Chapter 28: Reinsurance Flashcards
List thetypes of reinsurance
facultative
treaty
proportional (quota share - constant proportion, surplus - proportion varies depending on the cedant’s retention level)
non-proportional
financial
which can be written on original terms or risk premium basis
What is a general rule when deciding between proportional and non-proportional
proportional:
insufficient capital to write more new business, book of business relatively new
non-proportional:
more concerned with larger claims (individual/ in aggregate)
balance may depend on risk appetite, importance attached to solvency
reinsurance levels may be high initially for a new line of business, any may decrease as the insurer builds up own experience
Explainfacultative and treaty reinsurance
w.r.t thecedant,facultative means that it is free to place the reinsurance with any reinsurer
w.r.t thereinsurer,facultative means that it may accept or reject the reinsurance
agreement between cedant and reinsurerin atreatymay be facultative/ facultative, facultative/ obligatory or obligatory/ obligatory
List features of a treaty
inflexible - both parties must operate within the terms of the treaty
efficient - risks are generally reinsured automatically - administratively quicker and cheaper
certain - cedant knows reinsurance is available and on what terms
Explain original terms reinsurance
involvesasharing of all aspects of the original contract
cedant sets its own premium rates and the reinsurance premium is in the same proportion to the office premium payable as is the reinsured proportion of policy
reinsurance commission is usually significant and will usually cover the initial commission and part or all of the cedant’s other initial expenses
deposits back may be used so that the cedant maintains total reserves
reinsurer deposits back its share of total reserves to cedant reinsurer not exposed to investment risk
Describe the reinsurance commission
reinsurance commission isused to describe a payment from the reinsurer to the insurer
it issometimes structured as a deduction from the reinsurance premium
Explain risk premium reinsurance
reinsurance applies to the either the sum insured or the insurer’s sum at risk (excess of sum insured over the cedant’s reserves)
if insurer’s sum at risk - the treaty may specify the amount of the reserve from the outset, or the basis on which they are calculated, for ease of administration
can be level risk premiums/ yearly increasing risk premiums, guaranteed/ reviewable
cedant calculates its own premium rates in knowledge of the reinsurance premiums it will be paying
reinsurance commission usually not significant
Describe non-proportional reinsurance
reinsurer indemnifies the cedant for any loss above an excess point up to an upper limit - limiting reinsurer’s ultimate liability
cedant may purchase different layers of XL reinsurance from different reinsurers
limits may be indexed to allow for inflation
list the different forms of non-proportional reinsurance
risk XL:
cover for individual claims
aggregate XL:
cover for aggregate claims from specified perils (12 month period for example)
stop loss XL:
cover for aggregate claims from all perils
catastrophe XL:
cover for aggregate claims from a common cause or single event occurring within a defined period, usually 72 hours for example
term of contract is usually 1 year, after which reinsurance terms must be renegotiated
main aim is to reduce potential loss due to any non-independence of risks insured - particularly important for group business
separate catastrophe cover may be available for excluded risks such as war/ nuclear risks
Explain financial reinsurance
financial reinsurancetypically involves very little transfer of insurance risk
It can be structured as a loan or reinsurance commission
repayment may be spread over a number years and are added to the reinsurance premiums and/ or repayment may be contingent on (minimum) future profits (contingent loan)
it isonly effective under a regulatory reporting environment where credit cannot be taken for the insurer’s future profits and/or a realistic liability does not have to be held in respect of the loan repayments - improves solvency position (there is an increase in assets with no corresponding increase in liabilities)
given global movement towards realistic reporting bases, there is likely to be reduced adoption of such arrangements
List the reasons for reinsurance
limit exposure to risk:
consider free asset position/ size of insurer’s portfolio
avoid large single losses:
consider free asset position
smooth results/ profits and reduce volatility of claims:
more acceptable to shareholder/ regulator
provide expertise:
on product design, pricing, underwriting and claims management
increased capacity to write more business:
through reduced solvency capital requirements
provide financial assistance:
through financial reinsurance
attract more investors:
reinsurance might help the insurer demonstrate its financial resilience
Whatfactorsshould thecedant consider when determining its retention level?
average benefit level and the variability of the benefit
cedant’s risk appetite
free assetsposition and theimportance attached to stability of its free asset ratio (A-L)/(L)
effect on insurer’s capital requirements of increasing/ reducing retention level
terms on which reinsurance (cost of reinsurance) can be obtainedand how it varies with retention level
any profit-sharing arrangement in the reinsurance treaty
insurer’s familiarity with the underwriting process
insurer’s retention level on its other products
How can cedant use stochastic simulation to determine retention level?
Reinsurance only:
determine retention limit such that probability of loss/ insolvency kept below certain level
This can be done using a stochastic model for claims (mortality/ morbidity rates may be modelled stochastically) and a model of the business, so that claims can be projected forward together with the value of the insurer’s assets and liabilities.
Reinsurance and fluctuation reserve:
determine minimum total cost of financing an appropriate mortality/ morbidity fluctuation reserve and obtaining reinsurance, such that probability of loss/ insolvency kept below certain level
The cost of holding a reserve of size M is equal to M( j - i), where j is the expected return from the company’s capital, and i is the expected return from the assets that will back the reserve
as retention level increases, (1) will increase and (2) will decrease - choose retention level that minimises total of (1) and (2)
This can be done using a stochastic model for claims (mortality/ morbidity rates may be modelled stochastically) and a model of the business, so that claims can be projected forward together with the value of the insurer’s assets and liabilities.
