Chapter 28 Reinsurance

Question 1

Reasons for reinsurance

Answer 1

• limit exposure to risk
• avoid large single losses - cede top slice of potentially large losses to reinsurers. To ensure claim payouts do not threaten solvency of insurer.
• smooth results
• provide expertise - reinsurer may help new insurers with claims management, underwriting. Usually QS with low retention.
• increase capacity to accept risk
• provide financial assistance

Question 2

health and care insurance payouts will either be linked to?

Answer 2

• sum insured eg under CI insurance
• a sum insured with agreed uplift (some mechanism for automatic increasing of premium)
• indemnify the policyholder against medical costs eg under PMI

Question 3

The following factors will determine the insurer’s appetite for offsetting its risks by using reinsurance.

Answer 3

• size of reinsurer
• experience in the marketplace
• its available free assets
• size of its portfolio
• the degree to which it is felt that the business outcome is predictable within bounds.

Question 4

Smoothing of results

Answer 4

• Principle whereby reinsurance covers the large risks or accumulation of smaller risks above certain limits helps to achieve a smooth development of accounts year-on-year especially when portfolio is immature.
• a premium is paid to mitigate these fluctuations and the net result is more predictable for the insurer.
• reduces variance of insurer’s expected experience relative to the mean.

Question 5

Increasing capacity to accept larger risks

Answer 5

• Owing to insufficient capital backing, an insurer may be reluctant to accept, or incapable of accepting, particular risks by sector or by volume.
• Solvency requirements for a line of business are normally reduced in line with proportion ceded though this may be subject to an upper limit.
• surplud and excess of loss RI may be used here.

Question 6

Financial assistance (NB strain, merger/acquisition, improving free-assets)

Answer 6

• reinsurance funds are available to assist financially with particular business propositions.
• reinsurance commission may be paid to the insurer: reinsurer is paying money to improve its cash balance.
• Occassionally where a reinsurer agrees that a block of renewing business should produce regular profits in the future, it may be possible for reinsurer to provide capital to insurer to improve its free asset position by reinsuring this portfolio of profitable existing business.
• RI would pay an initial commission after which reinsurer would be entitled to future surplus arising on this porfolio.
• a similar exercise might facilitate the acquisition of an insurance company where a subset of business within the company being acquired is identified as potentially profitable and the reinsurer is prepared to advance funds in anticipation of this future profit.

Question 7

Types of reinsurance

Answer 7

• facultative
• treaty
• proportional : Quota share, surplus, coinsurance
• non-proportional :Risk,aggregate,catastrophe
• financial

Question 8

Reinsurance commission

Answer 8

• used to describe a payment from the reinsurer to the insurer.
• sometimes structured as a deduction from premium paid to the reinsurer, in which case it would typically be called a rebate.

Question 9

Proportional reinsurance can be ?

Answer 9

• quota share or surplus
• either of which can be written on original terms or risk premium bases.
• for short-term health only quota share is used.

Question 10

Discuss the arrangement under original terms

Answer 10

• applies both to long and short-term contracts.
• reinsurance premiums are in the same proportion to the original premium as the reinsured benefit is to the full benefit level.
• the cedant will provide the reinsurer with the premium rates it is using for the particular class of business it wishes to reinsure.
• commission paid by reinsurer depends on expected profitability of the business ceded.
• The reinsurer helps the finances of the insurer by paying it commission. to fund commission funded by cedant.
• deposits back may be used so that the cedant maintains the reserves for the whole contract.
• deposit back arrangement will also serve to mitigate reinsurer default risk to which cedant is exposed.

Question 11

discuss arrangement under the risk premium reinsurance

Answer 11

• a proportion of either the full benefit or the sum at risk is reinsured.
• reinsurer does not share the office premium of the cedant but charges a specific premium for the risk:
• reinsurance premiums can be net level payments or yearly increasing.
• level premiums are spread over term of contract. Easy for cedant to load RI premiums to charge policyholders.
• reinsurance premiums may be guaranteed or reviewable
• reinsurance premiums are determined by the reinsurer.
• risks are shared in proportions. For QS this proportion is the same for all risks, but for surplus it varies.

Question 12

Merits of quota share

Answer 12

+spreading risks
+writing larger portfolios
+encouraging reciprocal business
+financing and improving solvency

Question 13

Surplus reinsurance merits

Answer 13

+enables insurer to cover individual risk up to an agreed maximum retention level.
+normally used in short-term contracts & group contracts
+used to smooth results by reducing claims fluctuations.

