Exam Review Session RIMS 2014 – Denver, CO

Presented By: Rich Berthelsen, JD, MBA, CPCU, AIC, ARe, AU, ARM Senior Director of Content Development The Institutes 610-644-2100, ext. 7995

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Overview• Exam Basics – What to Expect• Test-Taking Tips• Review of Sections Students Find Most

Challenging

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What to Expect on the Exam• Educational Objectives• Balanced Exam• Pretest Items

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Test-Taking Tips• Time• Get the easy ones• Don’t get bogged down early • Use the “mark for later review” feature• Eliminate the obviously wrong answers• Use your scratch paper to keep track

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Assignment 2 – Estimating Hazard Risk

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Steps in Estimating Hazard Losses1st Collect and organize data2nd Limit individual losses3rd Apply loss development factors4th Forecast losses

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Exposure DataExposure unit defined:A fundamental measure of the loss exposure

assumed by the insurer.Examples: manufacturers – sales apartments – square footage retail stores - ?

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One step in forecasting expected losses based on historical data is to limit individual losses. Which one of the following occurs as a result of limiting individual losses?

A: There is a reduction in the size of the sample that can be used for forecasting.

B: The variability of forecast losses increases.

C: The forecaster is better able to match losses to the layer that is being forecast.

D: The organization will be able to reduce or eliminate losses.

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In developing its loss forecast, HCB Company's risk management professional prepares the following loss triangle:

Months from Beginning of Accident Year

Accident Year

18 30 42 54 66

20X2 $105,231 $157,003 $176,771 $188,676 $194,678

20X3 $101,137 $165,780 $189,083 $199,440

20X4 $115,781 $178,912 $192,801

20X5 $120,980 $167,413

20X6 $118,605

What is the 31- to 42-month period-to-period loss development factor for HCB Company for year 20X4?

A: 1.08

B: 1.15

C: 1.43

D: 1.67

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Planchette Processing Company (PPC) has determined that the appropriate loss development factors for its general liability loss exposures are:

Months after Beginning of Policy Year: 18 30 42 54

Loss Development Factor to Ultimate: 3.80 2.50 1.40 1.10

If PPC’s incurred general liability losses are $200,000 30 months after the beginning of a policy year, what are the projected ultimate losses for this policy year?

A: $80,000

B: $500,000

C: $700,000

D: $770,000

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Heart Monitor Company (HMC) manufactures parts for hospital emergency room equipment. Its products liability losses can be significant. As of June 30, 20X8, the products liability loss data for the last five years are as follows:

Losses by Year for Heart Monitor Company

Year 20X3 20X4 20X5 20X6 20X7 $58,000 $199,000 $44,000 $6,700,000 $24,000

$62,000 $1,900,000 $50,000 $20,000 $18,000

$25,000 $60,000 $22,000 $60,000 $48,000

$70,000

$22,000

$80,000

______________________________________________________________

Total $215,000 $2,181,000 $116,000 $6,860,000 $90,000

As of June 30, 20X8, HMC has calculated the following loss development factors:

54 months to ultimate 1.10




What is the estimated ultimate incurred loss for the accident year 20X7?

A: $90,000

B: $99,000

C: $117,000

D: $198,000

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Steps in Applying Increased Limit Factors1st Develop increased limit factors2nd Calculate the increased limit factor for each

layer of losses3rd Forecasting losses at various loss limits

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Increased limit factor for range from $50,000 to $1 million is:

2.50 divided by 1.20 which equals 2.08

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Carl is the risk manager of Benson Company. He obtained the following General Liability increased limit factors from Casualty Insurance Consulting Company: for a loss limit of $50,000 the increased limit factor is 1.00; for a loss limit of $100,000 the increased limit factor is 1.60; for a loss limit of $500,000 the increased limit factor is 2.10; and for a loss limit of $1,000,000 the increased limit factor is 2.40. What is the increased limit factor from $100,000 to $1,000,000?

