Study 2 - Methods and Types of Reinsurance

Question 1

Methods? Types?

Answer 1

Methods: Facultative (individual risks) & Treaty (portfolios of risks)

Types: Proportional (pro-rata) and Non-Proportional (excess)

Question 2

Binder

Answer 2

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.

Question 3

Advantages of Facultative Reinsurance

Answer 3

• 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

Question 4

Disadvantages of Facultative Reinsurance

Answer 4

• 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

Question 5

Underwriting Treaty Reinsurance

Answer 5

• 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

Question 6

Advantages of Treaty Reinsurance

Answer 6

• 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

Question 7

Proportional Reinsurance

Answer 7

A type of reinsurance where the company shares loss payments in the same proportion that it shares premium and policy amounts

Question 8

Non-proportional reinsurance

Answer 8

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

Question 9

Retention

Answer 9

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.

Question 10

Proportional Treaty forms

Answer 10

1. Quota Share
2. Surplus
3. Facultative Obligatory Treaty Arrangement

Question 11

Quota Share Treaty

Answer 11

• 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

Question 12

Surplus Treaty

Answer 12

• 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

Question 13

Net line

Answer 13

The amount of liability carried by the insurance company after deducting all reinsurance

Question 14

3 Limitations placed on any cessions made to the surplus treaty

Answer 14

1. a maximum dollar policy liability that may be ceded to the treaty
2. a maximum multiple of the dollars retained by the company
3. a minimum dollar retention by the company before the surplus treaty can be used at all

Question 15

Second Surplus Treaty

Answer 15

• 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

Question 16

Facultative Obligatory Treaty

Answer 16

• 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

Question 17

Shock Loss

Answer 17

A catastrophic event that has a significant negative impact on the loss ratio of an insurer or underwriter

Question 18

Working Layer

Answer 18

• 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

Question 19

Shock Layer

Answer 19

• 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

Question 20

Catastrophe Reinsurance

Answer 20

• 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

Question 21

Types of loss & Types to protect against

Answer 21

1. A loss to any one risk, such as a fire-damaged house
2. any one occurrence, such as a traffic accident involving one, two, or several vehicles
3. each and every loss event, such as a tornado
4. the aggregation of all losses, such as an entire season of crop damage
5. 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))
6. Per occurrence requires a closer look at higher layers of reinsurance protection (clash or contingency layers)
7. Catastrophe excess treaty “cat cover” protects the insurance company against an accumulation of losses arising from any one event
8. The final and least common is aggregate excess which is normally employed in specialty classes such as crop insurance (stop-loss reinsurance)