Proportional Reinsurance

Question 1

What is a cession rate?

Answer 1

The percentage of primary risk ceded to a reinsurer.

Question 2

What is a retention rate?

Answer 2

The percentage the primary insurer retains.

Question 3

What is a cession limit?

Answer 3

It describes the largest individual loss to which a reinsurer is exposed.

Question 4

Name two disadvantages of FAC

Answer 4

1. Time consuming and costly. Only economically viable to use FAC when large risks make up a small portion of the total portfolio (approx 1%).
2. Needs the reinsurer to agree before the insurer can offer its customer cover.

Question 5

What is a treaty limit?

Answer 5

As known as the treaty capacity, it specifies the maximum sums insured that can be included in the treaty.

Question 6

What is automatic underwriting capacity (AUC)?

Answer 6

The max sums insured that the primary insurer wants to be able to accept from its customers without having to buy FAC.

Question 7

In a QS, if the primary insurer wants an AUC of USD5m, the quota share treaty limit will be set at XX?

Answer 7

USD5m. Sums insured in excess of that either need to be retained or more commonly, covered by FAC.

Question 8

If an insurer’s AUC is USD5m and policy band D has USD6m sums insured, what percentage needs to go to FAC?

Answer 8

USD1m/USD6m = 16.67%.

Question 9

Three types of commission that reinsurers pay provide

Answer 9

1. Fixed commission
2. Sliding scale commission
3. Profit commission

Question 10

If the reinsured and reinsurer want to make the allocation of underwriting result proportional, the commission rate will be set at a XX to the reinsured’s expense ratio?

Answer 10

The commission rate will be set at a rate equal to the reinsured’s expense ratio. e.g if reinsurer received prem is USD40k and commission is 30%, it would be USD12k.

Question 11

If the reinsurer wants to give a greater proportional of the underwriting result to the reinsured than the cession rate, it can pay a commission rate XX than the reinsured’s gross expense ratio.

Answer 11

It can pay a commission rate higher than the reinsured’s gross expense ratio.

Question 12

If the reinsurer wants to give a smaller proportion of the underwriting result to the reinsurer than the cession rate, it can pay a commission rate XX than the reinsured’s gross expense ratio.

Answer 12

It can pay a commission lower than the reinsured’s gross expense ratio.

Question 13

when talking about primary insurer’s UW margin, what is diff between gross and net?

Answer 13

Gross is the primary insurer’s initial UW margin before ceding it via reinsurance. Net is after treaty/fac placement.

Question 14

Difference between Original Gross Rate Basis (OGR) and Original Net Rate Basis (ONR) for commission?

Answer 14

OGR - the commission is calculated based on the initial prem the primary insurer receives.

ONR - The commission is calculated as percentage of prem received by primary insurer AFTER deducting its acquisition costs eg. commission that the primary insurer pays to its brokers and internal costs related to acquiring the business.

Question 15

What is the sliding scale commission structure?

Answer 15

It rewards the reinsured for writing business with a low loss ratio. If the loss ratio is low, the reinsured receives a high commission rate.

Question 16

What is a profit commission?

Answer 16

Like a sliding scale, it rewards an insurer for writing business with a low loss ratio.

Question 17

What is credit risk?

Answer 17

Primary insurer shares its reinsurance programme between diff insurers so that it reduces the risk of them being exta liable if one or more were to default.

Question 18

When is a QS used? Name seven

Answer 18

1. When an insurer’s capital is constrained, QS provides relief.
2. When cost of buying a QS is less than the cost of capital. Lower cost implications over direct capital investment/loans. Improves solvency ratio.
3. Reinsured is not sure how much cap it needs or for how long and so wants cap that is flexible and can be changed year to year. e.g agricultural policies
4. When there is high risk of error or change.
5. When high acquisition costs are causing liquidity issues. e.g if insurer entering new market, project, it will need cash to pay upfront costs. Also known as financing quota share.
6. A reinsurer wants to share profitable business and not just UW high risk portfolio. It’s a package deal. Also known as supporting or compensating quota share.
7. Good for portfolios already diversified and balanced.

