Chapter 10 Reinsurance
Aggregate excess of loss observations
-Limited availability -addresses both loss severity and frequency-protects against unforeseen accumulations of non-cat losses during specified time -reinsurer only expects to pay losses after primary insured has been reimbursed under other reinsurance agreements
These Principal approaches reinsurers use to divide obligations under the reinsurance agreement to allocate losses are broadly defined
-Pro Rata reinsurance -Excess of loss reinsurance
Facultative Reinsurance serves these four functions
-Provides large line capacity for loss exposures that exceed the limits of treaty reinsurance agreements- -Reduces primary insurers exposure in a given geographic area -Insures atypical hazard characteristics and thereby maintains favorable loss experience of the primary insurers treaty reinsurance and any associated profit sharing arrangements -Insures a particular classes of loss exposures that are excluded under treaty reinsurance
Three reasons for the need for additional reinsurance during growth plans
-Rapid Growth can cause drain on PHS (Pro Rata Ceding commission -Unstable loss ratio caused by new business -Expanding into markets with greater coverage requirements
When withdrawing from the market segment, the primary insurer has these options?
-Stop Writing new business and continue in-force insurance until all policies expire -Cancel all policies and refund the unearned premiums to insureds -Withdraw from the market segment by purchasing portfolio reinsurance
Finite Risk Reinsurance Notes
-insures against combination of traditional insurable loss exposures and Traditional uninsurable loss exposures -Multi year term three to five years -promises long term protection and a predictable reinsurance cost over coverage period -flexible negotiations on the price and terms -Premiums high percentage of reinsurance limit -Generally designed to cover high severity losses
Line Guide
A document that provides the minimum and maximum line a primary insurer can retain on a loss exposure; used to allow insurers to primary insurer to increase line from a min to max amount
Ceding Commission
A fee paid to a primary insurer by a reinsurer to compensate the primary insurer for acquisition costs such as state premium taxes, agents' commissions, and other operating costs
Catastrophe risk exchange a capital market alternative
A forum through which primary insurers trade risks with other primary insurers to spread and diversify their risks. -Primary insurer can diversify the kinds of property insured -Primary insurer with geographic concentration of loss exposures can use cat loss exchange to reduce losses from a single loss occurance
Syndicate as reinsurance source
A group of insurers or reinsurers involved in joint underwriting to insure major risks that are beyond the capacity of a single insurer or reinsurer; each syndicate member accepted predetermined shares of premiums, losses, expenses, and profits; Key component of Lloyd's of London
Sidecar as capital market alternative
A limited existence SPV often formed as an independent Co. that uses quota share agreements with private investors to give the primary insurer additional capacity. -primary insurer charges a ceding commission - Primary insurer may receive a profit commission if book of business is profitable. -Investors in SPV assume a proportion of the risk -Investors earn a corresponding portion of profit on primary insurers book of business
Retention
A method of dealing with risk by intentionally or unintentionally keeping a portion of it for the insured's account; the amount of responsibility assumed but not reinsured by the insurance company.
Large-Line Capacity
A primary insurer's ability to provide larger amounts of insurance for property loss exposures, or higher limits of liability for liability loss exposures, than it is otherwise willing to provide.
Per Risk Excess of loss reinsurance (Property risk excess of loss)
A reinsurance agreement applied to property insurance polices under which a retention and a limit of coverage apply separately to each loss exposure insured by the primary insurer; NOTE-Primary insurer usually determines what constitutes one risk (loss exposure); Per occurrence limits are commonly included with per risk excess loss agreements and Cat excess of loss restricting one occurrence from affecting multiple risk.
Loss occurrence Clause
A reinsurance agreement clause that defines the scope of a catastrophic occurrence for the purposes of the agreement
Purpose of Retrocession
A reinsurance agreement whereby one reinsurer (the retrocedent) transfers all or part of the reinsurance risk it has assumed or will assume to another reinsurer (the retrocessionaire).
