Chapter 11: Managing Exposure

Question 1

Do all lines of business experience the same hardening or softening of the market at the same time?

Answer 1

No

Question 2

Starting from higher profits, what is the typical cycle in the insurance market?

Answer 2

Higher profits leads to...
Higher capacity leads to...
Lower premiums leads to...
Lower profits leads to....
Lower capacity leads to...
Higher premiums leads to...
Higher profits...and the cycle begins again

Question 3

How long does a cycle of the insurance market take?

Answer 3

It can be difficult to predict as it depends upon numerous influences

Question 4

What are some examples of how the cycle of the insurance market may be shortened?

Answer 4

Changes to legislation creating new liabilities
Major disasters such as weather related incidents, NatCats, or acts of terror
Changes to underwriting policy

Question 5

What is EML?

Answer 5

Estimated Maximum Loss

Question 6

For which line of business is EML particularly important?

Answer 6

Commercial property and business interruption

Question 7

Why is estimated maximum loss needed?

Answer 7

The maximum exposure for any one event may not be the same as the sum insured - particularly if the risk is spread across more than one location eg if there are two factories it is unlikely they would both be destroyed by the same event

The EML helps the underwriter decide if the risk is acceptable, how much if any they are willing to take on, and if reinsurance would be desirable

Question 8

Due to risk accumulation, insurers must be particularly aware of loss exposures arising from what?

Answer 8

Single risks

Single events

Question 9

What is meant by layering of liability?

Answer 9

If a proposer wishes to take out a policy for a £20 million limit of liability but can only find an insurer willing to accept a limit of liability of £10 million, they may place this £10 million then arrange additional policies with other insurer(s) in excess of this £10 million to reach the £20 million limit they require

ie they may have a primary layer of £10 million and another policy, an excess layer, covering £10 million in excess of £10 million

Question 10

What is meant by single event exposures?

Answer 10

Exposures to multiple losses arising from the same event eg a natural catastrophe or weather event

Question 11

What can be done about single event exposures in order to manage the risk?

Answer 11

Take out reinsurance

Question 12

What is reinsurance?

Answer 12

The underwriter, having accepted a risk, seeks to pass some of that risk on to other insurers or specialist reinsurers to limit their exposure to the risk

Question 13

What are some of the reasons why an underwriter might want to take out reinsurance?

Answer 13

Protection against single large events or claims
Protection against claim fluctuations from year to year
Limit capacity
Risk is above acceptable levels
Entering a new market

Question 14

If a claim arises on a policy which the insurer has reinsurance on, who is legally bound to pay for the claim?

Answer 14

The insurer - they are legally bound to pay for losses arising before seeking to claim indemnity under the reinsurance contract

Question 15

What are the two main types of reinsurance?

Answer 15

Proportional and non-proportional

Question 16

What are the two sub-categories of proportional reinsurance?

Answer 16

Quota share and surplus

Question 17

What are the sub-categories of non-proportional reinsurance?

Answer 17

Excess of loss and stop loss (also called excess of loss ratio)

Question 18

What is proportional reinsurance?

Answer 18

The reinsurer accepts an agreed percentage of the risk to be passed onto them and agrees to pay any losses in the same percentage

Question 19

What is quota share reinsurance?

Answer 19

An insurer has an agreement (treaty) with a reinsurer applying to all insurances written that comply with the terms of a treaty. The reinsurer will automatically accept liability for their share of any policy written that falls within the treaty

For example if an insurer has a treaty covering 50% of its property line of business, 50% of all policies written would be covered by the reinsurer

Question 20

What is the main advantage and disadvantage of quota share reinsurance?

Answer 20

Advantage: Easy to administrate which lowers costs

Disadvantage: The insurer cannot be selective about their risk retention - even if they would be willing to retain all of the risk it would still be reinsured and so they would pay a reinsurance premium on it

Question 21

When is quota share reinsurance normally used?

