Question 17
Hi,
I'm confused as to how the EPR works. From what I understand it's supposed to be used as a financial resource to reduce EQ capital required, but in the end it looks like it increases it since we do (ERC + EPR) x 1.25.
Why do we not subtract the EPR from the ERC with the other financial resources and how come we add the component when determining the final capital required?
Comments
EPR is part of reserves and is optional
ERC is part of reserves and is mandatory (or calculated as per regulation - see 4.5.1)
The calculation for ERC deducts EPR because it is a financial resource. ERC is not (it is a earthquake adjustment). Thus, ERC is effectively a earthquake reserve deficit that the insurer must report as part of their earthquake reserves (and add to their capital required for MCT)
It's worth pointing out that very few insures carry any ERC or EPR. ERC is basically used when the insurer accidentally doesn't buy enough CAT Reinsurance.
4.5.1.3. Earthquake Reserve Component
I personally prefer these equations:
Capital Required for Earthquake Reserves is:
Page 92.40 is helpful here. One of the reserves is optional: EPR. The other is mandatory: ERC. ERC cannot be less than 0, so if EPR is too big there are some additional rules to move those amounts around in the MCT testing process.
You may be asked to only calculate one of: ERC or EPR, so it generally helps to memorize this the way it is presented in the text:
Hi Graham,
Basically it looks like the CAS is doing it a different way than in your solution. In Spring 2019 Q18, EPR is deducted from ERC, and then added back in for the ER calculation. Can you clarify that?
Thanks,
In Question 17:
Financial Resources = 55,000
55,000 = EPR + 10% E + ReIns
55,000 = 29,600 + 10% E + ReIns
However, we don't really care what 10% E and ReIns is because all we need is EPR + ERC:
This is why I referred to: generally helps to memorize this the way it is presented in the text.
Hey @jptardif2 and @Zaharops ,
In the practice exam problem Q17, EPR is already part of financial resources (CREC-it) so it is already being subtracted from ERC when you subtract the 55,000 for financial resources. The difference in 2019.Spring Q18 is that they don't give you the total value for financial resources. They give you the separate pieces and you have to sum them to get the total. That's why you see the EPR of 10,000 explicitly used in the calculation (along with the reinsurance coverage of 192,500 and 10% of capital surplus of 26,000)
The reason EPR is added to ERC before multiplying by 1.25 is just that that's the formula given in the OSFI.MCT reading. Take a look at this related forum post for further information about the 2019.Spring Q18 earthquake calculation.
I think the examiner's solution for problem 2019.Spring Q18 has some issues. In other words, I don't think it's totally correct for the reasons I outlined in the above forum post. But the part where they subtracted EPR from PML is correct, if you're given the separate pieces for financial resources. And the part where they added EPR to ERC before multiplying by 1.25 to get the total earthquake reserve is also correct, according to the source text.
Thanks, the solution makes more sense for me now!