RMIN 4008 Final Exam

5 characteristics of reinsurance contracts :

1. Follows the Fortunes 2. Honorable Undertaking 3. Privity of Contract 4. Contract of Indemnity 5. Arbitration not Litigation

Two general forms of reinsurance:

1.) Facultative Reinsurance 2.) Treaty Reinsurance

An insurance company buys reinsurance for one or more of the following (5) reasons:

1.) Financial 2.) individual risk capacity 3.) Premium capacity 4.) Catastrophic Protection 5.) Stabilization

Two methods/solutions for resolving the problems insuring organizations face:

1.) non-reinsurance underwriting techniques 2.) reinsurance solutions and techniques

3. The premium on excess of loss reinsurance treaty is determined by Select one: a.) Loss history, negotiation, and market forces b.) Multiplying the underlying primary premium by a specific percentage c.) Adding the expenses of the primary insurer d.) Actuaries who work for the primary insurer

a.) Loss history, negotiation, and market forces

Premium Capacity reason for buying reinsurance:

quota share can reduce NWP(net written premium) and allow for higher premiums to be written

Three forms of facultative reinsurance agreements:

1) "pure" individual Facultative Agreement 2) Semiautomatic Facultative Agreement 3) Automatic Facultative Agreement

The reinsurer is also referred to as the

Market

"Primary Insurer" is also referred to as the

cedent

cedent

also known as ceding company -- the insurance organization buying reinsurance

10. On what continent are more of the top 10 reinsurers based than any other continent? Select one: a.) South America b.) Asia c.) North America d.) Europe

d.) Europe

7. There are 4 layers of coverage on an excess per risk or excess casualty program. The first layer is $2 million excess of $1 million. The third layer is $7 million excess of $6 million. How much will the 4th layer of coverage pay for a $22 million loss? Select one: a.) $7 million b.) $9 million c.) $15 million d.) It cannot be determined with only this information

d.) It cannot be determined with only this information

Surplus Share reinsurance

frequently done as a treaty; reinsurance where the reinsurer accepts only the surplus liability which exceeds a predetermined limit of liability that the insurer has agreed to retain; The surplus share is determined separately for each risk ceded, dependent upon the individual policy limit, and the reinsurer contributes to losses in proportion to its share.

Excess Catastrophe is a form of excess reinsurance which:

indemnifies cedent for amount of loss in excess of loss with respect to an accumulation of losses from a single catastrophic event -- has maximum limits

"pure" individual Facultative Agreement

individual offer by cement and individual acceptance by reinsurance markets on each risk; arrangement is non-obligatory for both insurance company and reinsurer

Aggregate Excess (including Stop Loss and Excess Loss Ratio) is based on:

the aggregate (or sum) of losses during a set period --usually a year; cedent's retention is usually a % of the earned premium (stop loss) or alternatively can be a dollar amount (aggregate excess)

Rate on Line (ROL)

the ratio of premium paid to loss recoverable in a reinsurance contract

(2)Honorable Undertaking

A clause used in some reinsurance treaties, the purpose of which is that the agreement not be defeated by a strict or narrow interpretation of the language in the treaty.

definition of reinsurance contract

The reinsurance contract is a legal document detailing the elements and parameters of the agreement and is referred to as a Treaty or a Facultative Agreement.

Follows the Fortunes contracts typically specifies that the reinsurer pays what two things?

(1)Extra Contractional Obligations (ECO; usually punitive damages awarded against insurer/cedent) and (2)Excess of Policy Limits (XPL: amounts not covered under underlying policy limits, such as insurer's duty to defend)

(2)As you know, insurance is a tool for risk pooling and loss sharing. Since insurance pooling has already occurred, why is reinsurance important as a tool for diversification of many primary insurers' risks? Give two examples of diversification.

