Friedland Flashcards
Reinsurance
Reasons to purchase reinsurance
- Promote stability: stabilizes the loss experience of ceding companies from year to year by retaining smaller, more predictable claims and ceding larger, more unpredictable claims
- Increase capacity: ceding companies to assume more risk by ceding a portion of all of their policies or by ceding their larger policies
- Protect against catastrophes: protects ceding companies from a single catastrophic loss event (ex. single hurricane) as well as multiple large loss events
- Manage capital and solvency margin: passes risk from the cedant to the reinsurer - with less risk present, less capital is needed
- Access technical expertise: reinsurers can lend their expertise in the areas of underwriting, marketing, claims, and pricing to insurers seeking to enter new lines of business or new regions
Treaty Reinsurance
Cede all business from certain lines of business - the reinsurer is not involved in the underwriting of the underlying policies written by the cedant.
Facultative Reinsurance
Reinsurers have the option of rejecting cession submissions from the cedant
Primary purpose is to increase a cedant’s capacity by ceding large risks (often high-value commercial risks)
Facultative Automatic
A bordereau of risks ceded is submitted to the reinsurer, which has limited rights to decline individual risks
Facultative Obligatory Treaty
A treaty under which the cedant has the option to cede or not cede individual risks. The reinsurer must accept any risks that are ceded.
Proportional Reinsurance
The reinsurer typically pays a ceding commission to the cedant to reimburse for acquisition and underwriting expenses associated with issuing the underlying policies
- Quota Share
- Surplus Share
Used to:
- Manage capital and solvency margins (net premium-to-surplus ratios are typically improved)
- Increase capacity
- Protect against catastrophes
Quota Share
Cedant cedes a percentage of loss and premium
Ultimate loss ratios are always the same for the cedant and the reinsurer under quota share reinsurance
Surplus Share
The cedant cedes the surplus amount of risk above its retained line subject to a maximum ceded percentage and limit
- The retained line is the amount the cedant is willing to retain per risk
- The reinsurer’s share is expressed as a multiple of the cedant’s retained line
Does not have a uniform cession percentage across risk unlike QS - he cession percentage differs depending on the policy limit of the underlying policy
Proportion ceded = (Policy Limit - Retained Line) / Policy Limit
Example: Retained line = 2.5
Policy limit = 5 -> % ceded = 50%
Policy limit = 10 -> % ceded = 75%
Non-proportional Reinsurance / Excess of Loss (XOL)
Premium paid is not proportional to the limits of coverage and reinsurer pays for all losses above a specified retention subject to any specified limits
Excess Per Risk
Indemnifies the cedant against the amount of loss in excess of a specified retention subject to specified limits on a per risk basis (where a risk is defined in the contract)
Typically used to protect property exposures and increase capacity
Excess Per Occurrence
Protects a cedant from an accumulation of losses due to a single occurrence
Catastrophe Reinsurance
Indemnifies the cedant for the accumulation of losses in excess of a specified retention arising from a single catastrophic event or a series of events, subject to a specified limit
Special case of excess per occurrence
- In the event of a full limit loss or some other amount specified in the reinsurance contract, cedants can obtain a restatement of the reinsurance policy limit
- Depending on the reinsurance contract terms, the restatement may or may not require an additional premium to be paid by the cedant to the reinsurer (reinstatement premium)
Inure to the benefit
When one reinsurance contract is applied first and reduces the loss subject to other reinsurance contracts, then we say that the first contract inures to the benefit of the other contracts
If all other reinsurance is ignored when considering a reinsurance contract’s impact on losses, then we say that the reinsurance contracts inure to the benefit of the reinsured
Annual Aggregate Excess of Loss (Aggregate Stop-Loss)
The total losses to the cedant cannot exceed a specified annual threshold (expressed as either a percent of premium or fixed dollar amount)
- Typically used to protect net results (i.e. this reinsurance kicks in after other contracts have already been applied) and an insurer’s capital base
- The issue with this type of reinsurance is that it is often unavailable or very expensive
Clash Reinsurance
Attaches above all other policy limits
Meant to cover exceptional events where traditional reinsurance contracts will not fully reimburse a cedant’s claims
In order for clash coverage to kick in, a clash event must occur. A clash event has three components:
- The loss must arise out of multiple policies held by one insured or similar policies held by multiple insureds
- All damages must be traceable to a specific event
- The event must take place in its entirety within a specific timeframe
