Ch 30: Reinsurance 2 Flashcards
List various reasons why insurer’s may use reinsurance (12)
Reinsurance mainly allows cedant to transfer risks from its balance sheet to reinsuerer’s balance sheet and acheive the following goals
- increase (raise)
- capital (where permitted)
- profits or risk adjusted return on capital
-
reduce
- insurance parameter risk that claims might differ to expected
- claim payout flactuation by reducing cedant’s claim cost variance
- costs (cost reduction)
- new business strain
- overall capital requirements
- limit
- amount paid on any particular claim
- total claims payout
- receive technical assistance
- seperate out different risks from a product
- manage aggregation of risks
What is insurance parameter risk, and what form of reinsurance best transfers this this type of risk? (2)
How might reinsurance assist with reducing parameter risk?
Broadly speaking, insurance parameter risk (also known as pricing risk) is,
- the risk that level of claims differ compared to what is expected
- may be caused by incorrect pricing, underwriting failures, fraudulent activities, etc
- best reinsurance for transfer this risk is through quota share reinsurance
- individual surplus reinsurance wouldn’t be useful for this, as significant portion of pols’ claims may fall below insurer’s retention limit
- under quota share reinsurance, the reinsurer would regulalry review insurer’s premium rates/controls and give expertise to assist with setting assumptions and carving actual experience which better represents assumptions
Describe 2 factors which lead to variance of claim amounts being high relative to the mean, and what forms of reinsurance can be used for each factor? (9)
One of the key benefits of resinsurance is its ability to help reduce risk by reducing the variance of its claim costs.
Claims costs may have high variance relative to the mean if
-
there are a small number of contracts, with very high levels of cover ie concentration of risk
- forms of reinsurance that help with this:
- either original terms reinsurance (coinsurance), or
- risk premium reinsurance, usually on an individual surplus basis
- forms of reinsurance that help with this:
-
lives insured not independant risks
- forms of reinsurance that could help are
- excess of loss reinsurance
- catastrophe reinsurance
- stop loss reinsurance
- excess of loss reinsurance
- forms of reinsurance that could help are
Why would flactuations in claim costs be undesirable for an insurer? (6)
Flactuations in claim costs are bad for an insurer for a number of reasons
- may make life company insolvent
- big risk for small companies, this have an strong need for reinsurance.
- for larger companies mortality fluctuations won’t plausibly threaten solvency
- may reduce excess of value of company’s assets over its liabilities below the level desired by the company
- may reduce rate of return on free assets below level desired by company in some years
- may cause fluctuations in shareholder dividends
Explain how reinsurance mirhg be used to reduce new business strain? (2)
What is the benefits or reducing new business strain? (1)
Provided it’s permitted under relevant supervisory regime, the cedant could use reinsurance to reduce financial risk associated with new business, either by:
- increasing its available capital, or
- reducing its financing requirement
Reducing new business strain has the benefit that
- more new business can be written for the same amount of capital
Which types of reinsurance would be used for the purpose of reducing new business strain? (6)
Types of reinsurance which might help reduce new business strain include
-
original terms coinsurance usually on quota share basis
- usually pass some liability to reins, so insurer can hold lesss reserves
- hence, reducing new business strain by around same proportion
- more significantly, large initial reinsurance comm contributes to insurer’s assets at time of sale, effectively discounting future profits that would’ve been tied up in the large reinsurance premiums
- risk premium reinsurance usually on quota basis
-
financial reinsurance (if effective under regulatory regime)
- improve balance sheet of insurer immediately, thereby increasing available capital
Why is invididual surplus reinsurance less useful than quota share reinsurance for reducing new business strain? (2)
Individual surplus reinsurance would be less useful than quota share for reducing new business strain because
- new business strain is a funtion of many constituents (init comm, init expenses, prem income, initi supervisory reserves, etc) relating to new business sold, whether made up of many small individual pols, or fewer individual larger pols
- using individual surplus reinsurance for financing would generate capital support that would be a function of new business mix by size (which is irrelevant to total amnt of strain)
Explain the circumstances in which an insurer may benefit from the technical assistance a reinsurer can provide (4)
What form of reinsurance best allows insurer to benefit from technical assistance from the reinsurer? (1)
Reinsurance can provide the following technical assistance to the insurer
- Reinsurer may have considerable degree of expertise on underwriting, product design, pricing and systems design
- This is particularly important when cedant starts a new line of business, as it can receive tehcnical assistance from reinsurer until it has built up its own expertise
- Likewise for recently established insurance company.
- Reinsurer can give support for existing lines in areas such as underwriting, eg treatment of unusual cases.