Reinsurance Pool As reinsurance Source
A reinsurance association that consists of several unrelated insurers that have joined to insure risks the individual members are unwilling to individually insure, A group of two or more insurance companies who jointly reinsure ceded risks.
Surplus Relief by way of Reinsurance
A replinishment of the policyholders surplus provided by the ceding commission paid to the primary insurer by the reinsurer; Satisfies regulatory constraints on excess growth;
Aggregate excess of loss reinsurance
A type of excess of loss reinsurance that covers aggregated losses that exceed the attachment point, Stated as dollar amount or loss ratio, and that occur over a specified period, usually one year; used for property or liability; When stated as loss ratio known as STOP LOSS REINSURANCE
Catastrophe excess of loss reinsurance
A type of excess of loss reinsurance that protects the primary insurer from an accumulation of retained losses that arise from a single catastrophic event.
Excess of Loss Reinsurance
A type of excess of loss reinsurance that protects the primary insurer from an accumulation of retained losses that arise from a single catastrophic event.
Catastrophe Excess of loss Reinsurance
A type of excess of loss reinsurance that protects the primary insurer from an accumulation of retained losses that arise from a single catastrophic event; Note-Protects insured on a net basis after all other reinsurance recoveries are made; Attachment point set high enough so only if the aggregation of a cat losses impair policy holder surplus; Subject to co-participation provision; protects against loss severity
Catastrophe Bond as Capital market alternative
A type of insurance-linked security that is specifically designed to transfer insurable catastprohe risk to investors -Loss less than specified loss amount = payment of interest and/or principle is deferred or forgiven -Loss exceeds specified loss amount = interest and principal forgone by bondholders used to pay loss -Usually issued by spv's
Surplus Share Reinsurance by way of pro rata distinguishing Characteristic
A type of pro rata reinsurance in which the underlying policies covered are those whose amount of insurance exceeds a stipulated dollar amount or line; reinsurer assumes surplus share amount of insurance-Typically only used with property insurance;
Pro Rata reinsurance Or Proportional Reinsurance
A type of reinsurance in which the primary insurer and reinsurer proportionately share the amounts of insurance, policy premiums, and losses (and LAE)
LOSS ADJUSTMENT EXPENSE-INCLUDED IN THE LIMIT
Add loss Adjustment expenses to the amount of the loss when applying the attachment point of the excess of loss reinsurance agreement-Used when liability losses involve substantial litigation EX; medical malpractice; reinsurer may have to pay a claim in which the loss amount alone does not exceed the attachment point
Novation?
Agreement under which one insurer or reinsurer is substituted for another; Eliminates liability assumed under issued policies of primary insurer
Facultative Certificate of Reinsurance
An agreement that defines the terms of the facultative reinsurance coverage on a specific loss exposure; issued by reinsurer
Catastrophe option as capital market alternative
An agreement that gives the purchaser the right to a cash payment if a specified index of catastrophe losses reaches a specified level. (Strike price)
Excess of loss Reinsurance (non-proportional reinsurance)
An agreement that requires a reinsurer to pay that portion of a loss that exceeds the primary insurer's retention up to the reinsurance limit or Attachment point (non-proportional reinsurance)
Working Cover by way of Excess loss Reinsurance
An excess of loss reinsurance agreement with a low attachment point; Used when primary insurers volume of losses is expected to be significant or primary insurer has little or no experience with type of insurance being offered; enables primary insurer to spread losses over several years;
Association as reinsurance source
An organization of member companies that reinsure by a fixed percentage the total amount of insurance appearing on policies issued by the organization; Use both reinsurance and risk sharing techniques
(PRO RATA IN ADDITION)
Based on the same percentage share that each is responsible for the loss-used primarily for property insurance and most types of liability; Primary insurer pays all of the loss adjustment expenses when the the loss amount does not exceed the attachment point
Why is Novation not considered portfolio reinsurance?
Because the substitute insurer assumes the direct obligations to insureds covered by the underlying insurance.
What may be used to combat the The Per Occurrence limit implemented in pro rata insurance that diminishes the usefulness of pro rata reinsurance in protecting the primary insurer from Catastrophic event.