Question 19

What is surplus reinsurance?

Answer 19

It’s a reinsurance in which an insurer transfers its sums insured in excess of a fixed sum insured to a reinsurer.

Question 20

Advantages to using surplus. Name 3

Answer 20

1. Allows the reinsured to retain more of its overall portfolio for its own account.
2. Reinsured can reduce its retention in the case of particularly high risk insurance contracts, thus achieving a better result in its retained portfolio.
3. Portfolio remaining in the reinsured’s retention is more balanced in terms of sums insured. Relives the peaks and the reinsured’s retained portfolio is homogenised.

Question 21

When is the surplus used?

Answer 21

Used in property business and most suited to reinsuring an insurance portfolio consisting of many policies which differ in size as regards their sums insured or limits of liability.
Balances portfolio.

Question 21

Name four disadvantages in using surplus.

Answer 21

1. For the reinsurer, it’s unbalanced, because risks ceded are more exposed in terms of both amounts and hazards involved. Elements of anti-selection
2. Lots of admin work, cost intensive.
3. Risk change over an entire portfolio can affect the reinsured more than the reinsurer.
4. CAT risk has greater impact on the primary insurer.

Question 22

What is a successive surplus treaty?

Answer 22

When reinsurers offer additional treaty cap, over and above a surplus but at tighter conditions.

Question 23

What does ‘open cover’ refer to?

Answer 23

It mostly refers to fac-oblic reinsurance cover.

Question 24

How does FAC oblig work?

Answer 24

Fac oblig is optional for the reinsured but obligatory for the reinsurer.

Question 25

Explain FAC oblig.

Answer 25

Reinsured can decide for itself which contracts (within treaty limits) it wishes to bring into fac oblig and for what shares, and how much of each insurance policy it wishes to retain for its own account. If the reinsured wishes, it can cede to the fac oblig treaty all or part of the portion exceeding both its retention and cessions to its oblig reinsurance treaties.

Question 26

2 Advantages and 3 disadvantages of Fac oblig.

Answer 26

Advantage 1. Gives reinsured the greatest possible room for maneuver and allows it to reinsurer risks which could jeopardise its underlying insurance treaties. 2. Gives reinsured the freedom in the selection of risks, which it wishes to reinsure. Disadvantage: 1. Above is disadvantage to reinsurer as it is exposed to the danger of anti-selection. 2. No longer a balanced portfolio. 3. Admin work and cost intensive.

Question 27

When is fac oblig used and why?

Answer 27

If a primary insurer has to place multiple facs, it will be interested in additional auto cap. Can be placed when there is an oversupply of reinsurance cap in the market. Reinsurer can try to accommodate to maintain relationship but would usually apply strict conditions to avoid anti selection.

Question 28

In the case if a fac oblig treaty, what limitations restrict a reinsured's freedom to cede?

Answer 28

Treaty limit, limitations in terms of class of business and territory, limitations in terms of time, exclusions.

Question 29

Name 2 potential reasons for a quota share after a suplus

Answer 29

1. The reinsured feels that after the surplus, it would like to further reduce its required capital and reduce its retention using quota share. 2. The reinsurer is unwilling to offer the surplus on a standalone basis because it is receiving a non-homogeneous portfolio. They require a quota share so it does not only have a share of the high sums insured policies. This QS is know as a supporting quota share. Cession rates also tend to be lower because reinsured isn't arranging for capacity.

Question 30

Name 2 reasons for a surplus after a quota share

Answer 30

1. The net sums insured (what the reinsured retains) after the quota share are non homogenous and the reinsured wants a surplus to homogenise them. 2. The reinsured wants to limit its maximum exposure per poilcy while retaining a high proportion of the prems from the portfolio.

