Chapter 30-Reinsurance (2) 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)
What is the benefits or reducing new business strain? (1)
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
Reducing new business strain has the benefit that
more new business can be written for the same amount of capital
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 (not true)?
financial reinsurance (if effective under regulatory regime)
Explain the circumstances in which an insurer may benefit from the technical assistance a reinsurer can provide (4)
What form of reinsurance best allows insurer to benefit from technical assistance from the reinsurer? (1)
Reinsurer may have considerable degree of expertise on underwriting, product design, pricing and systems design
This is particularly important when cedant starts a new line of business, as it can receive tehcnical assistance from reinsurer until it has built up its own expertise
Likewise for recently established insurance company.
Reinsurer can give support for existing lines in areas such as underwriting, eg treatment of unusual cases.
Best form of reinsurance to benefit insurer regarding technical assistance is
original terms reinsurance (with high quota share reinsured)
Discuss how reinsurance may help insurer’s in terms of cost reduction
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
List considerations that an insurer will take into account in deciding on
Whether to use reinsurance
Types of reinsurance to use
Amount of reinsurance to use
Reasons for acquiring reinsurance
Type of business being reinsurance
Cost of reinsurance
Retention limits - ie maximum amount of risk retained by cedant on any individual risk
Legal conditions applying
Types of reinsurance available and way in which amount reinsured is specified
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?
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
cost of financing an appropriate mortality fluctuation reserve, and
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.
When an insurer is deciding on reinsurance, describe how factors relating to counterparty risk may arise (2)
How might an insurer reduce its counterparty risk? (1)
Counterparty risk arises as follows
Cedant retains liability to the policyholder for the benefits even if the reinsurer becomes insolvent and can not meet claim payments as they become due. Amount of exposure known as credit risk.
The greater the counterpaty risk, the less valuable the value of reinsurance
An insurer may reduce its counterparty risk by:
re-insuring with multiple reinsurers, thereby diversifying its risk
