Study 2 - Methods and Types of Reinsurance Flashcards
Methods? Types?
Methods: Facultative (individual risks) & Treaty (portfolios of risks)
Types: Proportional (pro-rata) and Non-Proportional (excess)
Binder
A written or oral agreement given by an insurer to insure a risk, pending the issuance of a formal policy. A binder is deemed to be the policy and must be cancelled in the same manner.
Advantages of Facultative Reinsurance
- Provides additional capacity that may not otherwise be available
- Can place risks that have been excluded from the treaty
- Can use the reinsurer’s expertise for unusual and/or complex risks
- Can be used to protect the loss experience of a treaty
Disadvantages of Facultative Reinsurance
- Much time and effort is required
- Coverage is not automatically in place until bound due to offer and acceptance nature of method
- No guarantees of completion, original underwriting opportunity may be lost
Underwriting Treaty Reinsurance
- Analyze full portfolio of risks, assessing broad qualitative characteristics regarding the company and its management
- Characteristics include:
- Company’s financial strength
- past and projected performance
- management experience and standing in the industry
- underwriting policy and commercial objectives
- experience and abilities of key staff in UW and claims management
Advantages of Treaty Reinsurance
- Individual cessions are made with minimal documentation, and the reinsurer receives only periodic summaries of premiums and losses on a monthly or quarterly basis
- The cost of operating the treaty is nominal compared to the placing of facultative reinsurance
- Protection is in place from the moment each risk is accepted by the insurance company
- The automatic nature of this protection allows the company to plan its underwriting activities for the coming year and conduct marketing with the knowledge that its underwriting capacity is in place
Proportional Reinsurance
A type of reinsurance where the company shares loss payments in the same proportion that it shares premium and policy amounts
Non-proportional reinsurance
Reinsurance in which the reinsurer’s portion of loss depends on the size of the loss and the dollar level at which the reinsurance attaches
Retention
The amount of liability the ceding company (primary insurer) retains for its own account. It may be a percentage or a dollar amount of each risk.
Proportional Treaty forms
- Quota Share
- Surplus
- Facultative Obligatory Treaty Arrangement
Quota Share Treaty
- Simplest form of treaty reinsurance, least costly to administer
- Most effective in transferring large portions of the insurance company’s capital burden
- The insurance company keeps a fixed percentage of all business, called their retention. The retention plus the percentage ceded to one or more reinsurers equals 100% of the quota share
- If more than one reinsurer assumes a percentage of the quota share treaty, each reinsurer must be made aware of the insurance company’s quota share retention
Surplus Treaty
- Like quota share, also an automatic treaty, also a proportional form of reinsurance
- Difference is under a surplus treaty, the insurance company can decide what percentage it wishes to retain itself on each risk as it is underwritten
Net line
The amount of liability carried by the insurance company after deducting all reinsurance
3 Limitations placed on any cessions made to the surplus treaty
- a maximum dollar policy liability that may be ceded to the treaty
- a maximum multiple of the dollars retained by the company
- a minimum dollar retention by the company before the surplus treaty can be used at all
Second Surplus Treaty
- Insurance company automatically cedes business only after using the first surplus treaty
- This additional capacity is created without disturbing the balance of terms of the first surplus treaty because it is priced as a separate contract
- Likely receives a smaller volume of business, resulting in poorer balance and consequently less favourable terms to the ceding company
Facultative Obligatory Treaty
- An agreement in which the insurance company cedes to the treaty at its option while the reinsurer is obliged to accept all cessions that meet the agreed treaty criteria
- Such an arrangement often grows out of longstanding facultative relationships
Shock Loss
A catastrophic event that has a significant negative impact on the loss ratio of an insurer or underwriter
Working Layer
- a dollar range or band that experiences a higher frequency of loss activity
- the retention should not be so low that a steady flow of excess losses are ceded to the reinsurer or so high that company experience is disrupted by an unexpected frequency of large losses
- working layers are generally expected to smooth large loss activity and spread the cost of those expected losses over time
Shock Layer
- a dollar range or band that experiences a lower frequency of losses but losses are large and severe when they do occur
- at a higher level, the insurance company wants to remove claims of a financially disruptive size
Catastrophe Reinsurance
- protects the insurance company against an accumulation of losses arising out of any one event, such as large numbers of homeowners and businesses harmed by a hurricane or earthquake
Types of loss & Types to protect against
- A loss to any one risk, such as a fire-damaged house
- any one occurrence, such as a traffic accident involving one, two, or several vehicles
- each and every loss event, such as a tornado
- the aggregation of all losses, such as an entire season of crop damage
- Layers: There may be reason to structure risk excess protection in more than one layer (working layer, shock layer, variously named top layers (sleep at night))
- Per occurrence requires a closer look at higher layers of reinsurance protection (clash or contingency layers)
- Catastrophe excess treaty “cat cover” protects the insurance company against an accumulation of losses arising from any one event
- The final and least common is aggregate excess which is normally employed in specialty classes such as crop insurance (stop-loss reinsurance)