Finite Risk Reinsurance
Multi-year contracts that spread risk over time and considerthe investment income generated over the period
- Risk transfer and risk financing combined
- Emphasis on the time value of money with investment income explicitly included in the contract
- Limited assumption of risk by the reinsurer
- Sharing of the results with the cedant
Loss Portfolio Transfers (LPTs)
Transfers all or a portion of a cedant’s loss reserves present at a specific accounting date to a reinsurer
The cedant’s statutory surplus increases by the difference between the premium and the loss reserves
Reinsurers could lose money on an LPT contract in the event that claims are settled faster than expected, resulting in less than anticipated investment income
Adverse Development Cover
Alternative to an LPT where the cedant receives reimbursement from the reinsurer for losses in excess of a pre-agreed retention level
Attaches at the level of the cedant’s current carried reserves and covers any development beyond that point
Unlike an LPT, reserves are not transferred
Often used for Mergers & Acquisitions to transfer the risks of timing and adverse reserve development
Business Covered Clause
Describes which claims are covered under the reinsurance contract
- Losses-occurring-during: coverage for all losses that occur between the contract inception and expiration date REGARDLESS of when the cedant issued the underlying policy that resulted in the loss
- Risks-attaching: coverage only for those policies that began during the reinsurance contract effective period
Subscription Percentages
When the amount of coverage sought by the primary insurer is more than a single reinsurer wants to provide, the primary insurer can issue a subscription policy - policies in which multiple reinsurers share a risk subject to corresponding subscription percentages
Commutation Clauses
Under a commutation, the reinsurer pays the present value of reinsurance recoveries not yet due to the cedant in exchange for full termination of all future obligations related to the reinsurance contract
Cedants may commute a reinsurance contract for the following reasons:
- To exit a line of business or geographic region
- To manage reserves for transfer or sale
- To avoid the credit risk associated with its reinsurer, especially if the reinsurer has experienced a ratings downgrade
- To better manage claims and claims-related expenses
Reinsurers may commute a reinsurance contract for the following reasons:
- To end a relationship with a cedant that is in run-off or one with which it no longer conducts business
- To protect itself from the potential insolvency of the cedant
- To avoid disputes when there are significant differences of opinion with respect to future loss development of subject losses
Understanding commutations is important for the reserving actuary for the following reasons:
- Actuaries are often involved in the analysis of reinsurance contracts that are subject to commutation
- Commutations affect the estimation of unpaid ceded losses. Thus, a ceding company’s actuary should be aware of commuted contracts
- Commutations eliminate the corresponding liability to the reinsurer. Thus, a reinsurer’s actuary should also be aware of commuted contracts
- Loss development patterns for commuted contracts could be different from contracts that remain in-force
Sufficiency
Data are sufficient if they include the needed information for the work
Ensuring the sufficiency of the data can be challenging for reinsurers for the following reasons:
- Contract terms can differ from one cedant to another and from year to year
- Operational and strategic changes implemented at the cedant and the reinsurer can cause significant changes in mix of business, attachment points, policy limits, and claims processing
Reliability
Data are reliable if they are sufficiently complete, consistent, and accurate for the purposes of the work
To ensure the data are accurate, the actuary must validate the data
- Reconcile data against audited financial statements, trial balances, or other relevant records
- Test the data for reasonableness against external or independent data
- Test the data for internal consistency and consistency with other relevant information
- Compare the data to those for a prior period
Data validation for actuaries working for reinsurers may be more difficult than data validation for actuaries for primary insurers for the following reasons:
- For each cedant and broker, different IT systems capture different types of data and use different terms for similar types of data
- Bordereau reporting may differ by cedant and broker in the types of data reported, data labels, and the frequency of submission to the reinsurer
- There may be lags in reporting to the reinsurer (Claims must first be reported to the primary insurer, long-tailed nature of certain types of reinsurance, use of bordereau reporting, where losses are only reported on a quarterly or more infrequent basis)
- There may be gaps in reporting critical claims information from the cedants (ex. loss payments, case reserves, etc.)
