SP1 Chp 26 - Reinsurance

22 What is risk excess of loss reinsurance and for what class of health insurance is it used?

- Relates to individual losses, and affects only one insured risk at any one time - Sometimes this is found under PMI portfolios where individual large losses occur

15 What are the purposes of quota share reinsurance?

- To spread risk - Write larger portfolios of risk - Encourage reciprocal business - Smaller new insurers relies on quota to spread risk - Larger insurers use it for new products or going into new markets Advantages - Directly improves the solvency ratio - Helps the insurer to satisfy the statutory solvency capital requirement

FINANCIAL REINSURANCE

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12 State two advantages of a deposit back arrangement to the cedant.

.1. the cedant gets the bft of the reinsurance whilst being able to maintain a reserve for the whole contract and hence maintain the funds it invests 2. mitigates the default risk which the cedant is exposed to

9 Give an alternative name for original terms reinsurance.

Coinsurance

16 What are the two main limitations of quota share reinsurance?

Disadvantages - cedes same prop of risk, irrespective of size - passes a share of any profit to the reinsurer

19 Explain how excess of loss reinsurance operates.

- reinsurer indemnifies for the amount of any loss above a stated excess point - usually there is an upper limit to this - insurer usually purchases further layers of excess of loss cover which stacks on top of the primary layer from different insurers - higher layers come into operation on a particular loss when the lower layer cover has been fully used

20 What are the three main types of excess of loss reinsurance?

1. Risk excess of loss 2. Aggregate excess of loss (aka stop loss) 3. Catastrophe excess of loss (rarely appropriate for health covers)

NON-PROPORTIONAL REINSURANCE

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QUOTA SHARE

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REINSURANCE

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SURPLUS REINSURANCE

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1 Classify health and care insurance payouts into 3 categories.

1. linked to a sum insured 2. linked to a sum insured with agreed uplift 3. indemnify the PH against medical costs

17 (a) For what health insurance products can surplus reinsurance be used?

- Only applies where there is a fixed SI, chosen at policy inception by the PH - So does not apply to PMI business

25 Describe the main purposes of any form of excess of loss reinsurance.

- To permit an insurer to accept risks that could lead to large claims - Large claims means large relative to the insurer's free assets or premium income Other purposes are - To reduce the risk of insolvency from a catastrophe, a large claim or an aggregation of claims - To stabilise the technical results of the insurer by reducing claims fluctuations

26 What is financial reinsurance? Give one feature of financial reinsurance.

A wide variety of financial reinsurance contracts have been developed and used, although all were devised primarily as a means of improving the apparent accounting or supervisory solvency position of the cedant. One feature of a financial reinsurance contract is that it tends to involve only a small element, if any, of transfer of insurance risk from the cedant to the reinsurer.

5 Explain the terms 'facultative' and 'obligatory' in a reinsurance context, list the different possible types of agreement between the ceding company and a reinsurer, and state which of these would normally be formalised under a reinsurance treaty.

Facultative - the insurer is free to place reinsurance with any reinsurer - the reinsurer may accept or reject contracts offered from the insurer - usually for contracts that are outside of the normal range of policies accepted, such as those with large SI or unusual UW features Obligatory - the reinsurer does not have the decision the accept or reject, and must accept all contracts that falls under the agreement Types of agreements - Facultative/Facultative - agreement not always formalised - Facultative/Obligatory - Obligatory/Obligatory Both above are formalised as a 'treaty' between two parties Insurers tend to place the bulk of reinsurance cover on a treaty basis.

28 When is financial reinsurance not effective?

Financial reinsurance is not effective under accounting or supervisory regimes where credit can already be taken for the future profits and/or where a realistic liability must be held in respect of the loan repayments.

23 Describe why aggregate excess of loss / stop-loss reinsurance may be needed by a health insurer, and explain how it works.

