Chapter 5/6 - Reinsurance - Background & Types Flashcards
What is Reinsurance and Retrocession?
Reinsurance is a form of insurance for insurance companies against the risk of loss.
Retrocession is a form of reinsurance for reinsurers - being a very specialist area of the reinsurance market.
The reinsurer is called a retrocedant and the reinsurer in this is called a Retrocessionnaire.
Who are the main participants in the reinsurance markets? (5)
- insurers (seeking insurnace)
- Reinsurers (providing Reinsurance), they may also provide direct placements
- RI brokers (may be insurnace brokers or RI/Retrocession and other financial product broking specialists)
- fronters
- captives
What is fronting? And why may an insurer decide to ‘front’ its risks? (6)
Fronting is when an insurer, acting as a mere conduit, underwrites a risk and codes all (or nearly all) of the risk to another insurer (which is technically acting as an reinsurer).
The fronting insurer will usually get a fee (to cover its expenses and profits).
Reasons for fronting:
- obtains fees to cover expenses and make a profit
- it may wish to obtain a presence in a particular market while having limited risk there
- may benefit from a fronting arrangement with a well-known insurer and may build itself a presence in the market.
- may be able to keep a small portion of the risk (which may be profitable)
- build up expertise and knowledge in a particular industry
- may benefit from tax advantages
What is the main risk involved in fronting? And how would the insurer go about mitigating it? (3)
- there is a risk that the reinsurer is not able to pay the claims as they fall due, meaning the fronting insurer is liable to paying it.
- to limit the risk, the insurer should only go into agreements with reinsurer who have good credit ratings
- they should also require the risk-bearing party to provide some form of collateral to help mitigate the credit risk, e.g. a letter of credit - which allows the fronting insurer to draw funds from a bank in the case of a reinsurer not being able to pay a claim out.
- credit risk can further be reduced by entering into fronting arrangements with various reinsurers, I.e. diversification.
What are the main reasons to purchase reinsurance? (8)
- limitation of exposure to risk or spreading of risk (single risks, aggregations of single risks, accumulations, multi-class losses)
- avoidance of large single losses
- smoothing of results
- increasing profitability
- improving solvency margins
- increasing capacity to accept risk (singly or cumulative)
- financial assistance (new business strain, bolstering free assets, mergers/acquisitions)
- availability of expertise to develop new markets and products
What are the main 5 factors affecting an insurer’s appetite to limit risk? What other 2 factors should be considered
- size of the insurer
- the insurer’s experience in the marketplace
- the insurer’s free assets
- the size of the insurer’s portfolio or the individual line of business being protected
- the range within which the business outcome (or profit) can be forecast with confidence
- cost of RI
- availability of RI
Explain how reinsurance can help avoid large single losses.
- Reinsurance can help to recover costs of a claim above a specific threshold (I.e. an attachment).
- this is particularly helpful when there is no limit, I.e. liability policies
- small to medium-sized insurers will want to cede the top layer of their risks to reinsurer to help against large claims
How may RI used to smooth profits?
- by reinsuring large risks or accumulation of smaller risks above a certain level, the development of financial results (or profit) can be smoothed year on year, especially when the portfolio is relatively immature
- will protect the portfolio against large frequency of losses or against losses which are enormous.
- however, RI may reduce profits in the long term but will provide support for unforseen volatility
Who’s kiris favourite?
Chirrani bitches :)
How can insurers increase profits by obtaining RI? (2)
allows them to write more business (achieving diversification), better use of capital, and thus increase opportunity to make profit
How does RI help to improve the solvency position of a company? (3)
- increase the value of assets
- decrease its liabilities by ceding it away
- decreasing the regulatory minimum difference between assets and liabilities (as higher RI means lower solvency requirements - subject to a limit)
How does RI increase an insurer’s capacity to accept risk?
- writing a single risk fully may increase an insurer’s capital requirement beyond its available capital.
- Thus, RI can help cede much of the risk such that the capital required to write the risk is reduced
- allows the insurer to be more competitive in the market
How would RI provide an insurer with financial assistance? (3 ways with 2 points each)
New business strain/financing projects
- RI commission paid to insurer help insurer in initial costs (when these are higher than premium received at outset)
- commission paid by RI in the expectation of premiums less expenses and claims in the future
- proportional RI allows this reimbursement
Bolstering free assets
- commission is lent by the RI to renew a profitable set of business, in the expectation of receiving a share of future surplus of premiums less claims
- using a quota share agreement
Merger/acquisitions
- help pay for the merger or acquisition of an insurnace company
- the RI will want future surplus from a profitable class of business from the merged/acquired company
- using a quota share agreement usually
How can the expertise of an RI help insurers? (1)
- an insurer may lack knowledge in a certain product or territory
- uses RI’s expertise to develop and launch a new product/write business in new territory (RI brokers are usually used)
In what ways can RI brokers support an insurer? (3 + 5 - for monitoring stage)
- underwriting
- pricing
- claims management
During the monitoring stage, they can help with:
- pricing
- marketing
- sales
- sources of acquisition
- results
