Chapter 29-Reinsurance (1)

Question 1

Define reinsurance (6)

Answer 1

Reinsurance is

an agreement whereby on party (the reinsurer)…

…in return for a premium…

…agrees to indemnify another party (the cedant)

…against part or all of the liability assumed by the cedant

under one or more insurance policies, or under one or more reinsurance contracts.

Direct writer cedes to reinsurer (through a cession), who in turn may cede its liability to a second reinsurer (through a retro cession).

Question 2

What are the main “types” of reinsurance? (7 points)

Answer 2

Facultative and obligatory reinsurance

Original terms reinsurance (coinsurance)

Risk premium reinsurance

Excess of loss reinsurance
+Catastrophe
+Stop loss

Financial reinsurance
+risk premium financial reinsurance
+contingent loan financial reinsurance

Question 3

Describe factultative vs obligatory reinsurance (4)

What kind of facultative/obligatory agreements might we find between insurer and reinsurer? (3)

What is a treaty and what type of agreements are typically formalised via a treaty? (2)

What benefits does a treaty have? (2)

Answer 3

The use of facultative vs obligatory essentially refers to ‘having choice’ vs being ‘obliged/obligated’ within an insurance treaty

+The term ‘facultative’
applied to cedant’s part of reinsurance means it’s free to place reinsurance with any reinsurer

+so far as reinsurer is concerned means it may accept/reject the reinsurance offered
The use of ‘obligatory’ removes this freedom of action

Agreements between ceding company vs reinsurer may be (cedant’s view first)

(a) facultative/facultative
(b) facultative/obligatory
(c) obligatory/obligatory

A treaty is

+a legal contract which formalises the terms of reinsurance and is usually set up when either party has obligation ie type (b) and type (c) conctracts above

+where both are factultative, usually no treaty, though to avoid having to make up treaty documents at times these are prepared in advance

Treaties are advantageous in that

+allows insurer to write large cases without having to refer to reinsurer to ‘ask permission’ which may stall sales process

+they apply to specified products reinsurer is happy with, so even though reinsurer might be obligated to accept, as long as it knows the business insurer is writing, it can then charge appropriate reinsurance premium

Question 4

Define original terms reinsurance (4)

Answer 4

Original terms insurance involves

sharing of all aspects of original contract

hence, premium split between insurer and
reinsurer in fixed proportion

and any claim is split in same proportion

reinsurer shares in full risk of policy including investment/early lapse risks

Question 5

Describe the 3 steps involved in determining the reinsurance premium rates to charge for original terms reinsurance (coinsurance)

Answer 5

Cedant provides premium rates (aka retail rates) to reinsurer for business class to be insured, for reinsurer to check adequacy.

Reinsurer determines reinsurance commission rates prepared to pay cedant for business

+reinsurance commission thus determines overall net cost of reinsurance for cedant

+higher commission, lower reinsurance cost; insurer then decides to accept/not

Alternatively, reinsurer provides level premium rates to insurer upon which they load costs/profit test against intended retail rates

+ie reinsurer decides level premium rate for risk, to charge cedant for reinssurance

+also called ‘level risk premium reinsurance’,

+common for risk business
prems/claims not strictly shared in fixed %, so more risk premium reins

+reins comm likely much less significant with this variation, as reins prem probably has lower margins than retail rates

+more common approach, given recent competition level in retail markets requires frequent prem rates changes

Question 6

Under original terms reinsurance (coinsurance), when considering which reinsurer, in addition to considering reinsurance commission being offered by a reinsurer, in what other ways may a reinsurer appear more attractive over another? (3)

Answer 6

financial strength:
reinsurer with greater strength will be less likely to default

coverage offered:
reinsurer offering broader coverage will be more attractive eg
accept higher sums assured or accepting older-age applicants

profit-sharing arrangements:
reinsurers offering a profit sharing arrangement, or more generous arrangement will appear more attractive

Question 7

Under original terms reinsurance (coinsurance), what factors may influence the level of reinsurance commission the reinsurer is willing to pay to the cedant?

Overview of main considerations (3)

Answer 7

profits it expects to make from the cedant’s business

risks it takes on (eg likely uncertainty in cedant’s future claim experience)

how much it wants to obtain the business, accounting for competition from other reinsurers.

Question 8

Under original terms reinsurance (coinsurance) what 2 methods may be used to determine the amount of risk to be reinsured?

