AAA.RetainedRisk

Reading: “Retained Property Casualty Insurance-Related Risk: Interaction of Actuarial Analysis and Accounting,” April 2018

• Chapter 1, pages 7-10 ending with section on Trusts
• Chapter 4, pages 17-23.

Author: American Academy of Actuaries (AAA)

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BA Quick-Summary: Retained Risk Chapter 1 explores methods of risk retention and transfer, including: guaranteed cost policies, retrospectively rated policies, large deductible policies, self-insurance, and captives It explains how entities manage financial liability and the implications of these methods on their financial responsibilities and insurance coverage. Chapter 4 discusses key actuarial concepts for analyzing retained insurance risk, focusing on: financial reporting, internal cost allocation, and regulatory filings It highlights the importance of understanding the actuarial context, accounting standards, and considerations like discounting for the time value of money and handling unpaid claim estimates.

Study Tips

The full reading is 53 pages but you are only responsible for part of chapter 1 and part of chapter 4 which is about 9-10 pages:

• Chapter 1: definitions - 10 BattleCards - most of these are either obvious or were covered in previous readings

→ you can cover chapter 1 in under 5 minutes

• Chapter 4: relevant actuarial concepts & considerations - 14 BattleCards

→ you can cover chapter 4 in 15-20 minutes

Chapter 4 highlights important factors in analyzing retained insurance risk. A lot of it is either obvious or wouldn't make a good exam question so it shouldn't take long to go over it.

Estimated study time: 20-25 minutes (not including subsequent review time)

BattleTable

No past exam questions are available for this reading.

reference	part (a)	part (b)	part (c)	part (d)

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In Plain English!

Chapter 1 - Method of Retaining Risk and Associated Treatments

Introduction

Retained risk in property and casualty insurance refers to the amount of risk that an entity decides to keep instead of transferring it to an insurance company. It means that the entity takes financial responsibility for potential losses or liabilities without relying on insurance coverage. Retained risk can be managed through strategies like self-insurance, reserves, or captive insurance companies.

Colloquially, the terms “retained risk” and “self-insurance” refer to the same thing.

Types of Risk Transfer

This section is just definitions of different types of risk transfer. Most of them are obvious and things you already know. Quiz #1 covers the terms in the table below.

Term	Definition
Guaranteed cost policy	A policy where an entity transfers all liability to an insurer for a fixed premium.
Retrospectively rated policy	A policy where an entity transfers all liability to an insurer based on actual loss experience. The final premium depends on an audited exposure base and loss experience.
Large deductible policy	A policy where an entity transfers all liability to an insurer but retains a substantial deductible. The final cost includes: final premium losses within the deductible claims handling costs
Self-insurance	An arrangement where an entity retains all risk or purchases coverage for large claims only (common for exposures where insurance is not required by regulation).
Claims made coverage	Coverage where liability for claims reported after the policy expiration remains with the entity (unreported claims liability may accumulate for lines of business with reporting lags).
Captive	Affiliated insurance companies that can assume some or all of an entity's liability. Captives are subject to less stringent regulation than admitted carriers (and can directly insure or reinsure the entity's insurer).
Direct policy in relation to captive	A policy purchased directly from an affiliated captive insurer (typically used for coverages that would otherwise be self-insured).
Fronting arrangement	An arrangement where an entity, having purchased a guaranteed cost policy, can transfer risk back to its captive (with the commercial insurer acting as a "fronting" company for excess losses).
Deductible reimbursement	A policy written by a captive that directly reimburses the entity for its deductible obligations (it covers the entity’s obligations to the insurer but not to claimants).
Trust (in insurance)	A financial arrangement where funds or assets are set aside to cover potential losses. Commonly used to finance professional liability exposures (and provide coverage to affiliated entities on a direct basis).

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Chapter 4 - Relevant Actuarial Concepts and Considerations

Introduction

This chapter discusses key concepts for an actuarial analysis of retained insurance risk. Factors include the analysis's purpose, the company's insurance program, financial reporting timing, data availability, and accounting standards. Unusual considerations related to retained risk not covered in ASOP No. 43 are also highlighted.

Intended Purpose of the Actuarial Analysis

A 'retained risk' actuarial analysis will generally be used in one of three contexts.

Question: Identify the contexts where a 'retained risk' actuarial analysis is generally used. [Hint: AIR]

1.   Adequacy of Accruals for Financial Reporting
2.   Internal Financial Reporting and Cost Allocation
3.   Regulatory Filing for a Qualified Self-Insurance Designation

We'll discuss each of these below. Make sure your actuarial analysis is not full of hot AIR. ← That's a joke!

Adequacy of Accruals for Financial Reporting

Actuaries often receive requests to calculate the projected financial accrual for self-insured or retained liabilities. The actuarial estimates can be used by company management in 2 ways: [Hint: record & validate]

1. to directly record the accrual amount
2. to validate the reasonableness of management estimates

So if someone asks you to do that accrual calculation, you obviously have to be aware of what's included.

Question: Identify items included in these accruals for retained liabilities.

• provisions for: deductibles
• provisions for: self-insured exposure
• provisions for: potential retrospective premium amounts

When actuarial estimates are used for financial reporting, several important issues arise. This is because the actuarial estimates, as provided in an actuarial work product, may be compared to the amounts recorded in a company's general ledger.