Question 31

Both QS and surplus treaties calculate:

Answer 31

A cession rate for each policy and allocate sums insured, premiums and claims using this rate.

Question 32

What are the fundamental differences in the application of cession rates between QS and surplus treaties in the context of proportional reinsurance?

Answer 32

A QS treaty uses a single cession rate, which is applied to all policies in the treaty. A surplus treaty fixes the retention amount and calculates the retention rate by expressing this as a percentage of the sums insured for each policy.

Question 33

How does the commission rate in a proportional reinsurance treaty influence the distribution of the UW result between the reinsurer and the reinsured?

Answer 33

A commission rate equal to the reinsured's gross expense ratio will result in a proportional split of the UW result between reinsurer and reinsured. A higher commission rate will give the reinsured a greater proportion of the UW result.

Question 34

What ae the different types of commission structures used in proportional treaties, and how do they relate to the loss ratio and UW profit?

Answer 34

Commission rates are either paid as a fixed percentage of the ceded premiums or on a sliding scale where a higher commission is paid if the loss ratio is lower. A profit commission is another way of rewarding the reinsured for a low loss ratio since the reinsurer returns a share of any profit from the treaty to the reinsured.

Question 35

How do QS and surplus treaties in a proportional reinsurance differ in their impact on a portfolio's capital efficiency, homogeneity, and Return on Risk-Adjusted Capital (RORC), and how do they influence the solvency ratio?

Answer 35

A QS is unable to improve the capital efficiency of a portfolio because it does not improve the homogeneity of the book. If there is no commission override, the net RORC will be the same as the gross RORC since neither the UW margin nor the capital intensity ratios change. A surplus does have a homogenising effect and therefore does improve capital efficiency and increase RORC. Both are able to reduce capital required and hence improve and protect the solvency ratio although a QS does this more comprehensively.

Question 36

Why might a company in its start up phase choose a QS treaty and under what circumstances would a company prefer a surplus structure in proportional reinsurance?

Answer 36

A QS is common when a company is in a start up phase as it may be capital constrained, suffering liquidity challenges due to high start up costs and at a higher risk of error as it is new to the market. However, it can be an effective tool for managing solvency and providing capacity for growth for companies at any stage of their development. A surplus structure is more commonly used when a company wants to homogenise its portfolio.

Question 37

What are the strategic purposes of implementing a QS after surplus and a surplus after QS? How do these structures impact portfolio homogenization and capital requirements?

Answer 37

A QS after surplus is primarily designed to help the reinsured homogenise a portfolio while allowing it to flexibly adjust its capital required by the choice of cession rate of the QS. A reinsurer may demand a QS as a compensation for taking on a non homogeneous book even if the reinsured would not choose to add the QS. A surplus after QS is primarily designed to obtain the benefits of a QS with the addition of the surplus helping to homogenise the sums insured.

Question 38

Impact of QS on the reinsured? 1. UW margin 2. CIR 3. Solvency Ratio 4. Cost of capital

Answer 38

1. Impact depends on the commission rate 2. No effect because a QS does not make the portfolio more homogeneous. 3. Increases because a QS reduces the required cap by reducing the normal claims at the 99.5% confidence level and the CAT claims at the 1 in 200 year level. 4. Reduce because risk is reduced.

Question 39

Retention tables (tables of limit) are likely to be part of surplus treaties. Which statement is correct? 1. Retention tables exclude significant/serious risks. 2. Retention tables limit reduce the cedent's retention for certain risk categories and consequently the reinsurance capacity. 3. Retention tables limit/reduce the contractual reinsurance capacity per risk category whereas the primary insurer is free to choose its net retention. 4. Retention tables limit the number of risks belonging to certain categories of significant risks.

Answer 39

2. Retention tables limit reduce the cedent's retention for certain risk categories and consequently the reinsurance capacity.

Question 40

Which of te following best describes the impact of a proportional reinsurance treaty on an insurer's risk profile? 1. Has no impact on the insurer's risk profile. 2. Increase the risk profile due to shared premiums. 3. Decreases the risk profile by reducing the net liability. 4. Transfers all risks to the reinsurer.