A: 0.24

B: 1.50

C: 6.10

D: 8.06

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Using a loss limit of $100,000, the forecast general liability losses for ABC Company are $340,000. If a $1,000,000 loss limit is used, the forecast general liability losses are $880,000. What are ABC's expected general liability losses for the $100,001 to $1,000,000 range?

A: $160,000

B: $266,667

C: $540,000

D: $610,000

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When a frequency probability distribution is combined with a severity probability distribution, the resulting distribution is known as a

A: Catastrophe probability distribution.

B: Total loss probability distribution.

C: Increased limits probability distribution.

D: Stop-loss probability distribution.

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To determine the extent to which actual losses are likely to vary from long-term average losses, actuaries calculate the chance of outcomes falling within certain ranges of a distribution. What name is given to the chance that losses will fall between the endpoints of the range?

A: Mean severity distribution

B: Mean frequency distribution

C: Probability interval

D: Certainty range

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Assignment 5 – Retrospective Rating Plans

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Retrospective Rating Plan A rating plan that adjusts the insured’s premium

for the current policy period based on the insured’s loss experience during the current period; paid losses or incurred losses may be used to determine loss experience.

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Retrospective Rating Premium FormulaRetrospective rating plan premium = (Basic premium + Converted losses + Excess loss

premium) x Tax multiplier

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Converted LossesAn element of the retrospective rating formula

that includes the actual losses incurred increased by a factor (loss conversion factor) that reflects loss adjustment expenses.

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Loss Conversion FactorA factor applied to incurred losses so that the

converted losses reflect unallocated loss adjustment expenses (ULAE)

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The loss conversion factor in the retrospective rating premium formula is applied to incurred losses to reflect

A: Loss of the cash flow benefit that an insurer usually enjoys under a guaranteed cost insurance program.

B: The level at which an individual loss is limited for the purpose of calculating the premium.

C: The risk for the insurer that an individual loss will exceed the loss limit.

D: Unallocated loss adjustment expenses the insurer will incur.

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Formula for Converted LossesConverted losses = Loss conversion factor x

Incurred losses

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Excess Loss PremiumAn element of the retrospective rating plan

formula that compensates the insurer for the risk that an individual loss will exceed the loss limit.

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Loss LimitThe level at which a loss occurrence is limited

for the purpose of calculating a retrospectively rated premium.

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Formula for Excess Loss PremiumExcess loss premium = Standard premium x

Excess loss premium factor x Loss conversion factor

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Formula to Review in Preparation for Case Study

Retrospective rating plan premium = (Basic premium + Converted losses + Excess loss

premium) x Tax multiplier

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Assume that Cox Company has the following cost factors for its incurred loss retrospective rating plan:

Policy limit $1,000,000

Standard premium $500,000

Premium discount $35,000

Basic premium 25% of standard premium

Loss conversion factor 1.10

Loss limit $250,000 per occurrence

Excess loss premium factor 5%

Tax multiplier 1.04

Maximum premium 150% of standard premium

Minimum premium 50% of standard premium

Assuming incurred losses of $75,000, with no occurrences over the loss limit, what is the retrospective rating plan premium?

A: $238,875

B: $241,800

C: $250,000

D: $260,000

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Paid Loss Retrospective Rating Plan A retrospective rating plan in which the insured

pays a deposit premium at the beginning of the policy period and makes additional payments, usually monthly, to reimburse the insurer for the insured’s losses as they are paid.

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In a paid loss retrospective rating plan, cumulative paid premium tracks the

A: Cumulative paid losses.

B: Cumulative incurred losses.

C: Aggregate maximum premium adjustment.

D: Joint aggregate losses.

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A paid loss retrospective rating plan differs from an incurred loss retrospective rating plan in that a paid loss retrospective rating insurance plan

A: Has a higher deposit premium.

B: Provides a lower cash flow benefit to the insured.

C: Requires the insured to reimburse the insurer as losses are paid.

D: Does not require the insured to provide security to the insurer.

