Chapter 30: Risk transfer Flashcards
Who is the cedant / direct writer
The insurance company
What is a treaty
A treaty is a contract between an insurer and a reinsurer that specifies what risks the reinsurer is obligated to accept from the insurer and what the conditions are of the reinsurance arrangement
What is facultative reinsurance
An alternative to writing reinsurance through a treaty, under this type risks is transferred on a risk-by-risk basis
What is proportional reinsurance and name two types of proportional reinsurance
Proportional reinsurance: Is a type of reinsurance where a proportion of each risk is ceded
Types:
- Quota sare reinsurance: Same proportion of risk is ceded for each risk
- Surplus reinsurance: Different proportions of each risk are ceded
Quota share reinsurance
- Main uses (3)
- Advantages (2)
- Disadvantages (2)
Main use
- Spread risk
- Homogenous risks as same proportion is ceded
- Smaller insurers who share their risks in a simple manner
- Diversification
- Benefit from reinsurers’ expertise - as reinsurer and insurer share in same claim experience, so it benefits the reinsurer to help manage insurers risks
Advantages
- Simple to administer, as written by a treaty and a constant proportion of each risk is ceded
- Diversify risks, as more risks can be written
Disadvantages
- Same proportion ceded, regardless of size and risk profile
- Does not cap costs of very large claims
Surplus reinsurance
- Main uses (3)
- Advantages (2)
- Disadvantages (2)
Main use
- Gives direct writer more flexibility to fine-tune the experience, e.g., retain a small proportion of large risks and cede more small stable risks
- Written under a treaty - specifies the retention level and maximum level of cover
- Appropriate for heterogeneous risks
- Can write larger risks
Advantages
- Help to accept risks otherwise too big to spread
- Flexible, as the same proportion of each risk isn’t ceded, gives a better-balanced portfolio
Disadvantages
- Administratively more expensive
- No cap on large claims
How is the proportion of risks to be ceded under surplus reinsurance decided on
For homogenous risks, the insurer may have a monetary retention limit that it uses to determine an appropriate % retain
For heterogeneous risks, the issuer will choose a % based on the individual risk
What are non-proportional reinsurers and give 4 types?
Non-proportional reinsurance, the insurer will ay up to the retention level, after which the reinsurer will pay up to an upper limit, after which the insurer will pay the remaining. Can purchase several layers.
Types
1. Risk XL: Retention level and upper limit apply to individual claims for individual risks. It applies to specified perils, e.g., flooding
- Aggregated XL: Retention level and upper limit apply to aggregate claims. It applies to specified perils, e.g., adds all flooding
- Catastrophe XL: Retention level and upper limit apply to aggregate claims. It applies to specified event, e.g., earthquake
- Stop loss: Retention level and upper limit apply to all aggregate claims from all perils
What are the advantages and disadvantages of non-proportional reinsurance
+ Caps losses, hence allow cedent to take on risks that could produce large claims
+ Protects a cedent against large claims
+ Help stabilise profit from year to year
+More efficient use of capital as it reduces variance in claims
- Same proportion ceded regardless of size
- Does not cap costs of very large claims
What are the reasons for reinsurance?
SAD LIFE
S: Smooth profit (through reducing the volatility of claims)
A: Avoid single large losses, e.g., large liability claim
D: Diversification
L: Limit exposure to single or accumulation of risks can also reduce exposure to features of contract design, e.g., guarantees
I: Increase capacity to accept risks (singly and cumulatively)
F: Financial assistance (solvency, NB strain) e.g., financial reinsurance or reinsurance commissions
E: Expertise, e.g., data, pricing, underwriting, design, admin for new, unusual risks and new territories
Problems with reinsurance
- Reinsurance has a cost associated with it
- Insurers add an expense and profit loading to their premiums reinsurers do exactly the same
- So the value of the benefits paid is less than the premium paid
- Administration cost in paying reinsurer
- Cede profit to a reinsurer
- Additional risk
- Reinsurer default
- Liquidity risk
- Not always appropriate, e.g., with profit not straight forward how much reinsurance to buy
Discuss the reasons for reinsurance for a small company
A small company would need reinsurance for a number of reasons
- Worried about volatility in claims experience
- need reinsurance to limit exposure to risks and avoid large losses
- This would smooth results
It would also want to increase its capacity to accept risk which will, in turn, lead to diversification
Might lack data and other experts which could be sourced from reinsurance
Lack of capital so has a need for financial assistance
Verdict: Lots of reinsurance with low retention limits
Discuss the reasons for reinsurance for a company with a large number of free assets
Has less need for reinsurance as they can use their free assets to cover losses
Less worried about claim volatility and capital adequacy and less likely to want reinsurance, especially financial assistance and writing more and bigger risks
Discuss the reasons for reinsurance for a company selling group term assurance
Exposed to aggregations of risks
Verdict: Aggregate XL or Stop Loss
Discuss the reasons for reinsurance for a company selling non-reviewable premiums or charges
Exposed to the risk that premiums and charges are set at the wrong level, as they cannot be changed as experience is different than expected
Such a company would want to limit its exposure to such risks
Has a greater need for reinsurance than once that sells reviewable premiums and charges