- reinsurance is important as a tool for diversification of many primary insurers' risks because an insurer/cedent can have temporary "surplus relief" with reinsurance, which enhances leveraging ratios, and reinsurance provides cedents individual risk capacity, which allows them to write a larger policy limit than they would be able to without reinsurance, which in turn helps them to stay competitive in the marketplace. also premium capacity, catastrophe protection, and stabilization

Non-reinsurance underwriting techniques:

1) spreading of risk by geographical territory (avoiding concentrated risk) 2) modifying coverages 3) charging adequate premiums 4) restricting the classes or lines of business written 5) restricting the risk sized insured and the amount of insurance written

The 4 approaches to managing risk and how insurance companies could (or do) use them to manage their own risk :

1. Avoidance of the risk: not writing any business 2. Retention of the risk: pay for the risks themselves if they do occur, though this is not feasible for most insurers because of catastrophic loss potential 3. Control the risk: Tighten underwriting standards and avoiding less attractive risks 4. Transfer the risk: transfer some portion of the risk to one (or more) reinsurers for a portion of the premium it originally collected

different Excess Reinsurance coverage forms indicate the retention and limit that the reinsurance is based on. The types of Excess reinsurance forms include:

1. Property Excess Per Risk (XPR) and excess casualty reinsurance 2. Excess Catastrophe (CAT) 3. Aggregate Excess including Stop Loss/Loss Ratio

Options for basis of coverage of an excess of loss reinsurance policy for CASUALTY: (* = most common)

1. per occurrence* 2. per accident* 3. per event* 4. per policy 5. per coverage part 6. per insured 7. per person

Options for basis of coverage of an excess of loss reinsurance policy for PROPERTY: (* = most common)

1. per risk* 2. per location 3. per policy 4. per occurence*

In general, the principles of reinsurance are the same as the principles of insurance, but differences arise because of what two factors?

1. reinsurance is one-step removed from the original transaction of insurance 2. both parties to a reinsurance contract negotiate on equal footing- unlike with insurance, when the insurer has all expertise and bargaining power

Two basic categories of reinsurance:

1.) Pro Rata 2.) Excess

Two forms of Pro Rata Reinsurance agreements:

1.) Quota Share 2.) Surplus Share

Reinsurance is most appropriate for which breaches of elements of insurable risks?

1.) a sufficiently large number of risk exposure units(for a new product or company). This concept relates directly to the Law of Large Numbers. 2.) Risk exposure units that are homogeneous(the same/similar) in size and type 3.) Risk exposure units that are not exposed to a catastrophe.

If a treaty is 60% pro rata reinsurance, the reinsurer assumes __% of the exposure, and cedent assumes __%

60;40

(4) Contract of Indemnity

Cedent can make claim against reinsurer only after cedent has paid claims. Exceptions are (1)operation of law in event of insolvency, (2)mutual consent for loss advances, and (3)communication of outstanding losses.

(4)How does the need to monitor cedent's business different if the contract is pro rata vs. excess of loss? In-force vs. new and renewal only?

Pro rata: reinsurer shares pre-determined portion/percentage of cedent's liabilities, regardless of size; has a ceding commission Excess of loss: cessions of loss( or responsibility for loss); cedent's retention of loss is generally fixed and cedent only recovers from reinsurer after the loss exceeds that; typically structured as layers where loss size determines which excess reinsurer(s) is/are responsible; similar to a primary policy with a deductible. *pro rata is cessions of liability, while excess of loss is cessions of loss *Reinsurers assume more risk with New and Renewal business than In-force only business. The characteristic of reinsurance contracts that validates this most is that reinsurance is follows the fortunes.

ceding commission

a fee paid by a reinsurance company to a ceding company(insurance company) to cover administrative costs, underwriting, and business acquisition expenses. The commission also helps the ceding company offset loss reserve premium funds.

