Reinsurance products – types

Question 1

• Quota share (4/4)

Answer 1

o Quota share is proportional treaty reinsurance whereby the premiums and claims for all risks covered by the treaty are split in a fixed proportion. The reinsurer pays return and override commission to the insurer. Profit commission may also be payable.
o The cedant’s experience (in terms of loss ratios) will be the same before and after reinsurance. The reinsurer will have proportionately the same underwriting experience as the cedant.
o Quota share:
 + spreads risk, increasing capacity and encouraging reciprocal business
 + directly improves the solvency ratio (without losing market share)
 + is administratively simple
 + may provide commission that helps with cashflow
 - cedes the same proportion of low and high variance risks
 - cedes the same proportion of risks, irrespective of size
 - passes a share of any profit to the reinsurer
 - is unsuitable for unlimited covers

Question 2

• Surplus

Answer 2

o Surplus is proportional treaty reinsurance whereby the proportion of risk covered varies from risk to risk depending on the size and type of risk
o The EML for a risk is used in assessing the proportion of the risk to reinsure, defined in terms of “lines’. If k lines are used for a risk then premiums and claims are split in the proportion 1:k.
o The width of one line represents the amount the insurer would pay if a claim equal to the EML occurred. This amount is called the retention (r). Therefore: EML = (1+k) x r
o A surplus treaty will usually specify of a maximum number of lines and a minimum and maximum retention. Higher levels of cover can be obtained by purchasing a second (and third, and fourth) surplus treaty.
o The cedant and reinsurer will have different experience: smaller risks may be retained in full by the cedant, whereas larger risks may be covered primarily by the reinsurer.
o Surplus:
 + enables the insurer to fine-tune its experience
 + enables the insurer to write larger risks
 + is useful for classes where wide variation can occur in the size of risks
 + helps to spread risks
 + may provide commission that helps with cashflow
 - requires more complex administration
 - is unsuitable for unlimited covers and personal lines cover

Question 3

• Excess of loss:

Answer 3

o The reinsurer covers the risk (or a proportion of it) between defined layers, the limits of which are often indexed for inflation (using a stability clause). The insurer may choose to have a number of layers of cover with different reinsurers.
o Once the layer of cover has been “burnt through”, it will need to be reinstated, which might require a further reinsurance premium to be paid.
o The cedant’s and reinsurer’s experience will be different and will depend on the distribution of large losses.
o There are three main types of excess of loss reinsurance:
 Risk XL – this relates to individual losses and is usually written by treaty
 Aggregate – this relates to cumulative losses, where the aggregation may be by event, by peril or by class
 Catastrophe XL – this is a form of aggregate XL covering severe losses (within the hours clause) that result from a specified event
o Excess of loss:
 + allows the insurer to accept risks that could lead to large claims
 + reduces the risk of insolvency from a large claim, an aggregation of claims or a catastrophe
 + reduces claim fluctuations (and so smoothes results)
 + helps to make more efficient use of capital

Question 4

• Stop loss

Answer 4

o Stop loss is a specific type of aggregate XL, which covers against very bad experience across a whole account over a defined time period. The limits are usually defined as loss ratios (ie as percentages of premiums)

Question 5

• Time and distance policies

Answer 5

the insurer pays the reinsurer a premium and in return, the reinsurer pays an agreed schedule of claim payments, this has the effect of discounting the reserves of the insurer for the time value of money

Question 6

 Spread loss covers

Answer 6

the insurer pays an annual or single premium to the reinsurer for the coverage of specified claims, these may be used to provide liquidity and security to the insurer and may be used for catastrophes

Question 7

 Financial quota share

Answer 7

this is quota share purchased in order to obtain reinsurance commissions for financing assistance

Question 8

 Industry loss warranties

Answer 8

these are a type of reinsurance that pay out based on industry losses rather than losses to individual insurers

Question 9

• Run-off reinsurance

Answer 9

o Run-off reinsurance solutions focus on the full-scale risk transfer of reserve development risks
o Adverse development covers involve the purchase of reinsurance cover for the ultimate settled amount of a block of business above a certain pre-agreed amount. Reserves are maintained by the insurer.
o Loss portfolio transfers involve the purchase of reinsurance cover for the ultimate settled amount of a block of business in its entirety. Reserves are transferred to the reinsurer along with all remaining exposure to the business.