Chapter 5: Reinsurance products - background Flashcards
Define Reinsurance
Reinsurance is a means by which an insurance company can protect itself against the risk of losses by ceding the risk to other companies (reinsurers).
Define retrocession
Retrocession is a means by which a reinsurance company can protect itself against the risk of losses by retroceding the risk to other reinsurance companies (retrocessionaires).
Define “cede”
“pass on” or “give away”
Define facultative
“individual”, as in an individually negotiated arrangement
Define treaty
Treaty reinsurance is the reinsurance of a group of similar risks (several policies) under one reinsurance agreement.
in this arrangement, insurer is obliged to cede the risk and the reinsurer is obliged to accept, subject to conditions set out in a treaty
Define “direct writer”
The insurer with a direct contract with the insured (as opposed to a reinsurer, who has a contract with the direct writer),
also called the primary insurer or cedant.
Retrocedant
The ceding reinsurer in a retrocession.
The role of a reinsurance broker
The reinsurance intermediary sits between an insurer and its reinsurer.
Brokers use their specialist knowledge and their contracts to get the best reinsurance price.
In addition to placing reinsurance, brokers have specialist areas of expertise such as:
- actuarial and catastrophe modelling
- claims handling
- technical reinsurance accounting
- market security
- rating advisory
- capital markets and advisory
8 Reasons for purchasing reinsurance
SHORT:
- Limitation of exposure to risk or spreading of risk
- avoidance of large single losses
- smoothing of results
- increasing profitability
- improving solvency margin
- increasing capacity to accept risk
- financial assistance
- availability of expertise.
LONG (12M - CH 5 PRACTICE Q5.1)
1. Reinsurance may be used by an insurer:
to limit its exposure to risk (or spread risk) in respect of:
#single risks
#aggregations of single risks multi-class losses
#accumulations
2. to obtain additional business through reciprocity
3. to avoid single large losses in respect of:
#single large claims #catastrophes
4. to smooth its results
5. to increase profitability by:
#increasing the stability of results (and so the ability to plan)
#taking advantage of cheap reinsurance
6. to enable it to declare profits from outstanding liabilities more quickly
7. to improve the solvency margin and hence reduce the risk of insolvency
8. to increase the capacity to accept risk, either:
#singly, ie to enable it to write larger risks,
#or cumulatively, ie to enable it to write more business
9. to obtain financial assistance to help with:
#new business strain
#bolstering free assets
#a merger / acquisition
#any other short-term cashflow needs
10. to get technical assistance on:
#new risks
#unusual risks
#risks in new territories
11. as a supervisory condition.
5 Factors affecting an insurer’s appetite to limit risk
- the size of the insurer
(Larger insurance companies will generally have larger free reserves and a relatively more diversified portfolio of business and hence will be less exposed to random fluctuation of claims experience. As a result they may require less reinsurance.) - the insurer’s experience in the marketplace
(If a company has a lot of experience in the marketplace then it will hopefully have sufficient credible data to be able to make an objective estimate of the expected claims outgo when setting premium rates and reserves. It should also be able to set sensible policy conditions to help control the risk. As a result the company will be less likely to use reinsurance to help with these areas as well as generally limit the claims exposure.) - the insurer’s available free assets
- the size of the insurer’s portfolio
- the range within which the business outcome (or profit) can be forecast with confidence.
Why might reinsurers knowingly write loss-making business?
- If it expects to obtain compensating higher future profits or profits from other connected business.
- At the bottom of the (re)insurance cycle, premiums across the market will be low, and so in order to retain market share, reinsurance companies will be forced into accepting loss-making business.
Solvency margin
The excess of the value of the assets over the value of the liabilities.
How might reinsurance decrease the value of the liabilities?
By reinsuring the business, the insurer is reducing the value of its liabilities (as some of its liabilities are ceded to the reinsurer).
Typical basis for retrocession protections
An excess of loss basis
2 Ways of writing reinsurance business
- Facultatively (arranged individually for each risk requiring reinsurance)
- By treaty (whereby groups of similar risks are reinsured on pre-arranged terms under one reinsurance arrangement)
Main advantage of facultative reinsurance
The flexibility that both parties have within the process.
