10/10 Rule
The issue of analyzing and demonstrating risk transfer as a prerequisite
for using reinsurance accounting was codified in the early 1990s with the adoption
of Financial Accounting Standard 113 (and its statutory counterpart, SSAP 62).
FAS 113 was, itself, a response to perceived abuses, and set the standard for
testing whether or not something should be called a contract of insurance. FAS
113 required that risk transfer be demonstrated by comparing the present value
of the cash flows associated with a contract, and in particular by passing certain
thresholds of "significance" of risk. The thresholds, often termed the 9a and
9b tests, are:
9a. The reinsurer assumes significant insurance risk under the reinsured
portions of the underlying insurance contracts.
9b. It is reasonably possible that the reinsurer may realize a significant
loss from the transaction.
Although neither "significance" nor "reasonably possible" were defined in
this context, standard rules of thumb quickly arose in the implementation of
FAS 113. The most commonly cited is the "10/10 Rule." This rule states that
a contract passes the threshold if there is at least a 10 percent probability
of sustaining a 10 percent or greater present value loss (expressed as a percentage
of the ceded premium for the contract).
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CICR 1/2006