Chapter 5: Reinsurance products - background Flashcards
Reinsurance
A form of insurance. A means by which an insurance company obtains protection against the risk of losses from other insurance companies (reinsurers).
Retrocession
Reinsurance of reinsurance.
Reinsurance purchased by a reinsurer in relation to its inwards reinsurance liabilities.
A means by which a reinsurance company can protect itself against the risk of losses by retroceding the risk to other reinsurance companies (retrocessionaires)
“Cede”
“pass on” or “give away”
Facultative
“individual” as in an individually negotiated arrangement
Treaty
Covers a group of policies - reinsurance that the reinsurer is obliged to accept, subject to the conditions set out in the treaty
Direct writer
The insurer with direct contact with the insured (as opposed to the reinsurer, who has a contract with the direct writer), also called the primary insurer or cedant
Retrocedant and retrocessionaire
A ceding reinsurer in a retrocession is called the retrocedant and the assuming reinsurer is called the retrocessionaire.
Captive insurers
An insurer who is wholly owned by an industrial or commercial enterprise and set up with the primary purpose of insuring the parent company or associated group companies, and retaining premiums and risk within the enterprise.
Role of a reinsurance broker
The reinsurance intermediary sits between the insurer and its insurer. Brokers use their specialist knowledge of the industry and their customer and their reinsurance contacts to get the best reinsurance price.
In addition to placing reinsurance, brokers have other specialist areas of expertise such as:
- actuarial and catastrophe modelling
- claims handling
- technical reinsurance accounting
- market security
- rating advisory
- capital markets and advisory
Reasons for purchasing reinsurance
- limitations 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 assitance
- availability of expertise
Factors affecting an insurer’s appetite to limit risk
- size of the insurer
- insurer’s experience in the market place
- insurer’s available free assets
- size of the insurer’s portfolio
- the range within which the business outcome (or profit) can be forecast with confidence
When 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.
- May write some products as a loss leader knowing that it will also be able to sell other more profitable business on the back of the initial sales
Solvency margin
The excess of the value of the assets over the value of the liabilities
How can the solvency margin of an insurer be improved?
- increase the value of the assets
- decrease the value of the liabilities
- decrease the regulatory minimum difference between the assets and liabilities
How might reinsurance decrease the value of the liabilities?
The value of the liabilities is reduced because some of the liabilities are ceded to the reinsurer.
How does reinsurance decrease the regulatory minimum difference?
Required solvency level is often calculated with reference to the proportion of business reinsured. Therefore, more reinsurance means a lower solvency requirement and therefore a stronger solvency position.
Reduction may be subject to a limit called the Required Minimum Margin (RMM)
How does reinsurance offer financial assistance?
- new business strain/financing projects
- bolstering free assets
- merger/acquisition
Reasons for retrocession
Most relevant reasons:
- limitation of exposure to risk
- increasing capacity to accept risk
Since reinsurers tend to be larger than insurers:
- less need to avoid large single losses completely
- business is likely more diversified = smoother results
- solvency margin may already be adequate - solvency requirement may not be as onerous
- less likely to need financial assistance
- likely to have a fair amount of their own expertise
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)
Advantages of facultative reinsurance
Flexibility that both parties have within the process.
- direct writer can approach several reinsurers in search of the best terms for each risk individually
- reinsurer is under no obligation to accept the risk
Disadvantages to the insurer of facultative reinsurance
- it’s 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 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 find the required reinsurance cover. This means the insurer can’t accept business automatically when it’s offered and consequently its standing in the market may be reduced
Obligatory/obligatory basis
Treaties that are arranged so that the ceding insurer is obliged under the terms of the treaty to pass on some of the risk in a defined manner and the reinsurer is obliged to accept it. Common in quota share treaties.
Facultative/obligatory basis
For each risk, the insurer has a choice of whether to include it in the treaty, but the reinsurer is obliged to accept all the requested risks. Normally associated with reciprocal arrangements, whereby each insurer reinsures a block of business with the other.
FEatures of treaty reinsurance
- efficient: risks are reinsured automatically. This is administrativeky quicker and cheaper
- certain: the direct writer knows that reinsurance is available (if risks fall within limits of the treaty) and on what terms
- inflexible: once the treaty is set up, then both parties must operate within the terms of the treaty.
