Chapter 30 - Reinsurance (2)

Question 1

What are the benefits of reinsurance?

Answer 1

EVIL W

• access to EXPERTISE and data of reinsurer
• reduction in claim VOLATILITY and hence:
  –- smoother profits
  –- reduced capital requirements
  –- increased capacity to write more business
• reduce INSOLVENCY risk
• LIMIT large losses arising from:
  -– a single claim on a single risk
  –-a single event
  -– cumulative events
  -– geographical and portfolio concentrations of risk
  increased capacity to WRITE larger risks

Question 2

Why can large fluctuations in claims costs be a bad thing

Answer 2

• They may make the life company insolvent
• They may reduce the excess of the value of the company’s assets over its liabilities below the level desired by the company
• They may reduce in some years the rate of return on free assets below the level desired by the company
• They may cause fluctuations in dividends to shareholders

Question 3

What are the ways the insurer can avoid payout fluctuations

Answer 3

• Reinsurance
• Set up a ‘Payout’ or ‘Mortality fluctuations reserve’
• To turn down high sum insured proposals

Question 4

How can a cedant use reinsurance to reduce financial risk associated with new business

Answer 4

Through an increase in its available capital
Through reduction in its financing requirement

Question 5

Why is individual surplus less useful than Quota share to reduce new business strain

Answer 5

New business strain is a function of the total initial expenses, initial commissions, premium income, initial supervisory reserves and initial solvency capital requirement relating to new business sold, whether this is made up of many individual small policies or fewer individual large policies.

If the company used individual surplus for financing, then the amount of capital support it would obtain would be a function of the mix of new business by size ( which is actually irrelevant to the total amount of strain)

Question 6

What would allow the reinsurer to be able to price the risk at a lower cost than the cedant

And how can this lead to the insurer actually increasing its expected return using reinsurance

Answer 6

Different capital requirements,
diversification benefits,
different taxation,
and different assessment of risks

This means the reinsurer can write the business more cheaply than the insurer can, all else being equal, so it may be able to pass on some of those profits by offering more favourable terms for its reinsurance. In this way it is possible for both the insurer and reinsurer to make a profit from the reinsurance arrangement

Question 7

General factors to take into account when setting the retention limit

Answer 7

FORFAITER

• the level of the company’s FREE assets and the importance attached to stability of its free asset ratio
• the company’s retention on its OTHER products
• the effect on the company’s REGULATORY capital requirements of increasing or reducing the retention limit
• the level of FAMILIARITY of the company with underwriting the type of business involved
• the AVERAGE benefit level for the product and the expected distribution of the benefit
• the nature of any future INCREASES in sums assured
• the TERMS on which reinsurance can be obtained and the dependence of such terms on the retention limit
• the EXISTENCE of a profit-sharing arrangement in the reinsurance treaty
• the company’s insurance RISK appetite