Chapter 10 Flashcards
Why do insurers need reinsurance?
- to smooth claims experience;
- to limit large losses;
- to access the reinsurer’s expertise.
Describe smoothing of claims experience
Insurers use risk pooling to reduce the volatility of claims. In an ideal world,
the total claims an insurer would experience over time would have very little
variability. However, in reality insurers can still have claims that are volatile from
year to year
Describe limiting large losses
Insurers can be financially crippled by a very large single claim, or by a large
number of smaller claims.Reinsurance helps protect an insurer from becoming insolvent as a result of large losses. It can also allow the insurer to write policies for risks that are too large for it to handle alone, knowing that the reinsurer will accept part of the risk.
Describe accessing the reinsurer’s expertise
Reinsurers provide another service to insurers: their experience and skills in
the pricing and assessing of large risks. A reinsurer will offer its clients a wide
range of services, ranging from international data on various risks, to its own pricing and underwriting expertise.
What ways of writing reinsurance business are there
Treaty reinsurance
Facultative reinsurance
What is treaty reinsurance?
It is entered into at the beginning of a specified period, and it applies to a given class or given classes of business over that period. Once the treaty is in place, both the insurer and the reinsurer are bound by it: every single claim that is made on the specified book of business is automatically divided between the insurer and the reinsurer in an agreed way.
State the advantages of treaty reinsurance
- Risks are reinsured automatically. This is admin simpler, quicker and cheaper.
- The insurer knows that reinsurance will be available if the risk falls within the
limits of the treaty - As a result the insurer can issue new policies instantly without having to find
a reinsurer who is willing to accept the risk. (since the insurer knows the treaty terms)
State the disadvantages of treaty reinsurance
- Once the treaty is set up, then both parties must operate within the terms of
the treaty (may constrain insurer) - The insurer is bound to pay premiums, and only the specific types of risks
outlined in the treaty will be reinsured automatically. - The terms of the treaty are agreed at the outset and the insurer may find that they are paying too much for the reinsurance cover, and similarly the reinsurer may find the same. Neither party can change the terms of the treaty without the other
party agreeing.
What is facultative reinsurance?
A facultative agreement is a much less specific contract. It states that for a specific
type of risk, the reinsurer is prepared to consider providing cover, but it does not
obligate either party to provide or request cover, and it does not set out the terms
under which cover will be provided.
What are the advantages of facultative reinsurance?
- provides the insurer with flexibility and choice.
- The insurer is under no obligation to use a particular reinsurer, and so
they can choose who to reinsure with.
What are the disadvantages of facultative reinsurance?
- It can be a time-consuming and costly exercise to negotiate the terms a risk
will be reinsured on. - The insurer has no certainty that the required cover will be available
- Even if reinsurance cover is available, the price and terms may be unacceptable.
- The insurer may be unable to accept a large risk until it has been able to
find the required reinsurance cover. This means the insurer cannot accept
large risks automatically
What are the types of reinsurance?
Proportional reinsurance
What is proportional reinsurance?
Under proportional reinsurance, the reinsurer covers a proportion of each claim
What is non-proportional reinsurance?
Under non-proportional reinsurance, the reinsurer covers the part of the claim (or claims) exceeding some agreed amount.
What is it called when the proportion is constant for all risks covered?
quota share
What is quota share reinsurance?
Under quota share reinsurance, the reinsurer assumes an agreed percentage of
each risk.
Under a 30% quota share agreement, determine the amount paid by the insurer
and reinsurer for the following claims
(a) R50 000
(a) Reinsurer’s portion= 30% × R50000= R15000
Insurer’s portion= 70% × R50000= R35000
What is a quota share limit?
A quota share limit is the maximum rand amount that the reinsurer is willing to
pay for any claim.
What is individual surplus reinsurance?
Individual surplus reinsurance is similar to quota share reinsurance in that premiums and losses are shared on a proportional basis. However, the proportion paid
on each policy is not the same, but it depends on the original size of the policy.
What is estimated maximum loss?
The “size” of the policy is measured by using the estimated maximum loss (EML)
on the policy.
What is retention limit?
Is the maximum amount the insurer it is willing to pay for any claim
What happens when the EML is lower than or equal to the retention limit?
The insurer retains 100% of the claims
When EML > retention limit the proportion retained by the insurer is calculated as
retention% = retention limit / EML
When EML > retention limit the proportion ceded to the reinsurer is calculated as
ceded risk% = (EML-retention limit)/EML
What is Risk XL?
Under risk XL reinsurance, the cost of any single claim to an insurer is capped at
a certain level called the excess point.
What is the upper limit?
It is the portion above what the reinsurer’s portion is, and is payable by the insurer
What is Aggregate XL
Aggregate XL is similar to risk XL, except that instead of calculating the reinsurer’s
portion of each claim, the agreement covers the total amount claimed under the
conditions of the agreement. The reinsurer is required to pay if the aggregated
claims over a specified period, usually one year, exceed the excess point.