The direct writer can approach several reinsurers in search of the best terms for each risk individually.
Similarly, the reinsurer is under no obligation to accept risks.
4 Main disadvantages to the insurer of facultative reinsurance
- it is a time-consuming and costly exercise to place such risks
- there is no certainty that the required cover will be available when needed
- even if the cover is available, the price and terms may be unacceptable
- the primary insurer may be unable to accept a large risk until it has been able to fund the required reinsurance cover.
Obligatory / obligatory basis
Reinsurance basis under which the insurer is obliged to pass the risk on and the reinsurer is obliged to accept it.
It is common in quota share treaties.
Facultative / obligatory basis
Reinsurance basis under which the insurer has the choice of whether to include it in the treaty, but the reinsurer is obliged to accept all the requested risks.
It is common with reciprocal arrangements, whereby each insurer reinsures a block of business with each other.
3 features of treaty reinsurance
- Efficient (admin is quicker and cheaper)
- Certain (cedant knows available re)
- Inflexible
3 KEY terms in a reinsurance treaty
- what is and what is not covered
- the financial arrangements (ie premiums, commissions, timing of payments)
- the obligations of both parties
List 20 items that might be included in a reinsurance treaty
COVER
- Classes of business covered
- Period of cover
- Territorial limits
- Exclusions to the cover
- Retention of the ceding company
- Cover granted automatically by the reinsurer
ADMIN
- Names of the parties to the treaty
- Access by the reinsurer to risk details
- Definition of loss occurrence
- Terms for termination of the treaty
- An arbitration clause, in case of disagreements arising.
TECHNICALITIES
- Reinstatement provisions
- A stability clause
- A currency clause
- Sunset clause
PREMIUMS
- Premium rate
- Premium payment arrangements
COMMISSION
- Ceding commissions payable
- Profit commission payable to the direct writer and the method of calculation
- Commissions payable to reinsurance brokers
CLAIMS
- Claim notification arrangements
- Claim repayment arrangements
- Rendering and settlement of accounts
2 Main methods of reinsurance
- Proportional reinsurance
- Non-proportional reinsurance
Proportional reinsurance
The reinsurer covers an agreed proportion of each risk and the reinsurance premium is proportional to this risk ceded.
2 Types of Proportional reinsurance
Quota Share - The proportion is constant for all risks covered
Surplus - The proportion is at the discretion of the cedant
Non-proportional reinsurance
The reinsurer covers the loss suffered by the insurer that exceeds a certain amount (the excess point)
Excess of loss reinsurer
The cost to an insurer of a large claim is capped with the liability above a certain level being passed to a reinsurer.
A form of reinsurance whereby the reinsurer indemnifies the cedant for the amount of a loss above a stated excess point, usually up to an upper limit. The excess point and upper limit may be fixed, or indexed as specified in a stability clause. Usually this type of reinsurance relates to individual losses, but it can be a form of aggregate excess of loss reinsurance covering the total of all losses in a period and subject to a total aggregate claim limit.
- Risk excess of loss reinsurance:
Excess of loss reinsurance that relates to individual losses affecting only one insured risk at any one time.
- Aggregate excess of loss reinsurance:
A form of excess of loss reinsurance that covers the aggregate of losses, above an excess point and subject to an upper limit over a defined period, usually one year. This can be an aggregation of losses from a single insured event, or a defined peril (or perils).
3 Types of non-proportional reinsurance
- Excess of loss
- Stop loss
- Aggregate excess of loss
reinsurance
3 Different Reinsurance bases
- Policies-incepting basis
- Losses-occurring basis
- Claims-made basis
Policies-incepting basis
The reinsurer provides cover to the direct writer for claims arising from all policies written under the treaty over a period, ie corresponding to an “underwriting-period” cohort.
(common to all proportional types of reinsurance)
Losses-occurring basis
Provides the direct writer with cover for any claim incident(s) under the treaty occurring within a defined period (corresponding to an “accident-period” cohort.
(common to all non-proportional types of reinsurance)
Claims-made basis
Provides the direct writer with cover for any claims under the treaty reported to the direct writer within a defined period.
(common to all non-proportional types of reinsurance)
