Chapter 11 - Solution Manual

Certain insurance contractsdual trigger property and

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> > > Certain Insurance Contracts—Dual-Trigger Property and Casualty Insurance Contracts 55-37A common characteristic of dual-trigger policies is that the payment of a claim is triggered by the occurrence of two events (that is, the occurrence of both an insurable event and changes in a separate pre-identified variable). Because the likelihood of both events occurring is less than the likelihood of only one of the events occurring, the dual-trigger policy premiums are lower than traditional policies that insure only one of the risks. The policyholder is often purchasing the policy to provide for coverage against a catastrophe because if both events occur, the combined impact may be disastrous to its business. 55-38Paragraph 815-10-55-40 addresses seven contracts that illustrate the characteristics of dual-trigger policies offered to different types of policyholders that have different risk management needs. All seven contracts qualify for either the exception in paragraph 815-10-15-53(b) for traditional property and casualty contracts or the exception in paragraph 815-10-15-59(b) for non-exchange-traded contracts involving nonfinancial assets. Therefore, the dual-trigger variable in those contracts is not separated and accounted for separately as a derivative instrument. 55-39In contrast, paragraph 815-15-55-12 states that, if a contract issued by an insurance entity involves essentially assured amounts of cash flows based on insurable events that are highly probable of occurrence (as discussed in paragraph 815-10-15-55[c]), an embedded derivative related to changes in the separate pre-identified variable for that portion of the contract would be required to be separately accounted for as a derivative instrument. 55-40Following are descriptions of seven contracts: a. Contract A—electric utility. A dual-trigger policy pays for a level of actual losses caused by the following two events occurring simultaneously: 1. A power outage resulting from equipment failure or storm-related damage causes more than 500 megawatts of lost power. 2. The spot market price for power exceeds $65 per megawatt hour during the storm or equipment-failure period. The contract pays the difference between the strike price and the actual market price for the lost power (that is, the cost of replacement power).
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243 b. Contract B—trucking delivery entity. A dual-trigger policy pays extra expenses associated with rerouting trucks over a certain time period if snowfall exceeds a specified level during that time period. The snowfall causes delays and creates the need to reroute trucks to meet delivery demands. c. Contract C—hospital.A dual-trigger policy pays actual medical malpractice claims above a specified level only if the value of the hospital’s equity portfolio falls below a specified level during the same period.
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