Intensive Actuarial Training for Bulgaria January 2007

1. Intensive Actuarial Training for Bulgaria January 2007 Lecture 11 – Reinsurance By Michael Sze, PhD, FSA, CFA

2. Reinsurance Contract • Ceding company: primary insurer • Reinsurer: offers insurance of insurance companies • Each contract is unique: reflects the needs of the ceding company • Covers proportional or excess loss based on predetermined retention level • Domestic or foreign reinsurance companies

3. Reasons for Purchasing Reinsurance • Limit liabilities on specific risks • Stabilize loss experience • Protect against catastrophes • Increase capacities • Additional services provided by reinsurer

4. Limiting Liabilities • Retention limit refers to individual policies • Limit risk exposure to amount that the primary insurer can absorb • Allow primary insurer to offer coverage considerably higher than what they can provide • Of crucial importance: allow smaller insurers to compete with large companies

5. Stabilization • Characteristics of P & C risk • Many small claim, a few large ones • In catastrophe, aggregate claim is more than what smaller insurer can absorb • By ceding the excess loss, the profit or loss of the primary insurer is more stable

6. Catastrophe Protection • Two protections against catastrophic loss • Catastrophic loss from one single event • Fire of a large manufacturing factory • Catastrophic loss from aggregation of many smaller claims • Earth quake • hurricane

7. Increased Capacity • New business needs capital causing surplus drain: commission, administrative expenses,taxes • All expenses happens before profit develops • Proportional reinsurance shares part of the underwriting expenses: reduces surplus drain • Credit for reinsurance: accounting issue • Reduces risk and loss reserve • Ceding commission from reinsurer • For expenses paid by ceding company

8. Additional Services Provided by Reinsurer • Guidance in underwriting, claim reserves, claim handling, investment, and general management • Important note: reinsurance does not change the nature of the risk of the policy

9. Two Categories of Reinsurance Contracts • Treaty reinsurance: covers all risks written by the ceding insurer, with exceptions: • Long haul truckings, ammunition manufacturing • Reinsurer needs to carefully review ceding company • Underwriting philosophy, underwriting practice, • claim management procedure, claim experience, and • management background and expertise

10. Facultative Reinsurance • Covers specific risks • Catastrophic risks • Unusual risks • Used to supplement treaty arrangements on the specific exclusions • Different layers of reinusurance

11. Characteristics of Reinsurance Risks • Long tail • Loss may take long time to develop • Claims not reported to reinsurer until the primary retention is exceeded • Inflation and legal verdict increases cost • IBRN (incurred but not reported) claims are difficult to estimate • Law of large number may not work • Correlation between different claims • Much judgment call