Risk Markets Flashcards
Define a risk
An uncertain event or condition, which if occurs, would impact on the achievement of an objective. We are concerned with risks that have a possibility of loss exposure (an uncertain event leading to a possible loss.)
Define risk transfer
is passing risk onto to professional counterpartiesD
Define retrocession
is the reinsuring of a risk by a reinsurer.
Define a peril and give different types
Peril is the underlying cause of the loss – the risk event.
Natural Perils
Human Perils
Economic Perils
Define hazard
Hazard is a condition that increases the frequency or severity of a loss. Ex: smoking is a mortality hazard
What is a viatical settlement
Allows you to invest in another person’s life insurance policy. With a viatical settlement, you purchase the policy (or part of it) at a price that is less than the death benefit of the policy. When the seller dies, you collect the death benefit.
How does efficiency relate to risk transfer
The market is said to be risk efficient if there is a good market for risk transfer ie. many companies, good capacity, reasonable transparency on prices etc
What does reinsurance do to risks and what do reinsurers offer
Insurance/reinsurance replaces event risk (and liquidity risk) with (the much smaller) event-counterparty risk combination
Reinsurer is the insurance company that insurer (‘direct writer’)
uses- have very specialist expertise
Reinsurance premium is more than the expected value of the claim
Must assess total value of services by reinsurers as well as pure risk mitigation
Reinsurers you expect to lose money but purpose is to try reduce tail risk of lots of things in aggregate going wrong together
What risks are reinsurers exposed to
Reinsurers can be exposed to a lot of counterparty risk. Ex: Hurricane risk - Reinsurer may go bust and can’t pay the insurer who had them reinsuring them.
To transfer risks you need to know there’s no information asymmetry. Otherwise reinsurer may not know how much risk they take on.
Why are reinsurers used?
Balance sheet protection to protect the solvency of the company.
Stabilise profit stream and selling volatility
To increase capacity
Achieve a more balanced mix of business (reciprocity)
Gain experience in new markets/new products
Cash flow assistance
For arbitrage
Explain why reinsurance can help achieve a more balanced mix of business - reciprocity idea
Reciprocal insurance exchanges are a form of insurance organisation in which individuals and businesses exchange insurance contracts and spread the risks associated with those contracts among themselves.
What do reinsurance contracts look like?
Can be contracts for differences, meaning you settle up at the end
Contracts are often tailored to meet the particular needs of the ceding company
Coinsurance contracts may be in place
Risks can be ceded on a facultative basis or under a treaty arrangement
What is coinsurance
Coinsurance is reinsuring a risk with several reinsurers. (don’t want credit risk to one particular company for big amounts)
What is meant by faculative or treaty arrangement and what are the consequences of these
Risks can be ceded on a facultative basis (each risk on an individual basis) or under a treaty arrangement (a blanket arrangement across an entire class of business.)
Treaty contracts; only negotiated once and then in place. Generally personal lines
Facultative means every risk has to be approved.
What is meant by proportional reinsurance and name two types
Reinsurer covers an agreed proportion of each risk: may be constant or may vary by risk covered
Does not cap the cost to the insurer of very large claims
Ex: quota share or surplus reinsurance
Explain quota share reinsurance
Fixed % of every risk is reinsured. Often used to spread risk, write larger portfolios of risk and encourage reciprocal business. Reinsurer pays half claims and gets half the premium for example (plus reinsurance premium)
Explain surplus reinsurance
Treaty specified the retention level and a maximum level of cover available form the reinsurer. For each risk the total cover (up to max) is now divided between insurer and reinsurer so the insurer is left with Line/[Total Cover], if Total Cover>Line, otherwise 100%. The reinsurer meets the balance (up to max), Constant of proportionality would be different for bigger contracts. Retention and max levels are specified in the treaty. For commercial covers of property, business etc they can be selected by the cedant.
Explain non proportional reinsurance and name types
Used to get a cap on max loss
Enables the provider to accept risks that might give rise to large claims.
Stabilises the technical results of ceding provider by reducing claims fluctuations
Ex:
Excess of loss reinsurance
Risk excess of loss
Aggregate excess of loss (Aggregate XL)
Catastrophe excess of loss
Explain excess of loss reinsurance
Cost to a ceding company of large claims is capped with the liability above a certain level being passed to a reinsurer called the excess point. If the claim amount exceeds the upper limit of the reinsurance, the excess will revert back to the ceding company.
Explain Risk XL reinsurance
Relates to individual losses (one risk or per event basis)
Where a risk event can only result in the payment of the full sum insured, or no payment at all, claim amounts are identical under individual risk XL and surplus reinsurance.
Differ if there is a claim for less than the full sum.
Will be an excess point or deductible and a max limit.
Payout: Min(Max(direct claim minus deductible, 0),limit)
Explain Aggregate XL reinsurance
Covers the aggregate of losses over a portfolio above an excess point and subject to an upper limit, sustained from a defined peril (or perils) over a defined period, usually one year.
Used when events can occur which involve losses to several insured risks
Claims may not be of exceptional size, but collectively the aggregate cost might be damaging
Stop loss reinsurance is a particular type but its not generally used.
Explain Stop loss reinsurance
When all perils are covered for a ceding company’s whole account, or for a major class of business within the whole account, this is sometimes referred to as Stop Loss reinsurance. - type of Aggregate XL
Explain Catastrophe XL
Contract will outline the amount of payment which is typically excess of the total claim amount over the cedant’s catastrophe retention level.
Definitions can be a long period of negotiation: what is a CAT
Reinsurance liability in respect of a single catastrophe claim would be subject to a maximum amount
Available on a yearly basis and then are renegotiated.
What is ART?
Alternative risk transfer produces tailor-made solutions for risks that the conventional market would regard as uninsurable, using both capital market and insurance techniques.
Before ART insruance risks and capital market risks were separate
In theory capital markets have vastly greater capacity than the insurance sector to absorb those risks - hence market amergence. as insurers are restricted in the capital they can raise
