C25 Reinsurance 2

Question 1

List eleven reasons for reinsuring.

Answer 1

Reasons for reinsuring - LLR RRRIR RSM

1. Limit the amount paid on a claim
2. Limit total claims payout
3. Reduce claim payout fluctuations
4. Reduce new business strain
5. Reduce overall capital requirements
6. Raise capital (where permitted)
7. Increase profits or risk-adjusted return on capital
8. Receive technical assistance
9. Reduce parameter risk
10. Separate out different risks from a product
11. Manage aggregation of risks

Question 2

Outline what is meant by parameter risk.

State the type of reinsurance that would be used to used to share parameter risk with the reinsurer.

Answer 2

Parameter risk

 Risk that level of claims is different from that expected.
 May be due to incorrect pricing, underwriting failures, fraudulent activities, etc.
 Also known as pricing risk.
 Quota share reinsurance used to share it with reinsurer.

Although in practice the reinsurer would review the premium rates and the insurer’s controls

Question 3

Give two reasons why the variance of claim payouts may be high relative to the mean.

Which type(s) of reinsurance would be used to manage each reason?

Answer 3

Variance of claim payouts relative to mean can be high because:
1. there are a small number of contracts for very high levels of cover
2. lives insured are not independent risks.

For (1), reinsurance used would be either original terms (coinsurance) or risk premium, usually on an individual surplus basis.
For (2), use catastrophe, stop loss or excess of loss.

Question 4

Explain how reinsurance might be used to reduce new business strain.

Which type(s) of reinsurance would be used for this purpose?

Answer 4

Reducing new business strain

 Provided it is permitted under the relevant supervisory regime, the cedant could use reinsurance to reduce financial risk associated with new business, either by:
– increasing its available capital, or
– reducing its financing requirement.

 Types of reinsurance include:
– original terms or risk premium reinsurance (usually on a quota share basis)
– financial reinsurance (if effective under regulatory regime).
See also Cards 11-13 of Chapter 24.

Question 5

Explain the circumstances in which an insurance company may benefit from the technical assistance a reinsurer can provide.

Answer 5

Technical assistance from reinsurer

 Reinsurer may have considerable degree of expertise on underwriting, product design, pricing and systems design.
 This is particularly important when cedant starts a new line of business, as it can receive technical assistance from reinsurer until it has built up its own expertise.
 Likewise for recently established insurance company.
 Reinsurer can give support for existing lines in areas such as underwriting, eg treatment of unusual cases.
 Here, original terms reinsurance (with high quota share reinsured) most
likely to be used.

Question 6

List four reasons why a reinsurer may be able to price risk at a lower cost than the cedant.

Answer 6

Reasons reinsurer may price risk at lower cost than cedant
1. Different capital requirements
2. Diversification benefits
3. Different taxation
4. Different assessment of risks

Question 7

List eight considerations (including two additional risks) that an insurer will take into account before deciding:
 whether or not to use reinsurance
 which type(s) of reinsurance to use
 how much reinsurance to use.

Answer 7

Considerations before/when using reinsurance - CCT LLT RR
1. Cost of reinsurance (against benefits of reduced risk and capital requirements)
2. Type of business being reinsured
3. Counterparty risk – risk that reinsurer defaults in event of claim
4. Legal risk – if reinsurance treaty incomplete
5. Legal conditions applying
6. Type(s) of reinsurance available and way in which amount reinsured is specified
7. Reason(s) for requiring reinsurance
8. Retention limits – ie maximum amount of risk retained by cedant on any individual risk.

Question 8

State two ways in which a cedant can use stochastic simulation to determine its retention limit.

Answer 8

Use of stochastic simulation to determine retention limit

1. Determine retention limit so that probability of loss/insolvency kept below certain level.
2. Use stochastic simulation to determine minimum total of:
   (a) cost of financing an appropriate mortality fluctuation reserve; and
   (b) cost of obtaining reinsurance (the reinsurer naturally incorporates an expense and profit loading in its reinsurance terms, and the ceding company incurs administrative expenses).

Choose retention limit that minimises total of (a) and (b).
As retention limit increases, (a) will increase and (b) will decrease.

Question 9

State the general factors that an insurer might consider when setting a reinsurance retention limit.

Answer 9

Factors to consider when setting a retention limit - ARF TFC POI

 average benefit level and the expected distribution of the benefit
 company’s insurance risk appetite
 level of the company’s free assets and the importance attached to the stability of its free asset ratio
 reinsurance terms available and the dependence of such terms on the retention limit
 company’s familiarity with underwriting the type of business involved
 effect on the company’s regulatory capital requirements of increasing or reducing the retention limit
 existence of a profit-sharing arrangement in the reinsurance treaty
 company’s retention on its other products
 nature of any future increases in sums assured.