TREATY REINSURANCE

1. TREATY REINSURANCE WEEK 5 & 6 Facilitator : Mr Isoa Tubuna

2. CONTINUATION FROM LAST LECTURE

3. MULTIPLE SURPLUS TREATIES More than one surplus treaty may be arranged on top of the gross retention and the original surplus treaty, where more capacity per risk is required than any one group of reinsurers can or will provide in the 1st surplus treaty Each surplus treaty is numbered in order of its priority to the ceded business. If the SI of any risk exceeds the capacity provided by the gross retention and the 1st surplus treaty, the additional amount must be ceded to the 2nd surplus treaty and so on until the treaty capacity is exhausted.

4. CONT When are surplus treaties used? The following factors are amongst those considered in deciding whether to use surplus treaties: Increasing Risk Capacity – surplus treaties allow substantial multiples of a company retention to be underwritten and accepted. Greater capacity per risk can be generated utilizing surplus treaties than can generally be achieved with a quota share arrangement, while minimizing cessions and increasing retained premium

5. CONT Financial Capacity – as with quota share treaties, if the insurer’s financial capacity is under strain through expansion and accompanying costs of commission and brokerage, the exchange commission involved in surplus treaties may be useful in offsetting acquisition expenses Limiting Accumulation – since surplus treaties, like quota share treaties, reduces the net liabilities (exposures) of the portfolio, they will have the effect of reducing the insurer’s requirement for catastrophe insurance cover

6. ADVANTAGES For the insurer, surplus treaties have the advantages over quota share treaties of fully utilizing the retention on all risks in the portfolio reinsured. Since the bulk of risks (and premium) occurs within the insurers retention, surplus treaties allow the insurer to maximize its income and profit on the portfolio.

7. At the same time, a surplus treaty can dramatically increase the insurer’s capacity to insure large risks, without ceding more of its premium than is really necessary DISADVANATAGES ST are rather more complex to administer than a quota share treaties, since widely differing retentions may be used for different classes of risk within the portfolio

8. Surplus treaties also rely on the insurer having a good knowledge of the risk profiles in the portfolio, in order to allocate appropriate retention levels. They may therefore be inappropriate in a developing portfolio The main disadvantages of ST rest with the reinsurer. As the reinsurer participates only in the larger risk which normally comprise a lesser part of the insurer’s portfolio, the balance between premium and capacity is not

9. good as it would be for the insurer’s own account or for a QST. Reinsurers look carefully at past results in surplus treaties in order to match ceded premiums with capacity and risk history EVENT LIMITS In proportional treaties it is uncommon for reinsurers to take large shares of individual risks. If these individual risk have a common natural perils exposure, the reinsurer is exposed to a high level of catastrophe loss.

10. Sometimes a proportional treaty will have an event limit, which is the maximum the reinsurer will pay for a catastrophe event. Both the insurer and reinsurer need to carefully track their total exposure to such events.

11. Facultative Obligatory R/I Treaty FOT R/I (fac-oblig’ reinsurance) usually supplement STR/I facilities. The agreement is facultative in that it is not compulsory for the insurer to cede business but, if it does, it is obligatory on the reinsurer to accept the business ceded. FO Agreements are generally used by insurers for unusually large risks contained within a portfolio of risks within the treaty. The FOA provide additional capacity beyond the insurer’s normal surplus treaty capacity

12. Example, an insurer may have a significant proportion of high sum insured city office buildings, or high rise body corporate buildings, and wishes to use an automatic R/I facility rather that having to rely on individual facultative RI for what are essentially similar risks.

13. The advantages of fac-oblig agreement for the insurer are: Automatic availability of additional capacity Flexibility of RI arrangements-the insurer has the option of deciding to cede a particular risk Fac Oblig agreement present problems for reinsurers, due to the obligatory aspect: There may be a temptation for insurers to cede only bad risk, knowing that the reinsurer must accept them

14. Relatively little business is ceded compared to surplus treaties, so reinsurers may gain little extra premium while accepting substantial liabilities Before accepting a fac oblig agreement, reinsurer will normally make sure that: The insurer will not cede only bad risks A reasonable amount of business will be ceded

15. NON PROPORTIONAL TREATIES In NPT R/I, the ratio of the original SI protected by the treaty to the full SI under the original policy does not determine the ratio for dividing premiums and losses bet the insurer and the reinsurer. Instead, losses are apportioned according to the actual amount of loss incurred where the loss exceeds the insurer’s treaty deductible. The treaty premium is established on the basis of various factors including likelihood of loss and risk exposure.

16. NPT define an amount –the ‘deductible’ (sometimes called ‘net retention’) – up to which the insurer will pay all losses. The reinsurer will pay losses above the deductibles amount, in full or in part as agreed but not exceeding a contractually defined cover limit within the treaty. Layering of the risk exposure is often used in NPT. Its used is similar to that of additional ST in PR/I. The different is that layering relates to size of loss, not size of insured risk.