Question 14

What is the difference between risk premium reinsurance & original terms ?

Answer 14

• under original terms the insurance company sets the premium and then negotiates an amount of commission from the reinsurer.
• Under the risk premium, the reinsurer sets the premium rate which is independent of the premium charged by the insurer.
• with a risk premium structure changes in cedants premiums rates will not necessarily require changes in reinsurance rates.
• therefore gives cedant greater flexibility to respond to competitor changes in premium rates.

Question 15

Sum-at-risk reinsurance

Answer 15

• a variant proportional reinsurance is the concept of “sum-at-risk” reinsurance on long-term contract.
• here proporitions are applied, not to the whole sum-insured but to the insurer’s “sum-at-risk” ie excess of the stated policy benefit over the reserves that the cedant holds.
• this approach is less usual for unit-linked CI.
• for ease of administration the basis on which reserves are calculated may be stipulated at the outset.
• for unit-linked products the sum-at-risk will be the excess of benefit over the bid value of units.

Question 16

Uses of Non-proportional

Answer 16

• Non-proportional reinsurance helps to cap claims costs, and is normally used in short-term contracts and possibly group long-term contracts.
• it is also used to smooth results by reducing claims fluctuations.

Question 17

Types of non-proportional covers

Answer 17

• risk excess of loss - cover relates to individual losses and may be found on PMI portfolios.
• aggregate excess of loss - covers aggregations of claims over a whole account and is rare for long-term insurance.
• catastrophe excess of loss - covers events or pandemics.

-limits may be indexed for inflation.

Question 18

How excess of loss works

Answer 18

-Reinsurer agrees to indemnify the cedant for the amount of any loss above a stated excess point.
-Reinsurer will give cover up to a stated upper limit, with insurer purchasing a few layers staked on top of each other, from different reinsurers.
-the top llayer may be unlimited.
-

Question 19

What is indexed limits?

Answer 19

• where inflation has a significant effect on cost of claims a stability clause may be applied to excess point.
• this provides for the indexation o the monetary limit in line with a specified inflation index.
• this is done to achieve a more equitable division between the reinsurer and the cedant of inflationary element of claim.
• the cedant will normally be required to pay an extra premium to compensate the reinsurer for the added risk if the excess point is not indexed.
• the upper limit may similarly be indexed to preserve the original real value of the cover.

Question 20

Commission on non-proportional

Answer 20

• return commission and override commission are not relevant for excess of loss.
• however profit commission is possible.
• brokerage is likely to be paid.

Question 21

Risk excess of loss

Answer 21

• this is type of excess of loss reinsurance that relates to individual losses.
• it affects only one insured risk at any one time.
• this is sometimes found under PMI portfolios where individual large losses sometimes occur.

Question 22

Aggregate excess of loss

Answer 22

• is an extension of risk excess of loss
• however rather than operating on large individual claims, the excess point and the upper limit apply to the aggregation of multiple claims.
• sometimes a particular class of business may give rise to variations in level of total claims payable in any one year.
• this may be due to large individual losses or a large number of smaller claims.
• an insurer may therefore wish to protect the class of business by a form of reinsurance that extends cover to all events during the year.
• stop loss protects the insurer by covering the total losses for the whole account., above an agreed limit, for a 12 month period.
• The whole account can comprise of one or several classes of insurance.
• stop loss are often expressed as a percentage of the cedant’s premium income.
• eg given excess point of 110% claims ratio up to an upper limit of 140%.

Question 23

What is the main difference between aggregate excess loss and stop loss?

Answer 23

• aggregate XL covers specified perils
• whereas stop loss covers all perils.
• in healthcare aggregate excess of loss and stop loss cover are considered the same because healthcare covers only one peril ie morbidity.

Question 24

Catastrophe excess of loss

Answer 24

• cover may be defined in terms of a common cause or peril over a particular period of time.
• examples of above might be:
• a chemical explosion giving rise to a number of claims which together might exceed an insurer’s retention, though individually they would not.
• a pandemic that might result in a considerable increase in the number of claims.
• event-type cover is generally available. However, the risks associated with pandemic cover are very uncertain and so this is not normally available; at least not an affordable price.

