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INTRODUCTION TO REINSURANCE January 2017

Understand the purpose, parties, and operations of reinsurance strategies including proportional treaties like quota share and surplus treaties. Explore advantages, disadvantages, and examples to enhance your knowledge in the field.

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INTRODUCTION TO REINSURANCE January 2017

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  1. INTRODUCTION TO REINSURANCEJanuary 2017

  2. Agenda • Purpose of and the parties involved in reinsurance (2) Features and operation of proportional treaties (3) Features and operation of non-proportional treaties (4) Features and operation of facultative reinsurance (5) Uses of reinsurance

  3. Purpose of and the parties involved in reinsurance

  4. Purpose of and the parties involved in reinsurance • PURPOSE OF REINSURANCE • Spreads risk • Increases capacity • Provides security

  5. Purpose of and the parties involved in reinsurance PURPOSE OF REINSURANCE (cont.) • Increases stability in results • Increases confidence • Portfolio and asset management

  6. Purpose of and the parties involved in reinsurance • PURPOSE OF REINSURANCE (cont.) • Taxation advantages • Cash flow advantages • Corporate strategy

  7. Purpose of and the parties involved in reinsurance THE BUYERS THE SELLERS (The Insured) THE INTERMEDIARIES Insurers Reinsurers Lloyd’s brokers Lloyd’s Commerce Industry The Public Composite/General Insurance Companies Brokers Industrial Life Assurance companies Agents Friendly societies Reinsurance Companies Consultants Mutual indemnity associations Captive insurance companies Home Service representatives Self insurance The state Direct insurers

  8. Purpose of and the parties involved in reinsurance BUYERS OF REINSURANCE • Insurance companies • Lloyd’s syndicates • State-owned insurance corporations

  9. Purpose of and the parties involved in reinsurance BUYERS OF REINSURANCE (cont.) • Regional insurance corporations • Captive insurance companies • Mutual insurance companies

  10. Purpose of and the parties involved in reinsurance BUYERS OF REINSURANCE (cont.) • Reinsurance companies • Reinsurance pools Typically, reinsurance purchased via brokers

  11. Purpose of and the parties involved in reinsurance • SELLERS OF REINSURANCE • Reinsurance companies • Lloyd’s syndicates • Direct insurance companies • State reinsurance companies • Reinsurance pools

  12. Purpose of and the parties involved in reinsurance MOTIVATION FOR SELLING REINSURANCE • Profit • Investment income • Spread of risk • Reciprocity • National retention of premiums • Core business

  13. (2) Features and operation of proportional treaties

  14. Features and operation of proportional treaties

  15. Features and operation of proportional treaties TYPES OF PROPORTIONAL TREATIES • Quota Share • Surplus Treaty

  16. Features and operation of proportional treaties QUOTA SHARE TREATIES The quota share is an obligatory ceding treaty where the ceding company must cede and reinsurer must accept a fixed proportion of every risk which falls within scope of treaty, usually subject to a maximum amount any one cession Reinsurer receives a fixed proportion of all the original premiums (less ceding commission) and pay a fixed proportion of all the claims

  17. Features and operation of proportional treaties Gross Retention is amount of risk carried by the ceding company and quota share reinsurers added together Net retention is that part of the risk carried by the ceding company only

  18. Features and operation of proportional treaties Example Assume a direct insurer has a 40% quota share treaty, retaining 60% for its own account. Risk Sum Insured Cedant Cession to Treaty $ $ $ 1 200,000 120,000 80,000 2 1,000,000 600,000 400,000 3 1,500,000 900,000 600,000

  19. Features and operation of proportional treaties Losses apportioned PROPORTIONATELY Risk Sum Insured Cedant Cession to Treaty $ $ $ 3 1,500,000 900,000 600,000 Loss of $1,000,000 apportioned: Cedant: $600,000 (60%) Treaty: $400,000 (40%)

  20. Features and operation of proportional treaties Advantages of quota share treaties • Absolute relationship insurer/reinsurer (reinsurer follows fortunes) • Simple accounting and reporting • Flexibility to amend amount ceded • Unlimited cover for aggregation of losses in single event