- A class of business can give rise to large variations in the lvl of total claims payable in one year - Insurer may wish to have cover for all causes or all events during the year for that business - Stop loss covers the total losses for the whole account, above an agreed limit for a 12 month period - Whole account can comprise of one of several classes of insurance - Excess point and upper limit for stop loss are often expressed as a percentage of the cedant's premium income - Cover might typically be given from an excess pt og 110% claims ratio up to 130/140% - Profits in long-term insurance are rarely sufficiently volatile to warrant paying for this reinsurance type

4 What is 'reinsurance commission' and describe how it can be structured.

- A payment from the reinsurer to the insurer - Sometimes it is structured as a deduction from the premium paid to the reinsurer, in which cause it is called a rebate

11 Explain the concept of 'deposit back'.

- Where the supervisory authority may require the reinsurer to 'deposit back' its share of the total reserve under a reinsured contract with the cedant

3 Explain the reasons for reinsurance.

- Limitation of exposure to risk An insurer with a portfolio of business faces an uncertain future: despite the best advance statistical analysis and the utilisation of experienced underwriters, the claims outgo from any period of risk cannot be predicted to any degree of accuracy. That is, after all, the insurer's point of an insurance company: to cover the unknown financial consequences of possible future perils affecting members of the public. -Avoidance of large single losses What is large to an insurer will depend on the size of the free assets available. Many small to medium sized insurance companies will cede a top slice of potentially large payouts to reinsurers, to ensure, as far as possible, that claims payments can be made without detrimental effect to business results and, at the extreme, solvency. - Smoothing of results The principle whereby reinsurance covers the larger risks or accumulation of smaller risks above certain limits helps to achieve a smooth development of accounts year-on-year, especially when the portfolio is relatively immature. A premium is paid to mitigate these fluctuations and the net result is more predictable for the insurer, a predictability that may also be more acceptable to shareholders and regulators. Reinsurance thus helps to reduce the variance of the insurer's expected disability or mortality experience relative to the mean. Stop loss is a form of reinsurance that is used for these purposes. -Availability of expertise - for new risks, unusual risks, new territories When an insurer is adopting a strategy that will take it into new risk areas where it has little previous experience, the reinsurer can help with product design, rating / pricing, underwriting and claims management. Often in these circumstances, the method of coverage will be quota share, possibly with a low initial retention. Once the insurer's expertise and confidence has grown, the reinsurer's involvement will reduce. -Increasing capacity to accept risk - singly or cumulatively Owing to insufficient capital backing, an insurer may be reluctant to accept, or incapable of accepting, particular risks by sector or by volume. Reinsurance cover can assist in this situation. The solvency requirements for a line of business are normally reduced in line with the proportion ceded, though this may be subject to an upper limit. Surplus treaty or excess of loss reinsurance might be used here (and other forms of reinsurance might also be appropriate depending on the circumstances). -Financial assistance - NB strain, merger/acquisition, improving free assets Across both long-term and, to a lesser extent, short-term health insurance lines, reinsurance funds are available to assist financially with particular business propositions. Where a particular distribution strategy would involve substantially more cash outflow in the initial stages than premium income, reinsurance commission may be available to 'factor' future surplus streams ie lend now against the predicted future flows of premiums less expenses and claims. Occasionally, where the reinsurer agrees that a block of renewing business should produce regular profits in the future, it may be possible for the reinsurer to provide capital to the insurer to improve its free asset position by reinsuring this portfolio of profitable existing business. The reinsurer would pay an initial commission, after which the reinsurer would be entitled to (a proportion of) the future surpluses arising on this portfolio for as long as the arrangement remained in place. However, as described in Core Reading Question 28, whether there is any balance sheet benefit of such an arrangement depends on the regulatory reporting environment. A similar exercise might facilitate the acquisition of an insurance company, where a subset of business (or all policies) within the company being acquired is identified as potentially profitable, and the reinsurer is prepared to advance funds in anticipation of this future profit. In each of these cases quota share reinsurance is the norm, though any form of proportional reinsurance might be used.