Question 25

Purposes of non-proportional reinsurance

Answer 25

• The main purpose of any form of excess of loss reinsurance is to permit an insurer to accept risks that could lead to large claims.
• Large means large relative to insurer’s free assets or premium income.
• other purposes are to reduce the risk of insolvency from a catastrophe, a large claim or an aggregation of claims, and to stabilise the technical results of the insurer by reducing claims fluctuations.

Question 26

Advantages of excess of loss to an insurer

Answer 26

• allows insurer to take on risks that could produce very large claims
• protects company against individuals large claims
• helps stabilise profits from year to year
• helps make more efficient use of capital by reducing the variance of the claim payments.

Question 27

disadvantages of excess of loss

Answer 27

• insurer will pay a premium to the reinsurer which, in the long run, will be greater than expected recoveries under the treaty.
• premium load will load expected claims for expenses, profit and contingency margins.
• from time to time, XL premiums may e considerably greater than the pure risk premium for cover.
• after reinsurers have had a few years of poor results, the supply of reinsurance falls and premiums rise as reinsurers attempt to restore their solvency positions.

Question 28

Features of financial reinsurers

Answer 28

• Financial reinsurance can help cedant to relieve part of its new business financing requirement.
• means of improving solvency position of insurer.
• it can be structured like a loan, receiving either a lump sum or reinsurance commissions with repayments incorporated into reinsurance premium or paid out of future profits.
• Financial reinsurance typically involves very little transfer of insurance risk.
• Financial reinsurance is effective only under supervisory regimes where credit cannot be taken for the insurer’s future profits and/or where a realistic liability does not have to be held in respect of loan repayments.

Question 29

FinRe: Risk premium reinsurance

Answer 29

• risk premium reinsurance method is associated with financing agreement whereby the reinsurer relieves the cedant of part of its new business financing requirement.
• its like a loan from reinsurer to cedant presented as reinsurance commission.
• repayments are spread over a number of years, are added to the reinsurance premiums.
• reinsurer takes into account the lapse experience when determining the loan repayments.

Question 30

FinRe: Contingent loan

Answer 30

• makes use of future profits contained in a block of new or existing business.
• reinsurer provides a loan to the insurer but as repayment of the loan is contingent upon the stream of future profits being generated by the business.
• the cedant may not need a reserve for the repayment within its supervisory returns.
• may be used where a direct writing company needs to improve its solvency position eg after a large drop in asset values or where it wishes to fund a new project for eg setting up a new subsidiary overseas.

Question 31

Determining the retention level

Answer 31

• Retention level may be determined by estimating the distribution of claim costs under various retentions, and then picking one that gives a suitably low probability of adverse net experience.
• the insurer should judge how low a probability should be aimed at.
• this could be based on insolvency probabilities using a stochastic model.
• The model can be used to find the mix of reinsurance and of holding a risk experience fluctuation reserve that minimises the cost of the claim fluctuation protection.

Question 32

A company will go for more reinsurance if:

Answer 32

• it is less certain about future claims experience
• the lower the acceptable probability of future insolvency is
• the greater the variance of the benefit level distribution.

Question 33

Steps of procedure for determining suitable retention levels:

Answer 33

-decide on some criterion for claim volatility beyond which company cannot go.
-for differing retention levels model the function {total claims net of RI} less {total risk premiums less RI risk premiums}. done stochastically.
-look at the results to choose the retention level satisfying the criterion.
-we could use this retention level or assess how it can be achieved more cheaply.
-we could do this by assuming there is a cost of holding a risk experience fluctuation reserve of M.: M(j-i)
where j - is expected rate of return on company’s capital &
i is expected rate of return from assets that will back th reserve.

-we should model distribution of X where
X = {total claims net of RI} less {total risk premiums less RI risk premiums} - M
-compare the protection offered under this new construction against that offered by previous arrangement. recalculate P[ X > 250m]. if less than 1% then this cover is cheaper.
-try this for different level of reinsurance.

Question 34

Describe the previous approach in two steps

Answer 34

• another possible approach is to consider the total of:
  a) the cost of financing an appropriate risk experience fluctuation reserve and
  b) the cost of obtaining reinsurance - the reinsurer naturally incorporates an expense and profit loading in it reinsurance terms, and the cedant incurs administrative expenses.

-as retention level increases, a will increase and b will decrease, and a retention level can be adopted such that a+ b is minimised.