Question: Identify key considerations when comparing an actuarial estimate to a company's ledger.

• net or gross of insurance recoverables
• discounting
• combined accruals that include other insurance-related balances

The first 2 bullet points above are covered in here in Odomirok chapters 22-23 and don't require any further discussion.

Regarding the 3^rd bullet point on combined accruals:

• The presence of combined accruals in financial statements can pose challenges when comparing them to actuarial estimates. In some cases, the financial statement accruals may include items like third-party administrator fees that are not accounted for in actuarial calculations. This makes it difficult to directly compare the results of the actuarial analysis with the financial statement entry.

• The key idea is the concept of timing and its impact on the comparison between actuarial estimates and financial statements. The timing differences in payments, billing cycles, and the treatment of prepaid balances or amounts due to third-party administrators and excess insurers are discussed, emphasizing the need for adjustments and documentation to address these timing issues.

Here are several key points from this section phrased in BattleCard format. Note: The first 2 questions below are probably more important than the other 4. If you're pressed for time, at least learn the first 2. (I could be wrong but the others seem too detailed for a reasonable exam question.)

Question: What are combined accruals?  ← seems important?

• financial entries that include multiple related accruals, where only a portion is considered in the actuarial analysis

Question: What challenges can arise when comparing actuarial analysis with financial statement accruals?  ← seems important?

• financial statement accruals may contain items that are not accounted for in the actuarial calculation

(making direct comparisons difficult)

• Example: Third-Party Administrator (TPA) fees

Question: What timing-related issues arise with prepaid balances or amounts due to TPAs and/or excess insurers?  ← less important?

• payments made but not yet reimbursed (by company to TPA) result in higher accruals
• advance payments lead to lower accruals

Question: How do companies address timing differences in accruals related to TPAs and excess insurers?  ← less important?

• adjust accruals
• carry a separate timing accrual
• treat the timing difference as immaterial  ← this is the simplest option if it applies!

Question: What timing issues can arise with claims paid by the entity but not yet reimbursed by an excess insurance carrier?  ← less important?

• when claims are paid but not yet reimbursed by excess insurance carriers

Question: What timing discrepancies can occur with retrospectively rated and large deductible policies?  ← less important?

• timing gaps between claim payments and premium payments

mini BattleQuiz 2

Internal Financial Reporting and Cost Allocation

Actuarial indications help company management track financial performance and goals internally. However, limited data availability may pose challenges for actuaries when allocating reserves to subcomponents. (That seems pretty obvious so I don't think there's anything worth memorizing in this subsection.)

Regulatory Filing for a Qualified Self-Insurance Designation

When a company applies to self-insure, it usually needs an actuarial report. A qualified actuary should provide an opinion, covering appropriate reserves from the start of the self-insurance program. The opinion should explain the estimation method, show the methodology, and confirm that data checks have been performed. The report should also detail the actuary's credentials and scope of their opinion.

Question: What is the general requirement for a company applying for a Qualified Self-Insurance Designation?

• an actuarial report and certification along with its application package

Question: Who should provide the actuarial opinion for a self-insured application?

• a member in good standing of the Casualty Actuarial Society

Question: What should the actuarial opinion include for a self-insurance application?

• actuarially appropriate reserves based on reserves estimated from the program's inception to the valuation date

Question: What additional elements should the actuarial opinion include? [Hint: Most of these are obvious if you think about it.]

• identifying information about the actuary
• scope of the opinion
• description of the estimation method
• exhibit showing the methodology
• data source information
• data reconciliation
• explanation of any data checking, verification, or auditing

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Coverage or Policy Period

Here's a quick summary of this section. It is very obvious and I didn't create any BattleCards for this:

Understanding your insurance coverage's start and end dates is key when creating an actuarial valuation model. Aligning these dates with your data can either simplify or complicate things. For instance, matching the period of your excess coverage with your data exposure period can make liability calculations easier.

Also, remember your company's fiscal year might not match the calendar year. If you're using actuarial calculations for financial reports, make sure your data setup allows for quarter-end calculations.

Key Dates and Interactions

Here's a quick summary of this section. It is very obvious and I didn't create any BattleCards for this:

ASOP No. 43 talks about three important dates:

• accounting date
• valuation date
• review date.

In some cases, because of deadlines and data availability, the valuation might happen before the accounting date. When this happens, you need a process to compare the two.

Example: Suppose a company needs to record its year-end accruals. The actuary picks a valuation date in September to make sure they finish in time for the year-end close. They then have to adjust their results from September to match the December accounting date. This is done by projecting loss activity and factoring in fourth quarter exposure. After reviewing actual activity and having a discussion with the company in January, the report is finalized with a January review date.

Loss Adjustment or Claim Adjustment Expenses

Here's a quick summary of this section. It is very obvious and I didn't create any BattleCards for this:

Retained risk analysis considers not only loss amounts but also loss adjustment costs. Loss-related expenses are split into two categories: direct costs (like legal fees tied to a specific claim) and indirect costs (like administrative fees associated with multiple claims). Disagreements between an insurer and policyholder over coverage might lead to legal expenses, which are typically not included in retained risk calculations. Lastly, there can be assessments by government entities or excess insurers, which are calculated as a percentage of loss amounts.

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