Cut-Through Endorsement

a reinsurance contract endorsement providing that, in the event of the cedent's insolvency, the reinsurer will pay any loss covered by the reinsurance contract directly to the insured

3. Which reinsurance contract clause is most closely related to the privity of contract in that the result is that the cedent must pay the claim to the insured BEFORE the reinsurance is obligated to pay on the reinsurance contract? Select one: a.) Contract of indemnity b.) Follows the fortunes c.) Gentlemen's agreement d.) Honorable undertaking

a.) Contract of indemnity

8. The premium on excess of loss reinsurance treaty is determined by Select one: a.) Loss history, negotiation, and market forces b.) Multiplying the underlying primary premium by a specific percentage c.) Adding the expenses of the primary insurer d.) Actuaries who work for the primary insurer

a.) Loss history, negotiation, and market forces

6. Conservatex Insurer's management wants to reduce their exposure on a $5 million building to $1,000,000. They can either do this by purchasing a $4M XS $1M excess per risk contract or an 80% quota share. Which do you know about the difference in what they will pay for these two contacts? Select one: a.) The pro rata policy will be a higher premium than the excess of loss contract b.) The excess of loss policy will be a higher premium than the pro rata policy c.) The pro rata policy will most likely be lower cost after the ceding commission is paid d.) Both a and c are true

a.) The pro rata policy will be a higher premium than the excess of loss contract

Catastrophe Protection reason for buying reinsurance:

all companies writing property business have a catastrophic exposure, and reinsurance is a mechanism to absorb catastrophic loss

retention percentage

amount of liability cedent must retain on its own account on any risk before it may give any liability to its surplus reinsurers

Treaty Reinsurance definition

an obligatory reinsurance agreement where the ceding company is obligated to cede and the reinsurer is obligated to accept all risks that fall within the parameters of the agreement; contract specifying this agreement is called Treaty

1. On an excess per risk or excess casualty program with multiple layers of coverage, what can you say definitively about a layer of reinsurance coverage that is above another layer (e.g. the third layer over a second layer of coverage)? (page 12 of Reinsurance Text) Select one: a.) The reinsurance premium for the third layer will be lower than that for the second layer b.) The rate on line will be lower for the third layer than that for the second layer c.) Neither of the above are true...you cannot say them definitively d.) Both a and b will always be true

b.) The rate on line will be lower for the third layer than that for the second layer *rate on line (ROL) is: the ratio of premium paid to loss recoverable in a reinsurance contract

2. Reinsurance is used most commonly because Select one: a.) Insurers want to transfer off their highest risk policies to another entity b.) When insurers underwrite risk, elements of insurable risks are often violated c.) Insurers lack the expertise to underwrite certain types of risk d.) It allows insurers to charge less for their product and, thus, be more competitive

b.) When insurers underwrite risk, elements of insurable risks are often violated

4. Assume that a primary insurer's total underwriting expenses are $1,200,000 in underwriting costs, $600,000 in loss adjustment expenses, $700,000 in policy administration, $1,100,000 in agents fees and $100,000 in taxes on a NWP of $10,000,000. What will be the benchmark for setting their ceding commission? Select one: a.) 27% b.) Probably 30% c.) 31% d.) 37%

c.) 31%

(3)Privity of Contract

contract is between reinsurer and cedent; reinsurer has no obligation to the insured unless (1) a cut-through endorsement or (2) a decision of the court

difference between pro rata and excess of loss treaties

pro rata is cessions of liability, while excess of loss is cessions of loss

Facultative Reinsurance definiton

reinsurance of individual risks by individual offer and acceptance; insurance company/cedent can offer to transfer/cede any risks on its books, and reinsurer retains "faculty" to accept or reject the offer

(5) Arbitration not Litigation

requires disputes to be handled before reinsurance/insurance experts. Exceptions are Facultative Agreements and someone is too slow in paying, a judge can speed the process up.

