Sample 20
My understanding of Risk Adjustment is that it should be calculated on a gross basis for insurance contracts issued. Any reinsurance impacts would be reflected in the RA for reinsurance contracts held. This question seems inconsistent with how I would expect RA to be calculated.
When we get our capital required for UW risk, Reserve risk and EQ risk using MCT calculation this is on a net basis. For RA for insurance contracts issued wouldn't we want all this information on a gross basis?
For part C, ideally purchasing reinsurance would not affect the RA on insurance contracts issued because this would be on a gross basis. Purchasing additional reinsurance would increase the RA for reinsurance contracts held.
However, if we set our RA on a net basis our financial resources would increase lowering our EQ exposure and therefore lowering capital required on a net basis which would lower our RA when calculated on a net basis.
If our RA for insurance contracts issued is calculated on a net basis, wouldn't this understate our liability? And if that is the case should we really recognize an additional benefit from RA for reinsurance contracts held (which increases our assets)? Or in such an event would we only have 1 RA calculated on anet basis?
Comments
Everything you mentioned above is valid, including that using the MCT to determine the RA will understate the true RA needed. I don't actually know how it is done in practice for firms that do proceed with the MCT capital required route, it would depend on what the auditor is comfortable with. I have seen a firm gross up their RA that was determined using an internal capital model which was also on a net basis.
How would diversification credit be handled if it was given on the exam- would it be added or subtracted to the UW risk + Reserve risk to get the required capital
If you are referring specifically to using MCT risk factors directly, then the diversification credit between lines of business and also between LRC and LIC is already implicitly accounted for. But if you are provided it explicitly, then yes subtract it from your UW/ Reserve Risk depending on if it's the LRC or LIC