  21. Features and operation of proportional treaties Disadvantages of quota share treaties • Unnecessary premium may be ceded • Inflexible retention • Treaty terms fixed • Treaty terms restrictive • Loss aggregation not fully protected

  22. Features and operation of proportional treaties SURPLUS TREATIES Reinsurers must accept an amount of risk, which falls within the scope of the treaty and which is surplus to a cedant’s retention or “line” Reinsurers’ total retention is specified as a multiple number of “lines” No direct relationship between the number of lines and the number of reinsurers

  23. Features and operation of proportional treaties SURPLUS TREATIES (cont.) May specify different levels of maximum retention (“lines”) for different classes of business Cedant can choose whether to write the stated maximum retention for a specific class or some lower amount Both premiums and claims are proportionately shared between cedant and reinsurer

  24. Features and operation of proportional treaties Assume a direct insurer has a retention of $250,000 in respect of a clothing factory. It has a 10-line surplus treaty. Risk Sum Insured Retention Cession to Treaty $ $ $ 1 500,000 250,000 (50%) 250,000 (50%) 2 1,000,000 250,000 (25%) 750,000 (75%) 3 2,750,000 250,000 ? 4 2,750,000 200,000 ? 5 3,000,000 250,000 ?

  25. Features and operation of proportional treaties Losses apportioned PROPORTIONATELY Risk Sum Insured Cedant Cession to Treaty $ $ $ 2 1,000,000 250,000 (25%) 750,000 (75%) Loss of $500,000 apportioned: Cedant: $125,000 (25%) Treaty: $375,000 (75%)

  26. Features and operation of proportional treaties It is possible to arrange a second surplus treaty whereby another group of reinsurers will write a certain number of lines in addition to those written under the first surplus treaty

  27. Assume a direct insurer has a retention of $200,000. It has a 10-line first surplus treaty and a 5-line second surplus treaty. Risk Sum Insured Retention 1st surplus 2nd surplus $ $ $ $ 1 180,000 180,000 nil nil 2 300,000 200,000 100,000 nil 3 3,000,000 200,000 2,000,000 800,000 4 3,200,000 200,000 2,000,000 1,000,000 Features and operation of proportional treaties

  28. Features and operation of proportional treaties Risk Sum Insured Retention 1st surplus 2nd surplus $ $ $ $ 2 300,000 200,000 100,000 nil 4 3,200,000 200,000 2,000,000 1,000,000 How is loss of $250,000 apportioned for risks 2 and 3? 2 4

  29. Features and operation of proportional treaties Advantages of surplus treaties • Cedant can vary retention • Automatic capacity • Cedant can retain more premium • Ceding/profit commission • Unlimited cover for aggregation of losses in single loss event

  30. Features and operation of proportional treaties Disadvantages of surplus treaties • Optimal retention important • Results of insurer and reinsurer differ • Treaty terms fixed • Treaty terms restrictive • Reinsurer’s loss experience can vary • Ceding commission lower than QS • Loss aggregation not fully protected

  31. Features and operation of proportional treaties PROPORTIONAL PRICING Pricing in proportion to reinsurer’s share Reinsurance commission/brokerage deducted

  32. Features and operation of proportional treaties PROPORTIONAL COMMISSIONS AND DEDUCTIONS Reinsurance/ceding commission is paid by reinsurer to a cedant. It is usually a percentage of the reinsurance premium due to the reinsurer on a “flat rate” basis and influenced by: • type of reinsurance • history of profitability • state of reinsurance market • original broker’s commission • cedant’s administrative costs

  33. Features and operation of proportional treaties PROPORTIONAL Profit commission (flat-rate basis) An extra commission payable to a cedant over and above the flat rate commission, based on the net profit made by the reinsurer from the treaty

  34. Features and operation of proportional treaties PROPORTIONAL Sliding scale commission The ceding commission is varied according to the loss ratio experience of the treaty:- High loss ratio = Low commission Low loss ratio = High commission

  35. Features and operation of proportional treaties PROPORTIONAL Loss participation A share of losses under a proportional treaty must be borne by the cedant if loss ratio exceeds an agreed percentage. Acts as a form of reverse profit commission.

