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 (FAS) 113 (and
its statutory counterpart, SSAP 62). FAS 113 was, itself, a response
to perceived abuses and set the standard for testing whether 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).
Links for IRMI Online Subscribers