Catastrophe excess of loss reinsurance
What factors should a primary insurer evaluate when considering a reinsurer or reinsurance agreement?
Claim-paying ability, reputation, and management competence
These types of reinsurance are referred to as Pure Risk Covers
Clash cover and Cat excess loss reinsurance; b/c expected to cover only rare events
Reinsurance Program design
Combination of reinsurance agreements that a primary insurer purchases to meet its reinsurance need; Requires carful analysis of a primary insurer's needs, retentions, and reinsurance limits
Extra-contractual Damages
Damages awarded to an insured as a result of the insurer's improperly handling of the claim (Bad Faith) insurer has failed to deal fairly with insured, reinsurer agreement must specify this type of coverage
Reinsurance Association of America (RAA)
Domestic or U.S. international branch of Not-For-Profit trade association of professional reinsurers and intermediaries. Lobbies state and federal government and analyzes aggregate data and conducts seminars
Variable Quote share treaty advantage
Enables primary insurer to retain larger proportion of the small loss exposures that are within its financial capacity to retain, while maintaing safer and smaller retention on larger loss exposures
Factors Affecting Reinsurance Needs
Growth Plans Types of Insurance Sold Geographic spread of loss exposures Insurer Size Insurer Structure Insurer financial strength Senior management risk tolerance
Why do treaty reinsurance underwriters often do not have to exercise discretion in using reinsurance?
If treaty reinsurance permitted primary insurers to choose which loss exposure they ceded to the insurer, the reinsurer would be exposed to adverse selection
Reinsurance functions
Increase-line capacity, Provide catastrophe protection, Stabilize loss experience, provide surplus relief, facilitate withdrawal from a market segment, and provide underwriting guidance
List of influences on the maximum amount or line?
Insurance Regulation-Size of potential loss or losses that can be safely retained without impairing earnings or policyholder surplus- Characteristics of a particular loss exposure- Amounts types and cost of available reinsurance
In a reinsurance pool how is risk disbursed among members?
Insurance is issued by a member company and reinsured by the remainder of the members according to predetermined percentages?
Business goals reinsurance helps insurers achieve?
Insuring large exposures, protecting policyholders' surplus from adverse loss experience, and financing the insurer's growth
List three of the most widely known insurance professional and trade associations that serve member companies and provide information to interested parties
Intermediaries and Reinsurance Underwriters Association (IRU) Brokers and Reinsurance Markets and Association (BRMA) Reinsurance Association of America (RAA)
Intermediaries and Reinsurance Underwriters Associations (IRU)
Intermediaries and reinsurers that broker or assume non-life treaty reinsurance. Conducts claim seminars, sponsors internship program, and holds conferences for members
Industry loss warranty as capital market alternative
Is an insurance-linked security that covers the primary insurer in the event that the industry-wide loss from a particular catastrophe exceeds a predetermined threshold. -Triggered by industry losses as a whole
A primary insurer can stabilize loss experience by obtaining reinsurance to accomplish any, or all, of these purposes?
Limit its liability for a single loss exposure and liability for several loss exposures affected by a common event, and for loss exposures that aggregate claims over time
Define Intragroup Reinsurance Agreement?
Many primary insures are groups of commonly owned insurance companies; Intragroup insurance agreements are used to balance the financial results of members; do not preclude use of professional reinsurers
Finite Risk Reinsurance (financial Risk Reinsurance)
NON-Traditional reinsurance agreement in which the reinsurer's liability is limited and anticipated investment income is expressly acknowledged as an underwriting component; Designed to cover high severity losses
Observation of Quota Share Reinsurance
On policies with higher amounts of insurance, the primary insurer will have a higher dollar retention (B/C fixed %), even policies with low amounts of insurance that the primary insurer could retain are reinsured, Strait-forward fixed percentage used, reinsurer is not subject to adverse selection because the primary and reinsurer share liability for every loss exposure subject to Quota share treaty.