Automatic Facultative Agreement

similar to a Treaty; offer and acceptance of risk is obligatory for cedent and reinsurer; this agreement is "facultative" because each risk must be submitted individually to the reinsurer and ECO and XPL aren't covered under this, but are in most Treaty Agreements

definition of reinsurance

the process by which an insuring organization (cedent) transfers (cedes) part or all of the risk it has accepted to another organization (reinsurer/market), or the pooling of the risks of many insurance companies to cover the losses of a few.

cedes

to transfer; in reinsurance, part of or all of the risk

elements of insurable risks, if followed flawlessly, would eliminate need for reinsurance; but, it is almost impossible for an insurance company to produce a book of business that abides by all of those elements. So, if some elements are violated, insurance companies can ____ the risk through _____

transfer; reinsurance/reinsurers

Treaty vs. Facultative reinsurance difference

treaty reinsurance will generally cover entire line/class of business (such as all automobile policies or company's entire book of business), while facultative reinsurance is generally on individual risk by risk basis

quota share vs surplus share reinsurance difference

with quota share the reinsurer is responsible for predetermined % of all risks from cedent, but with surplus share reinsurer only accepts surplus liability (that exceeds limit of liability cedent has agreed to retain)

what is reinsurance contract also referred to as

(1) Treaty (2) Facultative Agreement

(1)Discuss three of the functions of reinsurance and state which kind of reinsurance works best for each of those functions and why.

1. Financial: Reinsurance can be utilized to modify an insurer's financial statements and offer temporary "surplus relief" due to handling of deferred acquisition costs under statutory accounting procedures. It can be an effective tool for enhancing leverage ratios. Excess of loss reinsurance treaties are quite distinct from pro rata reinsurance covers. Unlike pro rata reinsurance treaties, which are cessions of liability, excess of loss treaties are cessions of loss. The cedent's retention of loss is generally fixed. The cedent only recovers from the reinsurer after the loss exceeds the retention.There are many forms of Excess reinsurance, including: Property Excess Per Risk (XPR) and Excess Casualty Reinsurance, Excess Catastrophe (CAT), and Aggregate Excess including Stop Loss/Loss Ratio. 2. Catastrophe Protection: Regardless of what region of the country a carrier writes, they are susceptible to natural disasters such as hurricanes, tornadoes, hail, fire, flood, etc. Manmade disasters such as riot also expose insurers to catastrophic loss. Thus, all companies writing property business have a catastrophe exposure. Reinsurance is one mechanism to absorb the catastrophic loss potential.Excess Catastrophe (CAT). Excess Catastrophe is a form of excess reinsurance that indemnifies the ceding company for the amount of loss in excess of a specified retention with respect to an accumulation of losses resulting from a single catastrophic event. This indemnification is also subject to predetermined maximum limits. In other words, the reinsurance company pays a loss above the ceding company's retention from losses that have been accumulated from one event, such as flood, earthquake, or hurricane. The reinsurer usually insists on coreinsurance (90% of the excess will be paid by the Reinsurer, 10% of the excess will be retained by cedent). 3. Premium Capacity: The insurance company has confined leverage ratios of the Net Written Premium (NWP) to Policyholder Surplus (PHS), roughly a 3:1 ratio. If the company has $5,000,000 of PHS and is currently writing $15,000,000 NWP, it is limited with respect to writing any additional business. However, if it were to enter into a 25% Quota Share it could reduce the NWP and be allowed to write $20,000,000 on the $5,000,000 of PHS. Thus, the reinsurance allowed the company to increase its writings by $5,000,000 and keep its ratios in line. Quota Share reinsurance is an obligatory reinsurance agreement whereby the reinsurance company assumes a predetermined fixed percentage of all business coming within the confines of the agreement and underwritten by the ceding company. This involves a partnership relation between the cedent and the reinsurer and accepts the principle that the reinsurer depends, to a large extent, on the skill of the ceding company to underwrite the business profitably.

alternative format of surplus share reinsurance to a Treaty is ...?