  36. (3) Features and operation of non-proportional treaties

  37. Features and operation of non-proportional treaties

  38. Features and operation of non-proportional treaties $40M Limit of cover $38M Deductible $2M $2M

  39. Features and operation of non-proportional treaties TYPES OF EXCESS OF LOSS TREATY • Risk excess or per risk • Catastrophe or per event • Stop loss • Aggregate excess of loss • Other types of cover

  40. Features and operation of non-proportional treaties RISK EXCESS OR PER RISK Also referred to as working cover/working excess of loss cover per risk Used to protect individual risks on an excess of loss basis Reinsurer participates in the loss when the amount of a single claim exceeds the level of the deductible, and pays up to the amount of the maximum cover agreed Event limits prevent the contract being used as a catastrophe protection

  41. Features and operation of non-proportional treaties $40M $32M 4th layer $20M $20M 3rd layer $4M $16M $11.6M 2nd layer $8M $8M 1st layer $6M $2M $1.6M Deductible $2M Loss 1 Loss 2 Loss 3

  42. Features and operation of non-proportional treaties Q. Insurer A has arranged excess of loss reinsurance cover with reinsurer B for US$1,000,000 in excess of US$2,500,000. Identify how much each party would expect to pay out in the event of a loss amounting to: US$1,500,000 US$3,250,000 US$5,000,000

  43. Features and operation of non-proportional treaties CATASTROPHE OR PER EVENT Per event also known as “Working excess of loss cover per event” (WXL/E) Catastrophe cover used to protect against the consequences of a catastrophe when exposed to the problems of accumulation of risk and catastrophe perils Catastrophic loss = a specific, sudden, unexpected, shocking and external happening that can be located in time and place

  44. Features and operation of non-proportional treaties STOP LOSS (EXCESS OF LOSS RATIO) Used for aggregate losses arising in respect of a specific class or classes of business Loss/claims ratio = Losses or Claims * 100 Premiums (GNRPI) Note (1) Reinsured may be obliged to retain a proportion of the reinsured amount e.g. 10% (co-reinsurance) (2) GNRPI subject to maximum and minimum criteria

  45. Features and operation of non-proportional treaties Example of Stop Loss Assume an insurer has stop loss cover for 90% (i.e. bearing 10% itself) of any excess claims ratio above 90% up to 120%. In a year the GNRPI is US$5,000,000 and claims $6,250,000. Reinsured Reinsurer $ $ First 90% of loss ratio 4,500,000 nil Next 30% of loss ratio 150,000 1,350,000 Next 5% of loss ratio 250,000 nil ------------ ------------ 4,900,000 1,350,000

  46. Features and operation of non-proportional treaties AGGREGATE EXCESS OF LOSS Similar to stop loss reinsurance except that coverage is expressed in actual monetary amounts, not percentages

  47. Features and operation of non-proportional treaties Example of Aggregate Excess of Loss An insurer has an aggregate excess of loss arrangement as follows: Protection to pay up to US$4,000,000 in the aggregate of all losses falling under the 2016 underwriting year excess of US$8,000,000 in the aggregate of all losses falling under the 2016 underwriting year

  48. Features and operation of non-proportional treaties OTHER TYPES OF COVER • Clash excess of loss • Umbrella excess of loss • Buffer excess of loss • Back-up covers • Reinstatement premium protections • “Top & drop” and “cascade” protections

  49. Features and operation of non-proportional treaties • Advantages of excess of loss treaties • Accounting procedures simplified • Administration costs reduced • Reinsurance premium is all-inclusive • Reinsurance premium is predetermined • Usually no profit commission • Reinsurer does not deposit technical reserves

  50. Features and operation of non-proportional treaties Disadvantages of excess of loss treaties • Calculation of business is more complex • Cost of reinsurance can vary

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