Reinsurance

1. Reinsurance Nigel Davies December 2, 2008.

2. Reinsurance Session 1 Introduction & Overview. Case Study, Round 1. Session 2 Case Study Feedback. Life Reinsurance. Finite Reinsurance. Failure of Reinsurance. Session 3 Catastrophe Insurance. Securitization. Case study – Round 2. Session 4 Case Study Feedback. Supervisory Issues.

3. Reinsurance Session 1 Introduction & Overview. • Reinsurance Market • Definitions and Types of Contract

4. Reinsurance Reinsurance Company Retrocession Reinsurance Company Reinsurance Broker, Direct. Insurance Company Broker, Direct. Direct Insurance Broker, Agent, Phone, Online, In person. Insured

5. Reinsurance …and why do we measure it by premium? How much of this is reinsurance? Reinsurance Company Global Premiums in 2007 Reinsurance Insurance Company Broker, Direct. Source: Swiss Re, Sigma 3/2008.

6. Reinsurance Destination & Source of Reinsurance Premium (US$ million) Source: IAIS Global Reinsurance Market Report, December 2007 Data Source:- 59 Reinsurers: Bermuda 8; Europe 21; Japan 2; USA 28.

7. Reinsurance Reinsurance Premiums Assumed by Class of Business & Contract Type (US$ million) Proportional Reinsurance Ceding insurer and assuming reinsurer share an agreed portion or percentage of original premiums and subsequent losses in respect of the reinsured business. Non-proportional Reinsurance Reinsurer assumes the part of the ceding insurer’s claims that exceed a certain amount. The premium is a specially calculated amount. Source: IAIS Global Reinsurance Market Report, December 2007

8. Reinsurance Gross Premium Net Premium Retention Ratio Life 2003 4166 4080 98% 2004 4668 4589 98% 2005 4097 3993 97% Non-life Motor 2003 440 374 85% 2004 496 421 85% 2005 588 524 89% Property 2003 557 54 10% 2004 501 50 10% 2005 520 62 12% Other 2003 382 268 70% 2004 391 241 62% 2005 613 417 68% Reinsurance Profile – Trinidad & Tobago (TT$million)

9. Reinsurance Non-Life Life Reinsurance Market Dynamics – How do reinsurers make money?

10. Reinsurance Non-Life High returns in low cat. years attracts capital. New capital creates overcapacity and reduces prices (market softens). Cats wipe out capital and prices increase (market hardens). Hard market attracts capital. Life Information asymmetry. Reinsurers have annually updated loss experience – better than (time-lagged) mortality tables. Risk profile: pandemics vs. advances in medical science. Life vs. Pensions products hedge mortality and longevity risks. Primary market trend for savings products reduces need for life reinsurance. Reinsurance Market Dynamics – How do reinsurers make money? HIGHLY CYCLICAL INCREASING LONGEVITY

11. Reinsurance Capital Movements in a Major Reinsurers – 2007 (Overall 7% increase) Source: Global Reinsurance Market Review 2007. Benfield. www.benfieldgroup.com

12. Reinsurance Non-life Reinsurance Prices For expected loss of 4%, premium was 11% of sum insured in 2008 (2007, 13%). For expected loss of 1%, premium was 4% of sum insured in 2008 (2007, 5.5%).

13. Reinsurance Increasing Longevity in the Caribbean For 18 age-group cohorts. Source: Caribbean Epidemiology Centre. October 2000. www.carec.org

14. Reinsurance Story so far………. • Reinsurance activity, measured by premium, is substantial but impossible to make cross-sectoral comparisons • Reinsurance risk tends to migrate to large European reinsurers. • Non-life RI >> Life RI. • Proportional & non-proportional reinsurance • Non-life RI highly cyclical – 7% increase in capital in 2007 led to price drops of 10%-20% in ROL for 2008. • Life primary market driven by increasing longevity….. • ….. growing due to savings products, but this has little effect of Life RI. Life RI based on information asymmetry.

15. Reinsurance • Prioritize Non-life reinsurance over Life reinsurance. • Cover Proportional & Non-proportional contracts equally.

16. Reinsurance Classification of Reinsurance Contracts

17. Reinsurance Reinsurance Contracts TREATY REINSURANCE FACULTATIVE REINSURANCE } Reinsures bundles of primary policies Reinsures individual primary policies Non-life / Life. Proportional / Non-proportional. Obligatory / non-obligatory.

18. Reinsurance Reinsurance Contracts TREATY REINSURANCE FACULTATIVE REINSURANCE } Reinsures bundles of primary policies Reinsures individual primary policies Non-life / Life. Proportional / Non-proportional. Obligatory / non-obligatory.

