Module 4: Reinsurance

Question 1

What is reinsurance?

Answer 1

Reinsurance is insurance purchased by insurers in order to transfer a portion of their insured risks to other insurers.

Question 2

What other reasons are there for writing a reinsurance contract?

Answer 2

1. It is a way for an insurer to enter a new market (for example, property or aviation) without the effort and expense of employing new underwriters.
2. It also allows insurers to work in parts of the world where the local regulations only permit local insurers to write direct risks but are more flexible about reinsurance to ensure that the risks are well spread.
3. It is a balancing act for the direct insurers buying it in that they do not want to pay out too much of their hard earned inwards premium (i.e that charged on the direct risks they have written)

But, in turn, they want to protect themselves against an unexpected large loss like a hurricane or an oil refinery exploding.

Question 3

What does to cede mean?

Answer 3

The verb used which means to transfer.

Question 4

What does cedant mean?

Answer 4

The organisation buying the reinsurance or transferring the risk.

Question 5

What does cession mean?

Answer 5

The noun describing what is being transferred - i.e. the risk

Question 6

What is a reinsurance programme?

Answer 6

A combination of different types of reinsurance that the insurers construct, having analysed their book of business and tried to calculate where they need protection and how best to obtain maximum protection for minimum payment of premium.

Question 7

What is facultative reinsurance?

Answer 7

Reinsurance that only covers a single risk.

Question 8

What is treaty reinsurance?

Answer 8

Reinsurance that covers a variety of risks.

An agreement is usually set up for a whole year whereby both parties agree that risks will be automatically ceded or bound to the treaty.

A treaty can protect an individual line of business.

For example, cargo or property, or can protect all marine lines or all aviation lines, or could actually be set up to protect everything that the insurer wrote during a certain year of account or underwriting period.

Question 9

What is facultative/obligatory reinsurance?

Answer 9

A blend between fac and a treaty where the original insurer has the choice as to which risks to present to his reinsurer; but if he does present them, then the reinsurer is obliged to accept them.

Question 10

What does a reinsurer consider when he is presented with a risk?

Answer 10

1. What is the cedant’s business like?
2. How do they run their business?
3. Do they have proper systems for collecting data about the risks that they write so they can provide you, as the reinsurer, with proper data?

Question 11

What is the hours clause?

Answer 11

If there is a storm or other natural catastrophe, then the reinsurers can cap their likely exposure by saying that the original insurer can only group together those losses it receives that fall within a tight time window, usually 72 or 96 hours.

This means that for a storm that lasts a long time the original insurer will probably have to pay two excesses on his reinsurance as he will have to split his claim to his reinsurance into two.

Question 12

What is the full reinsurance clause?

Answer 12

This is also known as a back to back clause and the intention is that the reinsurance will mirror the original insurance loss written so that there are no gaps.

Reinsurers have to be very careful in these situations that they know exactly on what terms and conditions the original placement has been made as the idea with this clause is that reinsurers will generally pay up what they owe with little or no question.

Question 13

What is the claims control clause?

Answer 13

The reinsurer has full control over claims and dictates how they are handled and when and if they are paid.

This type of clause will often be used when the amount of the risk remaining with the original insurer is very small (say 0.5%) and, essentially, it is reinsurers’ money that they are using.

Question 14

What is the claims co-operation clause?

Answer 14

A clause which requires the original insurer to promptly advise the reinsurer, keep them advised and co-operate with them etc. but does not give the reinsurer the final say in whether the original insurer actually pays the claim.

Question 15

What does risks attaching basis mean?

Answer 15

This means that any risk written by the original insurer (cedant) during the reinsurance treaty period - say, 12 months at 1 January 2010, will be covered under the reinsurance.

It doesn’t matter what the date of loss is, as long as the date the risk attached can be identified and it is within the treaty period.

Question 16

What does losses occurring basis mean?

Answer 16

This means that the date of loss must be within the reinsurance treaty period, irrespective of when the risk attached which may be before the reinsurance treaty came into effect.

Question 17

What does claims made/losses discovered basis mean?

Answer 17

The claim must be made against the original insurer during the reinsurance treaty period. This is most often used for long-tail risks where the original policies should also be written on that basis.

Question 18

What is the order to claim on reinsurance?

Answer 18

The general rule, in terms of the order to claim on reinsurance, is that the more specific the policy, the nearer to the front of the claim queue it stands.

1. Fac reinsurance will always be claimed on first if it exists.
2. Specific treaties such as a property or hull treaty will always be claimed on before a more general marine or non-marine treaty.
3. Whole account treaties will be claimed on last.

Question 19

How does proportional reinsurance operate?

Answer 19

The reinsurer receives an agreed share of the premium and pays the same portion of any loss.

The key concept in relation to proportional reinsurance is that of sharing and more particularly sharing of both premiums and claims in equal proportions.

Question 20

What is a quota share?

Answer 20

It can be imagined as pie chart with a slice of the pie representing the cession of premium to the reinsurer and the share of any claims that he will pay.

Question 21

Quota share calculation example:

A risk of £2,000,000 producing a premium of £2,000. The insurance company has a 30% quota share treaty. It is asked to pay a £450,000
claim.

How much of the risk, premium and claim is retained and ceded?

Answer 21

Risk retention: £1,400,000
70% of £2,000,000.

Premium retention: £1,400
70% of £2,000.

Risk cession: £600,000
30% of £2,000,000.

Premium cession: £600
30% of £2,000.

Claim retained: £315,000
70% of 450,000.

Claim ceded: £135,000
30% of 450,000.

Question 22

What is a surplus treaty?

