Chapter 30 - Reinsurance Flashcards
List various reasons why insurer’s may use reinsurance (12)
Reinsurance mainly allows cedant to transfer risks from its balance sheet to reinsuerer’s balance sheet and achieve the following goals
- increase (raise)
+capital (where permitted)
+profits or risk adjusted return on capital - reduce
+insurance parameter risk that claims might differ to expected
+claim payout fluctuation by reducing cedant’s claim cost variance
+costs (cost reduction)
+new business strain
+overall capital requirements - limit
+amount paid on any particular claim
+total claims payout - receive technical assistance
- separate out different risks from a product
- manage aggregation of risks
What is insurance parameter risk, and what form of reinsurance best transfers this this type of risk? (2)
- the risk that level of claims differ compared to what is expected
- may be caused by incorrect pricing, underwriting failures, fraudulent activities, etc
- best reinsurance for transfer this risk is through quota share reinsurance
Describe 2 factors which lead to variance of claim amounts being high relative to the mean, and what forms of reinsurance can be used for each factor?
Small number of contracts, with very high levels of cover ie concentration of risk
- Forms of reinsurance that help with this:
+either original terms reinsurance (coinsurance), or
+risk premium reinsurance, usually on an individual surplus basis
Lives insured not independent risks
- Forms of reinsurance that could help are
+excess of loss reinsurance
+catastrophe reinsurance
+stop loss reinsurance
Why would fluctuations in claim costs be undesirable for an insurer?
- may make life company insolvent
- may reduce excess of value of company’s assets over its liabilities below the level desired by the company
- may reduce rate of return on free assets below level desired by company in some years
- may cause fluctuations in shareholder dividends
Explain how reinsurance might be used to reduce new business strain? (2)
Provided it’s permitted under relevant supervisory regime, the cedant could use reinsurance to reduce financial risk associated with new business, either by:
- increasing its available capital, or
- reducing its financing requirement
Which types of reinsurance would be used for the purpose of reducing new business strain?
- original terms coinsurance usually on quota share basis
- risk premium reinsurance usually on quota basis - negotiating high initial reinsurance commission, in return for higher risk premium rates
- financial reinsurance (if effective under regulatory regime)
What form of reinsurance best allows insurer to benefit from technical assistance from the reinsurer? (1)
original terms reinsurance (with high quota share reinsured)
Discuss how reinsurance may help insurer’s in terms of cost reduction
Cost reduction benefit of reinsurance derives from reinsurer perhaps being able to price risk at lower cost than insurer due to
* different capital requirements it faces
- diversification benefits of due to reinsurer having greater spread of risks than any individual cedant
- tax differences across regions/regimes, across certain types of business
- different assessments of risks
What key questions should an insurer ask itself regarding the use of reinsurance? (3)
- whether or not to use reinsurance
- which types of reinsurance to use
- how much reinsurance to use
What kind of risks does the use of reinsurance introduce? (2)
- Legal risk: if reinsurance treaty incomplete
- Counterparty risk: risk that reinsurer defaults in event of claim
Once a suitable form of reinsurance has been chosen, the cedant needs to decide on how much risk it will retain (ie retention limit)
What factors should the insurer/cedant consider when determining its retention limit?
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- the average benefit level and the expected distribution of the benefit
- insurer’s/cedant’s insurance risk appetite
- level of company’s free assets and the importance attached to stability of its free asset ratio
- terms on which reinsurance can be obtained and dependence of such terms on retention limit
- company’s familiarity with underwriting the type of business involved
- effect on company’s regulatory capital requirements of increasing or reducing retention limit
- existence of profit-sharing arrangement in the reinsurance treaty
- the company’s retention on its other products
- the nature of any future increases in sums assured
State 3 ways in which a cedant can use stochastic simulation to determine its retention limit
Stochastic simulation - reinsurance only - Determine retention limit such that probability of loss/insolvency (ruin probability) kept below certain level
Stochastic simulation - reinsurance and fluctuation reserve
Use stochastic simulation to determine minimum total of
(1) cost of financing an appropriate mortality fluctuation reserve, and
(2) cost of obtaining reinsurance
as retention limit increases,
(1) will increase and (2) will decrease
choose retention limit that minimises total of (1) and (2)
Financial economics approach
Based on the theory of efficient investment frontiers, and looks at reinsurance as an asset class that allows the company to optimise its risk and reward trade off.
Allows identification of asset portfolios including reinsurance, which cannot be bettered in terms of either reducing risk for no reduction in return, or increasing return for no increase in risk.
how might a supervisory authority help insurers to manage counterparty risk from reinsurers
To manage insurers’ counterparty risk from reinsurance, supervisory authorities in certain countries may
- require reinsurer to collaterise/deposit back its share of the total reserve under a reinsurance contract with a cedant
When it comes to counterparty risk for reinsurance contracts, what are the benefits of direct deposits for
(a) insurer (1) and
(b) reinsurer (2)?
Benefits of deposits back
For insurer/cedant/direct write
* more profitable, allows for maximum funds (reserve) available to invest, hence can earn investment profits
For reinsurer
* e.g. on with profits business an original terms arrangement would normally leave reinsurer with significant investment risk, because it would have to match the insurer’s bonus rates on maturity, but by depositing back reserves it will avoid investment risk.
* avoid problems of investing in unfamiliar market.
