Ch 30: Risk Transfer Flashcards
1
Q
When faced with a risk, each stakeholder can decide whether to:
A
- Avoid the risk altogether
- Reduce the risk (probability, severity, both)
- Reject the need for financial coverage - risk trivial / largely
diversified - Retain in full
- Transfer in full - payment of a premium
- Partly retain and partly transfer
2
Q
The extent of risk transfer will
depend on the:
A
- Probability of the risk occurring
- Risk appetite
- Existing resources to finance
the risk event if it happens - Cost of transferring the risk
- Willingness of a third party to
accept the risk
3
Q
The choice of mitigation approach will depend on:
A
- Impact on frequency and severity of the risk
- Feasibility & cost of implementing the option
- Cost and impact on profit
- Secondary risks arising and how they might be dealt with
Overall impact on distribution of NPVs
4
Q
The extent of risk transfer will
depend on the:
A
- Probability of the risk occurring
- Risk appetite
- Existing resources to finance
the risk event if it happens - Cost of transferring the risk
- Willingness of a third party to
accept the risk
5
Q
Cost
A
- Cost of transferring risk & profit
- If risks are transferred, the cedant (party
transferring the risk) removes potential
downside and upside exposure - If upside
exposure preserved - increased costs
6
Q
Counterparty risk
A
- Investment bank / reinsurer
- Failure / default returns risk to cedant
- May be regulatory restrictions that reduce the
effectiveness of risk transfer - Maximum permissible amount that can be
transferred - Capped reduction in regulatory capital reduces
attractiveness of option - Effectiveness constrained by capacity / risk appetite
of market
7
Q
Reinsurance - benefits & costs
A
- Benefits of reinsurance have to be weighed up
against the cost - Reinsurance premium - loadings for expenses,
contingencies, and profits - Reinsurer may be able to offer very
competitive terms for administration, actuarial
services, and other insurance advice if
contract is purchased - Technical assistance - reduces business and
operational risk
8
Q
Areas in which insurance company might
seek assistance from reinsurer:
A
- Product design
- Pricing
- Guidance in setting underwriting
policies and claims controls - Wording of policy documents
- Establishment of suitable
administration systems
9
Q
Benefits of reinsurance:
A
- Reduction in claims volatility and hence
- Smoother profits
- Reduced capital requirements
- Increased capacity to write more business and achieve diversification
- Limitation of large losses arising from
- Single claim on a single risk
- Single event
- Cumulative events
- Geographical and portfolio concentrations of risk and hence
- Reduced risk of insolvency
- Increased capacity of writing larger risks
- Access to expertise and data of the reinsurer
10
Q
Cost of reinsurance:
A
- Reinsurance premiums
- Cost in management
- Providing policy and claims details to
reinsurer - Managing recoveries
11
Q
Cost vs benefit:
A
- Calculate realistic estimate of net cost of
reinsurance (premium - expected benefits) - Together with a range over which this net
cost may vary depending on experience - Consider liquidity risk
12
Q
Basic product types
A
- Main types - proportional and non-
proportional - May be arranged on
- Case-by-case, non-obligatory basis
(facultative) - Obligatory basis using a treaty
13
Q
Reinsurance terminology
A
- Cede: ‘pass on’ or ‘give away’
- Treaty: covers a group of policies, reinsurer is
obliged to accept these risks from insurer, subject
to conditions - Direct writer: insurer with direct contract with
policyholders – primary insurer /cedant
14
Q
Proportional reinsurance
A
Reinsurer covers an agreed proportion
of each risk - proportion may
* Be constant for all risks covered -
quota share
* Vary by risk covered - surplus
Have to be administered automatically -
require treaty
15
Q
Advantages of quota share reinsurance:
A
- Simple to administer - written by treaty
and constant proportion - Helps diversify risk
