Moody's Corporation · NYSE:MCO
Moody's — Technical Presentation (October 2019)
26 slides from Moody's's technical presentation, October 2019
Slide 1: Reinsurance Receivables Under CECL
Reinsurance Receivables Under CECL October, 2019
Slide 2: Agenda
Agenda 1. Understanding CECL requirements for Reinsurance Receivables 2. Modeling approach 3. Q&A Reinsurance Receivables under CECL, October 2019 2
Slide 3: Speakers
Speakers Masha Muzyka Yashan Wang Senior Director, Regulatory and Senior Director Accounting Solutions Quantitative Research Moody’s Analytics Moody’s Analytics Reinsurance Receivables under CECL, October 2019 3
Slide 4: Common CECL Challenges for Reinsurance
Common CECL Challenges for Reinsurance » Contracts are highly customized and tailored » Lack of historical loss experience data » Accounting offset may exist Actuaries Accountants Credit Risk Leverage the expertise and experience on existing GAAP, SAP, SII and credit risk management practice Reinsur
Slide 5: Understanding the CECL Requirements
1 Understanding the CECL Requirements
Slide 6: Reinsurance Receivables: Definition
Reinsurance Receivables: Definition » Current FASB accounting master glossary: Reinsurance Recoverable/Receivable All amounts recoverables from reinsurers for paid and unpaid claim settlement expenses, including estimated amounts receivables for unsettles claims, claims incurred but not reported, or
Slide 7: Source of Uncollectible Receivables
Source of Uncollectible Receivables » Disputes: due to the complexity of reinsurance contract, ceding company and its reinsurers may have different interpretation of the coverage – the terms of the reinsurance contract do not reflect the intent of the parties of the contract or there is a disagreeme
Slide 8: CECL Requirement
CECL Requirement » ASU 2016-13 – An entity shall measure contingent losses relating to disputed amounts in accordance with Subtopic 450-20 on loss contingencies. However, the ceding entity shall measure expected credit losses relating to reinsurance receivables in accordance with Subtopic 326-20 on
Slide 9: CECL Requirements (continued)
CECL Requirements (continued) » Collective vs. individual assessment: – If similar risk characteristics are not present in the reinsurance receivables, the ceding insurer should measure expected credit losses on an individual basis. – Similar risk characteristics include, but not limited to: › Reins
Slide 10: CECL Modeling for Reinsurance Receivables
2 CECL Modeling for Reinsurance Receivables
Slide 11: Reinsurance Receivables and Impairments
Reinsurance Receivables and Impairments » Reinsurance Receivables – All amounts recoverable from reinsurers for paid and unpaid claim settlement expenses, including estimated amounts receivables for unsettles claims, claims incurred but not reported, or policy benefits – Only expected losses related
Slide 12: Lifetime ECL Measurement
Lifetime ECL Measurement » Bottom up approach – Lifetime Expected Credit Loss (ECL) is calculated as 𝐸𝐸𝐸𝐸𝐸𝐸 𝑡𝑡0 = 𝐴𝐴𝐴𝐴𝑡𝑡0 � 𝑃𝑃𝐷𝐷𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 � 𝐿𝐿𝐿𝐿𝐿𝐿 » Amortized Cost (AC) can be thought of as the discounted value of Exposure at Default (EAD) »…
Slide 13: CECL Modelling for Reinsurance Receivables
CECL Modelling for Reinsurance Receivables » CECL allowance covers losses from three types: Type 1: ECL on paid and unpaid claim, not settled yet (Life & P&C) • Term is usually less than 6 months Type 2: ECL from the IBNR claim (Life and P&C) • Term is around 6 month; typically less than one year Ty
Slide 14: Measuring PDs
Measuring PDs » PDs should reflect › The likelihood that the contract will not be fulfilled, due to financial difficulties › Term structure of PDs – type 1 has shorter maturity than type 3 › Point-in-Time and forward looking assessment of future risk » PD sources: forward-looking assessments from th
Slide 15: Moody's Expected Default Frequency (EDF) Measure
Moody’s Expected Default Frequency (EDF) Measure » EDF measures are predicted probabilities of default over some time horizon, e.g., one year » EDF measures are cardinal, or absolute, measures of credit risk: they do not just rank order credit risk; rather, they provide exact probabilities – An EDF
Slide 16: EDF Measures Lead Realized Default Rates, and Generally Get the Levels Right As Well
EDF Measures Lead Realized Default Rates, and Generally Get the Levels Right As Well Average EDF US Speculative Default Rate 16% 12% 8% 4% 0% Mar90 Sep93 Mar97 Sep00 Mar04 Sep07 Mar11 Sep14 Mar18 Reinsurance Receivables under CECL, October 2019 16
Slide 17: EDF model in a nutshell
EDF model in a nutshell Distribution of Value Market Value of Expected Market Assets at Horizon Value of Assets (1 Year) Asset Volatility Market σ (1 Standard Deviation) Value of Assets Distance-to-Default (DD) Default Point EDF™ Today 1 Year Time Distance-to-Default (DD) ≈ The number of standard de
Slide 18: Annualized EDF: Large Reinsurers in the US Market
Differentiate Credit Risk for Each Company Large Reinsurers in the US market 1.2% 1.0% 0.8% Annualized EDF 0.6% 0.4% 0.2% 0.0% 0 2 4 6 8 10 12 14 16 18 20 Berkshire Hathaway Lincoln National Corp American Financial Group Reinsurance Group America Munich Re Prudential Hartford Financial Swiss Life Ho
Slide 19: What if the Reinsurer Is a Private Firm? Rating to PD Convertor
What if the Reinsurer Is a Private Firm? – Rating to PD Convertor EDFs by Rating • Use the public firm EDF database to estimate the typical EDF given the rating • Adjust for sector and country trends Country Point in • Use the EDF term structure to generate a adjustment Time PD Point-in-Time PD term
Slide 20: Ratings Converted into Point-in-Time 1-year PD
Ratings Converted into “Point-in-Time 1-year PD” Reinsurance Receivables under CECL, October 2019 20
Slide 21: Should the PDs be Macro Scenario Conditioned?
Should the PDs be Macro Scenario Conditioned? » PDs based on market consensus reflect forward-looking assessment and implicit weighting of all possible future scenarios » Reinsurers’ PDs are less sensitive to the macro variables than corporate borrowers » CECL does not require explicit scenario cond
Slide 22: Modeling EAD
Modeling EAD » EAD and LGD for the three types should be estimated separately EAD = ─ Otherwise, EAD and LGD need to be expected value averaged across the Excess of these types Reinsurer Losses ─ The degree of uncertainty and difficulty in estimation increases from type 1 to type 3 » EAD Ceding Comp
Slide 23: Modelling LGD
Modelling LGD » LGD is closely linked to how EAD is parameterized – If EAD is the total amount in default, LGD =(1- recoverable portion) of the EAD – If EAD is the amount the cannot be received, LGD =100% » LGDs for reinsurance contracts are typically low because of high seniority of reinsurance cla
Slide 24: Questions & Answers
Questions & Answers
Slide 25: moodysanalytics.com
5) Better Moop YS Faster Decisions ANALYTICS moodysanalytics.com
Slide 26: Reinsurance Receivables under CECL, October 2019
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