Clark - reinsurance1

Question 1

one major difference between primary insurance and reinsurance

Answer 1

reinsurance is generally customized to each individual buyer

Question 2

2 main methods by which reinsurance can be applied

Answer 2

1. facultative reinsurance – designed and purchased separately for each individual risk of ceding company
2. treaty reinsurance – allows a reinsurer to cover multiple risks of ceding company; priced based on risks in aggregate

Question 3

2 main types of treaty reinsurance & subtypes

Answer 3

1. proportional – assumes given % of losses and premium
   - quota share - % ceded is same across all risks
   - surplus share - % ceded varies by risk
2. non-proportional – assumes losses in excess of ceding company’s retention limits (XL reinsurance)
   - Per risk XL – assumes losses between a retention and limit for each risk; offers protection against large individual claims
   - Per occurrence XL – assumes losses between retention and limit for each occurrence across multiple risks; offers protection against CATs
   - Aggregate XL – assumes losses between retention and limit for aggregate total of losses for given time period; offers frequency protection

Question 4

policies can be provided upon 1 of several bases

Answer 4

1. risks attaching – all policies that begin or renew during contract period are covered regardless of when losses occur or are reported; think of losses typically on PY basis and relate them to WP
2. losses occurring – all claims that occur during contract period are covered regardless of when policies were incepted or losses are reported; think of losses typically on AY basis and relate them to EP

Question 5

2 methods to price reinsurance policies

Answer 5

1. experience rating – use adjusted historical experience of either the reinsurance contract or ceding company to calculate premium for prospective reinsurance contract
   - primary approach used to price proportional reinsurance
2. exposure rating – use current risk profile and estimated loss distributions to calculate premium for prospective reinsurance contract
   - often used in combination with experience rating to price non-proportional

Question 6

exposure rating - determining expected losses in layer

Answer 6

• loss distributions are used to determine expected losses in treaty layer
• can be based on ILFs, ELF for WC, or exposure curves

Question 7

reinsurer will also pay a ceding commission to

Answer 7

ceding company to reflect that ceding company will have much larger UW expenses

Question 8

why buy surplus share

Answer 8

if want to retain low risk policies and cede higher risk policies

• for any risks with insured value below retained line, ceding company keeps risks in full
• for risks with insured values above retained line, reinsurer will assume a % of loss, alae, and premium on those risks

Question 9

sliding scale commission

Answer 9

commission paid by reinsurer to ceding company varies with actual LR on treaty, subject to max and min commission

Question 10

in balanced sliding scale plan

Answer 10

commission at expected LR = expected commission

-not always the case, so it is best to calculate expected commission as probability weighted average of commission at each LR

Question 11

sliding scale commissions may also have

Answer 11

carryforward provision

-this means if actual LR exceeds LR for min commission, then amount of LR in excess of LR for min commission is added to LR in subsequent year for purposes of determining next year’s commission

Question 12

there are 2 approaches to pricing carryforward provisions

Answer 12

1. assume that any past carryforward amounts only apply to current year’s LR
   - can assume this by subtracting carried over LR amount from LRs in current year’s sliding scale
   - problem with this approach is that it ignores potential for future carryforward
2. look at expected ultimate commission ratio for block of years together
   - problem with this is that it isn’t obvious how to reduce variance of aggregate loss distribution when you combine the years and it ignores that contract might not renewed

Question 13

Profit Commission

Answer 13

• returns some of reinsurer’s profit to ceding company as additional commission
• similar to sliding scale commission that is based on actual LR and increases commission with low loss result

Question 14

loss corridors

Answer 14

-allow ceding company to reassume some liability if LR exceeds certain amount

Question 15

propert per risk XOL - treaty premium

Answer 15

treaty premium is set as % of ceding company’s subject premium base which will either be:

Gross net EP income for policies on loss occurring basis

Gross net WP income for policies on risks attaching basis

• net refers to net of any other inuring reinsurance (reinsurance that applies before this treaty)
• gross refers to property per risk XL treaty being priced

Question 16

exposure rating is done by

Answer 16

using exposure curves

-exposure curve P(p) = portion of loss capped at given percent p of insured value relative to total value of loss

Question 17

usually exposure curves are constructed separately for

Answer 17

different risk sizes and all risks of given size are assumed to be homogeneous

• but you may only have 1 exposure curve to use for different risk sizes -> implies probability of 10k loss on 100k risks is same as probability of 100k loss on 1M risk
• assumption may not be realistic in practice particularly for commercial insurance

Question 18

Free Cover

Answer 18

• one issue that arises in using experience rating for excess of loss treaties is when there is no loss experience in highest portion of layer
• experience rating would give away any excess coverage for which there is no loss experience -> concept is called free cover
• one way to deal with this is to use experience rating for lower portion of layer and then use exposure rating relativities to price higher portion of layer

Question 19

Credibility for Experience Rating

Answer 19

• 2 measures of credibility to use for experience rating property per risk XL treaties
  1. expected number of claims or expected dollars of loss during historical period; use expected claims since actual claims would assign more credibility to worse than average years
  2. use variance of historical projected loss costs; more stable LRs, more credibility that should be assigned to experience

