30. Risk transfer Flashcards
What are the responses a stakeholder can choose from when faced with a risk?
PI RATE
- Partially transfer=> to another party
- Ignore=> trivial or largely diversified
- Reduce=> frequency or severity
- Accept=> retain all
- Transfer=> to another party
- Evade=> avoid the risk altogether
How can each risk mitigation option be evaluated?
FIRM
- Feasibility + cost
- Impact on Frequency+ severity and expected value
- Resulting secondary risks
- Mitigation required in response to secondary risks
What factors affect whether a stakeholder retains or transfer risk?
5
- Cost of passing it on
- Willingness of another party to take it on
- Likelihood of the event occurring
- Capital with which the stakeholder has to hold to absorb the event
- Stakeholders risk appetite
What are the benefits and costs of reinsurance?
2/6
Benefits
- Reduction in/ removal of risk
- Re offer competitive terns for admin, actuarial service+ advice
Costs
- Profit passed from cedant to Re
- Re premium likely> cost of benefit in the long run
- Liability may not be fully matched by Re
- Possible liquidity issue
- Re default
- Re may not be available on the terms sought
Why would a provider purchase Re?
Reduces claims volatility
* Smooth profits
* Reduced Cap re
* Increased capacity to write more business+ achieve diversification
Limitations of a large loss arising from:
* Single claim
* Single event
* Cumulative claims
* Geographical+ portfolio concentrations, AND HENCE:
* Reduce risk of insolvency
* Increased capacity to write larger risks
Access to expertise of the Re
What are the two contract variations on which Re can be arranged?
1.Facultative Re => arranged on a case by case basis.
* Large risks usually
* Insurer NOT obliged to cede risks
* Re NOT obliged to accept risks
2.Treaty=> Defined group of policies covered by Treaty
* i. Re obliged to accept risk - subject to conditions in treaty
What are the key features of proportional Re?
7
- Claims split between cedant and Re in predefined proportions
- Does not cap the claim payment by the cedant
- Written by treaty
- Two types are Quota share and surplus
- Quota share => prop split is equal for all risks
- Surplus= prop split can vary by risk
- Re pay insurer commission
What is quota share Re? Adv and disadv
2/3
- Prop spilt between the cedant and Re is constant for all risks in the treaty
- +useful for small, new or expanding cedants who want to diversify risk, write more risks or who would like reciprocal business
- +Admin is simple=> treaty and all prop same
- -Inflexible
- -Share of profits transferred to Re
- -Does not cap Large claims
What is surplus Re? Adv and Dis?
2/2
- Prop Re varies for each risk covered in the treaty
- Treaty specifies retention level and a maximum level of cover available
- +Cedant can fine tune exposure
- +Useful for cedants who want to diversify risk or write more business or larger risks
- -More complex and expensive to write than quota share contracts
- -Does not cap large claims
Under surplus reinsurnace, the retention level may be:
* Specified in the treaty (and hence the same for all risks)
* Allowed to vary at the discretion of the cedant
Give examples of classes of business that might be reinsured using each of these two approaches
- Fixed retention - used for high volume, relatively homogeneous classes of business, such as life or PL general insurance
- Variable retention - heterogeneous classes of business e.g. commercial property and business interruption insurance
What are the key features of non-proportional (or excess of loss - XL) Re?
9
- Cedant specifies a retention level=> Pays claim amount up to this level
- Re pays amount over level
- May be an upper limit on what Re will pay
- Different layers of XoL Re each with different Re
- Cedant may be required to retain a portion of risk within layer=> maintain an insurable interest
- Retention level and upper limit may be indexed over time for inflation
- Re determines the Re premium
- XL caps claims paid by the cedant
- May or may not be written using a treaty
Define four different types of excess of loss (XL) reinsurance contracts
- Risk XL - covers losses from a single claim from one insured risk
- Aggregate XL - covers the aggregate (or sum of) losses from several insured risks, sustained from a defined peril (or perils) over a defined period, usually one year
- Catastrophe XL - Form of aggregate XL that pays if catastrophe (as defined in the reinsurance contract) occurs
- Stop loss - form of aggrgate XL that provides cover based on aggregate losses, from all perils, arising on a company’s whole account (or major class of business) over a specified period
What the main uses of XoL Re?
- Opportunity to write larger risks
- Reduces risk of insolvency from a large single claim, an aggragation of claims or a catastrophic event
- Smooths profits=> reduces claim fluctuation in return for premium
When would Surplus and Xol Re provide the same cover?
- Where risk event can only result in the payment of the full SI
What factors influence the type of Re products used?
6
- Type of business - homogeneous (quota share) or heterogeneous (surplus)?
- Size or volatility of claims - is insurer worried about single risks (risk XL), accumulations (agg XL) or catasrophes (cat XL)
- Does the insurer have lots of free assets? - Commission from proprotional reinsurance
- Insurer mutual or proprietary
- Insurer need expertise in a new or unusual product or territory?
- Does insurer want diversification through reciprocal arrangements (quota share)?
List 5 alternative risk transfer products (ART)Does the Insurer want diversification through the reciprocal arrangement?
- Integrated risk covers
- Securitisation
- Post loss funding
- Insurance derivatives
- Swaps
What are integrated risk covers?
- Multi-year
- Multi-line Re contracts
Give premium savings by:
- Cost savings of not having to negotiate Re separately for each class each year
- Greater stability of results over time and across more diversified lines
They are used to:
* Avoid buying excessive cover
* Smooth results
* Lock into attractive terms
What is securitisation?
- Transfer of insurance risk (often cat risk) to banking and capital markets
- Banking and Cap markets use=> provides diversification from credit and market risks+ capacity
- Packaged as catastrophe bond
- Repayment of both interest and capital=> depends on the Cat not occurring
- Yield on such bonds expected to be greater than similarly rated Corporate bonds
What is post loss funding?
- Insurer pays commitment fee
- Funding will be guaranteed on the occurrence of a specific loss
- Funding is often a loan on pre-arranged terms or equity
- Commitment fee < cost of insurance
- Dependent on loss event occurring
- May appear cheaper than conventional insurance
What are insurance derivatives?
- Cat and weather options
- Strike value based on certain value of Cat or weather index
- Option will be exercised depending on the value of the index at strike date
What are swaps?
- Organisations with matching but negatively correlated or uncorrelated risks
- Can swap packages of risk
- Such that each organisation has a greater diversification
- E.g. Japanese reinsurer exposed to earthquakes may swap with hurricanes in Florida
What are the possible reasons for using ART?
DESCARTES
- Diversification
- Exploit risk as an opportunity
- Solvency improvement
- Cheaper cover than Re
- Available when Re may not be
- Results smoothed or stabilized
- Tax advantages
- Effective risk management tool
- Security of payments improved