Answer 40

3. Decreases the risk profile by reducing the net liability.

Question 41

In a QS treaty, the reinsurer's share of premiums and losses is typically determined based on: 1. A fixed proportion regardless of the size of the loss. 2. The ceding company's overall profitability. 3. Varying proportions based on the loss size. 4. Equal proportions.

Answer 41

1. A fixed proportion regardless of the size of the loss.

Question 42

The 'line' in a surplus share treaty refers to: 1. The total amount of reinsurance provided under the treaty. 2. The ratio of premium to the amount of coverage. 3. A unit of retention by the ceding company. 4. The maximum amount the reinsurer will indemnify.

Answer 42

3. A unit of retention by the ceding company.

Question 43

Which of the following is true about ceding commission in proportional reinsurance? 1. It is paid by the ceding company to the reinsurer. 2. It is determined by the size of the claim. 3. It compensates the ceding company for acquisition and admin costs. 4. It is always a fixed percentage of the premium.

Answer 43

3. It compensates the ceding company for acquisition and admin costs.

Question 44

The retention limit in a surplus treaty is determined by: (2) 1. The financial strength of the ceding company. 2. A fixed percentage of the policy limits. 3. The reinsurer's underwriting guidelines. 4. The ceding company's past loss experience.

Answer 44

1. The financial strength of the ceding company. and 4. The ceding company's past loss experience.

Question 45

In a scenario where an insurer has surplus after QS reinsurance treaty, which of the follow best describes how losses are typically allocated? 1. Losses are first applied to the surplus treaty, with any remaining amount covered by the QS treaty. 2. Losses are shared equally between the QS and surplus treaties. 3. Losses are first allocated to the QS treaty, with any excess applied to the surplus treaty. 4. The QS and surplus treaties operate independently, with losses assigned randomly.

Answer 45

3. Losses are first allocated to the QS treaty, with any excess applied to the surplus treaty.

Question 46

How does the combo of QS and surplus treaty impact an insurer's retention limit? 1. The retention limit is determined solely by the surplus treaty, irrespective of the QS arrangement. 2. The retention limit remains unchanged, but the overall risk exposure is reduced. 3. The retention limit is typically lowered due to the additional coverage provided by the QS treaty. 4. The retention limit increases, as the QS treaty absorbs a portion of the risk.

Answer 46

2. The retention limit remains unchanged, but the overall risk exposure is reduced.

Question 47

In the context of proportional reinsurance, 'retention' most accurately describes: 1. The insurer's portion of risk on each policy. 2. The premium income retained by the insurer. 3. The number of policies in the portfolio retained by the insurer. 4. The maximum liability assumed by the reinsurer.

Answer 47

1. The insurer's portion of risk on each policy.

Question 48

A surplus share treaty is distinct from a QS treaty in that it: 1. Requires a fixed retention limit for all policies. 2. Shares risks and premiums in an equal ratio. 3. Covers all risks regardless of size. 4. Only applies to losses exceeding a certain threshold.

Answer 48

4. Only applies to losses exceeding a certain threshold.

Question 49

In proportional reinsurance, the ceding company transfers a portion of its XX to the reinsurer in exchange for an XX portion of the XX.

Answer 49

Claims/losses Equal Premiums

Question 50

The XX in a surplus reinsurance is the maximum amount of sum insured that can be included in the treaty.

Answer 50

Treaty limit/Treaty capacity

Question 51

A XX is paid by the reinsurer to the ceding company to cover XX and as a XX for writing profitable business. The three most common types are XX, XX and XX.

Answer 51

Commission Costs/expenses Reward Profit/Sliding scale/Fixed

Question 52

The reinsurer is motivated to request QS after surplus reinsurance if the cedent portfolio is too XX, so it does not only have a share of the high sum insured policies.

Answer 52

Heterogeneous