Chapter30-Risk transfer Flashcards
Framework
1 Responses to risk (PIRATE) 2 Evaluation of risk mitigation options 3 Factors to consider when deciding to transfer or retain risk 4 Costs and benefits of reinsurance 5 Reasons for reinsuring 6 Reinsurance contract variations 7 Proportional reinsurance 8 Quota share 9 Advantages and disadvantages of Quota share 10 Surplus reinsurance 11 Examples of fixed and varying retention level 12 Advantages and disadvantages of surplus reinsurance 13 Non-proportional reinsurance (XL) 14 Types of excess of loss reinsurance 15 Risk XL vs Surplus 16 Uses of excess of loss 17 Factors when deciding on reinsurance products to use 18 Alternative risk transfer (ART) 19 Integrated risk cover 20 Securitisation 21 Post loss funding 22 Swaps 23 Insurance derivatives 24 Reasons for ART (DESCARTES)
Reasons for reinsuring (12)
A reduction in claims volatility and hence:
– smoother profits
– reduced capital requirements
– an increased capacity to write more business and achieve diversification
The limitation of large losses arising from:
– a single claim on a single risk
– a single event
– cumulative events
– geographical and portfolio concentrations of risk and hence:
– a reduced risk of insolvency
– increased capacity to write larger risks
Access to the expertise of the reinsurer
Alternative risk transfer (ART)
- Integrated risk covers
- Securitisation
- Post loss funding
- Insurance derivatives
- Swaps
Integrated risk cover
These are multi-year, multi-line reinsurance contracts between insurers and reinsurers.
They give premium savings due to:
the cost savings (of not having to negotiate reinsurance separately for each class each year)
greater stability of results over time and across more diversified lines.
They are used to:
avoid buying excessive cover
smooth results
lock into attractive terms
Securitisation
This is the transfer of insurance risk (often catastrophe risk) to the banking and capital markets.
The banking and capital markets are used because of their capacity and because insurance risks provide diversification to their more usual credit and market risks.
Securitisation may be packaged as a catastrophe bond. The repayments of interest and capital from the insurer to the banking and capital markets are contingent on the specified catastrophe not happening.
The yield on such bonds is likely to be higher than similarly rated corporate bonds.
Post loss funding
Post loss funding guarantees that, funding will be provided on the occurrence of a specific loss, in exchange for a commitment fee. The funding is often a loan on pre-arranged terms or equity.
The commitment fee will be lower than the equivalent insurance cost (because the cost of the funding will in the most part be borne after the event has happened). Thus, before the loss happens the contract appears cheaper than conventional insurance.
Swaps
Organisations with matching but negatively correlated or uncorrelated risks can swap packages of risk so that each organisation has a greater risk diversification.
Examples
A reinsurer with exposure to Japanese earthquakes may swap some of this risk with a reinsurer with exposure to hurricanes in Florida.
Longevity swaps may exchange expected annuity payments (the ‘fixed leg’) with actual annuity payments (the ‘floating leg’).
Energy companies (which have lower profits in warm weather) may swap temperature risk with household insurers (which suffer more claims in cold weather)
Insurance derivatives
Insurance derivatives include catastrophe and weather options.
The strike price will be based on a certain value of a catastrophe or weather index. Whether or not the option is exercised will reflect by how much the value of the index is different to that on which the strike price is based.
Reasons for ART
Diversification
Exploits risk as an opportunity
Solvency improvement / source of capital
Cheaper cover than reinsurance
Available when reinsurance may not be
Results smoothed / stabilised
Tax advantages
Effective risk management tool
Security of payments improved
