11 - Managing Exposure

Question 1

Starting from higher profits, what is the typical cycle in the insurance market?

Answer 1

Higher profits leads to –>
Higher capacity leads to –>
Lower premiums leads to–>
Lower profits leads to–>
Lower capacity leads to–>
Higher premiums leads to–>
Higher profits…and the cycle begins again

Question 2

What are some examples of how the cycle of the insurance market may be shortened?

Answer 2

1. Changes to legislation creating new liabilities
2. Major disasters such as weather related incidents, NatCats, or acts of terror
3. Changes to underwriting policy

Question 3

What is EML?

Answer 3

Estimated Maximum Loss

Question 4

For which line of business is EML particularly important?

Answer 4

Commercial property and BI

Question 5

Why is estimated maximum loss needed?

Answer 5

The maximum exposure for any one event may not be the same as the sum insured , particularly if the risk is spread across more than one location, eg. if there are two factories it is unlikely they would both be destroyed by the same event.

The EML helps the underwriter decide if the risk is acceptable, how much if any they are willing to take on, and if reinsurance would be desirable.

Question 6

Due to risk accumulation, insurers must be particularly aware of loss exposures arising from what?

Answer 6

Single risks
Single events

Question 7

What is meant by layering of liability?

Answer 7

If a proposer wishes to take out a policy for a £20 million limit of liability but can only find an insurer willing to accept a limit of liability of £10 million, they may place this £10 million then arrange additional policies with other insurer(s) in excess of this £10 million to reach the £20 million limit they require.

i.e. they may have a primary layer of £10 million and another policy, an excess layer, covering £10 million in excess of £10 million.

Question 8

What is meant by single event exposures?

Answer 8

Exposures to multiple losses arising from the same event, e.g. hurricane, CAT losses

Question 9

What can be done about single event exposures in order to manage the risk?

Answer 9

Reinsure

Question 10

What is reinsurance?

Answer 10

The underwriter, having accepted a risk, seeks to pass some of that risk on to other insurers or specialist reinsurers to limit their exposure to the risk.

Question 11

Why an underwriter might want to take out reinsurance?

Answer 11

To protect against single large events or claims
To protect against claim fluctuations from year to year
To limit capacity
Risk is above acceptable levels
Entering a new market

Question 12

If a claim arises on a policy which the insurer has reinsurance on, who is legally bound to pay for the claim?

Answer 12

The insurer - they are legally bound to pay for losses arising before seeking to claim indemnity under the reinsurance contract.

Question 13

What are the two main types of reinsurance?

Answer 13

Proportional
Non-proportional

Question 14

What are the two sub-categories of proportional reinsurance?

Answer 14

Quota share
Surplus

Question 15

What are the sub-categories of non-proportional reinsurance?

Answer 15

Excess of loss
Stop loss (also called excess of loss ratio)

Question 16

What is proportional reinsurance?

Answer 16

The reinsurer accepts an agreed percentage of the risk to be passed onto them and agrees to pay any losses in the same percentage.

(If a reinsurer takes 20% of the risk from the insurer - the sum insured - for that risk, he will receive 20% of the premium paid by the insured to the insurer, and should there be a loss on that risk, he will pay 20% of the loss paid by the insurer to the insured)

Question 17

What is quota share reinsurance?

Answer 17

An insurer has an agreement (treaty) with a reinsurer applying to all insurances written that comply with the terms of a treaty. The reinsurer will automatically accept liability for their share of any policy written that falls within the treaty.

For example if an insurer has a treaty covering 20% of its property line of business, 20% of all policies written would be covered by the reinsurer.

Question 18

What is the main advantage and disadvantage of quota share reinsurance?

Answer 18

Advantage: Easy to administrate which lowers costs.

Disadvantage: The insurer cannot be selective about their risk retention - even if they would be willing to retain all of the risk it would still be reinsured and so they would pay a reinsurance premium on it.

Question 19

When is quota share reinsurance normally used?

Answer 19

By new insurers or when a insurer starts to write a new line of business.