14 Under quota share reinsurance, explain how (a) the underwriting experience will differ between insurer and reinsurer, and (b) how the reinsurer might reflect its satisfaction with the insurer's business.

.(a) - cedant and reinsurer have proportionately the same overall UW experience on the business, apart from differences in expenses and commissions (b) Reinsurer is concerned about --nature of business being offered -- cedant's attitude to UW and claims settlement -- any previous experience of this business -Lvl of reinsurance commission offered reflects the Re's view of the expected claims - Re will reserve the right by the treaty to be involved in the approval and settlement process for claims above a certain size - Re can negotiate for part of the commission payment to be a profit commission, payable only if the business ceded meets specified profitability criteria - Treaty may contain portfolio volume limits

29 How is the retention level determined for health reinsurance?

To determine the retention level to adopt, it is necessary first to estimate the statistical distribution of the risk experience costs of the portfolio on various assumed retention levels. The insurer then needs to judge how low a probability should be aimed at for various degrees of departure from the overall average risk costs. One approach is to set the retention level at such a level as to keep the probability of insolvency (or ruin probability) below a specified level. Using a stochastic model for expected claims rates and a model of the business, expected claims can be projected forward together with the value of the company's assets and liabilities. By using simulation, a retention level can then be determined such that the company stays solvent for 995, say, out of 1,000 runs. Another possible approach is to consider the total of: (a) the cost of financing an appropriate risk experience fluctuation reserve, and (b) the cost of obtaining reinsurance - the reinsurer naturally incorporates an expense and profit loading in its reinsurance terms, and the cedant incurs administrative expenses. As the retention level increases, (a) will increase and (b) will decrease, and a retention level can be adopted that minimises the total (a) + (b). To calculate (a), the simulation approach discussed above would probably need to be used to determine the reserve that the company needs to hold.

24 Describe, with examples, why (a) catastrophe excess of loss reinsurance may be needed by a health insurer and (b) if it is available in the market.

(a) Examples - chemical explosion which gives rise to claims exceeding insurer's rentention - a pandemic that results in a considerable increase in claims (b) - Event-type cover is generally available - However, pandemic risks are very uncertain and so not usually available at an affordable price

10 Describe the operation of original terms reinsurance.

- Involves sharing all aspects of the original contract - Applies to both long and short-term contracts - Cedant provides the reinsurer with premium rates is it using for the class of business it wishes to reinsure - Reinsurer determines the rates of reinsurance commission they are prepared to pay to the cedant for the business - Re would want to make a profit on the business - Reinsurance commission usually covers the commission that has been pd by the cedant and part or all of the cedant's other initial expenses

7 Explain the main features of proportional reinsurance.

- Reinsurer covers an agreed prop of each risk - Quota share - prop is constant for all risks covered - Surplus - prop is related to insurer's preferred monetary retention to the overall size of the SI - Reduces the size of the cedant's net account, so is mostly used as a means of accepting a larger size of risk than would otherwise be possible - In certain circumstances, the reinsurance will diminish over time, as the insurer gains experience of the new product or the new territory. Thus, the treaty will incorporate an increasing monetary retention (surplus) or a reducing proportional share (quota share). - These lower cessions would normally only apply to new business, ie the proportions set for a policy at its inception remain unchanged until the policy expires. However, on agreement between the two parties, changes in proportion can apply also to existing business. - A proportional reinsurance arrangement allows reinsurance commissions to be payable, whereby the insurer's new business costs or other appetite for revenue is satisfied by 'factoring' the future margins in premiums to be passed to the reinsurer.

2 Discuss the factors that determine a health insurer's appetite for reinsurance.

- Size of the insurer - Experience in the marketplace - Available free assets - Size of its portfolio (credibility factor) - Degree to which it is felt that the business outcome is predictable within bounds This is set against the availability of reinsurance. Some insurers may have an approach to underwriting and claims management that means that some reinsurers are reluctant to offer cover. Generally, where an insurer has fears of a claim or combination of claims that would materially (negatively) affect the shape of results within that business line, reinsurance will be considered. This may occur due to a single event (eg outbreak of insured disease), and/or a concentration of risk in a territory.