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Assignment 6 - Reinsurance

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ReinsuranceThe transfer of insurance risk from one insurer

to another through a contractual agreement under which one insurer (the reinsurer) agrees, in return for a reinsurance premium, to indemnify another insurer (the primary insurer) for some or all of the financial consequences covered by the primary’s insurance policies.

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Reinsurance TransactionsNo single reinsurance agreement performs all

the reinsurance functions. A primary insurer often combines several reinsurance agreements. There are 2 types of reinsurance transactions: treaty and facultative.

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Which one of the following statements regarding treaty reinsurance and facultative reinsurance is true?

A: Administrative costs per-risk are higher under a facultative reinsurance arrangement than under a treaty reinsurance arrangement.

B: Treaty reinsurance arrangements allow the primary insurer to select which risks will be transferred to the reinsurer on a case-by-case basis.

C: Facultative reinsurance is designed to address the need to reinsure many loss exposures over a period of time.

D: Primary insurers wishing to reinsure a few loss exposures are more likely to use treaty reinsurance than facultative reinsurance.

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Facultative ReinsuranceReinsurance of individual loss exposures in

which the primary insurer chooses which loss exposures to submit to the reinsurer, and the reinsurer can accept or reject any loss exposure submitted

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One function of facultative reinsurance is to

A: Protect a primary insurer’s treaties from adverse loss experience.

B: Increase the primary insurer’s exposure in a given geographic area.

C: Allow primary insurers to accept otherwise undesirable risks.

D: Reduce the administrative expenses of maintaining a reinsurance program.

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Facultative reinsurance

A: May be used to address a primary insurer’s ongoing need for reinsurance.

B: Is used to place loss portfolio transfers.

C: Involves more administrative expense than treaty reinsurance transactions.

D: Avoids concerns regarding adverse selection against the reinsurer.

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Per Occurrence Excess of LossA type of excess of loss reinsurance that applies

the attachment point and reinsurance limit to the total losses arising from a single event affecting one or more of the primary insurer’s policies.

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Attachment PointThe dollar amount above which the reinsurer

responds to losses.

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An amusement park ride malfunctioned, injuring four individuals. ABC Insurer, the general liability insurer for the both the amusement park and the ride manufacturer, paid each of the four individuals $500,000 under the amusement park's policy and paid each of the four individuals $250,000 under the ride manufacturer's policy. ABC has a $5 million xs $200,000 per occurrence excess of loss treaty with XYZ Reinsurer. How much would XYZ pay for these losses?

A: $1,400,000

B: $1,500,000

C: $2,800,000

D: $3,000,000

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Pro Rata ReinsuranceA type of reinsurance in which the primary

insurer and reinsurer proportionally share the amounts of insurance, policy premiums, and losses (including LAE).

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The two major types of pro rata reinsurance are

A: Clash cover and catastrophe reinsurance.

B: Proportional reinsurance and non-proportional reinsurance.

C: Per risk excess of loss reinsurance and catastrophe reinsurance.

D: Quota share and surplus share reinsurance.

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Quota Share ReinsuranceA type of pro rata reinsurance in which the

primary insurer and the reinsurer share the amounts of insurance, policy premiums, and losses (LAE) using a fixed percentage.

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Boca Insurance Company enters a quota share reinsurance treaty with Beetle Reinsurance Company. Boca retains 60 percent of each loss exposure subject to the treaty while reinsuring the remaining amount to Beetle Re. Assuming a $100,000 loss occurs that is subject to this reinsurance agreement, Beetle Re's portion of the loss is

A: $0.

B: $40,000.

C: $60,000.

D: $100,000.

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Surplus Share ReinsuranceA type of pro rata reinsurance in which the

policies covered are those whose amount of insurance exceeds a stipulated dollar amount.

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Red Insurance Company has a surplus share treaty with Black Reinsurer and retains a line of $25,000. The treaty contains nine lines and provides for a maximum cession of $225,000. Red Insurance issues a policy insuring a building for $200,000 for a premium of $1,900 with one loss of $60,000. What percentage of insurance, premiums, and losses is ceded to Black Reinsurer?

A: 12.5 percent

B: 75 percent

C: 87.5 percent

D: 100 percent

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Assignment 7 – Captive Insurance

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Obtaining Potential Cash Flow Advantages on Income Taxes

Generally, a parent company may deduct from its taxes losses and other expenses paid by its captive insurer. IRS may also allow deduction of premiums paid to the captive if there is risk shifting and risk sharing.

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One reason that a parent company must moderate its pressure on a captive to insure in an economically advantageous fashion is that

A: Residual market loadings are calculated based on those administrative expenses.

B: Reinsurers control, to a large extent, the efficiency of the captive’s operations.

C: The IRS requires an arm’s-length relationship for premiums to be deductible.

D: Such pressure reduces the organization’s leverage in negotiating with insurers.

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Premium Taxes and Residual Market Loadings

One of several disadvantages of a captive insurance plan is that the losses retained by a captive insurer are paid for by the parent company as a premium on which premium taxes and residual market loadings are levied.

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Assignment 10 – Transferring Risk to the Capital Markets

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Advantages of Contingent Capital Arrangements

• The funds cost less than funds made available by insurance.

• Lower initial cost that lowers opportunity cost• Able to obtain instant funds when most

needed at predetermined price.

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Catastrophe Equity Put OptionA right to sell equity (stock) at a predetermined

price in the event of a catastrophic loss

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Contingent Surplus NotesSurplus notes in which an insurer, at its option,

can immediately obtain funds by issuing notes at a pre-agreed rate of interest and are counted as policyholders’ surplus rather than as a liability.

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Organizations Transferring RiskOrganizations that use insurance-linked

securities and insurance derivatives to transfer risk are concerned with cost, the financial security (credit risk) of the parties supplying the risk capital, and the risk that the amount received may not match the amount of their loss (basis risk).

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Assignment 11 – Allocating Costs of Managing Risk

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Allocated and Unallocated Loss Adjustment Expenses

• ALAE – attributed to a particular loss or claim• Must be ALAE to be included in risk

management costs• ULAE – are not attributed to a particular loss

or claim but still need to be charged to a dept.

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Allocating Retained LossesLoss costs can be calculated 3 ways:• Incurred loss basis: add amount paid for losses

to reserves for pending claims, to the additions to those reserves and to IBNR

• Claims-made basis: add actual payments to changes in reserves for claims made during the period

• Claims-paid basis: use amount paid on losses during the period, regardless of when incurred

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Types of Hazard Risk Management Costs to be Allocated

• Costs of accidental losses not reimbursed by insurance or outside sources

• Insurance premiums• Cost of risk control techniques• Costs of administering risk management

activities

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In a hazard risk management cost allocation system, costs that are most beneficial to allocate to a particular department are those that are

A: Clearly incurred by a given department.

B: Only partially within the organization’s control.

C: Beneficial to the organization as a whole.

D: Difficult to charge as general overhead.

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Bases for Allocating Hazard Risk Management Costs

• Exposure based system – allocates costs to departments on the basis of their exposures, regardless of loss experience.

• Experienced based system – allocates costs to departments according to their pro rata portion of past losses.

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An experience-based system of hazard risk management cost allocation for a small department could

A: Stabilize the departmental budget.

B: Simplify risk management budgeting.

C: Discourage loss control efforts.

D: Cause significant fluctuations in costs.

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General LiabilityGeneral liability loss exposures vary widely

depending on the organization’s operations. The dominant liability exposure for allocating general liability costs could be square footage, payroll, number of full time employees, and sales.

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When allocating hazard risk management costs, a common basis for measuring an organization’s dominant general liability exposure is

A: Sales.

B: Number of vehicles.

C: Departmental budget.

D: Property replacement cost.

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Questions?

Documents

ARM 56 – Risk Financing Exam Review Session RIMS 2014 – Denver, CO