Semiautomatic surplus share: retention and limit is predetermined like in the Treaty, however ceding company may ceding company can pick/choose which risks to cede/transfer to the contract; reinsurer is still bound to accept it

5. A reinsurance intermediary is broadly and most commonly referred to as Select one: a.) The market b.) The client c.) A broker d.) A director

c.) A broker

2. If a reinsurer owes money to the cedent for the cost of providing a defense for the insured in a case of the insured's potential liability, these losses are known as _______________________ and are shared with the reinsurer because of this concept:______________________. Select one: a.) Extra contractual obligations; Follows the fortunes b.) Extra contractual obligations; Honorable undertaking c.) Excess of policy limits; Follows the fortunes d.) Extra contractual obligations; Privity of contract

c.) Excess of policy limits; Follows the fortunes

9. Treaty reinsurance that protects against catastrophic property losses are typically written on what basis? Select one: a.) Per risk b.) Per accident c.) Per event d.) Per location

c.) Per event

1. Which of the following is true of the reinsurance intermediary? Select one: a.) They work with mid-level underwriters and other employees rather than the executives to place the reinsurance b.) They are paid by the ceding commission c.) They always work on teams d.) They typically only work on very large accounts

c.) They always work on teams

Semiautomatic Facultative Agreement

cedent isn't obligated to offer every risk, but reinsurer must accept every risk offered --but typically, reinsurer retains the "right of rejection"

excess of loss reinsurance treaty

cessions of loss( or responsibility for loss); cedent's retention of loss is generally fixed and cedent only recovers from reinsurer after the loss exceeds that; typically structured as layers where loss size determines which excess reinsurer(s) is/are responsible similar to a primary policy with a deductible

4. Reinsurers assume more risk with New and Renewal business than In-force only business. The characteristic of reinsurance contracts that validates this most is that reinsurance is Select one: a) An honorable undertaking b.) A contract of indemnity c.) Arbitrated, not litigated d.) A follows-the-fortunes contract

d.) A follows-the-fortunes contract

Quota Share reinsurance

obligatory reinsurance agreement where reinsurance company assumes predetermined fixed % of all business (within confines of the agreement) underwritten by the cedent; involves partnership relation from reinsurer and cedent; dependency from reinsurer on cedent to underwrite business skillfully/profitably

Financial reasons for buying reinsurance:

reinsurance can modify an insurer's financial statements and offer temporary "surplus relief" because they handle deferred acquisition costs (allows a company to postpone/put off the sales costs that are associated with acquiring a new customer over the term of the insurance contract) and can enhance leverage ratios(financial measurement used to assess the ability of a company to meet its financial obligations)

Individual Risk Capacity reason for buying reinsurance:

reinsurance provides insurers with capacity to write a larger policy limit than is possible without it. Additional risk capacity is supplied by reinsurers. Example: A insurance company may only be comfortable with $500,000 limits of risk, but need to offer $1million to be competitive in the marketplace. They can utilize $500,000 excess of $500,000 Excess Per Risk(EXP) Treaty. Thus, the largest loss they can sustain is still $500k, but they can write a $1million policy.

Stabilization reason for buying reinsurance:

reinsurance reduces potential for large unexpected losses in insurance company; may have to give up some profit in good years to maintain stabilization in the bad years, but insurance company results will become stabilized

excess per risk/excess casualty is a form of excess reinsurance which:

reinsurer indemnifies cedent against excess of a specified retention with respect to each risk; cedent retains fixed dollar amount on each risk -- has maximum limits

(1)Follows the Fortune

reinsurer is obligated to the cedent in the same way that the cedent is obligated to the reinsurer; important for reinsurer to ensure confidence in cedent's underwriting, claims, and other operational abilities

"right of rejection" in Semiautomatic Facultative Agreement

reinsurer normally has 10 days after cement's offer or risk to decide to reject(not common) and cedent typically has 30 to 35 days to replace coverage with reinsurance from another carrier; reinsurer could be bound to reinsuring the risk, even if rejected, for several weeks/months (as it may take 45 days or more to receive the report from cedent stating the assets covered/claims paid)

Pro Rata reinsurance

reinsurer shares pre-determined portion/percentage of cedent's liabilities, regardless of size; has a ceding commission