Chapter 3 - Reinsurance

Question 1

The four reasons why insurers buy reinsurance

Answer 1

1. Risk transfer
2. Peace of mind
3. Balancing peaks and troughs - some classes of business may be not profitable every year
4. Releasing capacity

Question 2

Three reasons why firms sell reinsurance

Answer 2

1. Accessing business not otherwise available - local insurer seeks reinsurance in international market as they don’t have capacity for the whole risk.
2. Becoming involved in a class of business on trial basis - safer way to try out new class of business
3. Pure business preference

Question 3

What percentage of business written in Lloyd’s is reinsurance?

Answer 3

31%

LM has reputation for having capacity

Question 4

What is retention/retained line?

Answer 4

Amount of original risk the insurer is retaining.

Maximum size important when working out how much reinsurance needed.

Question 5

What are the three types of claim pay out decisions? (Who decides on claims, reinsurer or original insurer)

Answer 5

1. Full follow clause - Insurer makes all claims decisions
2. Claims co-op clause - Original insurer has to advise reinsurer of loss and keep updated
3. Claims control clause - Reinsurer has full decision making control

Question 6

Cede
Cedant
Cession

Retrocedant
Retrocession
Retrocessionaire

Answer 6

Cede - Share risk with reinsurer
Cedant - Original insurer
Cession - Share of risk passed on

Retrocedant - Reinsurer obtaining reinsurance for itself
Retrocession - Cession where Reinsurer ceding to another
Retrocessionaire - Reinsurer accepting reinsurance from another reinsurer

Question 7

Collecting note

Answer 7

Document used to present claim to reinsurers for excess of loss reinsurance

Question 8

Facultative reinsurance definition

Answer 8

Reinsurance purchased for individual risk.

Question 9

Non proportional reinsurance

Answer 9

Premium and claims don’t have direct correlation
More in line with direct insurance
Claims dealt with on financial rather than shared basis
Eg. Excess of loss, Stop loss

Question 10

Proportional reinsurance

Answer 10

Premium and claims shared between insurer and reinsurer
No financial limitations
Eg. Quota share, surplus treaty reinsurance

Question 11

Treaty reinsurance

Answer 11

Purchased to cover wider portfolio of risks or whole book of business

Question 12

Fac reinsurance

Answer 12

Protects one individual risk only

• Reinsurance protecting account may have restrictions. Insurer may purchase Fac if a risk falls outside group definition.
• only responds to one risk
• insurer may have written unusual risk and Fac is only reinsurance which will cover it
• Time consuming and expensive administratively

Question 13

Fac obligatory reinsurance

Answer 13

Insurer agrees with reinsurer
For all risks written within pre-agreed criteria
Insurer has choice to cede risks to reinsurer
If it decides to cede, reinsurer has obligation to accept.
Insurer could potentially keep good risks to itself (anti-selection)
Operates best when trust each other

Question 14

Excess of Loss reinsurance

XL

Answer 14

• Non-proportional (no concept of sharing premium in proportions)
• Cover bought in layers to build reinsurance program
• Insurer considers potential claim size to decide how many layers needed to protect itself.
• Reinsurance starts from 0 at bottom
• Each layer is a policy limit and will respond depending on size of claim. Lower layers (working layers) more likely to have claims than catastrophe layers and so will charge more
• might reinstate to bring layers back to life if total amount reached but charge for this

Question 15

Claims under XL

Answer 15

XL can be purchased as Fac but tends not to be. Reinsurance contracts usually cover more than one risk and group them:

• single classes of business
• single risk
• all marine/all non-marine
• whole account

Insured considers if claims can be grouped together and presents to reinsurers on collecting note.

Question 16

Stop Loss Reinsurance

Answer 16

Variation on XL policy - layers used but linked to insurers combined ratio.

Combined ratio = percentage of premium represented by claims and operating costs.

If combined ratio is less than 100 insurer is in profit.

Eg. £1m premium.
£800,000 Claims and operating costs.
Combined ratio = 80%

Stop Loss cover bought to protect in event of loss. Provides layer of reinsurance protection. Triggered when insurers combined ratio exceeds a stated point.

Question 17

Proportional reinsurance’s

Answer 17

Clear relationship between premium original insurer receives and amount passed to reinsurers.

Two standard contracts:

• Quota share treaty
• Surplus treaty/surplus line treaty

Question 18

Quota Share Treaty

Answer 18

Set up between insurer and reinsurer at start of year.
- for every risk insurer accepts it will cede it to the treaty and pay agreed proportion to reinsurer
- insurer will retain a percentage of the risk and can transfer rest to reinsurer
Eg. Retains 70%
Accepts 10% line on a risk
Can transfer 30% of the 10% to reinsurer
(This is a 30% quota share)
Reinsurer receives 30% premium and pays 30% claims

Question 19

Surplus treaty/Surplus line treaty

Answer 19

Original insurer buys reinsurance in ‘lines’

Each UW has a ‘maximum retained line’
Insurer controls how large a share of any risk it can accept.
For a good risk, a larger than permitted share might make good business sense. This reinsurance allows UWs permitted line to be increased in multipliers of the original line.

If UW writes risks eligible for cession to this treaty, they have to share premium with reinsurers in proportions

Question 20

TRIA

Answer 20

Terrorism Risk Insurance Act

• Government based reinsurance programme
• Terrorism related reinsurance cover for commercial market, property
• If loss occurs on commercial market claims can be made on the US government scheme.

UK: Pool Re
France: Gareat
Australia: ARPC

Question 21

Reinsurance programme construction

Answer 21

Ideal: gives not too little or too much reinsurance
Basic principles:
1. Whether any risks unusual enough not to fit proportional or non-proportional treaty contracts (Fac)
2. Individual classes of business and reinsurance for all risks that fall into those classes.
Proportional classes considered first, then non.
3. XL protection for all marine classes together / all non marine classes together. Specific risk excess.
4. XL protection for whole account
5. Catastrophe XL protection for whole account