Two common approaches to handling loss adjustment expenses during reinsurance
PRO RATA IN ADDITION and LOSS ADJUSTMENT EXPENSE-INCLUDED IN THE LIMIT
Five Types of Excess of Loss Reinsurance
Per risk excess of loss Catastrophe excess of loss Per Occurrence excess of loss Aggregate excess of loss
Observation of surplus treaty
Percentage of policy premiums and losses varies for each loss exposure ceded, making it more costly to administer; Provides less surplus relief than does quota share treaty
How do Reinsurance Pools Reinsure
Policy for the full amount of insurance is issued by a member company and reinsured by the remainder of the pool members according to predetermined percentage
Line of credit as capital market alternative
Prearranged borrowing agreement with bank in which funds up to a certain amount are readily available to the borrower -Provides line of credit, not risk transfer -Commitment fee is paid in exchange for line of credit
Quota Share Reinsurance distinguishing Characteristic
Primary insurer and reinsurer us a fixed percentage; Used more frequently in property insurance but can be used for liability Ins
Increasing its large-line capacity allows an insurer to grow b/c?
Primary insurer is able to assume more significant risks than its financial condition and regulations would otherwise permit
Newly Incorporated insurers or insurers with limited capital choose what type of reinsurance agreement for effective surplus relief?
Pro Rata because of ceding commissions under pro rata treaty; practice not common under pro rata
Reinsurance Direct Writer?
Professional Reinsurer that deals directly with primary insurer
Reinsurance Sources Listed
Professional reinsurers Reinsurance departments of primary insurers Reinsurance pools, syndicates, and associations
Per occurrence excess of loss
Provide coverage when one occurrence results in 2+ losses (depending on retention level); used with liability insurance; Applies the attachment point and reinsurance limit to the total losses arising from a single event affecting one or more of the primary insurer's policies
Describe the function of Reinsurance pools, syndicates and associations?
Provide member companies the opportunity to participate in a line of insurance with a limited amount of capital and a propionate share of admin cost-without having to employ the specialists needed for such a venture.
Two Types of Pro Rata Reinsurance
Quota Share and Surplus Share
A group of Reinsurers that share the loss exposure of the group?
Reinsurance Pools, Syndicates, and Associations
A broad Generalization made about professional reinsurers?
Reinsurance intermediaries often use more than one reinsurer to develop a reinsurance program for primary insurance, secure high coverage limits and catastrophe coverage, access to domestic and international, and obtain reinsurance under a favorable terms and at a competitive price; Primary insurers dealing with direct writing reinsurers often use fewer reinsurers in the reinsurance program
Portfolio Reinsurance
Reinsurance that transfers to the reinsurer liability for an entire type of insurance, territory, or book of business after the primary insurer has issued the policies; Helps maintain good will with insureds, regulators, and calm uncertainty about outstanding policy claims, etc
Treaty or Obligatory Reinsurance
Reinsurance transaction uses one agreement for an entire class of portfolio exposure; Reinsurance transaction where the reinsurer agrees in advance to reinsure all loss exposures that fall within it; Reinsurance transaction is used as a foundation of an insureds reinsurance program?
Facultative Obligatory Treaty (Hybrid)
Reinsurance treaty where the insurance company has the option of ceding risks, but once the insurance company has decided to cede those risks, the reinsurer is obliged to accept them.
Brokers & Reinsurance Markets Association (BRMA)
Represents intermediaries and brokers engaged in U.S. Treaty reinsurance obtained through reinsurance brokers. Focused efforts on reinsurance contract wording. Addresses industry wide operational issues.
Per policy excess of Loss reinsurance
The "in excess of" (x) amts apply to each policy. Mainly used with liability insurance; Applies the attachment point and the reinsurance limit separately to each insurance policy issued by the primary insurer regardless of the number of losses occurring
Attachment point
The dollar amount above which the reinsurer responds to losses
Line
The maximum amount of insurance or limit of liability that an insurer will accept on a single loss exposure.