17. The 3 main form of excess of loss R/I: Per Risk Per Event, and Stop Loss Treaties

18. Per Risk Excess of Loss Treaty PRELT apply in respect of individual risks, rather than group of risks that may be affected by a catastrophic event such as cyclone. The later are covered in the catastrophe excess of loss treaties. PRELT cover all risk within the portfolio of business, subject to any exclusions or limitations incorporated by the parties into the agreement. They are designed to limit the size of loss that an insurer can suffer from any one risk

19. When are PRELT used? PRELT are used in property & liability type covers PRELT coverage allows financially strong insurers to retain greater proportion of gross premium income, servicing the available capital and freeing reserves to the maximum extent.

20. If the portfolio is well established and the insurer is experienced in the class of business, with demonstrated underwriting expertise, PRELT can be used to obtain RI terms that are more favorable than with other treaty types. PRELT are generally limited in respect of losses occurring as a result of a ‘catastrophe event’. A ‘two risk warranty’ is generally placed on the limitation of the cover provided, restricting the insurer from using the per risk treaty as a de facto per event (catastrophe) treaty.

21. As an alternatives to a two- risk warranty under a property per risk excess of loss treaty may be subject to a monetary ‘event limit’ which caps the reinsurer’s exposure from catastrophe losses to a specified amount. ADVANATAGES Maximum Level of Retained Premium – since the reinsurer does not participate in the smaller losses that makes up the majority of the insurer’s claim portfolio, the reinsurer will require a smaller portion of the premium than for a comparably sized quota or surplus share treaty

22. Stability of Results –stability is achieved in terms of maximum size of loss, giving a relatively low cost protection for the insurer Maximizing Capacity – the insurer is able to retain large risk without having to share the premiums obtained from smaller, easily retained risks with the reinsurer DISADVANTAGES No exchange commission to assist in covering the acquisition expenses

23. Per event (Catastrophe) excess of loss Treaty Cat XL RI is an essential form of protection for insurers writing cover for property class of business, since they are exposed to a large accumulation of risk exposures from single event such as cyclones, floods and other catastrophe events. Since PREL RI specifically limits the number of risk covered by a single event, insurers without catastrophe RI could face ruin from aggregate losses following large no.s of individual claim from such as events

24. Cat XL protects the insurer where a single loss event affects a multitude of insured risks. Cat XL acknowledges that the risks an insurer accept in some circumstance are not independent-losses can result from a single event, generating virtually simultaneous losses on a large scale. Cat XL provides cover for such loses across a range of portfolios.

25. For the purpose of this form of RI, a catastrophe is defined as occurring if; Two or more risks are affected by the same event, and The event occurs over a defined period (hours clause) The define period varies depending on the type of catastrophe event. Example earthquake, storm, riot must occur within 72 consecutive hours while bushfire may occur within 168 hours

26. In determining how much cat XL they need, insurers must identify accumulated exposures in defined area of their portfolios. These may vary with the type of policy cover and its exposure to a catastrophe perils (eg home building & contents and commercial fire insurance in relation to storm, earthquake, bushfire) and with the geographical and infrastructure zone. Eg. Eastern & Central Viti- Levu are prone to Cyclone, Nadi prone to Flood

27. Like a per risk XL, cat XL may use a number of layers to build up the necessary protection It may also a requirement of catastrophe cover RI that the insurer participate in the treaty loss. This is referred to as a co-insurance clause and typically, it may be to the order of 10% of the treaty cover. The agreed loss % must be borne by the insurer in all layers affected by the loss

28. Reinstatement Catastrophe treaties usually provide for one reinstatement of cover, often worded ‘one reinstatement at 100% additional premium. E.g Period of Insurance- 31/1/10 to 31/12/11, Cyclone happen on the 18/2/11 and Earthquake on 01/10/11

29. Function of cat XL The primary function of cat XL is to prevent the ruin of the insurer. Reduction in net capital following losses from a catastrophe may also constrain the insurer’s future operations, and severely affect the return to shareholders. It influence on the insurers regulatory position to carry on business [Solvency Margin] Cover’s the ability to minimize massive single-event losses contributed to stability

30. STOP LOSS TREATIES SLT operates when retained losses for a class exceed a certain deductible expressed as a % of retained premium income, up to maximum % (and/or monetary figure). SL RI therefore protects a class of insurance as a whole, rather than providing cover on individual losses. SLT are normally used to provide cover for specific classes of insurance where losses vary unpredictably from yr to yr

31. A SLT requires the insurer to bear all losses up to a pre-determined loss ratio. The reinsurer only pays those claims above that loss ratio and then only within predetermined treaty limits. The deductible for the treaty is expressed as an ultimate net loss ratio [UNLR] of pure losses[not incl. expenses and profit margin] as a % of the total premium income for the class of insurance protection by the treaty

32. Functions SL covers provide stabilization, since they protect the insurer from random fluctuations in claims levels and changes in underlying trends affecting loss frequency Disadvantages