Answer 22

Surplus treaties involve variable quota shares.

The underwriter defines his maximum retained line (i.e. the maximum size of line he can share of any risk.

He can then increase that limit through obtaining identical clones or replicas of that line.

The maximum amount he obtains is entirely down go how much he is prepared to pay in premium and whether there are reinsurers prepared to write his reinsurance.

Question 23

Surplus treaty calculation example:

How might a surplus cession work for a company whose maximum retained line is £1,000,000?

Answer 23

Risks
1 - original sum insured £1,000,000.
Company retains £1,000,000. Cedes £0 to the surplus.

2 - original sum insured £2,000,000.
Company retains £1,000,000. Cedes £1,000,000 to the surplus (50%. £1,000,000 to reinsurer 1).

3. original sum insured £3,600,000.
   Company retains £1,000,000. Cedes £2,600,000 to the surplus (83.3%. £1,000,000 to reinsurer 1, £1,000,000 to reinsurer 2 and £600,000 to reinsurer 3).

Question 24

What is a probable maximum loss?

Answer 24

The original insurer will decide what excess or retention he is happy to retain (along the same principles as with direct insurance) and then buys reinsurance to stack on top to a level at which they believe they will be covered for the biggest loss they might have.

This calculation of the largest loss they might have is known as working out the probable maximum loss - it will vary based on a number of factors, such as the type of risk and the locations.

Question 25

What are the four types of excess of loss (XL) reinsurance that can be purchased?

Answer 25

1. Fac - an XL contract to cover a single risk.
2. Working on risk layer - this is operating at a low position in the stack and, therefore, is likely to her hit with claims more frequently.

This policy could be set up to cover a single type of business, such as property or energy, or a more general area, such as marine or non-marine.

3. Catastrophe layer - this is designed to be further up the stack and only get hit if a catastrophe loss occurs.
4. Stop loss - a very specialist type of XL that actually protects the whole of an insurers profit, and will be triggered once a loss ratio (the balance between premiums and claims) reaches a certain level.

Question 26

Excess of loss calculation example:

Layer 1: £500,000 xs £500,000
Layer 2: £1,000,000 xs £1,000,000
Layer 3: £3,000,000 xs £2,000,000
Layer 4: £5,000,000 xs £5,000,000.

How would a £5,500,000 claim be collected from the reinsurers?

Answer 26

Retention: £500,000 - the insurers retention.

Layer 1: £500,000 - a total loss of the first layer provided by the reinsurer.

Layer 2: £1,000,000 - a total loss of the second layer provided by the reinsurer.

Layer 3: £3,000,000 - a total loss of the third layer provided by the reinsurer.

Layer 4: £500,000 - from the fourth layer (not a total loss) provided by the reinsurer.

Question 27

What is clash clover?

Answer 27

Clash cover is an excess of loss agreement where the underlying amount to be retained by the ceding insurer is at an amount which is higher than the limit on any one reinsurer policy.

Question 28

What is ceding commission?

Answer 28

An appropriate share of the original costs of acquiring or producing the business paid by the reinsurer to the insurance company. It is the one area of proportional business where the arithmetic is not truly proportionate.

Question 29

What is profit commission?

Answer 29

If the reinsurance turns out to be profitable for the reinsurer, he can also reward the cedent by giving him a profit commission which will
be worked out at the end of the agreed period of time

(this may not be the end of the policy period but maybe a year of two later once all the premiums and claims have been settled down and the true position of the contract is known)

Question 30

What is overriding commission?

Answer 30

It is an amount over and above the ceding commission paid by the reinsurer to the original insurer, which is paying for the costs of obtaining the business.

This is purely a commercial decision and should be clearly evidenced in the treaty terms and conditions.

Question 31

What are the two methods of excess of loss rating?

Answer 31

1. Exposure rating

2. Experience rating

Question 32

What is the exposure rating method of excess of loss rating based on?

Answer 32

Exposure rating is based upon the sums insured exposed to a particular level of coverage.

1. It is used extensively in property and casualty business, especially where there is little known loss experience or where a new account is to be reinsured.
2. It would be used for both individual facultative excess of loss placements and for excess of loss contracts involving a substantial number of risks.

Question 33

What is the experience rating method of excess of loss rating based on?

Answer 33

The experience rating method is based on known, estimated or projected loss experience to calculate excess of loss premiums.

Question 34

What must an excess of loss premium cover?

Answer 34

1. The expected claims cost, including an allowance for the problems of inflation and losses which have been incurred but not yet reported (IBNR).
2. An allowance for the reinsurers own administrative expenses and management requirements.
3. Brokerage.
4. An allowance for both a margin of profit and other contingencies.

Question 35

What main factors will affect the excess of loss rate?

Answer 35

1. The level of the reinsured retention.
2. The limit of the reinsurers liability.
3. The class of business and where it is situated.
4. The exclusions under the contract.
5. The past and projected loss experience of the business or the number and size of risks exposed to the layer and any changed in the account over the observation period of historic information.
6. Market conditions and general experience for that business.
7. The degree of competition which existed at a particular time.

Question 36

How will an underwriter go about using experience or exposure ratings?

Answer 36

1. Burning cost - Also known as a swing rated, this uses the experience gained on the past portfolio to predict future losses applying some adjustments for inflations and any other trends.
2. Fixed or percentage premium - generally used for contracts with a low number of losses.
3. Flat premium - used when neither of the above are suitable.

Question 37

In non-proportional reinsurance, what is a reinstatement?

Answer 37

A facility whereby the reinsurer allows the original insurer to buy a reinsurance that will cover more than one total loss.