C - Blanchard

Question 1

BLANCHARD

6 functions of reinsurance

Answer 1

INCREASE LARGE LINE CAPACITY
cie wants to limit exposure per risk but market demands more coverage

PROVIDE CATASTROPHE PROTECTION cie wants to reduce losses from cats

STABILIZE LOSS EXPERIENCE
to reduce annual fluctuations to please capital providers

PROVIDE SURPLUS RELIEF
to reduce net leverage ratios to a desirable level

FACILITATE WITHDRAWAL FROM A MARKET SEGMENT
allow to do it more quickly than runoff

PROVIDE U/W GUIDANCE
reinsurer may provide expertise on pricing and u/w (when entering new market for example)

Question 2

BLANCHARD

Type of reinsurance treaty to achieve :

Increase Large Line Capacity
Catastrophe Protection
Stabilize loss experience
Provide Surplus Relief
Facilitate withdrawal from a market segment

Answer 2

–increase large line capacity–
SURPLUS SHARE PRO RATA SHARE TREATY
(covering ratio of Value in XS of 500K / Home Value)

--catastrophe protection--
CAT TREATY (paying loss from single event in XS of 10% of premium)

–stabilize loss experience–
AGGREGATE XOL TREATY (paying 90% of losses above LR of 100%)

–provide surplus relief–
STRAIGHT 50% QUOTA SHARE

–facilitate withdrawal from a market segment–
PROSPECTIVE REINSURANCE TO CEDE 100% OF REMAINING UNEARNED PREMIUM

Question 3

BLANCHARD

Contrast
impact on SURPLUS from :

Increase Large Line Capacity
Catastrophe Protection
Stabilize loss experience
Provide Surplus Relief
Facilitate withdrawal from a market segment

Answer 3

–increase large line capacity–
NO IMPACT. In reality, insurer may want to hold surplus to support the greater risk.

–catastrophe protection–
If NO CAT : surplus decrease due to cost of reinsurance.
If CAT EVENT : reinsurance helps reducing the drop in surplus

–stabilize loss experience–
surplus decrease because of cost of reinsurance

–provide surplus relief–
LOWER ASSETS due to cost of reinsurance
LOWER LIABILITIES due to cession of loss and unearned premium
RESULT: small decrease in surplus, since ceded business was profitable

–facilitate withdrawal from a market segment–
LOWER ASSETS due to cost of reinsurance.
LIABILITIES falls to 0.
RESULT: small decrease in surplus, since the ceded business was profitable.
Surplus becomes less volatile if there are large losses.

Question 4

BLANCHARD

Contrast
impact on LOSS RESERVES from

Increase Large Line Capacity
Catastrophe Protection
Stabilize loss experience
Provide Surplus Relief
Facilitate withdrawal from a market segment

Answer 4

–Increase Large Line Capacity–
Both GROSS and NET INCREASES (due to more premium volume)

–Catastrophe Protection–
NET not impacted, unless there’s a CAT

–Stabilize loss experience–
NET increases, but more stable.
GROSS increases by much

–Provide Surplus Relief–
NET are a fixed percentage of GROSS

–Facilitate withdrawal from a market segment–
No change in GROSS.
NET falls to 0.
No more exposed to volatility in NET RESERVE

Question 5

BLANCHARD

Contrast
impact on UNEARNED PREMIUM from

Increase Large Line Capacity
Catastrophe Protection
Stabilize loss experience
Provide Surplus Relief
Facilitate withdrawal from a market segment

Answer 5

–Increase Large Line Capacity–
GROSS and NET increase, but stays proportional to premium

–Catastrophe Protection–
No change

–Stabilize loss experience–
Lower NET due to purchase of reinsurance, unless (as in the example) the reinsurance is purchased with a single effective date.

–Provide Surplus Relief–
NET are a fixed percentage of GROSS

–Facilitate withdrawal from a market segment–
GROSS reserves decrease to 0 as the business runs off
NET reserves decrease to 0 immediately when the unearned premium is ceded

Question 6

BLANCHARD

Contrast
impact on LEVERAGE RATIOS from

Increase Large Line Capacity
Catastrophe Protection
Stabilize loss experience
Provide Surplus Relief
Facilitate withdrawal from a market segment

Answer 6

–Increase Large Line Capacity–
Huge increase in GROSS and NET due to change in business model.
REINSURANCE LEVERAGE increase due to purchase of reinsurance.

–Catastrophe Protection–
If NO CAT: As surplus (denominator) drops, leverage ratios INCREASE.
If CAT, WO REINSURANCE : gross and net ratios significantly impacted without the reinsurance,
If CAT, W REINSURANCE: only GROSS impacted with the reinsurance
Significant impact on CEDED REINSURANCE LEVERAGE RATIO

–Stabilize loss experience–
NET will be more stable but a bit higher (due to smaller surplus)

–Provide Surplus Relief–
Large decrease of NET
Large increase in CEDED REINSURANCE LEVERAGE RATIO

–Facilitate withdrawal from a market segment–
NET = zero
only remaining insurance risk is reinsurance collectability risk.

Question 7

BLANCHARD

Contrast
impact on INCOME STATEMENT from

Increase Large Line Capacity
Catastrophe Protection
Stabilize loss experience
Provide Surplus Relief
Facilitate withdrawal from a market segment

Answer 7

–Increase Large Line Capacity–
small INCOME change, but over time book is riskier, so more volatile

–Catastrophe Protection–
INVESTMENT INCOME decrease due to cost of reinsurance.
UW INCOME is protected.

–Stabilize loss experience–
Smaller INCOME, but more stable year-to-year UW RESULTS and smaller INVESTMENT INCOME

–Provide Surplus Relief–
Decrease in UW INCOME (by 50%).
Big decrease in INVESTMENT INCOME.

–Facilitate withdrawal from a market segment–
SMALLER PROFIT than if business had not been ceded
However risk is greatly reduced
(limited to reinsurance collectability and investment results)

Question 8

BLANCHARD

Impact of Providing UW Guidance to the Financial Statement

Answer 8

Equivalent to
-Increase Large Line Capacity-,
as reinsurance creates new business opportunities for the insurer