Study 1 - Intro to Reinsurance Flashcards
Law of Large Numbers
The mathematical premise that states that the degree of uncertainty is reduced as the number of events increases
Reinsurance
Allows insurers to buy insurance that further spreads the risk of random large losses or unexpected loss frequency against their insurance portfolio
Retrocede
To cede part of a risk to another insurer or reinsurer
Retrocessionaire
The reinsurance company that accepts a retrocession from another company
Intermediary
1) The agent/broker negotiating insurance or reinsurance contracts for another
2) Any party representing another party, in negotiation with a third party
Reasons for forming a reinsurance pool
- Members can draw on the experience and expertise of a lead underwriter who is knowledgeable in a certain class or in a certain region
- They can group themselves behind the specialized knowledge of a common manager
- Participating in a pool is an efficient means of entering a new market or a complex class of business without making a full financial and overhead commitment
- In the case of difficult types of business, particularly when the exposure is out of proportion to available premiums, a pool may be the best or only means of creating reinsurance capacity
Reciprocal insurance exchange
A means of insurance whereby each subscriber appoints a central underwriter as attorney-in-fact to share insurance costs with other insureds in the same group
Underlying Principles of Reinsurance
- Utmost Good Faith
- Follow the Fortunes
- Reinsurance as an honourable engagement
4 Functions of Reinsurance
- To gain surplus relief against the capital demands of a growing portfolio of premium, losses, and other capital strains
- To acquire underwriting capacity sufficient to compete with other insurers for business yet limit exposure to the largest risks and potential losses
- To stabilize operating experience by limiting exceptional fluctuations caused by loss severity, frequency, or both
- To protect capital resources from abnormal or extreme (catastrophic) loss events
Surplus Relief
- An insurance company’s ability to assume risk is based on its capital strength
- Financial capacity may be described as capital resources sufficient to assume the liabilities of policyholders and pay anticipated losses while meeting capital margin requirements
- When reinsurance is used to reduce the size of each risk, the company can increase the number of risks in its portfolio without increasing premiums
Alternatives to reinsurance with respect to surplus relief
- Borrow money which for insurers does not contribute to financial capacity
- Restrict underwriting which would not be as competitive and attractive business would go elsewhere
- Coinsurance, however this tends to be limited to very large individual risks or highly specialized portfolios
- Acquire additional capital which involves convincing new investors. Not a short term solution, requires a relatively permanent commitment
Underwriting Capacity
Reinsurance can be used to transfer portions of individual large risks and allow the company to manage its underwriting by 1) reducing the size and nature of individual liabilities in relation to capital and total premium income and 2) making its portfolio of business more homogenous and thus, more predictable
Stability
Reinsurance can smooth experience by spreading inconsistencies in loss experience over time, over an entire market, or both.
Resource Protection
- One of the most important duties of management is to protect and preserve the company’s capital and surplus
- Reinsurance is designed to protect against random, unpredictable, and capital-threatening loss events such as a catastrophe and is one of the most effective tools for resource protection
