Ch 30: RE 2

Question 1

Benefits of reinsuring (13)

Answer 1

• As a method to raise capital
• Limit the amount paid on a single claim
• Limit the total claims payout in a period with stop loss
• Reduce insurance parameter risk
• Reduce claim payout fluctuations
• Receive technical assistance
• Reduce new business strain by reducing solvency requirements or through financial reinsurance
• Protect against aggregations of risk
• Increase profits, return or risk-adjusted return on capital (by reducing risk or increasing volumes)
• Reduce overall capital requirements by using a reinsurer’s capital. (Reinsurers may have lower capital requirements due to overall risk diversification or regulatory position)
• Seperate out different risks from a product - allowing the cedant to disaggregate risks and to optimise its risk management and capital requirements.
• Allow aggregation of risks the cedant cannot manage on its own, so allowing manufacture of product lines
• Reinsurance may help insurer to demonstrate its financial strength and attract more investors if this is required

Question 2

Parameter risk (reinsurance)

Answer 2

• Risk that the level of claims may be different than expected.
• May be due to number of factors incl. incorrect pricing, underwriting failures, fraudulent activities etc.
• If assumptions in pricing basis turns out to be incorrect, risk that losses could arise from this parameter risk.

Question 3

Considerations before reinsuring

to decide whether to, type and how much

Answer 3

• Cost of reinsurance
• Retention limits
• Counterparty risk
• Legal risk
• Type of reinsurance will depend on:
  * Reason ceding company is using reinsurance
  * Reinsurance costs
  * Type of business
  * Legal conditions
  * Forms of reinsurance coverage actually on offer

Question 4

Factors to consider when setting retention limits: (9)

Answer 4

• Average benefit level for the product and the expected distribution of the benefit
• Company’s insurace risk appetite
• Level of company’s free assets and the iportance attached to the free asset ratio
• Terms on which reinsurance can be obtained and the dependence of such terms on the retention limit.
• The familiarity of the company with the underwriting of the type of business involved
• Effect on the comany’s regulatory capital reqs of increasing or reducing the retention limit
• Existence of a profit-sharing arrangement in the reinsurance treaty
• Company’s retention on other products
• Nature of any future increases in sums assured

Question 5

Approaches to determine the level of retention limits (3 approaches)

Answer 5

Stochastic simulation - reinsurance only
* Set retention limit at such a level as to keep the probability of insolvency below a specified level or alternative approaches which relatd to the risk appetite of company
* Can be done by using a stochastic model for projecting claim rates and a model of the business, so that claims can be projected forward together with the value of the company’s assets and liabilities.
* By using a simulation, a retention limit can be chosen such that the company stays solvent or earnings stay above a certain level, 99.5% of the time say.

Stochastic simulation - reinsurance with fluctuations reserve
* Consider the cost of financing an appropriate mortality fluctuation reserve and the cost of obtaining reinsurance.
* As retention limit increases the first cost will increase and the second will decrease.
* Choose retention limit which minimises the total cost.

Financial economics approach
* Based on theory of efficient investment frontiers and looks at reinsurance as an asset class that allows the firm to optimise its risk and reward trade off.
* Approach allows you to identify those asset portfolios (including reinsurance) which cannot be bettered in terms of either reducing risk for no reduction in return or increasing return for no increase in risk.