Question 20

Describe two ways the insurer can stabilize its results for its sliding scale commission structure over time

Answer 20

• Introduce a carryforward provision in which the portion of the loss ratio in excess of the loss ratio corresponding to the minimum commission will be added to the following year’s loss ratio for the purpose of determining the sliding scale commission.
• A profit sharing provision would incentivize the insurer to manage losses before thepotential return in premiums.
• Reduce the range of possible commissions so they will be more certain. • Reduce the range of loss ratios leading to the commissions, so the commissions will be more stable.
• Decrease the sliding scale sensitivity to losses (e.g., make it sliding 0.05:1 instead of 1:1 and 0.5:1.). This will stabilize the commissions.
• Add a provision to cap the losses being used in the determination of the commission.

Question 21

whether the smoothing mechanisms should be used in the determination of an aggregate loss distribution model

Answer 21

include: I would include the smoothing mechanisms in the aggregate loss distribution as this will be a way to estimate aggregate commissions at an ultimate level. The challenge is that it is difficult to reflect the potential that policies can non-renew or be cancelled and then there is no longer the carryforward component.

dont: I would not include the smoothing mechanisms because you want the aggregate loss distribution to reflect the expected potential losses. If the insurance treaty is non-renewed or cancelled, the aggregate distribution will not be representative of the true expected losses.

Question 22

T/F ”Basics of Reinsurance Pricing,” a loss corridor is a common feature of property per risk treaties.

Answer 22

it is a common feature of proportional treaties, not property per risk treaties

Question 23

coninsurance clause

Answer 23

it increases retained losses and reduces ceded loss

Question 24

What is the correct method to interpret the potential profitability of a sliding scale reinsurance agreement from the reinsurer’s perspective

Answer 24

A probability distribution should be associated with intervals of possible loss ratios. For each interval, the sliding scale commission is calculated for the average LR in the interval. These commissions should be weighted by the probabilities to determine the expected commission ratio

Question 25

purpose of the ceding commission

Answer 25

or the reinsurer to pay for the primary insurer’s policy acquisition costs that were incurred in obtaining the business ceded to the reinsurer.

Question 26

From the point of view of the ceding company, describe two advantages of excess of loss reinsurance over pro rata reinsurance

Answer 26

• Can retain a larger portion of premium on small profitable risks
• Helps stabilize underwriting results

Question 27

a problem arises when trended losses are capped at policy limits when using experience rating to price a casualty excess treaty.

Answer 27

The concern is that insureds tend to purchase higher limits over time, so capping losses at historical policy limits and using those to predict future losses may understate the future loss potential.

i. Trend historical losses and cap them at historical limits (i.e., ignore the problem).
ii. Trend the policy limits and the losses, and assume that limits increase at the same rate as inflation.

A disadvantage of method (i) would be that historical limits may not reflect the selected limits in the future.

A disadvantage of method (ii) would be that subject premium would also need to be adjusted to reflect the higher limits, but an appropriate adjustment for this can be difficult to quantify.

Question 28

two reasons why exposure rating can be distorted when deductible levels change.

Answer 28

• When deductibles increase, the subject premium decreases, but the expected excess losses may not change significantly. So the old exposure rate would be inadequate.
• When deductibles decrease, the subject premium increases, but the expected excess losses may not change significantly. So the old exposure rate would be too high.
• When deductibles decrease, losses below the original deductible may be unknown, so information is missing about the loss distribution. This makes it challenging to derive a new exposure curve for the lower deductible

Question 29

Give two reasons why report lags are longer for reinsurance companies than for primary carriers.

Answer 29

• For XOL reinsurance, a primary company may not have expected a loss to penetrate the reinsurance layer, in which case the reinsurer only gets notified after the claim has had some development.
• A claim could impact multiple reinsurance treaties, resulting in longer delays to reinsurers covering higher layers of loss.
• Claims still have the report lag of the primary company before it even gets to the reinsurer.

Question 30

loss development data from the Reinsurance Association of America (RAA) as benchmarks. What are two items the actuary should consider when using these patterns?

Answer 30

• Report lag can vary by company.
• The mix of attachment points and limits may not be cleanly broken out.
• The data may contain asbestos and environmental claims.
• For WC, the data may include inconsistent tabular discoun

Question 31

Does either alae method generally favor one party over the other?

Answer 31

Neither method generally favors one party over another. The amount of ALAE included varies based on the size of loss and the reinsurance treaty limits. Furthermore, any expected difference would be reflected in the reinsurance premium assuming it is priced properly.

Question 32

inuring reinsurance

Answer 32

Inuring reinsurance means that one reinsurance treaty is primary to another treaty, so the inuring treaty reduces the amount of loss that is considered for coverage under the second treaty.

Question 33

purpose of co-participation

Answer 33

Co-participation provides a financial incentive for the primary insurer to responsibly manage losses that exceed the attachment point