30. Risk transfer

Question 1

Risk control methods

Answer 1

• Avoid
• Reduction, i.e. probability of occurrence/ consequences/ both
• Reject need for financial coverage of risks if it is trivial/ highly diversified
• Retain all risk
• Transfer risk e.g. reinsurance
• Transfer part of risk

Question 2

Constraints on risk transfer

Answer 2

• Cost
• Counterparty risk
• Regulatory restrictions
• Capacity of the market
• Administration

Question 3

Benefits of reinsurance

Answer 3

• Reduction in claims volatility = smoother results = reduced capital requirements = write more business + diversification
• Limits large losses arising from:
> 1 claim on 1 risk
> 1 event
> accumulation of events
> geographical and portfolio concentration of risk
• Decreased risk of insolvency = can write larger risk
• Extra expertise
• Reinsurer may offer competitive terms for administration, actuarial services or other advice.

Question 4

Proportional reinsurance

Answer 4

• Quota share

* Surplus

Question 5

Non-proportional reinsurance

Answer 5

• Risk XL
• Aggregate XL
• Stop loss (form of agg XL)
• Catastrophe XL

Question 6

Advantages of XL

Answer 6

• Caps losses
• Stabilise results
• Reduce risk of insolvency from large losses

Question 7

Disadvantages of XL

Answer 7

• Premium paid to reinsurer may exceed recoveries from time to time

Question 8

Advantages of quota share

Answer 8

• Simple to administer
• Spreads risk
• Write larger risk portfolios
• Encourage reciprocal business

Question 9

Disadvantages of quota share

Answer 9

• Cedes same proportion of low variance and high variance risks
• No cap on very large claims

Question 10

Advantages of surplus

Answer 10

• Write larger risks
• Spread risk
• Flexible

Question 11

Disadvantages of surplus

Answer 11

• More admin than QS

- No cap on very large claims

Question 12

Uses of ART

Answer 12

• Provision of conventionally unavailable cover
• Stabilisation of results
• Cheaper cover
• Tax advantages
• Greater security of payment
• Management of solvency margins
• More effective provision of risk management
• Source of capital

Question 13

Types of ART

Answer 13

• Integrated risk cover
• Securitisation
• Insurance derivatives
• Partial loss funding
• Swaps

Question 14

Distinguishing features of ART

Answer 14

• Multi-year, multi-line cover
• Multi-trigger products
• Tailored to specific client problems
• Use of captive insureres
• Risk assumption by non-insurers, e.g. securitisation, derivatives
• Finite risk cover

Question 15

Advantages of integrated risk cover

Answer 15

Cost savings
- No need to reneogiatiate separate arrangements / each year

Cost savings may arise from greater stability of results due to diversification by:

• type of risk insured
• timing

Can avoid buying excessive cover from individual insurance contracts for uncorrelated risks

Smooth results or lock into attractive terms

May cover financial risks

Question 16

Disadvantages of integrated risk cover

Answer 16

Credit risk from single provider

Lack of availability

Expenses arising from extra info required by provider due to tailor-made nature of contracts

May be more difficult to allocate insurance cost to different divisions of company

Less flexible

Difficult to structure risk control in holistic, multi-line way since separate risk managers would be used for separate risk