Ch30: Risk transfer Flashcards
Methods/Choices of risk control (6)
- Avoid
- Reduce the risk (mitigation)
- Accept the risk i.e. reject need for financial coverage since risk is small or diversified
- Retain all the risk
- Transfer all the risk
- Transfer part of the risk
Benefits of reinsurance
- Reduction in claims volatility
+ Smoother profits
+ reduced capital requirements
+ increased capacity to write more business and achieve diversification - Limitation of large losses arising from:
+ single large claim on a single risk
+ single event
+ cumulative events
+ geographical and portfolio concentrations of risk
+ reduces risk of insolvency
+ increased capacity to write larger risks - Access to the expertise and data of a reinsurer
Alternative risk transfer definition and types
Non-traditional methods by which organizations can transfer risk to third parties. Often uses both banking and insurance techniques, producing tailor-made solutions for risks that the conventional market would regard as uninsurable.
- Integrated risk covers
- Securitization
- Post loss funding
- Insurance derivatives
- Swaps
Integrated risk cover used for
- Avoid buying excessive cover
- Smooth results
- Lock into attractive terms
- Reduces the need for capital therefore acts as a substitute to debt or or equity
Securitization
- Transfer of insurance risk to banking and capital markets
- Involves turning a risk into a financial security
- Catastrophe bond:
+ Repayment of capital contingent on risk event not happening
+ If event does happen, insurer uses money provided from investor to cover cost of claims
arising from the catastrophe.
+ If event does not occur, investor gets their interest and capital back in a normal way
Proportional reinsurance definition
- Reinsurer covers an agreed proportion of each risk
- Proportion may be:
* Constant for all risks covered (quota share)
* Vary by risk covered (surplus reinsurance)
Quota share description
Uses (3) Advantages (2) Disadvantages (3)
Uses:
* Spread risk
* Write larger portfolios of risk
* Encourage reciprocal business
Advantages:
* Simplicity of administration
* Diversify risks - can write more business for same amount of capital
Disadvantages:
* Same proportion ceded for each risk regardless of its size
* Regardless of its volatility
* Does not cap loss of very large claims
Surplus reinsurance description
More flexibility since gives writer greater discretion in amount of each risk to retain
Specifies a retention level and a maximum level of cover
Advantages:
* Allows ceding provider to accept risks that would otherwise be too big
* Helps ceding provider to spread risks
* Flexible - can choose proportion to cede - helps maintain a well-balanced portfolio of risks
Disadvantages
* More complex administration
* Does not cap the cost of very large claims
Excess of loss reinsurance description
- Non-proprotional cover
- Cost to ceding company is capped with liability above certain level being passed to reinsurer
- If it exceeds upper limit, excess will revert back to ceding company
3 types:
* Risk XL: Individual losses
* Aggregate excess of loss: Covers aggregate losses above excess point and subject to upper limit from defined perils over a defined period, normally 1 year
* Catastrophe XL: Covers aggregate losses from a single event normally over 24 to 72 hour period after event
Advanatges:
* Cap losses - cedant can take on risks that could produce very large claims
* Protects against indivdual or aggregate large claims
* Stabilise profits from year o year
* More efficient use of capital by reducing variance of claim payments
Disadvantages:
* Premium expected to be greater than the expected recoveries due to profit margins and loadings for expenses
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Each option to mitigate a risk can be evaluated by assessing: (5)
Extent to which risk is passed on depends on (5)
- Likely effect on frequency, consequence and expected value
- Feasibility and cost of implementing the option
- Secondary risks resulting from the option
- Futher mitigation options to respond to secondary risks
- Overall impact of option on distribution of NPVs
- Extent to which risk is to be passed on:
* Likely stakeholder believes the risk event is to happen
* Risk appetite
* Resources available to finance the cost of risk should it happen
* Amount required by another party to take on the risk
* Willingness of another party to take on the risk
