Reinsurance

Question 1

What is reinsurance, and how does it differ from coinsurance?

Answer 1

Reinsurance is a financial arrangement where an insurer (cedant) transfers risk to a reinsurer for a premium, while in coinsurance, multiple insurers share the risk. In reinsurance, the cedant and reinsurer have a contractual relationship, and the reinsurer does not have direct contact with the insured.

Question 2

What are the primary reasons an insurance company uses reinsurance?

Answer 2

Key reasons include increasing underwriting capacity, improving risk capital and diversification, gaining surplus relief, obtaining catastrophic protection, and transferring expertise. Reinsurance allows insurers to manage large or unfamiliar risks without jeopardizing their financial stability.

Question 3

How does reinsurance help insurance companies manage catastrophic risk?

Answer 3

Reinsurers provide coverage for rare, large-scale events like natural disasters by spreading such risks globally. This geographic diversification reduces the capital insurers need to hold for such events, improving financial stability.

Question 4

What is the difference between treaty and facultative reinsurance?

Answer 4

Treaty reinsurance automatically covers all risks within the agreement, while facultative reinsurance involves individual case-by-case risk assessments. Treaty reinsurance is used for predictable, high-volume risks, while facultative reinsurance is used for unique or large risks.

Question 5

What is proportional quota share reinsurance?

Answer 5

In proportional quota share reinsurance, the cedant and reinsurer share premiums, expenses, and claims proportionally. For example, in a 50% quota share agreement, the reinsurer covers 50% of each risk, while the cedant retains 50%.

Question 6

How does surplus or excedent reinsurance differ from quota share reinsurance?

Answer 6

In surplus reinsurance, the cedant sets a retention limit, and only the risk exceeding this limit is transferred to the reinsurer. Each risk may have a different cession percentage, unlike quota share where the same percentage applies to all risks.

Question 7

What is excess of loss reinsurance, and how does it work?

Answer 7

Excess of loss (XL) reinsurance is a non-proportional agreement where the reinsurer covers losses exceeding a predetermined threshold (priority) up to a limit (capacity). It is used to protect against large individual claims.

Question 8

What is stop loss reinsurance, and when is it typically used?

Answer 8

Stop loss reinsurance covers aggregate losses over a defined period, usually a year, once claims exceed a certain percentage of premiums. It is used to protect insurers from unexpected high cumulative losses across their entire portfolio.

Question 9

What are the advantages of combining different types of reinsurance agreements?

Answer 9

Combining reinsurance types, like quota share and excess of loss, allows insurers to share regular risks while also securing protection against catastrophic or large claims, providing a more balanced and flexible risk management solution.

Question 10

What role do reinsurance brokers play in the reinsurance market?

Answer 10

Reinsurance brokers act as intermediaries between insurers and reinsurers, helping to structure and negotiate reinsurance contracts tailored to the insurer’s needs. They leverage their market expertise and relationships to secure the best terms, especially when reinsurance capacity is limited or specialized coverage is needed. Brokers also provide administrative support, assist with claims management, and ensure regulatory compliance. Their role ensures insurers can effectively transfer risks while maintaining financial stability and meeting their risk management goals.

Question 11

How do captives and pools function in the reinsurance industry?

Answer 11

Captives are insurance companies owned by a parent group that insures risks within the group. Pools are agreements between insurers to share risks of a certain type, which allows them to achieve more predictable results through diversification.

Question 12

What is retrocession, and why is it used by reinsurers?

Answer 12

Retrocession is when a reinsurer transfers part of its assumed risk to another reinsurer (retrocessionaire). It helps reinsurers manage their own risk exposure, ensuring they don’t retain too much risk.

Question 13

What are the main regulatory concerns regarding reinsurance?

Answer 13

Regulators ensure that reinsurance arrangements are sound and that the reinsurers are solvent enough to honor their commitments. The cedant may need to increase its capital if using low-rated reinsurers, and in some cases, regulators may monitor reinsurance agreements for compliance.

Question 14

How does reinsurance provide surplus relief to insurers?

Answer 14

Reinsurance transfers risk off the insurer’s balance sheet, reducing the statutory surplus required by regulators. However, it introduces counterparty risk, and insurers may need to hold additional capital depending on the reinsurer’s solvency rating.

Question 15

What is the role of expertise transfer in reinsurance?

Answer 15

Reinsurers, through their global experience and expertise in underwriting and claims management, transfer valuable knowledge to insurers. This is particularly important when entering new markets or launching new products.

Question 16

What is a reinsurance treaty, and what key elements should be examined?

Answer 16

A reinsurance treaty is a formal contract that defines the terms of risk transfer between a cedant and a reinsurer. Important elements include the reinsurer’s solvency, the definition of reinsured risks, payment terms, cancellation conditions, and dispute resolution clauses.

Question 17

What is a burning cost evaluation, and how is it used in reinsurance pricing?

Answer 17

Burning cost evaluation is a method of pricing non-proportional reinsurance by analyzing historical claims data to determine the likelihood and cost of claims exceeding the reinsurer’s priority. The calculated risk premium is then adjusted for expenses and profit.

Question 17

How does non-proportional reinsurance differ from proportional reinsurance?

Answer 17

In non-proportional reinsurance, the reinsurer covers claims that exceed a specified threshold, while in proportional reinsurance, premiums, expenses, and claims are shared proportionally between the cedant and reinsurer.

Question 18

What is a catastrophic excess of loss (Cat-XL) reinsurance?

Answer 18

Catastrophic excess of loss (Cat-XL) reinsurance covers claims arising from catastrophic events like earthquakes or floods once losses exceed the agreed priority. It is designed to protect insurers from rare, extreme events.

Question 19

What is the significance of the choice of law and arbitration clauses in reinsurance treaties?

Answer 19

The choice of law clause determines which jurisdiction’s laws will govern the treaty, while the arbitration clause provides a method for resolving disputes without litigation. Both clauses are critical for defining the legal framework and dispute resolution process in reinsurance agreements.

Question 20

What is a “premium” in the context of insurance and reinsurance?

Answer 20

A premium is the payment made by the insured to the insurer in exchange for risk coverage. In reinsurance, the cedant pays a portion of the premium to the reinsurer to transfer part of the risk. For example, if an insurer charges a $1,000 annual premium for coverage, it may pay 20% of that to the reinsurer for sharing the risk.

Question 21

How is “capacity” defined in reinsurance agreements?

Answer 21

Capacity is the maximum amount of risk the reinsurer is willing to accept. For example, in a $100,000 excess of $20,000 treaty, the capacity is $100,000, meaning the reinsurer will cover losses above $20,000 up to a maximum of $100,000.

Question 22

What is “risk premium,” and how does it differ from a regular premium?

Answer 22

The risk premium refers to the part of the premium allocated specifically for covering the expected cost of future claims. It is calculated based on the historical loss experience. In contrast, the regular premium also includes operational costs and profit margins for the insurer.

Question 23

What is the difference between “quota share” and “surplus share” reinsurance?

Answer 23

In quota share reinsurance, the cedant and reinsurer share premiums and losses based on a fixed percentage. In surplus share, the cedant retains a fixed amount of each risk (retention), and the reinsurer covers the remainder. For instance, a $200,000 risk with a $50,000 retention means the reinsurer covers $150,000 under surplus share.

Question 23

What is a “catastrophic excess of loss” (Cat-XL) treaty?

Answer 23

Catastrophic excess of loss (Cat-XL) reinsurance provides protection against large-scale catastrophic events like earthquakes or hurricanes. It only kicks in after a predefined loss threshold has been met, such as after a single event causing at least $10 million in damage.

Question 24

What does “priority” mean in excess of loss reinsurance?

Answer 24

Priority, also known as retention, is the amount the insurer retains before the reinsurer’s coverage kicks in. For example, in an excess of loss treaty with a $100,000 priority, the insurer pays for all losses up to $100,000, and the reinsurer covers the rest.

Question 24

What is a “ceding commission,” and why is it important in reinsurance?

Answer 24

A ceding commission is a payment from the reinsurer to the cedant to cover the administrative and acquisition costs of obtaining the business. For example, if the cedant spends $10,000 on marketing and underwriting, the reinsurer may compensate a portion through the ceding commission.

Question 25

What is meant by “surplus relief” in the reinsurance context?

Answer 25

Surplus relief is the reduction in an insurer’s required surplus reserves due to reinsurance. By ceding risks to reinsurers, insurers reduce the capital they need to hold to meet regulatory requirements, thereby enhancing their ability to underwrite new business.

Question 25

How does “retrocession” function in reinsurance?

Answer 25

Retrocession occurs when a reinsurer transfers some of its risk to another reinsurer, known as the retrocessionaire. This helps reinsurers manage their own risk exposure. For example, a reinsurer that takes on high-risk policies may retrocede a portion to mitigate financial strain.

Question 26

What are “proportional” and “non-proportional” reinsurance?

Answer 26

Proportional reinsurance involves sharing premiums, losses, and expenses between the cedant and reinsurer based on a predetermined percentage (e.g., quota share). Non-proportional reinsurance only covers losses above a specific threshold, such as excess of loss treaties, where the reinsurer only pays for losses exceeding the cedant’s retention.

Question 27

What is “burning cost” in reinsurance pricing?

Answer 27

Burning cost is the method of pricing reinsurance by analyzing the historical claims that exceed the retention. For example, if claims exceeding $1 million occurred three times in five years, the burning cost helps predict future claims, informing the reinsurance premium calculation.

Question 28

How does “experience rating” work in reinsurance?

Answer 28

Experience rating adjusts the reinsurance premium based on the past claims experience of the cedant. If an insurer has fewer claims than expected, they might receive a lower future premium, while higher-than-expected claims could increase the premium.

Question 29

What is a “treaty reinsurance” agreement?

Answer 29

Treaty reinsurance is an automatic agreement that covers all risks of a specific type, as defined in the treaty, between the cedant and reinsurer. For example, an insurer might enter a treaty to cede 40% of all auto policies to the reinsurer without needing individual approval for each policy.

Question 30

What is the significance of the “errors and omissions” clause in reinsurance?

Answer 30

The errors and omissions clause ensures that unintentional clerical or administrative mistakes do not invalidate the reinsurance agreement. If a cedant accidentally omits a risk from the treaty, this clause allows the error to be corrected without canceling the entire treaty.

Question 31

What is a “retrospective rating” in reinsurance?

Answer 31

Retrospective rating adjusts the premium after the reinsurance period based on the actual loss experience. For example, if the actual losses are lower than expected, the cedant may receive a premium refund. If losses are higher, the reinsurer may charge additional premiums.

Question 31

What is “stop loss reinsurance,” and when is it typically used?

Answer 31

Stop loss reinsurance protects an insurer against aggregate losses that exceed a specified threshold during a set period, often a year. For example, if an insurer has a stop loss agreement with a 75% loss ratio threshold, the reinsurer will pay for losses exceeding 75% of the premiums collected.

Question 32

What is “following the fortunes” in reinsurance contracts?

Answer 32

Following the fortunes” means that once the reinsurer agrees to cover a risk, it must follow the decisions of the cedant regarding claims settlements. This clause ensures that reinsurers cannot dispute claims decisions made by the cedant, provided they are reasonable and in good faith.

Question 33

What is the purpose of a “reinstatement clause” in reinsurance?

Answer 33

A reinstatement clause allows the cedant to restore reinsurance coverage after a claim has exhausted the original coverage. The cedant pays an additional premium to reinstate the coverage. For example, if a catastrophic loss exhausts a $10 million limit, the reinstatement clause enables the insurer to continue receiving protection.

Question 34

What is an “ultimate net loss” in reinsurance?

Answer 34

Ultimate net loss refers to the total amount the insurer is liable to pay after all recoveries and deductions. It includes legal costs and expenses. For example, in liability insurance, the ultimate net loss might cover not just the settlement but also court and legal fees.

Question 35

How does “loss adjustment expense” (LAE) factor into reinsurance?

Answer 35

Loss adjustment expenses are the costs incurred by the insurer in investigating and settling claims. This includes legal fees, adjusters’ fees, and administrative expenses. LAE is an important part of reinsurance contracts because it impacts the reinsurer’s share of the total claim.

Question 36

What is the “ceding company’s” role in a reinsurance agreement?

Answer 36

he ceding company is the original insurer that transfers part of its risk to a reinsurer. For example, a health insurer may cede 50% of its risk to a reinsurer to reduce its exposure to high-cost claims.

Question 37

What is “premium earned” versus “premium unearned” in insurance?

Answer 37

Earned premium is the portion of the premium that corresponds to the period during which the insurer has provided coverage. Unearned premium is the amount paid for future coverage. For example, a one-year policy halfway through its term has 50% of the premium earned and 50% unearned.