Reinsurance products – background

Question 1

Reasons for purchasing reinsurance (8)

Answer 1

• Limitation of exposure to risk or spreading of risk –
  o Single (large) risks
  o Aggregations of single risks
  o Accumulations
  o Multi-class losses
• Avoidance of large single losses – Helps reduce its involvement in very large risks to containable levels
• Smoothing of results – Reduces the potential for fluctuations or variations from the planned result when losses are subject to variations in number and/or size
• Increasing profitability – In the long term reinsurance premiums are likely to be higher than the reinsurance recoveries, however, in any one year the insurer’s profits might be higher as a result of having reinsurance
• Improving solvency margin – Strengthens the balance sheet
• Increasing capacity to accept risk – Reinsurance reduces the solvency requirement and thus allows the insurer to accept more risk based on a given amount of available capital
• Financial assistance – Helps new business strain, and bolsters the free assets
• Availability of expertise – ability to use the reinsurer’s knowledge in the development and operation of new or unusual risks/ products

Question 2

• Facultative (1/4):

Answer 2

o Definition:
 When each individual risk on which reinsurance is required is offered separately to a reinsurer
 Each case is considered on its own merits and the reinsurer is free to quote whatever terms and conditions it see fit to impose for that risk
o Advantages:
 Flexibility that both parties have within the process
o Disadvantages:
 It is time-consuming and costly exercise to place such risks
 There is no certainty that the required cover will be available when needed
 Even if cover is available, the price and terms may be unacceptable
 The primary insurer may be unable to accept a large risk until it has been able to find the required reinsurance cover

Question 3

• Treaty:

Answer 3

o Definition:
 This allows them to place business with the reinsurer automatically
 The terms and conditions of the treaty are carefully laid down so that both parties know exactly where they stand
 Obligatory/ Obligatory basis – the insurer is obliged to pass the risk on and the reinsurer is obliged to accept it
 Facultative/ Obligatory basis – the insurer has the choice of whether to include it in the treaty, but the reinsurer is obliged to accept all the requested risk
o Advantages:
 Efficient – risks are reinsured automatically
 Certain – the direct writer knows that reinsurance is available and on what terms
o Disadvantages:
 Inflexible – once the treaty is set up, then both parties must operate within the terms of the treaty

Question 4

• Proportional

Answer 4

o The reinsurer covers an agreed proportion of each risk and the reinsurance premium is proportional to this risk ceded

Question 5

• Non-proportional

Answer 5

o The reinsurer covers the loss suffered by the insurer that exceeds a certain amount, called the excess point (or retention)

Question 6

• Policies-incepting basis

Answer 6

The reinsurer provides cover to the direct writer for the claims arising from all policies written under the treaty over a period, ie corresponding to an ‘underwriting-period’

Question 7

• Losses-occurring basis

Answer 7

Provides the direct writer with cover for any claim incidents under the treaty occurring within a defined period, ie corresponding to an ‘accident-period

Question 8

• Claims-made basis

Answer 8

Provides the direct writer with cover for any claims under the treaty reported to the direct writer within a defined period, ie corresponding to a reporting-period