Chapter 5: Reinsurance products - background

Question 1

Define Reinsurance

Answer 1

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).

Question 2

Define retrocession

Answer 2

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).

Question 3

Define “cede”

Answer 3

“pass on” or “give away”

Question 4

Define facultative

Answer 4

“individual”, as in an individually negotiated arrangement

Question 5

Define treaty

Answer 5

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

Question 6

Define “direct writer”

Answer 6

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.

Question 7

Retrocedant

Answer 7

The ceding reinsurer in a retrocession.

Question 8

The role of a reinsurance broker

Answer 8

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

Question 9

8 Reasons for purchasing reinsurance

Answer 9

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.

Question 10

5 Factors affecting an insurer’s appetite to limit risk

Answer 10

• 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.

Question 11

Why might reinsurers knowingly write loss-making business?

Answer 11

• 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.

Question 12

Solvency margin

Answer 12

The excess of the value of the assets over the value of the liabilities.

Question 13

How might reinsurance decrease the value of the liabilities?

Answer 13

By reinsuring the business, the insurer is reducing the value of its liabilities (as some of its liabilities are ceded to the reinsurer).

Question 14

Typical basis for retrocession protections

Answer 14

An excess of loss basis

Question 15

2 Ways of writing reinsurance business

Answer 15

• 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)

Question 16

Main advantage of facultative reinsurance

Answer 16

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.

Question 17

4 Main disadvantages to the insurer of facultative reinsurance

Answer 17

• 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.

Question 18

Obligatory / obligatory basis

Answer 18

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.

Question 19

Facultative / obligatory basis

Answer 19

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.

Question 20

3 features of treaty reinsurance

Answer 20

• Efficient (admin is quicker and cheaper)
• Certain (cedant knows available re)
• Inflexible

Question 21

3 KEY terms in a reinsurance treaty

Answer 21

• what is and what is not covered
• the financial arrangements (ie premiums, commissions, timing of payments)
• the obligations of both parties

Question 22

List 20 items that might be included in a reinsurance treaty

Answer 22

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

Question 23

2 Main methods of reinsurance

Answer 23

• Proportional reinsurance

- Non-proportional reinsurance

Question 24

Proportional reinsurance

Answer 24

The reinsurer covers an agreed proportion of each risk and the reinsurance premium is proportional to this risk ceded.

Question 25

2 Types of Proportional reinsurance

Answer 25

Quota Share - The proportion is constant for all risks covered
Surplus - The proportion is at the discretion of the cedant

Question 26

Non-proportional reinsurance

Answer 26

The reinsurer covers the loss suffered by the insurer that exceeds a certain amount (the excess point)

Question 27

Excess of loss reinsurer

Answer 27

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.

1. Risk excess of loss reinsurance:

Excess of loss reinsurance that relates to individual losses affecting only one insured risk at any one time.

2. 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).

Question 28

3 Types of non-proportional reinsurance

Answer 28

• Excess of loss
• Stop loss
• Aggregate excess of loss
  reinsurance

Question 29

3 Different Reinsurance bases

Answer 29

• Policies-incepting basis
• Losses-occurring basis
• Claims-made basis

Question 30

Policies-incepting basis

Answer 30

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)

Question 31

Losses-occurring basis

Answer 31

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)

Question 32

Claims-made basis

Answer 32

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)