Best form of reinsurance to benefit insurer regarding technical assistance is
- original terms reinsurance (with high quota share reinsured)
Dicuss how reinsurance may help insurer’s in terms of cost reduction (6)
Cost reduction benefit of reinsurance derives from reinsurer perhaps being able to price risk at lower cost than insurer due to
- different capital requirements it faces
- diversitication benefits of due to reinsurer having greater spread of risks than any individual cedant in terms of
- number lives covered, geographical region, original sales channel, etc
- reduce reinsurer’s random flactuation risk relative to any insurer
- …and quantity of data should help reduce parameter risk
- hence reinsurer won’t need to build in such large risk margins into reinsurance prems, potentially making it more profitable for cedant to cede this business than retain risk on it
- tax differences across regions/regimes, across certain types of business
- different assessments of risks
What key questions should an insurer ask itself regarding the use of reinsurance? (3)
Before deciding on the use of reinsurance, an insurer should ask itself the following questions:
- whether or not to use reinsurance
- which types of reinsurance to use
- how much reinsurance to use
We’ve touched on the questions an insurer should ask itself regarding the use of reinsurance.
List considerations that an insurer will take into account in deciding on the answers to these questions (5)
What kind of risks does the use of reinsurance introduce? (2)
Key considerations for insurer when answering above questions about reinsurance
- reasons for acquiring reinsurance
- type of business being reinsurance
- cost of reinsurance
- retention limits - ie maximum amount of risk retained by cedant on any individual risk
- legal conditions applying types of reinsurance available and way in which amoutn reinsured is specified
In addition, the use of reinsurance introduces the following important risks:
- Legal risk: ir reinsurance treaty incomplete
- Counterparty risk: risk that reinsurer defaults in event of claim
Reinsurance considerations: cost of reinsurance
What factors influence the cost of reinsurance? (1)
What key considerations should be factored into a decision about reinsurance regarding the cost thereof? (6)
The cost of reinsurance is influenced by the following factors
- the reinsurer intends to make profit as well as meet its cost of capital and expenses when writing reinsurance, which will reduce the expected absolute level of profit for the cedant
Most importantly, the cedant needs to consider
-
The return/risk adjusted return on capital
- risk reduction from reinsurance may leverage up return or risk adjusted RoC
- given insurer holds less capital, RoC will increase (leverage up return)
- implying lower RDR for future profit stream, making them more valuable to shareholders (increasing the risk adjusted RoC)
-
The balance between risk and return
- balance must be struck between increased cost of reinsurance against increased risk of loss from adverse experience if less reinsurance used
What different types of insurance are there (4) and what are the different ways in which the amount reinsured might be specified (2)?
For reinsurance we have the following types
- original terms, risk premium, excess of loss, financial reinsurance
And the way that the amount reinsured might be specified is
- individual surplus, quota share
What factors will influence the
- type of reinsurance acquired
- the way in which the amount reinsured is specified
(total 5 key points)
Factors influencing type of insurance taken + way in which amount reinsured is specified
- insurer’s reason for use of reinsurance
-
costs of reinsurance
- eg recently, unrestricted form of catastrophe cover became extremely expensive and terms increasingly restrictive, as reinsurers have become better at modelling extent of tail risk from extreme events
-
type of business sold by insurer
- term assurance:
- with profits:
- individual immediate annuity
- group business
- unit linked
- legal conditions applying
- forms of reinsurance cover actually available in market
When considering what type of reinsurance to purchase, the type of reinsurance acquired is an important factor.
One factor which influences this, is the type of business the cedant/insurer writes.
List what types of contracts the cedant might write, and what reinsurance would be best suited for each (15)
Factors influencing type of insurance taken + way in which amount reinsured is specified: type of business sold by insurer
-
term assurance:
- original terms or risk prem reins, with differences in reins prem
- original terms: level prem, set at outset, with initial waiting period where no/low reinsurance premiums paid
- risk premium: recurring single premium based on current age, rates may be guaranteed for few years
-
with profits:
1. original term reins may be difficult, as reins would be obligated to follow cedan’t bonus rates
2. reinsuring guaranteed elements/options attaching becoming popular in market
-
with profits:
-
individual immediate annuity
1. normally no reinsurance, unless very large case
2. consider impact on mortality profits of unexpectedly light mortality of annuitants
3. reinsurers can also provide advice on impaired life annuities or smoker/non-smoker rates
-
individual immediate annuity
-
group business:
1. catastrophe cover important (for risk accumulation)
-
group business:
-
unit linked:
1. normally risk premium reinsurance
-
unit linked: