Reinsurance Flashcards
Define the term ‘reinsurance’ [1]
Reinsurance us a form of insurance. It is a means by which an insurance company obtains from other insurance companies protections against the risk of losses.
State what is meant by the term ‘retrocession’ [2]
Retrocession is reinsurance of reinsurance and is a very specialist area of the reinsurance market. A retrocession protection is necessary where a reinsurer that accepts substantial amounts of reinsurance business requires reinsurance protection itself.
The ceding reinsurer in a retrocession is called the retrocedant and the assuming reinsurer is called the retrocessionaire.
Explain why reinsurance brokers may often compete with professional reinsurers [2]
Reinsurance need not only be handled by reinsurance brokers. In some international markets, professional reinsurers often deal directly with insurers in placing their reinsurance. These relationships could have come about historically based on business culture, customs, practices or language.
Define the term ‘fronting’ and explain its advantages and disadvantages [4]
Fronting occurs when an insurer, acting as a mere conduit, underwrites a risk and cedes all (or nearly all) of the risk to another insurer (which is technically acting as a reinsurer). The ceding or ‘fronting’ insurer will typically receive a fee for its involvement to cover its expenses and profit.
Advantages of assuming insurer using a fronting arrangement:
- it may not be licensed to write a specific line of business in a particular country or state of the US
- its credit rating may be inadequate to satisfy the insured’s minimum requirement
- tax advantages
Disadvantages:
- although the fronting insurer is not generally concerned with the profitability of the business, it is liable if the assuming insurer fails to meet its obligations
- the fronting insurer should assess the credit rating of the assuming insurer prior to entering a fronting agreement and may require the risk-bearing party to provide some form of collateral to help mitigate the credit risk, for example, a letter of credit
- in some jurisdictions, regulators do not look favourably on fronting agreements
Define the term ‘captive’ [1]
A captive insurance company may be established to self-insure insurance risk. Captive insurance companies are generally allowed more flexibility that traditional insurers in the creation of their reinsurance arrangement, taking advantage of local regulatory or tax regimes.
State the main reason for purchasing reinsurance [1]
To cover the unknown financial consequences of possible future perils
Outline how reinsurance can be used to limit exposure to accumulations of risk [3]
In general, when an insurer fears a loss of a combination of losses that would materially (adversely) affect the results within its portfolio, it will consider reinsurance.
This adverse effect could be due to one single event or from related events and it may arise because an insurer is particularly exposed to a certain peril or territory.
Thus, geographic exposure of risk is an important consideration in reinsurance purchases. An insurer must control its aggregations of many individual risks in one specific area or zone, especially if those risks are subject to natural peril events. An insurer might also accept business from different sources.
Therefore, an insurer could have an accumulation of different interests on the same risk and reinsurance offers protection against these.
State the factors that influence an insurer’s appetite for reinsurance [2]
An insurer’s appetite for offsetting its risk through reinsurance is influence by the:
- size of the insurer
- insurer’s experience in the marketplace
- insurer’s available free assets
- size of the insurer’s portfolio
- range within which the business outcome (or profit) can be forecast with confidence
- the cost and availability of reinsurance
Explain the main feature of a particular risk that would influence the need for reinsurance [2]
The size of a particular risk is very important. Reinsurance can help an insurer to reduce its involvement in very large risks to containable levels.
What is large to an insurer will depend on the size of the free assets available. Many risks in insurance have very high payout limits; some may even offer unlimited cover. Many small to medium-sized insurers will cede a top layer of the potentially large payouts to reinsurers as cover against this eventuality. This is especially true in liability lines where excess of loss reinsurance is common place.
Explain how reinsurance can help smooth results [3]
By reinsuring larger risks or accumulations of smaller risks, the development of financial results can be smoother. Reinsurance prevents the potential for fluctuations or variations from planned results when losses are subject to variations in number and/or size. Purchasing reinsurance will usually reduce profit but it might also protect and insurer against severe losses.
The insurer pays a premium to mitigate these fluctuations and its net result is more predictable. This predictability may be more acceptable to shareholders and regulators.
State how reinsurance can help improve an insurer’s financial results [1]
Reinsurance can increase the opportunity for an insurer to make a profit and plan its business more accurately
Outline the link between solvency and the use of reinsurance [2]
Solvency depends on the relationship between an insurer’s solvency margin and the total premium income that insurers generate from all the lines of insurance business written. Governments everywhere use financial regulation to protect consumers. Calculating an insurer’s solvency margin is an important part of financial regulation and allowance is often made for reinsurance in its calculation.
Reinsurance is an accepted management tool to improve an insurer’s solvency margin. It helps an insurer to plan its operations more effectively and strengthen its balance sheet.
State how reinsurance can increase an insurer’s capacity to accept risk [1]
Owing to insufficient capital backing, an insurer may be reluctant to accept, or be incapable of accepting, particular risks by sector or by volume. For example, an insurer may be unable to accept risk that is larger than its financial strength allows.
Reinsurance can increase the size of an insurer’s underwriting capacity, allowing it to compete more effectively in the market.
Explain how reinsurance can provide financial assistance [3]
Reinsurance funds can assist financially with particular business propositions. Where a particular distribution strategy would involve substantially more cash outflows in the initial stages than premium income, reinsurance commission may be available in return for future surplus streams. In effect, the reinsurer lends now againstt the predicted future flows of premium less expenses and claims.
Propertional reinsurance allows this reimbursement. As companies grow and become stronger, they tend to use more excess of loss and less proportional reinsurance.
An insurer could use a reinsurer as a partner to support its new operations. It can share developmental and operational costs with the other party.
Where a block of renewing business which is producing regular profits is identified, capital can be found for the insurer to bolster the free asset position by reinsuring this portfolio of profitable policies. The reinsurer would pay an initial commission in return for which the reinsurer would pay an initial commission in return for which the reinsurer would be entitled to the future surplus of premiums over claims for as long as the arrangement remained in place.
