Chapter 6: Reinsurance products - types (F203 Appx. 4)

Question 1

Quota share

Answer 1

A proportional treaty reinsurance whereby the premiums and claims for all risks covered by the treaty are split in a fixed proportion.

Question 2

Commissions payable under a quota share agreement

Answer 2

The reinsurer pays return and override commission to the insurer.
Profit commission may also be payable.

Question 3

Return commission

Answer 3

The reinsurer will reimburse the direct writer with some percentage of the premium to help cover the acquisition expenses.

Question 4

Override Commission

Answer 4

Commission over and above the return commission, compensating the direct writer for attracting and administering the business.

Question 5

Ceding commission

Answer 5

The sum of return and override commission.

Question 6

Profit commission

Answer 6

Commission the reinsurer pays the direct writer as a reward for passing on good business.

Question 7

4 Advantages of quota share

Answer 7

• It spreads risk, increasing insurer’s capacity and encouraging reciprocal business
• Directly improves the solvency ratio (without losing market share)
• It is administratively simple
• may provide commission that helps with cashflow

Question 8

Solvency ratio

Answer 8

free assets divided by net written premiums.

Question 9

4 Disadvantages of quota share reinsurance

Answer 9

• Cedes the same proportion of low and high variance risks
• cedes the same proportion of risks, irrespective of size
• passes a share of any profit to the reinsurer
• it is unsuitable for unlimited covers

Question 10

Surplus reinsurance

Answer 10

A proportional treaty reinsurance, whereby the proportion of risk covered varies from risk to risk depending on the size and type of risk.

Question 11

Define “Estimated Maximum Loss (EML)”

Answer 11

The largest loss that is reasonably expected to arise from a single risk.

Question 12

Define Minimum retention

Answer 12

The minimum level of retention the reinsurer requires to prevent the insurer from having too little interest in the risk.
This requires the insurer to retain all risks that fall below the minimum retention.

Question 13

Define Number of lines of cover

Answer 13

This is specified in the contract and is used to calculate the maximum cover available from the reinsurer.
The maximum cover available is calculated as L multiplied by R, the Maximum retention

Question 14

What is the main difference between quota share and surplus reinsurance?

Answer 14

Whereas quota share has the same proportion of every risk ceded to the reinsurer, the proportion ceded will vary from risk to risk with surplus reinsurance.

Question 15

5 Advantages of surplus reinsurance

Answer 15

• Enables the insurer to fine-tune its experience
• Enables the insurer to write larger risks
• It is useful for those classes where a wide variation can occur in the size of risks
• It helps spread the risks
• The commission may help with cashflow

Question 16

3 Disadvantages of Surplus reinsurance

Answer 16

• It requires more complex administration
• It is unsuitable for unlimited covers (liability) and personal lines cover
• The terms may not be flexible enough to cover the largest risks

Question 17

Excess of loss reinsurance

Answer 17

The reinsurer covers the risk (or proportion thereof) between defined layers, the limits of which are often indexed for inflation (using a stability clause).

The higher layer cover(s) come into operation only when the lower layer cover has been fully used (“burnt through”).

Question 18

3 Main types of excess of loss reinsurance

Answer 18

• Risk XL
• Aggregate XL
• Catastrophe XL

Question 19

Risk XL

Answer 19

Indemnifies an insurer for the amount of an individual loss in excess of the excess point - in return for a premium.

Question 20

Aggregate XL

Answer 20

Relates to cumulative losses, where the aggregation may be by event, by peril or by class.

Question 21

Catastrophe XL

Answer 21

A form of aggregate XL covering sever losses (within the hours clause) that result from a specified event.

Question 22

4 Advantages of Excess of loss

Answer 22

• Allows the insurer to accept risks that could lead to large claims
• Reduces the risk of insolvency from a large claim, an aggregation of claims or a catastrophe
• Reduces claim fluctuations (and smoothes results)
• helps to make more efficient use of capital

Question 23

Working layer

Answer 23

A low layer above the cedant’s excess point, where moderate to heavy loss activity is expected by the cedant and reinsurer.

