RIMS Risk Financing & Transfer Strategies 2 — Questions and Answers
Question 1: How does a self-insured retention (SIR) differ from a standard deductible in a commercial insurance policy?
- An SIR requires the insured to defend and pay claims up to the retention before insurer involvement, while a deductible typically involves the insurer advancing defense costs (Correct answer)
- An SIR is always larger than a deductible
- A deductible applies only to property losses, while an SIR applies only to liability losses
- An SIR is paid after the policy limit is exhausted, while a deductible is paid first
Correct answer: An SIR requires the insured to defend and pay claims up to the retention before insurer involvement, while a deductible typically involves the insurer advancing defense costs
With an SIR the insured controls and pays claims within the retention layer independently; with a deductible the insurer typically defends and pays then seeks reimbursement.
Question 2: A fronting arrangement in captive insurance programs involves:
- The captive reinsuring a commercial insurer that issues admitted policies on its behalf (Correct answer)
- The captive issuing policies directly to third-party commercial policyholders
- A state guaranty fund assuming the captive's liabilities
- The parent company guaranteeing the captive's reinsurance obligations
Correct answer: The captive reinsuring a commercial insurer that issues admitted policies on its behalf
In a fronting arrangement an admitted commercial insurer issues the policy and cedes most or all of the risk back to the captive via reinsurance.
Question 3: A parametric insurance product pays a predetermined amount when:
- The insured's actual documented losses exceed the policy deductible
- A specified triggering event or index reaches a defined threshold, regardless of actual loss (Correct answer)
- An independent adjuster certifies that physical damage occurred
- The total cost of risk exceeds the organization's budget allocation
Correct answer: A specified triggering event or index reaches a defined threshold, regardless of actual loss
Parametric (index-based) insurance pays upon occurrence of a measurable trigger such as wind speed or earthquake magnitude, eliminating the need for loss adjustment.
Question 4: Catastrophe bonds (cat bonds) transfer risk to the capital markets by:
- Allowing insurers to issue equity shares to policyholders after a major loss
- Having investors provide upfront capital that is forfeited if a defined catastrophe trigger is met (Correct answer)
- Creating a government reinsurance backstop funded by premium taxes
- Requiring reinsurers to post collateral equal to their maximum treaty obligation
Correct answer: Having investors provide upfront capital that is forfeited if a defined catastrophe trigger is met
Cat bond investors receive above-market interest payments but lose principal if a qualifying catastrophe trigger occurs, providing the issuer with funded loss protection.
Question 5: Which factor is MOST critical when an organization selects a captive domicile?
- Proximity of the domicile to the parent's corporate headquarters
- The domicile's regulatory environment, capital requirements, and tax treatment (Correct answer)
- The size of the domicile's domestic insurance market
- Whether the domicile has a bilateral tax treaty with the U.S.
Correct answer: The domicile's regulatory environment, capital requirements, and tax treatment
Captive domicile selection centers on the regulatory framework, minimum capital requirements, reporting obligations, and tax efficiency of the jurisdiction.
Question 6: Insurance-linked securities (ILS) are PRIMARILY used by insurers and reinsurers to:
- Raise equity capital to fund merger and acquisition activity
- Transfer peak catastrophe exposure to capital market investors (Correct answer)
- Comply with Solvency II reserve requirements in the European Union
- Hedge interest rate risk on their fixed-income investment portfolios
Correct answer: Transfer peak catastrophe exposure to capital market investors
ILS instruments such as cat bonds and sidecars allow (re)insurers to offload concentrated catastrophe risk to non-traditional capital providers in the financial markets.
Question 7: A risk purchasing group (RPG) differs from a risk retention group (RRG) primarily because an RPG:
- Is owned by its members and retains the risks it insures
- Purchases commercial liability insurance on behalf of its members from a licensed insurer (Correct answer)
- Is exempt from all state insurance regulations under federal law
- Can write first-party property coverage as well as liability coverage
Correct answer: Purchases commercial liability insurance on behalf of its members from a licensed insurer
An RPG is a purchasing cooperative that buys liability coverage from an admitted insurer, while an RRG is an insurer that retains member risks.
RIMS Risk Financing & Transfer Strategies 2
How does a self-insured retention (SIR) differ from a standard deductible in a commercial insurance policy?