Question 20

What is surplus reinsurance?

Answer 20

The insurer only takes out reinsurance on risks that exceed their own retention limit. They take out additional lines of reinsurance equal to the maximum line they wish to retain.

e.g. if a risk is £500,000 but they wish to retain only £100,000 they would take out 4 lines of reinsurance for £100,000 each.

Question 21

What are the main advantages and disadvantages of surplus reinsurance?

Answer 21

Advantage: The insurer can be more selective about when they take out reinsurance.

Disadvantages: The cost of administrating this is higher as it requires more active involvement.

Question 22

What is non-proportional reinsurance?

Answer 22

The reinsurer agreed to contribute to all losses exceeding a pre-agreed figure.

Question 23

What is excess of loss reinsurance?

Answer 23

The reinsurer agrees to take on the part of the risk in excess to the insurer’s retention.
e.g the insurer writes a policy with a £50 million limit of indemnity. It then takes out reinsurance on this policy with a £25 million excess £25 million limit. This means the insurer has retained a £25 million limit and any claims exceeding this are passed to the reinsurer.

Question 24

On what basis can excess of loss reinsurance be taken out?

Answer 24

Per risk or per event

Question 25

What is stop loss (excess of loss ratio) reinsurance?

Answer 25

Reinsurance for claims which would cause the insurer’s maximum loss ratio to exceed a certain figure.

e.g. the insurer may take out reinsurance for claims which would cause maximum loss ratio to exceed 75%.

Question 26

What would a reinsurer usually do in a stop loss reinsurance policy?

Answer 26

Limit their maximum liability and only pay a share of any reinsured loss with the original insurer sharing the rest. Otherwise, the insurer would be guaranteeing it could not suffer a loss.

Question 27

Who is a cedant?

Answer 27

The original insurer that is passing on part of the risk to reinsurers.

Question 28

What is facultative reinsurance?

Answer 28

Reinsurance purchased for an individual risk, not as part of a treaty.

Question 29

What is retrocession?

Answer 29

It is reinsurance on reinsurance - the original reinsurer seeks to further share the risk.

Question 30

What is treaty reinsurance?

Answer 30

Reinsurance covering a wide portfolio of risks.

(The ceding company transfer all risks within a book of business to the reinsurer. E.g., a primary insurer might transfer its entire book of commercial auto or all of its homeowners risk. The two parties will enter into an agreement, known as the treaty, in which the reinsurer is obliged to accept all covered business.)

Question 31

What does it mean for an insurer to set their maximum retention or maximum retained line?

Answer 31

The maximum line the insurer is willing to accept, they will take out reinsurance on anything larger.

Question 32

An insurer has a maximum retained line of £250,000. If they arrange a five line surplus treaty with their reinsurers, what will their maximum capacity be?

Answer 32

£1.5 million

£250,000 of their own retention
5 lines of £250,000 from their reinsurers

Question 33

Which type of insurance usually leads the other lines of business in the insurance market cycle? What typically follows?

Answer 33

Motor, followed by casualty, followed by property.

Question 34

How is surplus reinsurance normally arranged?

Answer 34

By treaty - the treaty will only apply to risks that exceed the insurer’s maximum retained line. Reinsurance will be taken out on any risks over this.

Question 35

What type of an insurance would typically be taken out to protect an account against large losses?

Answer 35

Excess of loss.

Question 36

What type of insurance would typically be taken out to protect a line of business against large losses?

Answer 36

Quota share

Question 37

An insurer wants to write a single risk with a large limit of liability. What type of reinsurance are they most likely to purchase?

Answer 37

Excess of loss.

Question 38

An insurer wants to expand into a new line of business. What type of reinsurance are they most likely to purchase?

Answer 38

Quota shares.

Question 39

On what basis is quota share or surplus reinsurance usually purchased?

Answer 39

In a treaty where the reinsurer automatically reinsures all policies falling under the treaty.

Question 40

When is the best time to write new business?

Answer 40

In a hard market