Chapter 30: Risk transfer Flashcards
List 6 possible responses from which a stakeholder can choose when faced with a risk.
PIRATE
- Partially transfer (to another party)
- Ignore (reject then need for financial
coverage as the risk is either trivial or
largely diversified) - Reduce (frequency and/or severity)
- Accept (retain all)
- Transfer (to another party)
- Evade (avoid the risk altogether)
What factors affects the choice of mitigation approach?
FIRM
- Feasibility and cost
- Impact on frequency / severity / expected
value - Resulting secondary risks
- Mitigation required in response to
secondary risks
What factors affect the extent to which risk is transferred?
- probability of the risk occurring
- risk appetite
- existing resources to
finance the risk event if it happens - cost of transferring the risk
- willingness of a third party to accept the
risk
Outline the main benefits and costs of reinsurance.
Benefits:
- Reduction in/removal of risk.
- Reinsurer may offer competitive terms for
admin, actuarial services and advice.
Costs:
- Profit is passed from cedant to reinsurer.
- Reinsurance premium is likely to exceed
cost of benefits (in the long run) as it will
contain loadings for expenses, profit and
contingencies.
- Liability may not be fully matched by
reinsurance.
- Possible liquidity issues.
- Reinsurer may default.
- Reinsurance may not be available on
terms sought.
Outline the reasons why a provider might purchase reinsurance.
- A reduction in claims volatility and hence:
- smoother profits
- reduced capital requirements
- an increased capacity to write more
business and achieve diversification.
- The limitation of large losses arising
from:- a single claim on a singe risk
- a singe event
- cumulative events
- geographical and portfolio
concentration of risk
and hence:
- a reduced risk of insolvency
- increased capacity to write larger risks
- Access to the expertise and data of the reinsurer.
Outline the two contract variations on which reinsurance may be arranged.
- Facultative:
- Arranged on a case-by-case basis.
- This is typically done for particularly large
risks, but the insurer is not obliged to cede
these risks to the reinsurer, but neither is
the reinsurer obliged to accept them. - Treaty
- A defined GROUP of policies is covered by
the treaty.
- The reinsurer is OBLIGED to accept these
risks, subject to conditions as set out in
the treaty.
What are the key features of proportional reinsurance?
- Claims are split between the cedant and
the reinsurer in pre-defined proportions. - Does NOT CAP the claim paid to the
cedant. - Is written by TREATY.
- The two types are Quota Share and
Surplus. - Under QS, the proportion claim split is the
same for ALL risks. - Under Surplus, the proportion can vary by
risk:
% retained = (retention limit)/(estimated
maximum loss) - The reinsurer may also pay the cedant a
reinsurance commission, which can be
used to provide financial assistance.
What are the advantages and disadvantages of quota share reinsurance?
Advantages:
- QS is useful for small, new or expanding
cedants who want to diversify their risk,
write more risks or who would like
reciprocal business.
- Administration is relatively simple, since it
is written by treaty and a constant
proportion is ceded for ALL risks.
Disadvantages:
- It is inflexible in that the same proportion
of each risk is ceded, irrespective of the
size or potential volatility.
- A share of profits will also be passed to
the reinsurer.
- It does not cap large claims.
For which type of business is a fixed retention level Surplus reinsurance used?
Used for high volume, relatively homogeneous classes of business, such as life insurance or personal lines general insurance.
For which type of business is a variable retention level Surplus reinsurance used?
Used for heterogeneous classed of business, eg. commercial property and business interruption insurance.
What are the advantages and disadvantages of surplus reinsurance?
Advantages:
- The proportion of each risk passed to the
reinsurer can vary from risk to risk,
allowing the cedant the opportunity to
‘fine-tune’ its exposure. It is therefore
useful where risks are heterogeneous in
nature. - Surplus is useful for cedants who want to
diversify their risk, write more risks or who
would like to be able to write larger risks.
Disadvantages:
- Surplus treaties are more complex and
expensive relative to quote share due to
the extra administration in particular of
assessing and recording each risk
separately. Therefore, surplus is generally
more appropriate for larger, more
heterogeneous risks such as commercial
property. - It does not cap large claims.
What are the key features of non-proportional reinsurance?
- The cedant specifies a retention level. The
cedant pays the claim amount up to the
retention level; the reinsurer pays the
claim amount over the retention level. - There may be an upper limit on what the
reinsurer is prepared to pay. - There may be different layers of excess
of loss reinsurance, each with a different
reinsurer. - The cedant may be required to retain a
proportion of risk within each layer, so as
to retain an interest in the risk
(insurable interest). - The retention level / upper limit may be
indexed over time for inflation. - XOL can cap the claims paid by the
cedant. - XOL may or may not be written using a
treaty.
Define 4 different types of XOL reinsurance contracts.
- Risk XL covers losses from a single claim
from one insured risk. - Aggregate XL covers the aggregate losses
from several insured risks, sustained
from a defined peril (or perils) over a
defined period, usually one year. - Catastrophe XL is a form of aggregate XL
reinsurance that pays out if a
“catastrophe”, as defined in the
reinsurance contract, occurs. - Stop loss is a form of aggregate XL that
provides cover based on aggregate
losses, from all perils, arising on a
company’s whole account (or major class
of business) over a specified period,
usually one year.
State the 3 main uses of XOL reinsurance.
- Opportunity to write larger risks.
- Reduces risk of insolvency from a large
single claim, a aggregation of claims or a
catastrophic event. - Soothes profits by reducing claims
fluctuations.
In what situation would surplus reinsurance and risk XL reinsurance provide the same cover?
Where the risk event can only result in the payment of the full sum assured, there is no difference between risk XL and surplus.
In the case of life insurance, the estimated maximum loss will normally be equal to the claim amount, as they are fixed, known amounts.
