Chapter 44: Risk Management Tools (1) Flashcards
What are the benefits of reinsurance?
- Reduce claims volatility
- Smooth profits
- Reduce capital requirements
- Increase capacity to write business and more diversification
- Reduce risks
- Business
- Operational
- Limit large losses
- Single event
- Single claim
- Cumulative events
- Concentration of risks -> geographically or portfolio
- > increases solvency and capacity to write business
- Access to reinsurance expertise
- Cost saving (tax)
- Easier to plan
What factors must you consider when choosing reinsurance?
- Value for money
- Stable profits
- Management and shareholder’s attitude to risk
- Company
- Size and structure
- Amount of business written
- Type
- Experience
- Free assets
- Security of reinsurance
- Terms of reinsurance
- Underwriting cycle
- Mary’s = Market reputation
- Technical assistance needed
- Accumulation of risks
- Statutory solvency
What can reinsurers help with?
- Risk cover
- Expertise
- Product design
- Pricing advice and the actual service
- Underwriting advice and the actual service
- Provide data
- Information on competitors and their prices
- Admin systems
- Computer power
- Claims controls
- Provisioning
- Contract wording
- Marketing and distribution channels - New business strain and solvency
- Through FinRe
- Increase solvency, and tax position, reduce capital requirement, help with liquidity
- E.g. contingent loans or financial quota share arrangements -> financing commission attractive
List the main types of reinsurance.
Proportional - Quota share - Surplus Non-proportional - Risk XL - Aggregate XL - Catastrophe XL
Discuss quota share.
-> Reinsurance is a fixed % of each risk \+ Simple admin \+ Spread risks \+ Write more business \+ Encourage reciprocal business -> company reinsures part of business in exchange for accepting part of the reinsurer’s business. - Same percentage regardless of size - Same percentage regardless of volatility - No cap on claims
Discuss surplus as a proportional reinsurance tool.
- > The treaty specified a RL and EML
- > Company retains RL/EML
\+ Spread risk \+ Accept larger risks \+ Flexibility \+ Fine tunes experience - Complex admin
What are the advantages and disadvantages of non-proportional reinsurance?
\+ Caps losses \+ Take larger risks \+ Stabilise profits \+ Reduce variance of claim amounts \+ Efficient use of capital \+ Protect cedant against large losses
- Premiums over LT > recoveries
- premiums > pure risk premium
What factors will be negotiated in the reinsurance treaty?
- Type of reinsurance
- Start and end dates
- Retention limits, upper and lower limits
- Perils included
- Classes of business included
- Territorial scope
- Arbitration clause
- Stability clauses
- Other data requirements of parties
- When and how premiums will be paid
- When and how claims will be paid
- Cancellation policy
- Commission arrangements
List the ART methods.
- Integrated risk covers
- Securitisation
- Post-loss funding
- Insurance derivatives
- Swaps
What are the key features of ARTs?
- Tailor made to suit needs
- Multi-year, multi-line products
- Diversifies across portfolio and over time
- Non-insurers take on the risk
- Not indemnity cover
What is a captive insurer?
It is when a parent company creates a licensed insurance company to ensure it’s own business. It is a form of self-insurance.
How do discounted covers work?
- The insurer needs to show the liability undiscounted
- But the reinsurer can show it discounted
- So reinsurer offers reinsurance on attractive terms
What markets offer ARTs?
- Banking markets
- Capital markets
Why do insurance companies use ARTs?
- Tax
- Security
- Management of solvency margin
- Stable results
- Cost availability
- Cheaper
- Effective risk management
- Source of capital
- Diversification
- Expand range of insurable risks
- Increase capacities
What are the structural inefficiencies of traditional insurance?
- Moral hazard
- Anti-selection since good risks subsidise bad risks
- Limited options
- Credit risk for p/h
What is integrated risk cover?
- Arrangement between insurers and reinsurers
- Risks are aggregated and then sold in one block
- There is an excess point and upper limit
- Multi-year and multi-line
- Financial, credit and market risks
What is integrated risk cover used for?
- Avoid buying excess cover
- Lock into attractive terms
- Smoothing profits
- Reduce need for capital
What are the advantages of integrated risk cover?
+ Premium savings
+ Stability of results
+ Diversification over time and portfolio
+ Reduce need for capital
What are the disadvantages of integrated risk cover?
- Credit Risk
- Availability
- Expensive since it is tailor made
- Difficult to structure
In ART context, what is securitisation?
- Risk is transferred to the capital and banking markets
- Risk is converted into a financial security
- Used to manage catastrophe risk
- > Buy a bond, but repayment is contingent on a risk event not happening.
- > Interest may be paid regularly or only at the end
E.g. a catastrophe bond
What is the role of the Special Purpose Vehicle in securitisation?
- Assurance
- Security and protection
- The capital sits in it
What is post loss funding or contingent capital?
- Guaranteed funding if the risk event occurs
- Pay a commitment fee
- Get a ‘loan/equity’ on pre-arranged terms
What is insurance derivatives?
- there is a wide range of possibilities
- Mostly OTC, but exchange-traded doe exist
- Design according to business needs
E.g. catastrophe or weather options
Derivatives = options, warrants, swaps, futures, forwards
How do swaps work in an ART context?
- > Organisations can swap matched and negatively correlated packages of risks
- > Risks can be uncorrelated too
- > Need a unit of trading
+Diversification
