Chapter 1 - Purpose of Reinsurance

Question 1

What is an insurer’s likely course of action if the cost of reinsurance is high?

Answer 1

The insurer is likely to buy less protection and raise retention limits instead. If the cost of reinsurance is prohibitively expensive, the insurer might be obliged to limit the extent of cover it can offer to insureds. In extreme cases, the insurer may consider withdrawing from that particular market sector altogether.

Question 2

What are an insurers risk transfer options?

Answer 2

Avoid - Decline Risk
Prevent - Add Warranties
Limit - Fix retention and limit of insurance
Transfer - Reinsure
Accept / Retain - Put up with a loss

Question 3

What is a catastrophic loss?

Answer 3

Can mean a very large loss on an individual risk, as well as a large loss resulting from an accumulation of losses arising from a single catastrophic event.

Question 4

Why would an insured, or a broker acting on behalf of an insured, prefer to use an insurer that can accommodate the whole of a risk offered?

Answer 4

The administrative burden of having to place the risk with more than one company is reduced, as is the claims collection process, thus representing significant economy of scale benefits. It is also easier to track the performance of and security offered by just one insurer.

Question 5

What are the benefits of purchasing reinsurance?

Answer 5

• Spreads Risk
• Increases Capacity
• Provides Security
• Increases Stability in Results
• Increases Confidence
• Portfolio and Asset Management
• Taxation Benefits
• Cashflow Advantages
• Corporate Strategy

Question 6

What is a mutual fund / risk retention group?

Answer 6

Some industries set up mutual funds or risk retention groups to manage its risks and purchase reinsurance directly from the reinsurance market. They do this where there is a lack of insurance capacity, or where such insurance capacity is only available at prohibitive cost.

Question 7

What is an example of a mutual fund?

Answer 7

Flood Re is a joint initiative between the UK Government and insurers. It is a not-for-profit scheme funded by insurers which aims to help households situated in flood risk areas find affordable home insurance.

Flood Re collects an annual tax from home insurers in the UK and places this into a centrally managed fund. This allows insurers to pass on the flood risk from policies that are eligible for the scheme to Flood Re. When an insurer pays a valid claim made as a result of a flood, it is reimbursed from the central fund.

Question 8

Who are the buyers of reinsurance?

Answer 8

• Insurance Companies
• Lloyds Syndicates
• State owned insurance corporations
• Regional insurance corporations
• Takaful companies
• Captive insurance companies
• Mutual insurance companies
• Reinsurance companies
• Reinsurance Pools

Question 9

What is a reinsurance pool?

Answer 9

Pools are multi-reinsurer agreements under which each
reinsurer in the pool assumes a specified portion of each risk ceded to the pool. They buy reinsurance as a means of protecting their trading results.

Question 10

Motivation for selling reinsurance?

Answer 10

• Profit
• Investment Income
• Spread of Risk
• Reciprocity
• National retention of premiums
• Core business

Question 11

What encompasses a combined ratio?

Answer 11

• the loss ratio: this is the percentage of incurred losses (may also include loss adjustment expenses) to earned premiums; and this is added to
• the expense ratio: this is the percentage of incurred expenses to written premiums.

Question 12

Sellers of reinsurance?

Answer 12

• Reinsurance companies
• Syndicates
• Direct insurance companies
• State reinsurance companies
• ReTakaful Companies
• Reinsurance pools
• Sidecars

Question 13

What does the operator of a ReTakaful receive?

Answer 13

The operator receives a fee and a share of the investment income coming from the managed fund.

Question 14

What is a sidecar?

Answer 14

So-called ‘sidecars’ provide additional capacity to a sponsoring (re)insurer through, typically, a fully collateralised quota share arrangement. Third-party investors, such as hedge funds
and private equity funds, provide these extra resources by being offered debt in the sidecar. Sidecars are often targeted at specific lines of business and tend to have a short lifespan, although some are permanently structured to underwrite new business at each renewal season.

Question 15

What is the inherent danger for a large multinational insurance company in adopting a strategy of creating their own internal reinsurance vehicles?

Answer 15

Excessive retention of risk cuts across one of the basic principles of insurance practice, that of spread of risk.

Question 16

For its part, what is the reinsured promising to do in a reinsurance contract?

Answer 16

The reinsured is promising to pay a set premium by an agreed date. Sometimes this is at the start of the contract but more often it is through its duration with a ‘settling of accounts’ at the end in the form of an adjustment premium.

Question 17

What is a bordereaux?

Answer 17

The contractual relationship between the insurer and reinsurer may require the insurer to submit regular bordereaux to the reinsurance company. A bordereaux is a detailed list of either the:

• risks and related premiums ceded to the reinsurer (a cession bordereaux); or
• claims made on those risks (a loss bordereaux).

The list is prepared on a monthly or quarterly basis and sent to the reinsurer to enable it to see the names of risks and business ceded, along with associated losses. They are not always used in the modern reinsurance market.

Question 18

Role of the reinsurance broker?

Answer 18

• Risk management
• Mid-term changes
• Checking security ratings
• Claim notification and recovery
• Reviewing client needs
• Negotiating renewal
• Providing market intelligence
• issuing documentation

Question 19

Agents and other intermediaries with non-insurance backgrounds may introduce business to insurance companies from private individuals and small trading companies seeking insurance.

Why is it likely that only professional reinsurance brokers and other suitably qualified parties have a role to play in creating reinsurance relationships?

Answer 19

Reinsurance, and for that matter retrocession, relationships are several steps removed from the private individual requiring private car or home insurance, and call for a level of expertise that an agent with a non-insurance background will certainly not possess.

Question 20

What can change the structure of a reinsurance programme?

Answer 20

• Change in senior management
• Change in an insurers financial situation
• Mergers and acquisitions
• Regulatory Changes
• Change in law

Question 21

How do Robert and Stephen Kiln describe reinsurance?

Answer 21

As the business of insuring an insurance company or underwriter against suffering too great a loss from their insurance operations and allowing an insurance company or underwriter to lay off or pass on part of their liability to another insurer which they have accepted.

Question 22

Why do insurers seek to spread risk?

Answer 22

Insurers may not want a concentration of liability for one type of business, class of risk, geographical area or other classification. By effecting reinsurance as part of a risk management strategy they are able to achieve a spread of risk.

Question 23

Why are State insurance corporations important buyers of reinsurance?

Answer 23

They have a pressing need to divest accumulations of risk that arise in the area from which they receive business, either voluntarily or compulsorily. This is especially so if that area is prone to natural hazards, such as windstorms and earthquakes.

Question 24

What are the main incentives to sell reinsurance?

Answer 24

To generate profits for the owners of the reinsurer and to produce premiums that can be used for investment purposes. Insurers themselves can also act as reinsurers in order to spread risk and to balance the inflow and outflow of premiums.

Question 25

What is a reTakaful company?

Answer 25

A company set up to transact Islamic reinsurance and accepts business from Takaful ceding companies. The Takaful system is based on mutual cooperation, shared responsibility, joint indemnity, common interest and solidarity between groups of participants.

Question 26

How are brokers in the UK and USA regulated?

Answer 26

In the UK, brokers must be authorised and regulated by the FCA. In the USA, each state has specific laws to regulate the activities of brokerage firms complemented by limited Federal involvement.