Pro Rata Quiz

Question 1

Fac vs Treaty

Answer 1

“Fac (15% of premiums) used on individual risks, way to provide higher limits, one-off contracts, involve the reinsurer immediately before the primary contract is sold so can pass on the cost to the insured

Treaty (85%) cornerstone of reinsurance, blanket rate, cannot pass on costs to insureds”

Question 2

Five Functions of Reinsurance

Answer 2

1. Increasing premium capacity (cede premium to RI which frees up capacity and capital to write more business)
2. Increase primary policy limit / risk capacity (allow for higher limits on primary policies)
3. Stabilization of net results (stabilize loss ratio)
4. Increase PHS / Financing (cede UEPR and receive ceding commision performs accounting maneuver to up surplus)
5. CAT protection (top end protection against catastrophic losses)

Question 3

Quota Share Characteristics

Answer 3

“Pre-determined, fixed percentage

Primary policy limit determines what primary policies can be ceded ($1M max limit, a 1.2M last 200k is not ceded)

1st dollar recovery, loss ratio does not change”

Question 4

Calculation reminders

Answer 4

“Per occurrence cap – need to apply total loss to per occurrence cap first, then calculate the ceded loss amount

Limit cap – need to double check only the policies with limits below the QS policy limit are applied to the contract”

Question 5

Underwriting Expenses

Answer 5

Includes agent commissions, general expenses like state fees, premium taxes, etc. — usually ends up being 25%-35% of premium

Question 6

PHS Relief

Answer 6

“Ceded UEPR * Ceding Commission % at point of inception

Will vary based on amount of incoming UEP, Ceding Commission %, Cession %; PHS relief will be reversed when contract is cancelled so you need to consider how to come off the QS (ideally gradually as you improve PHS organically)

Useful to write business in hard markets (high prices -> high UEPR)”

Question 7

Leverage Ratio

Answer 7

“Net Written Premium / Surplus

Ideally this ratio is 2:1 or lower (no more than 3:1)”

Question 8

QS Response Limits

Answer 8

“Per Occurrence
Per Occurrence, Per Policy – most common to ensure adequate protection
Per Insured”

Question 9

QS Reinsurance Function Effectiveness

Answer 9

“1. Increasing Primary Policy Volume or Leverage — VERY EFFECTIVE (has potential to cede significant premium and free up capacity to write more business)
2. Increase Primary Policy Limit — SOMEWHAT EFFECTIVE (QS can be written to provide limit for liability policies like umbrella policies, esp gross QS)
3. Stabilization of Net Results — SOMEWHAT EFFECTIVE (not effective to stabilize for a particular LOB but can be effective net of all LOBs (ex 100% on umbrella that have bad results))
4. Increase in PHS — VERY EFFECTIVE (can be very effective but depends on ceding commission size, cession %, and SEP; by decreasing expenses (recouped through ceding commission) the financial impact to the insurer is that their policyholders’ surplus (PHS) is temporarily increased)
5. CAT Protection — SOMEWHAT EFFECTIVE (QS can be very effective on CAT protection bc it is first dollar loss but also is very costly to build cat capacity this way – both gross and net can be used in different ways)”

Question 10

Surplus Relief QS vs Policy Limit Capacity QS

Answer 10

“Surplus Relief – need large amount of ceded premium, high cession %, ceding commission is crucial, limited to no property cat exposure

Policy Limit QS – often LOB specific, modest ceded premium, modest ceding commission, % cession is very important, carves out policies from the larger portfolio”

Question 11

Per Occurrence QS Notes

Answer 11

Caused by Hurricane Andrew, they reconstitute after each loss without reinstatement

Question 12

QS Swiss Army Knife (6)

Answer 12

“(1) PHS relief and manage leverage
(2) Private label policy limit capacity
(3) Build CAT capacity (gross) or complement CAT program (net)
(4) Wall off unwanted pieces of business
(5) Provide implied parental support (to secure Best rating)
(6) Move profit to more favorable tax enviroment”

Question 13

Surplus Share (5)

Answer 13

“(1) Ceded on a per risk basis
(2) Cession % depends on each risk and is formula driven
(3) Retained liability can be variable or fixed
(4) Cede liability per risk vs losses
(5) Definition of risk is crucial as it defines how the contract cedes”