Excess loss reinsurance premiums are based on likelihood that losses will exceed the attachment point-Subject premium (Rate of Policy premium)
The premium the primary insurer charges on its underlying policies and to which a rate or percent is applied to determine the reinsurance premium; Note why non-proportional
Facultative Treaty (Hybrid)
The primary insurer and the reinsurer agree on how subsequent individual facultative submissions will be handled
Facultative or Non-Obligatory Reinsurance
Transaction where the primary insurer negotiates a separate reinsurance agreement for each loss exposure that it wants to reinsure; Neither party is obligated to purchase or reinsure
Type of reinsurance transaction provides primary insurers with the certainty needed to formulate underwriting policy and develop underwriting guidelines?
Treaty Reinsurance
Two Types of Reinsurance Transactions
Treaty and Facultative
contingent surplus note as capital market alternative
Type of unsecured debt insturment, issued only by insurers, that has characteristics of both conventional equity and debt securities and is classified as policyholders' surplus rather than as a liability on the insurer's statutory balance sheet -Increases insurer's assets without increasing its liabilities
Insurance Risk
Uncertainty about the adequacy of insurance premiums to pay losses; Institute of America defines as Uncertainty about the occurrence of loss
Reinsurance Departments of primary insurer?
Where some primary insurers also provide treaty reinsurance and facultative reinsurance, and are involved in Intragroup agreements?
Reinsurance Intermediary?
Works with primary insurers to develop reinsurance programs and negotiates contracts between the primary insurers and reinsurer sometimes receiving a commission for placement
Sliding Scale commission
a ceding commission based on a formula that adjusts the commission according to the profitability of the reinsurance agreement; alternative to profit sharing and flat commission
Flat commission
a ceding commission that is a fixed percentage of the ceded premium
Special purpose vehicle
a facility established for the purpose of purchasing income-pruducing assets from an organization, holding title to them and then using those assets to collateralize securities that will be sold to investors
Excess of Policy limits losses
a loss that reuslts when an insured sues an insurer for failing to settle a claim within the insured's policy limits when the insurer had the opportunity to do so; NOTE- Caused by mistake of primary insurer separates from being seen asExtracontractual Damages
Co-participation provision
a provision in reinsurance agreement that requires the primary reinsurer to retain a specified percentage of the losses that exceed its attachment point
Bordereau
a report the primary insurer provides periodically to the reinsurer that contains a history of all loss exposures reinsured under the treaty;
Clash Cover by way of per occurrence excess of loss
a type of per occurrence excess of loss reinsurance for liability loss exposures that protects the primary insurer against aggregates of losses from one occurrence that affects several insureds or several types of insurance; used for auto, general, professional, and workers compensation
Quota share reinsurance by way of pro rata
a type of pro rata reinsurance in which the primary insurer and the reinsurer share the amounts of insurance, policy premiums, and losses (including LAE) using a flat commission, Profit sharing commission, or sliding scale commission
contingent capital arrangement
an agreement, entered into before any losses occur, that enables an organization to raise cash by selling stock or issuing debt at prearranged terms after a loss occurs that exceeds a certain threshold
Professional Reinsurer
an insurer whose primary business purpose is serving other insurers' reinsurance needs
Profit sharing commission
ceding commission that is contingent on the reisnurer realizing a predetermined % of excess profit on ceded loss exposures
Insurance Derivative
financial contract whose value is based on the level of insurable losses that occur during a specific time period
Surplus Share by way of pro rata Reinsurance observation
primary insurer does not have to cede any loss exposures that can be safely retained; Large number of loss exposures may be to small to cede but in aggregate may cause primary insurer significant loss; Percent of each varying ceded loss exposures and premiums makes costlier than quota share to administer, a report called a Bordereau may be request periodically from reinsurer; typically Provides less surplus relief than Quota share b/c amounts less than line are not reinsured
In portfolio reinsurance the reinsurer accepts all liability for certain loss exposures covered under the primary insurer, but?
the primary insurer must continue to fulfill its obligations
Securitization of risk
the use of securities of financial insturments (stocks, bonds, commodities) to finance an insurer's exposure to catastrophic loss
