Part 10 Flashcards
Main benefits of reinsurance to an insurance company
- Reduction in claims volatility and hence
- Smoother profits
- Reduced capital requirements
- Increased capacity to write more business and achieve diversification
- 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:
- Reduced risk of insolvency
- Increased capacity to write larger risks
- Access to the expertise of the reinsurer
Variance of the total claim amount paid by the insurer if the proportion retained is alpha and the total claim amount is S
alpha2 var[S]
Areas in which an insurance company might seek assistance from a reinsurer for a critical illness product
- Product design (which critical illnesses should be included)
- Pricing (reinsurer will be able to provide past claims experience data)
- Guidance in setting underwriting policies
- Wording of policy documents (e.g. definition of critical illnesses, exclusion clauses, etc.)
- Establishment of suitable administrations systems
Definition of treaty
A treaty covers a group of policies - reinsurance that the reinsurer is obliged to accept from the insurer, subject to conditions (which are set out in the treaty)
Two forms of proportional reinsurance
- Quota share reinsurance (proportion is constant for all risks)
- Surplus reinsurance (proportion varies by risk covered)
Advantages (2) and disadvanatages (3) of quota share reinsurance
+ simplicity of administration
+ helps diversify risk
- same proportion of each risk is ceded regardless of its sie
- same proportion of each risk is ceded regardless of its likely volatiliy / risk profile
- it does not cap the cost of very large claims
Advantages (3) and disadvantage (1) of surplus reinsurance
+ allows the ceding provider to accept risks that would otherwise be too big
+ helps the ceding provider to spread risk
+ it is flexible - the ceding provider does not have to cede the same proportion of every risk
- more complex administration compare to a quota share treaty
Three main types of excess of loss reinsurance
- risk XL
- aggregate XL
- catastrophe XL
Risk XL definition and difference to surplus reinsurance
Risk XL is a type of excess of loss reinsurance that relates to individual losses. It affects only one insured risk at any one time.
Where a risk event can only result in the payment of the full sum insured, or no payment at all, there is no difference between the claim amounts under an individual risk XL and surplus reinsurance (e.g. life insurance)
Aggregate XL definition
Aggregate XL covers the aggregate of losses, above an excess point and subject to an upper limit, sustained from a defined peril (or perils) over a defined period, usually one year
Definition of stop loss cover
Same as aggregate XL cover but ceding company’s whole account is covered
Catastrophe XL definition
The reinsuring company will agree to pay out if a “catastrophe”, as defined in the reinsurance contract, occurs
Advantages (4) and disadvantages (2) of excess of loss reinsurance
+ caps losses, hence it allows the cedant to take on risks that could produce very large claims
+ protects the cedant against individual or aggregate large claims
+ helps stabilise profits from year to year
+ helps make more efficient use of the capital by reducing the variance of the claim payments
- ceding provider will pay a premium to the reinsurer, which, in the long run, will be greater than the expected recoveries under the treaty as it must include loadings for the reinsurer’s expenses and profits
- From time to time, excess of loss premiums may be considerably greater than the pure risk premium for the cover. For example, after reinsurers have had a few years of poor results, the supply of reinsurance falls and premiums rise, as reinsurers attempt to restore their solvency positions
5 types of Alternative Risk Transfer (ART)
- Integrated risk covers
- Reinsurance arrangements that typically several lines of general insurance business for several years. It is common for such arrangements to include cover of financial risks.
- securitization
- transfer of insurance risk to the banking and capital markets
- Post loss funding
- raising capital to cover the losses from a risk after the risk event happened
- Insurance derivatives
- catasrophe or weather options
- swaps
Advantages (4) and disadvantages (3) of integrated risk covers
+ No need to negotiate several separate reinsurance arrangements
+ Avoid buying excessive cover
+ smooth results
+ lock into attractive terms
- credit risk from the cover provider
- lack of availability
- expenses arising from the tailor-made aspect of the deal