Question 14

Surplus Share Line

Answer 14

Amount of liability ceded as part of the surplus share

Question 15

SS Capacity

Answer 15

Total of ceded lines plus retention amount

Question 16

Fixed Retention Formula

Answer 16

(Policy Limit - Retention) / Policy Limit

Question 17

9 Line SS Over 100k Retention (example of)

Answer 17

Fixed SS example with 1M in capacity and any risk over 100k cedes surplus liability to RI

Question 18

Variable Retention Formula

Answer 18

Policy Limit / Capacity = Suggested Retention (subject to the min); after suggested retention, need to apply the max as needed to get ceded liability

Question 19

Variable Retention Parameters

Answer 19

“(1) Minimum retention liability
(2) Maximium cession liability
(3) Capacity of surplus share”

Question 20

SS Reinsurance Function Grades

Answer 20

“(1) Increasing Premium Capacity – EFFECTIVE (similarly effective but no
(2) Increasing Primary Policy Limit / Risk Capacity – VERY EFFECTIVE (designed for this)
(3) Stabilization of Net Results – SOMEWHAT EFFECTIVE
(4) Financing / Increase PHS – SOMEWHAT EFFECTIVE (similar mechanism to QS but not as effective)
(5) CAT Protection – SOMEWHAT EFFECTIVE”

Question 21

Similiarities (3) and Differences (3) between QS and SS

Answer 21

“Similarities
(1) Both cessions of liability
(2) Both 1st dollar recoveries
(3) Premiums and liabilities shared on pro rata

Differences
(1) Calculation of cession % is different (fixed for QS, formula for SS)
(2) SS more flexible in building primary line limit
(3) SS used more with property business, QS used with both P & C”

Question 22

Ceding Commission Types

Answer 22

“(1) Flat – predetermined % based on ceded premium
(2) Sliding – requires provisional loss ratio and CC that slides with loss ratio
(3) Contingent – hybrid; starts with flat with potential for contingent commission if loss ratio is low

Sliding is more administration to apply & contingent as well plus contingent may not be known for a while due to delayed losses”

Question 23

Contingent Formula / Steps

Answer 23

“(1) Ceded premium
(2) less Ceded losses
(3) less Flat Commission (Based on #1)
(4) less RHOE (factor applied to #1)
(5) less deficit carryforward
(6) equals RI Net P/L
(7) if P, then apply contigent commission to profit”

Question 24

Sliding Formula / Steps

Answer 24

“(1) Calculate ceded loss ratio (ceded losses to ceded EP)
(2) compare loss ratio to provisional to adjust ceding commission based on slide
(3) double check min and max ceding commissions”

Question 25

Types of QS Inception Points

Answer 25

“(1) In Force Only – covers on those policies in force at the time of inception; UEP starts high and earns off (only used to wall off business)
(2) New & Renewal – UEP and EP starts at 0, UEP rises and peaks at 12 months, and EP earns off over the full 24 month period (2nd most common with UW year)
(3) In Force, New, Renewal – generally the same level of exposure over the 12 month contract (most common with accident year)”

Question 26

QS Termination

Answer 26

“(1) Cut-Off – RI has no obligation for losses after 12 months while policies earn off (common)
(2) Run-Off – RI has obligation for losses after 12 mo while IN FORCE policies earn off (no N&R) – less common but beneficial for full protection (don’t have to rewrite terms, allows for more ceded premium, larger ceding commissions, etc.)”

Question 27

QS Accounting Periods

Answer 27

“(1) Calendar Year (rarely used in RI) = when was the loss reported
(2) Accident Year = when did the loss occur
(3) Underwriting Year = when did the policy first go into effect

Definition of accounting period causes issues for termination policies (i.e. is the runoff included in the accounting period?)”

Question 28

Loss Corridors

Answer 28

“Less common than per occurrence caps but used for:
(1) protecting RI margin
(2) when loss ratio is stable
(3) buyers accept loss corridors for higher ceding commissions
(4) large corridors may cause risk transfer issues (not enough ceding)
(5) expressed as # of loss ratio percent

Amount of loss that corresponds to the loss ratio corridor is retained as net for the cedent”

Question 29

RI Margin

Answer 29

Remember to remove the RHOE from the RI margin calculation