Answer 21

By new insurers or when a insurer starts to write a new line of business

Question 22

What is surplus reinsurance?

Answer 22

The insurer only takes out reinsurance on risks that exceed their own retention limit. They take out additional lines of reinsurance equal to the maximum line they wish to retan

eg if a risk is £500,000 but they wish to retain only £100,000 they would take out 4 lines of reinsurance for £100,000 each

Question 23

What are the main advantages and disadvantages of surplus reinsurance?

Answer 23

Advantage: The insurer can be more selective about when they take out reinsurance

Disadvantages: The cost of administrating this is higher as it requires more active involvement

Question 24

What is non-proportional reinsurance?

Answer 24

The reinsurer agreed to contribute to all losses exceeding a pre-agreed figure

Question 25

What is excess of loss reinsurance?

Answer 25

The reinsurer agrees to take on the part of the risk in excess to the insurer’s retention

For example the insurer writes a policy with a £50 million limit of indemnity. It then takes out reinsurance on this policy with a £25 million excess £25 million limit. This means the insurer has retained a £25 million limit and any claims exceeding this are passed to the reinsurer

Question 26

On what basis can excess of loss reinsurance be taken out?

Answer 26

Per risk or per event

Question 27

What is stop loss (excess of loss ratio) reinsurance?

Answer 27

Reinsurance for claims which would cause the insurer’s maximum loss ratio to exceed a certain figure

EG the insurer may take out reinsurance for claims which would cause maximum loss ratio to exceed 75%

Question 28

What would a reinsurer usually do in a stop loss reinsurance policy?

Answer 28

Limit their maximum liability and only pay a share of any reinsured loss with the original insurer sharing the rest - otherwise the insurer would be guaranteeing it could not suffer a loss

Question 29

Who is a cedent?

Answer 29

The original insurer that is passing on part of the risk to reinsurers

Question 30

What is facultative reinsurance?

Answer 30

Reinsurance purchased for an individual risk, not as part of a treaty

Question 31

What is retrocession?

Answer 31

Essentially it is reinsurance on reinsurance - the original reinsurer seeks to further share the risk

Question 32

What is treaty reinsurance?

Answer 32

Reinsurance covering a wide portfolio of risks

Question 33

What happened to the insurance market following the 2001 World Trade Centre attack?

Answer 33

It entered a hard market. Capacity reduced and insurance and reinsurance premiums increased

Question 34

What does it mean for an insurer to set their maximum retention or maximum retained line?

Answer 34

The maximum line the insurer is willing to accept, they will take out reinsurance on anything larger

Question 35

An insurer has a maximum retained line of £250,000. If they arrange a five line surplus treaty with their reinsurers, what will their maximum capacity be?

Answer 35

£1.5 million

£250,000 of their own retention
5 lines of £250,000 from their reinsurers

Question 36

What is an insurer’s operational capacity?

Answer 36

The size of risks an insurer is able to accept

Question 37

Which type of insurance usually leads the other lines of business in the insurance market cycle? What typically follows?

Answer 37

Motor, followed by casualty, followed by property

Question 38

How is surplus reinsurance normally arranged?

Answer 38

By treaty - the treaty will only apply to risks that exceed the insurer’s maximum retained line. Reinsurance will be taken out on any risks over this

Question 39

What type of an insurance would typically be taken out to protect an account against large losses?

Answer 39

Excess of loss

Question 40

What type of insurance would typically be taken out to protect a line of business against large losses?

Answer 40

Quota share

Question 41

An insurer wants to write a single risk with a large limit of liability. What type of reinsurance are they most likely to purchase?

Answer 41

Excess of loss

Question 42

An insurer wants to expand into a new line of business. What type of reinsurance are they most likely to purchase?

Answer 42

Quota shares

Question 43

On what basis is quota share or surplus reinsurance usually purchased?

Answer 43

In a treaty where the reinsurer automatically reinsures all policies falling under the treaty

Question 44

When is the best time to write new business?

Answer 44

In a hard market