Counterparty Risk:
A Reinsurer’s Perspective
2003 CAS/SOA Enterprise Risk Symposium – Session CS-9
Doug Knowling
Agenda
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•
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What is it?
What causes it?
How is it measured?
How is it managed?
Practical issues for implementation
2
What Is It?
• Threat that payment owed from ceding
company or retro won’t be made due to
financial impairment of the counterparty
3
What Causes It?
RGA
Cedants
Retros
(Allowances)
(Reserve Credits)
4
How Is It Measured?
•
Two risks evaluated (analogy to mortgages)
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–
•
Run on the bank (LTV ratio)
Collection risk (can’t foreclose)
Potential net GAAP losses
–
Projected asset and liability balances
5
How Is It Measured?
Collection Risk
• Measured as GAAP loss incurred by RGA under
“melt down” scenario
– Projected GAAP balance sheets
– Assumes all deals terminated without any termination
settlement between companies
• Reflects retrocessions only if collection risk was
passed to retro
6
How Is It Measured?
Run On The Bank Risk
• Measured as GAAP loss under spike lapse
– each and every future year
– greater of (40%, 2 times expected)
• guideline only – actuarial judgment required
• Reflects retrocession recoveries adjusted for
credit rating of retro and time to exposure
7
How Is It Measured?
Simple Example
Collection
Liabilities Exposure
ROB
Exposure
Year
Assets
1
100
20
80
32
2
80
30
50
20
3
60
40
20
8
4
40
50
(10)
(4)
8
How Is It Measured?
Complicating Factors
• Look at treaty by treaty
– Individual projections
– Recognize unique transaction features
– Isolate “positive” exposures
• Evaluated for all deals with a specific company
or any of its affiliates
• Open treaties
9
How Is It Managed?
• Limits on amount of exposure willing to take
with any one counterparty
• Ensure transactions are properly collateralized
• Scrutinize counterparties prior to entering into
any transaction and monitor going forward
10
How Is It Managed?
Basis For Counterparty Limits
• Relative risks based on historical default rates
• Set comfort level of exposure for 1-year A
• Limits for all years and ratings
– Probability of default in year t (“tPxQx+t”)
– Ratio of “tPxQx+t” to “Qx” for 1-year A
– Provision for growth
• May want to constrain and smooth
11
How Is It Managed?
Sample Risk Limits
Rating
AAA
AA
A
BBB
1
100
100
40
8
Years from Current Date
2
3
4
5
10
110
74
27
6
121
51
20
5
133
41
17
4
12
146
35
14
4
76
24
11
4
20
53
26
16
4
30
72
46
35
4
Practical Issues For Implementation
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Need corporate database of current exposures
Layer on new deals
Coordination among divisions
Approximations given complexity
What to do for non-rated companies
Interaction effects among counterparties
13