2015-Spring #27
Concerning the treatment of the Profit Commission, I'm not sure I understand the reasoning behind the answer.
I agree, that they should not be included in the risk transfer analysis, but when reading the source text, the reason is that Profit Commission are only affects the transaction when there is a profit while the risk analysis focus on the negative scenario. So we should not account for them.
However, in the Battle Card and the examiner report, ibt of the answer is:
"The results of the ceding company should not be considered in a risk transfer analysis
But the risk transfer analysis should consider cashflows between the ceding and the reinsurer. So even if it is related to the result of the ceding, the profit commission is still an cashflow between the two entity.
Also, it seems like the examiner's report insist on the fac that it will increase the premium so we should not include the profit commission. Why is it a bad thing to have an increased premium? If a provision in the contract says that there is a Profit Commission, then it makes sense the premium is higher and won't the results be inaccurate if we don't account for that?
Comments
The risk transfer analysis focuses on scenarios that would cause losses for the reinsurer. Given that information, when we take a look at tail scenarios, this profit commission will never be "active". The profit commission inflates the premium because this profit will never be realized in a tail scenario which means you could in theory conclude there is no risk transfer due to the profit commission when there has actually been a risk transfer. I think this is what the examiner's report is saying when it is talking about considering the results of the ceding company.
Kind of thinking that you want to see whether loss transfer exists, conditional on there being big losses which means you should remove things that won't occur when there is a big loss (profit commission)