6 Explain why a treaty is often used in health reinsurance, and what the treaty would contain.

- Treaty arrangement allows the insurer to more easily use reinsurance to control its solvency and growth requirements - Treaties are usually arranged so that the cedant is obliged to pass some of the risk in a defined manner and the reinsurer is obliged to accept it - Sets out all relevant details and obligations under the arrangement

21 Describe the purpose of a stability clause.

- Where inflation has a significant effect on the cost of claims, a stability clause may be applied to the excess point; this provides for the indexation of the monetary limit in line with a specified inflation index. This is done to achieve a more equitable division between the reinsurer and cedant of the inflationary element of claims covered under the treaty. - The cedant will normally be required to pay an extra premium to compensate the reinsurer for the added risk if the excess point is not indexed. - The upper limit (where one exists) may similarly be indexed to preserve the original real value of the cover.

18 Explain briefly the purpose of non-proportional reinsurance, and whether it applies to long-term health insurance business.

- limit an insurer's loss from a single event or over a given period - unlikely to be found in long-term insurances where the size of the bft is known at the outset, though aggregate excess of loss may be appropriate, eg for group IP covers

13 Describe the operation of risk premium reinsurance, including the two main types of risk premium reinsurance.

.The reinsurer charges a specific premium for the risk instead of sharing the premium. It may be level over the policy term, or may vary annually with the prob of the claim Advantages - changes in the cedant's prem rates will not necessarily require changes in reinsurance rates - gives cedant greater freedom to respond to competitor changes in prem rates 1. Level risk premiums - Re spreads risk premiums so that they are level throughout the contract term - may or may not be guaranteed - often inline with cedant's own product approach Advantage - cedant can simply load the reinsurance charges to obtain the premium payable by the PH 2. Increasing yearly risk premiums - Re determines risk premium rates by assessing the likely experience of the business that it is to reinsure, then adds expense and profit margins - may or may not guarantee rates for pol term - prem rates are applied to sum insured, which may be a prop of SI or sum at risk

27 Explain two types of reinsurance financing.

1. The risk premium reinsurance method is one type of arrangement that has been associated with a financing arrangement whereby the reinsurer relieves the cedant of part of its new business financing requirement. A straightforward loan from the reinsurer would not achieve the purpose, as the cedant would usually have to add the amount of the loan to its liabilities. So, the 'loan' is usually presented as a reinsurance commission related to the volume of business reinsured. The 'repayments' - spread over a number of years - are added to the reinsurance premiums. The reinsurer considers the expected lapse experience of the portfolio of reinsurances in determining the loan repayments. 2. An alternative approach makes use of the future profits contained in a block of new or existing business. The reinsurer again provides a loan to the cedant, but as the repayment of the loan is contingent upon the stream of future profits being generated by the business, the cedant may not need to reserve for the repayment within its supervisory returns (depending on the regulatory regime). This second approach may also be used where an insurer needs to improve its solvency position, for example after a large drop in asset values, or where it wishes to fund a new project, for example the setting up of a new subsidiary overseas. _

17 (b) What are its advantages?

Advantages - can write larger risks beyond its usual risk capacity - enables insurer to limit its exposure for policies above this retention limit - if SI increases (from inflation for example), the treaty will stipulate whether the sum retained remained fixed in monetary terms or whether the insurer and reinsurer continues to share the increases in line with the original proportion

8 Describe the concept of sum-at-risk reinsurance.

Aka non-proportional reinsurance - proportions are applied not to the SI, but to the insurer's sum at risk, namely the excess of the stated policy benefit over the reserve that the cedant holds - for ease of admin, treaty terms may stipulate amounts of reserves from the outset or the basis on which they are calculated - for unit-linked products, sum at risk will be the excess of bft over the bid value of units - premiums under the treaty are risk premiums