Answer 8

Quota share:

amount reinsured specified % of each policy

eg 30% quota share: 30% reinsured, and 70% risk retained by cedant

Individual surplus:
reinsured amount is excess of original benefit
over cedant’s reiteration limit on any individual life

Question 9

Define risk premium reinsurance

Answer 9

Under a risk premium reinsurance arrangement

+cedant reinsurers part of sum assured, or
sum at risk ie excess of benefit over reserve

+on the reinsurer’s risk premium basis

+which can be either
annually renewable or
guaranteed

Question 10

Describe the steps involved in determining the reinsurance premium rates to charge for risk premium reinsurance

Answer 10

Reinsurer determines risk premium rates by

+assessing likely experience of the business it is to reinsure

+and then adding expense and profit margins

+reinsurer may or may not guarantee these rates for the term of the policy

+Risk premium may be level of the term of the policy or may vary annually with the probability of the claim

+Amount reinsured may be based on individual surplus or quota share

Question 11

Define two bases on which excess of loss reinsurance can be entranced (3)

Answer 11

This is a form of reinsurance that cane be enacted on

a risk basis, where the reinsurer pays any loss on an individual risk in excess of a predetermined retention.

an occurrence basis where the aggregate loss from any one occurrence of an event exceeds the predetermined retention.

in practice, the ‘occurrence basis’ is more commonly enacted form of reinsurance

Question 12

What are the general features of excess of loss reinsurance? (4)

Answer 12

This reinsurance useful where loss unknown until it occurs

Renegotiated annually

Non-proportional form of reinsurance

May be organised in levels/lines

Different reinsurers may then take different proportions of each line

Question 13

The main types of excess of loss reinsurance used in life assurance are catastrophe reinsurance and stop loss reinsurance.

Explain how catastrophe reinsurance works?

Answer 13

The main aim of catastrophe reinsurance is to:

reduce the potential loss to the cedant due to any non independence of risks insured (where non-independence usually leads to catastrophes)

Particularly important for group business, where group contract is for many

Usually available on a yearly basis and must be renegotiated each year

Reinsurer agrees to pay out if ‘catastrophe’ as defined in the contract occurs

Typically to qualify there needs to be minimum deaths from single incidence with deaths occurring within a specified time.

Question 14

Describe the cover typically provided by a catastrophe excess of loss reinsurance contract (7)

Answer 14

Cover provided is usually as follows:

contract specifies how much reinsurer will pay if catastrophe happens

typically, this might be excess of total claim amount, net of any amounts already reinsured, over cedant’s retention limit

reinsurer’s liability in respect of single catastrophe claim subject to maximum amount, and any amount above this would revert to cedant

there is also usually a maximum amount of cover per life

reasons for maximums could be
+so that reinsurer doesn’t face unlimited liability
+to help reduce cost of reinsurance for cedant
+regulation/legislation may require this

Catrastrophe excess of loss reinsurance cover usually excludes

war risks
epidemics
nuclear risks
however, seperate catrasrophe covers may be available for excluded risks

Question 15

How does stop loss excess of loss reinsurance operate? (2)

Answer 15

Stop loss excess of loss reinsurance operates as follows

Reinsurer pays the aggregate net loss over the predetermined retention for a portfolio over a given time period, usually a year. So cedant’s loss on a portfolio in any such period is capped

As with catrasrophe excess of loss reinsurance, reinsurer’s liability is limited to specified maximum amount, and reinsurance needs to be renegotiated

Question 16

What are the key features of financial reinsurance? (3)

Under which situations would financial reinsurance not be effective? (3)

Answer 16

Key features of financial reinsurance

Devised to improve apparent cedant’s accounting/supervisory solvency position

help insurer manage its capital position

normally only involves a small element, if any, if transfer of insurance risk from cedant to reinsurer

Financial reinsurance not effective under accounting/supervisory reserving regimes where

credit can already be taken for future profits

a realistic liability has to be held for the loan repayments under fin re

in addition, given global movement towards realistic reporting bases, there’s likely to be reduced adoption of such arrangements

Question 17

Describe how risk premium financial reinsurance can be used to facilitate a financing agreement between insurer and reinsurer

Answer 17

reinsurer relieves cedant of part of its new business financing requirement

a loan is presented to insurer in the form of initial reinsurance comm, as part of the risk premium reinsurance agreement

the repayments for the ‘loan’ are spread over several years and are added to the reinsurance premiums

reinsurer takes into account the expected future lapse experience of insurer when determining repayments

loan is effectively repaid by insurer from its future premium receipts - it doesn’t have to set up any additional liability for the repayments, as they are only payable for as long as policy remains in force

so assets increase by amount of reinsurance commission, the liabilities are unaffected, and therefore net assets of insurer will increase

a straighforward loan from reinsurer would not achive this as cedant would have to add amount of loan to its liabilities

Question 18

What sort of traditional (i.e non-financial reinsurance) contract would achieve the same result as a risk premium financial reinsurance financing arrangement? (3)

Answer 18

Same result can be achieved by

original terms reinsurance
in return for large loadings that reinsurer received, a substantial reinsurance comm would be paid to insurer, producing similar effect
original terms actually more natural method, as premiums don’t need to be artificially increased to cover reinsurance comm payments

Question 19

Describe how contingent loan financial reinsurance works (5)

Answer 19

Contingent loan financial reinsurance works as follows

makes use of future profits contained in a block of new or existing business

reinsurer, again, provides loan to cedant, but
repayment of loan is contingent upon stream of future profits being generated by business

hence, cedant may not need to reserve for the repayment within its supervisory returns (depending on regulatory regime)