30. Risk transfer Flashcards
Risk control methods
- 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
Constraints on risk transfer
- Cost
- Counterparty risk
- Regulatory restrictions
- Capacity of the market
- Administration
Benefits of reinsurance
• 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.
Proportional reinsurance
- Quota share
* Surplus
Non-proportional reinsurance
- Risk XL
- Aggregate XL
- Stop loss (form of agg XL)
- Catastrophe XL
Advantages of XL
- Caps losses
- Stabilise results
- Reduce risk of insolvency from large losses
Disadvantages of XL
- Premium paid to reinsurer may exceed recoveries from time to time
Advantages of quota share
- Simple to administer
- Spreads risk
- Write larger risk portfolios
- Encourage reciprocal business
Disadvantages of quota share
- Cedes same proportion of low variance and high variance risks
- No cap on very large claims
Advantages of surplus
- Write larger risks
- Spread risk
- Flexible
Disadvantages of surplus
- More admin than QS
- No cap on very large claims
Uses of ART
- 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
Types of ART
- Integrated risk cover
- Securitisation
- Insurance derivatives
- Partial loss funding
- Swaps
Distinguishing features of ART
- 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
Advantages of integrated risk cover
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
Disadvantages of integrated risk cover
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