Question 24

Indexed limits

Answer 24

Where inflation has a significant effect on the cost o claims, a stability clause may be applied to the excess point.
This is so that the reinsurer does not receive a higher proportion of the risks purely because of inflation.

Question 25

Commission on XL Re

Answer 25

Return commission and override commission are not normally relevant (since the reinsurer charges a premium to cover the risk, and commission would effectively just lower the premium)

Profit commission is possible (in the lower layers).

Question 26

Deductibles on XL

Answer 26

It is possible the reinsurer will cover only a proportion of the claims within the layer, by applying a deductible.

The reason for this type of arrangement is to give the direct writer more incentive to keep the claim settlements low.

Question 27

Define “Hours clause”

Answer 27

A clause within a catastrophe reinsurance treaty that specifies the limited period during which claims can be aggregated for the purpose of one claim on the reinsurance contract.

Question 28

Stop loss

Answer 28

A form of XL reinsurance that indemnifies the cedant against the amount by which its losses incurred during the specific period exceed either:
- a predetermined monetary amount or
- a percentage of the company’s subject premiums (loss ratio) for the specific period.

Question 29

2 Types of financial reinsurance funding arrangements

Answer 29

• Pre-funded arrangements
• Post-funded arrangements

Question 30

Pre-funded financial re arrangement

Answer 30

The insurer pays premiums into a fund held by the reinsurer (which earns interest), and claims are paid from the fund.

Question 31

Post-funded financial re arrangement

Answer 31

The reinsurer pays the losses and the insurer pays back the losses over time.

Question 32

4 Specific financial reinsurance products

Answer 32

• time and distance deals
• spread loss covers
• financial quota share
• industry loss warranties

Question 33

Time and distance policies

Answer 33

The insurer pays the reinsurer a premium and in return, the reinsurer pays an agreed schedule of claim payments;
This has the effect of discounting the reserves of the insurer for the time value of money.

Question 34

Spread loss covers

Answer 34

The insurer pays an annual or single premium to the reinsurer for the coverage of specified claims; these may be used to provide liquidity and security to the insurer and may be used for catastrophes.

Question 35

Financial quota share

Answer 35

This is quota share purchased in order to obtain reinsurance commissions for financing assistance.

Question 36

Industry loss warranties

Answer 36

These are a type of reinsurance that pay out based on industry losses rather than losses to individual insurers.

Question 37

Run-off reinsurance

Answer 37

Focus on the full-scale transfer of reserve development risks.
It provides cover against the insurer’s earning volatility arising from past activities.

Question 38

6 Circumstances in which run-off solutions are commonly sought

Answer 38

• corporate restructuring
• mergers and acquisitions
• closing lines of business
• economic changes in the value of the liability
• regulatory, accounting or tax changements
• legal developments

Question 39

Adverse development cover

Answer 39

Involves the purchase of reinsurance cover for the ultimate settled amount of a block of business above a certain pre-agreed amount.
Reserves are maintained by the insurer.

Question 40

Loss portfolio transfers

Answer 40

Involve the purchase of reinsurance cover for the ultimate settled amount of a block of business in its entirety.
Reserves are transferred to the reinsurer along with all remaining exposure to the business.

Question 41

Define “novation”

Answer 41

The transfer of the rights and obligations under a contract from one party to another.

Question 42

2 Advantages of Loss portfolio transfers

Answer 42

• They can improve the credit rating of the original insurer.
• The new insurer will gain diversification if not already in this area and achieve a larger client database.

Question 43

4 Disadvantages of Loss portfolio transfers

Answer 43

• assets may need to be realised to pass across the value of the reserves to the accepting insurer (might be mismatching or tax gains / losses)
• If the new insurer defaults, this could damage the reputation of the original insurer
• The transfer may require the buy-in of reinsurers where there are existing reinsurance arrangements covering the portfolio.
• There will be an associated cost to the original insurer of the risk transfer, which will depend on the current risk appetite of the market.