19. Reinsurance Non-life Treaty Reinsurance Non-proportional Proportional Excess of Loss Stop Loss Quota Share Surplus Treaty Excess of Loss and Quota Share Treaties are most common. Stop Loss contracts are very rare nowadays

20. Reinsurance 1. Excess of Loss Contracts - Basics RI cover exhausted! Claim: For a $5m claim, $3m is recoverable under this contract. $5m $4m Limit $3m $3m xs $1m Reinsurance cover for specified line(s) of business $2m } $1m Attachment point Deductible / Risk retention

21. Reinsurance 1. Excess of Loss Contracts $50m 3rd Layer, $20m xs $30m No reinstatements $40m $30m 2nd Layer, $10m xs $20m 1 reinstatement 2nd Layer, $20m xs $10m 1 reinstatement $20m 1st Layer, $10m xs $10m 1 reinstatement $10m 1st Layer, $5m xs $5m 3 reinstatements $5m Line of Business A Line of Business B

22. Reinsurance 1. Excess of Loss Contracts $50m $40m $30m }* * $20m $10m $5m 1 2 3 Line of Business A Line of Business B

23. Reinsurance 2. Stop Loss Contracts Limit (e.g. loss ratio of 130%) Stop loss covers a specified %age of losses between attachment point and limit. Aggregate Losses / Claims of Insurer Attachment point (e.g. loss ratio of 110%) Aggregate Premiums • Attachment points and limits expressed as either: • Loss ratios, or • Absolute amounts

24. Reinsurance 3. Quota Share Contracts Proportional Reinsurance Ceding insurer and assuming reinsurer share an agreed portion or percentage of original premiums and subsequent losses in respect of the reinsured business. • Quota Share Contracts have 2 types of limits: • Per risk limit • Aggregate exposure limit

25. Reinsurance 3. Quota Share Contracts Aggregate exposure limit Reinsurer imposes a limit on aggregate exposure (total sums insured). A breach of this limit will mean an averaging down of the QS cover. $6m $5m } $4m $3m $4m per risk limit $2m 75% Quota Share $1m

26. Reinsurance 3. Quota Share Contracts Aggregate exposure limit Reinsurer imposes a limit on aggregate exposure (total sums insured). A breach of this limit will mean an averaging down of the QS cover. Profit Commission With extensive reinsurance cover in the lower layers, insurers may allow underwriting standards to drop (in order to gain market share) & this reduces underwriting profit. To counteract this, QS contracts typically allow a retroactive payment from the reinsurer of, say, 20% of its profit on the contract. $6m $5m } $4m $3m $4m per risk limit $2m 75% Quota Share $1m

27. Reinsurance 4. Surplus Treaty Contracts Surplus Treaty Ceding insurer retains a specified amount – calledthe line. The amount ceded to the reinsurer is defined as aspecified number of lines. Example: 4 line surplus treaty of $1m $6m $5m $4m Reinsurance cover for 4 x retention in a 4 line surplus treaty. NOTE – 100% COVER FOR THESE CEDED LINES. $3m $2m $1m Retention

28. Reinsurance 4. Surplus Treaty Contracts Example: 4 line surplus treaty of $1m $6m $5m 1 Cedant retains all premiums and claims. $4m $3m 2 Cedant retains 25% of premiums and claims. Reinsurer assumes 75% of premiums and claims. 2 premium $2m $1m 1 premium

29. Reinsurance What type of reinsurance contract suits the loss scenarios in these lines of business? Household Fire & Contents (Non-catastrophe) Property Catastrophe Amount Workers’ Compensation Motor Time

30. Reinsurance Motor Property Catastrophe Household Fire & Contents (Non-catastrophe) Amount Workers’ Compensation Time

31. Reinsurance The Ideal Reinsurance Program? Motor Catastrophe XL. 2 reinstatements to cover 3 events in total. Property Catastrophe Household Fire & Contents (Non-catastrophe) Casualty XL. 3 reinstatements on bottom layer to cover 4 events. Workers’ Compensation Quota Share. To cover attritional losses in all lines of business. Amount Claims Arranged by Line of Business

32. Reinsurance CASE STUDY – ROUND 1. • Contract wordings are “standardized” throughout the industry. • Terms & conditions can vary greatly. • Wordings do vary in quality and are capable of misinterpretation. • Wordings contain jargon…….. • Please read the handout which is about a • Non-life Casualty XL Program. • Prepare questions for discussion & reasons for your questions • Prepare suggestions on how this program can be improved upon.