Chapter 44: Risk management tools (1) Flashcards
Main benefits of reinsurance
Reduction in claims VOLATILITY and hence:
- smoother profits
- reduced capital requirements
- and increased capacity to write more business and achieve diversification
the LIMITATION of LARGE LOSSES arising from:
- a single claim on a single risk
- a single event
- cumulative events
- geographical and portfolio concentrations of risk
And hence:
- reduced risk of insolvency
- increased capacity to write larger risks.
Access to EXPERTISE of the reinsurer
2 Main types of reinsurance
- proportional
- non-proportional
Proportional reinsurance
The reinsurer covers an agreed proportion of each risk.
This proportion may:
- be constant for all risks covered (ie QUOTA SHARE REINSURANCE)
- vary by risk covered (ie SURPLUS REINSURANCE)
3 Main uses of Quota share
Quota share is widely used by ceding providers to:
- spread risk
- write larger portfolios of risk
- encourage reciprocal business
Disadvantages of quota share (3)
- it cedes the same proportion of low variance and high variance risks
- it cedes the same proportion of each risk, irrespective of size
- it passes a share of any profit to the reinsurer
Surplus treaty
Specifies a retention limit and a maximum level of cover available from the reinsurer.
The proportion of risk ceded is then used in the same way as for quota share.
Excess of loss reinsurance
Non-proportional cover where the cost to a ceding company of such large claims is capped with the liability above a certain level being passed to a reinsurer.
However, if the claim amount exceeds the upper limit of the reinsurance, the excess will revert back to the ceding company.
4 different forms of non-proportional (excess of loss, XL) reinsurance:
- risk XL
- aggregate XL (including stop loss)
- catastrophe XL
- stop loss
Risk XL
relates to individual losses.
It affects only one insured risk at any one time.
Aggregate XL
covers the AGGREGATE of losses,
… above an EXCESS point
…. subject to an UPPER LIMIT,
sustained from DEFINED PERIL (or perils)
… over a DEFINED PERIOD, usually one year.
Stop loss
A form of aggregate XL that provides cover based on TOTAL CLAIMS, from ALL PERILS on a ceding company’s WHOLE ACCOUNT.
Catastrophe XL
pays out if a “catastrophe”, as defined in the reinsurance contract, occurs.
There is no standard definition of what constitutes a catastrophe.
3 Main uses of excess of loss reinsurance
- to permit a ceding provider to accept risks that could lead to larger claims
- to stabilise the technical results of the ceding provider by reducing claims fluctuations
- to reduce the risk of insolvency from large losses
- to make more efficient use of capital by reducing the variance of the claim payments (and thus the capital requirement)
Alternative risk transfer
An alternative to traditional reinsurance.
It involves tailor-made solutions for risks that the conventional reinsurance market would regard as uninsurable or does not have the capacity to absorb.
5 Examples of alternative risk transfer contracts
- integrated risk covers
- securitisation (catastrophe bonds)
- post loss funding
- insurance derivatives
- swapts
8 Reasons why providers take out ART (alternative risk transfer) contracts
- provision of cover that might otherwise be unavailable
- stabilisation of results
- cheaper cover
- tax advantages
- greater security of payment
- management of solvency margins
- more effective provision of risk management
- as a source of capital.
How is technical assistance (from a reinsurer) in itself a means of risk management?
- it reduces business risk
- it can reduce operational risk by transferring certain activities to the reinsurer