Ch 30: Risk Transfer Flashcards
List 6 possible responses from which a stakeholder can choose when faced with a risk
PIRATE
- Partially transfer (to another party)
- Ignore (reject then need for financial coverage as the risk is either trivial or largely diversified)
- Reduce (frequency and/or severity)
- Accept (retain all)
- Transfer (to another party)
- Evade (avoid the risk altogether)
How could each risk mitigation option be evaluated?
FIRM
- Feasibility and cost
- Impact on frequency / severity / expected value
- Resulting secondary risks
- Mitigation required in response to secondary risks
What 5 factors affect whether a stakeholder retains or transfers risk?
- The cost of passing it on
- The willingness of another party to take it on
- The likelihood of the risk event occurring
- The capital the stakeholder has with which to absorb the risk event.
- The stakeholder’s risk appetite
Outline the main benefits and costs of reinsurance
Benefits:
- Reduction in/removal of risk
- Reinsurer may offer competitive terms for admin, actuarial services and advice
Costs:
- Profit is passed from cedant to reinsurer
- Reinsurance premium is likely to exceed cost of benefits (in the long run) as it will contain loadings for expenses, profit and contingencies.
- Liability may not be fully matched by reinsurance
- Possible liquidity issues
- Reinsurer may default
- Reinsurance may not be available on terms saught
Outline the reasons why a provider might purchase reinsurance.
- A reduction in claims volatility and hence:
- smoother profits
- reduced capital requirements
- an increased capacity to write more business and achieve diversification. - The limitation of large losses arising from:
- a single claim on a singe risk
- a singe event
- cumulative events
- geographical and portfolio concentration of risk
and hence:
- a reduced risk of insolvency
- increased capacity to write larger risks
- Access to the expertise of the reinsurer.
Outline the two contract variations on which reinsurance may be arranged.
- Facultative:
- Arranged on a case-by-case basis.
- This is typically done for particularly large risks, but the insurer is not obliged to cede these risks to the reinsurer, but neither is the reinsurer obliged to accept them. - Treaty
- A defined GROUP of policies is covered by the treaty.
- The reinsurer is OBLIGED to accept these risks, subject to conditions as set out in the treaty.
What are the key features of proportional reinsurance?
- Claims are split between the cedant and the reinsurer in pre-defined proportions.
- Does NOT CAP the claim paid by the cedant.
- Is written by TREATY.
- The two types are Quota Share and Surplus.
- Under QS, the proportion claim split is the same for ALL risks.
- Under Surplus, the proportion can vary by risk.
- The reinsurer may also pay the cedant a reinsurance commission, which can be used to provide financial assisstance.
What are the advantages and disadvantages of quota share reinsurance?
Advantages:
1. QS is useful for small, new or expanding cedants who want to diversify their risk, write more risks or who would like reciprocal business.
- Administration is relatively simple, since it is written by treaty and a constant proportion is ceded for ALL risks.
Disadvantages:
1. It is INFLEXIBLE in that the same proportion of each risk is ceded, irrespective of the size or potential volatility.
- A share of profits will also be passed to the reinsurer.
- It does not cap large claims.
For which type of business is a fixed retention level Surplus reinsurance used?
Used for high volume, relatively homogeneous classes of business, such as life insurance or personal lines general insurance.
For which type of business is a variable retention level Surplus reinsurance used?
Used for heterogeneous classed of business, eg. commercial property and business interruption insurance
What are the advantages and disadvantages of surplus reinsurance?
Advantages:
- The proportion of each risk passed to the reinsurer can vary from risk to risk, allowing the cedant the opportunity to ‘fine-tune’ its exposure. It is therefore useful where risks are heterogeneous in nature.
- Surplus is useful for cedants who want to diversify their risk, write more risks or who would like to be able to write larger risks.
Disadvantages:
- Surplus treaties are more complex and expensive relative to quote share due to the extra administration in particular of assessing and recording each risk separately. Therefore, surplus is generally more appropriate for larger, more heterogeneous risks such as commercial property.
- It does not cap large claims.
What are the key features of non-proportional reinsurance?
- The cedant specifies a retention level. The cedant pays the claim amount up to the retention level; the reinsurer pays the claim amount over the retention level.
- There may be an upper limit on what the reinsurer is prepared to pay.
- There may be different layers of excess of loss reinsurance, each with a different reinsurer.
- The cedant may be required to retain a proportion of risk within each layer, so as to retain an INTEREST in the risk. (insurable interest)
- The retention level / upper limit may be indexed over time for inflation.
- The reinsurer determines the reinsurance premiun
- XOL can cap the claims paid by the cedant.
- XOL may or may not be written using a treaty.
Define 4 different types of XOL reinsurance contracts
- Risk XL covers losses from a single claim from one insured risk.
- Aggregate XL covers the aggregate losses from several insured risks, sustained from a defined peril (or perils) over a defined period, usually one year.
- Catastrophe XL is a form of aggregate XL reinsurance that pays out if a “catastrophe”, as defined in the reinsurance contract, occurs.
- Stop loss is a form of aggregate XL that provides cover based on aggregate losses, from all perils, arising on a company’s whole account (or major class of business) over a specified period, usually one year.
State the 3 main uses of XOL reinsurance
- Opportunity to write larger risks
- Reduces risk of insolvency from a large single claim, a aggregation of claims or a catastrophic event.
- Soothes profits by reducing claims fluctuations.
In what situation would surplus reinsurance and risk XL reinsurance provide the same cover?
Where the risk event can only result in the payment of the full sum assured, there is no difference between risk XL and surplus.
