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ST7 Oct 2015 Q5 (ii), (iii) and (iv)

A

ac0914

Member
Hi all,

Can someone explain to me how does the US trust fund works in this question? For example, does that means all claims and expenses are still paid out of the fund requirement or does it pay from any surplus in excess of the fund? Also, the question says the fund requirement needs to be gross of any reinsurance recoveries. In that case, can the firm still use reinsurance to meet any claims from its outward reinsurance arrangement?

thanks,

ac
 
Not sure what you mean for the 1st part. My understanding is that insurer posts asset equal to outstanding claims, and if I a claim will be paid, the requirement will fall(unpaid liabilities falling), hence some assets from trust fund is released to insurer and claims can hence be paid from this

Part 2, the insurance can definitively use reinsurance recoveries for claim payment
 
Not quite Avnish.

We're told the funding requirement is 100% of gross unpaid claims and claims and expenses will be paid out of this funding requirement (or out of margins / free assets, if the funding requirement is insufficient).

Now think how it meets that funding requirement: If business is sold at profitable rates, the premium income should be sufficient - simply pay it into the fund and the requirement will be met (always assuming there isn't too much delay in receiving premiums).

Now think what happens in the event of bad claims experience (this will be cat-exposed business after all): Claims could be much higher than the 100% funding requirement - liquidity risk will be very high. So the company will need liquid assets and access to other sources of capital, such as contingent capital / cat bonds etc.

Now ask yourself why it matters that the funding requirement is gross of reinsurance: There's likely to be lots of reinsurance in place, so any effect will be exaggerated. It's not the market norm to draw down on reinsurance recoveries in advance of a request for payment being presented, so that's another reason for liquidity risk to be high.
 
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