- The unique nature of reinsurance policies can lead to different coverage for similar loss events with different cedants
Homogeneity
Homogeneous reinsurance obligations, known as homogeneous risk groups (HRGs), are managed together and have similar risk characteristics such as underwriting policies, claims settlement patterns, product features, etc.
When separating data into HRGs for the purposes of estimating unpaid losses, actuaries should consider the following:
- Consistency of the coverage triggered by the losses in the group
- Length of time to report the claim once an insured event has occurred (i.e. reporting patterns)
- Length of time to settle the claim once it is reported (i.e. payment patterns)
- Average settlement value (i.e. severity)
- Volume of losses in the group
Credibility
A measure of the predictive value in a given application that the actuary attaches to a particular set of data
When estimating unpaid losses, the goal is to divide the data into homogeneous groupings without compromising credibility
Variables that affect the pattern of claim report lags to the reinsurer
- Line of business: property, casualty, ocean marine, etc.
- Type of contract: facultative, treaty, finite
- Type of reinsurance cover: quota share, surplus share, excess per risk, excess per-occurrence, aggregate excess, etc.
- Primary line of business for casualty
- Attachment points for casualty
- Contract terms: flat-rated, retro-rated, sunset clause, etc.
- Type of cedant: small, larger, or excess and surplus
- Broker
Accident Year Aggregation
Advantages:
- Easy to achieve
- Easy to understand
- Become reliably estimable sooner than underwriting year data since accident year data represents losses occurring over a shorter time frame
- Industry benchmarks are based on AY losses
- Tracking losses by accident year is valuable when there are changes due to economic or regulatory forces (ex. inflation or law amendments) or major loss events (ex. hurricane) that can influence loss experience
Disadvantage is the potential mismatch between losses and premiums (the matching of calendar year earned premiums and accident year losses is only approximate)
Underwriting (i.e. Treaty) Year Aggregation
Advantages:
- Exact match of losses and premiums (especially important when underwriting or pricing changes occur)
Disadvantages:
- Data takes longer to mature (losses can extend over 3 calendar years)
- Difficult to isolate the effect of a single large event
Loss Adjustment Expenses (LAE)
- Included with the claim amount when determining excess of loss coverage
- Included on a pro-rata basis: ceded loss & ALAE = (Total loss - Retained loss) + (Total loss - Retained loss)/Total loss * Total ALAE
- Not included in the reinsurance coverage
Reinsurance Association of America (RAA)
The RAA publishes a biannual study of loss development triangles. The study:
- Includes historical loss development patterns by accident year for reinsurers writing casualty excess reinsurance for auto liability, general liability, and medical malpractice
- Organizes patterns separately by treaty and facultative business and five ranges of attachment points
- Discusses how loss development patterns have changed over the last few years and provides possible reasons for those changes
- Discusses how loss development has varied depending on the business being considered
Shortcomings of External Data
- Reinsurance contract terms and conditions
- Mix of assumed business
- Types of reinsurance
- Underwriting processes
- Claims management processes
- IT systems
Key Differences in Assumptions Between Primary Insurance & Reinsurance
- For a similar LOB, loss development factors in the earlier maturity age intervals are often higher for reinsurance than for primary insurance due to reporting lags
- For a similar LOB, tail factors are often higher due to reporting lags and the nature of large claims associated with excess of loss reinsurance
- Loss trend factors tend to be higher for excess of loss reinsurance than primary insurance
- There is less precision in premium on-level factors that adjust for rate changes
- Adjustments for changes such as tort and product reform are less common in reinsurance reserving
Effect of Changes in Currency Exchange Rates
Use the latest FX rate to aggregate triangles of different currencies together
This retains the true reporting pattern
