Download Reinsurance Theory Practice Design

REINSURANCE, THEORY
PRACTICE & DESIGN
PRESENTER: S GWASIRA – FIISA, AIRMSA
Baobab Reinsurance
Baobab Re offers the following capacities
Fire
US$ 20 Million
Engineering
US$ 10.5 Million
All Accident classes US$ 3 Million
Marine Hull
US$ 1.5 Million
Marine Cargo
US$ 1.5 Million
Fire Treaty
US$ 3 Million
Engineering
US$ 1.5 Million
Contacts
[email protected]
[email protected]
[email protected]
Alternative Risk Transfer (ART)
Products designed to offer risk solutions outside conventional insurance /
reinsurance models.
According to AON Securties, these now account for 13% of Global
Reinsurance capital i.e $ 75.1 Billion as @ June 2016.
Alternative carriers – Self insurance, Captives (insurance companies owned
by parent), Pools (government entities or insurance companies grouping
to provide coverage for certain risks).
Alternative products – Finite risks (seek to reduce year to year volatility
associated with commercial insurance policies) Contingent capital
(transfer of cat risks to capital mkt via a bond issue) Weather derivatives
(mitigate earnings volatility associated with weather changes) Credit
securitisation (hedging against credit risks).
CONTENT
Reinsurance Language
Functions Of Reinsurance
Major Types Of Reinsurance (Facultative &Treaty )
Risk Measurement (EML, PML, MPL Application)
Reinsurance Program Design
Conclusion / Question & Answer
REINSURANCE LANGUAGE
Insurance
Reinsurer
Reinsurance
Direct Underwriter / Cedant / Primary Insurer
Retrocession – Retrocedant – Retrocessionaire
Retention Limit
Insurance Vs Reinsurance
REINSURANCE LANGUAGE
The insurer insures the individual or the corporation.
REINSURANCE LANGUAGE
Reinsurer
THE REINSURER INSURES THE INSURANCE COMPANY
Robert Kiln, Reinsurance Practice, 3rd Edition
REINSURANCE LANGUAGE
Reinsurance definition
“…Reinsurance is insurance of insurers. It is an agreement between an
insurer and a reinsurer. Reinsurer agrees to indemnify all or part of
loss which the ceding company may incur under certain policies of
insurance that it has issued. In turn the cedant pays a consideration,
typically a premium and discloses information needed to asses, price
and manage risks covered by the reinsurance contract.
REINSURANCE LANGUAGE
Direct underwriter / cedant
The insurance company
Retrocession
Transfer of risk from a reinsurer (retrocedant) to another reinsurer
(retrocessionaire).
Retention limit
The amount of risk that cedant / insurance company keeps for its net
account.
FUNCTIONS OF REINSURANCE
WHAT ARE THE FUNCTIONS?
FUNCTIONS OF REINSURANCE
•
Capacity
•
Stabilisation of underwriting results
•
Catastrophe protection
•
Surplus / capital relief (increase in portfolio income requires
corresponding increase in assets).
•
Underwriting expertise
•
Withdrawal from a territory or line of business
•
Risk spreading
LIMITATIONS OF REINSURANCE
• WILL NOT MAKE BAD BUSINESS PROFITABLE
• TRANSACTION COSTS INVOLVED
TYPES OF REINSURANCE
TYPES OF REINSURANCE
TREATY
FACULTATIVE
PRO-RATA
XOL
PRO-RATA
XOL
FACULTATIVE
A Facultative reinsurance] .. Is one in which each party to the
transaction has absolute free choice in arranging the matter; the
ceding company may choose, and the reinsurer has an entirely
unfettered discretion (faculty) whether or not to accept any risk
offered. It follows that each risk to be reinsured has to be dealt with
separately and each facultative reinsurance forms a complete
reinsurance contract in itself”
The Law and Practice of Reinsurance - C.E. Golding
FACULTATIVE
The two basic features of the facultative method of handling
reinsurances are:
(1) Its optional character, with the ceding insurer and the
prospective reinsurer being free respectively to offer or reject the
reinsurance; and
(2) Its use for placing individual risks’.
Reinsurance (2nd Edition) - R.L. Carter
Facultative reinsurance can be written on either a pro rata or excess
of loss basis.
Premium and losses are shared in predetermined proportions.
Requires disclosure of all material facts relating to risk being placed.
FACULTATIVE
Needs met by Facultative
•Capacity is one of the best known reasons to buy facultative
reinsurance.
•Allows the underwriter to write or retain those accounts where
additional capacity in excess of their net and treaty limits is needed to
secure the order.
•Acceptance of risks, though not excluded from the treaty but represent
increased exposure and could distort treaty results.
•Acceptance of tailor made policies (New products) for preferential
clients that fall outside standard conditions owing to size and
complexity.
•Market conditions or geographic expansion may lead to a decision
to entertain a new line of business. A partnership with a facultative
reinsurer who has had the experience in the line can be a safe and
cost effective investment to protect the company from unpredictable
or large losses during the development and learning period.
FACULTATIVE
Needs met by Facultative
•Non availability of specific protection under a
treaty or small number of policies issued by cedant
which does not warrant treaty arrangement.
•Acceptance of risks excluded from treaty eg
geographical location, nature of business, perils etc.
•Withdrawal from certain territory or line of
business.
•Possibility of increasing company’s net account
through offering business in exchange for inward
facultative business.
FACULTATIVE
Needs met by Facultative
Alternative use of capital.
The underwriter can choose the layer where it is more
advantageous to use the company’s capacity. As an example, if
the company’s capacity is US$ 5 million and the required limits
are US$10 million, underwriter can choose to use the
company’s capacity by keeping the first million in-house and
buying facultative reinsurance in the layer believed to have a
more catastrophic potential. Then the underwriter can use the
remaining net and treaty capacity in the next layer, which is
considered to have less potential for a catastrophic loss to
complete the required limits.
For example
$First million = ceding company
$5 million xs $1 million = facultative reinsurer
$4 million xs $6 million = ceding company
FACULTATIVE
Advantages
Increases underwriting capacity.
Allows flexibility of cedant’s underwriting policy.
Good protection against frequency/severity potential.
Protection of net retention on first dollar basis.
Permits recovery on smaller losses.
Provides access to reinsurer’s experience on specific types of risks or
cover.
Cedant is able to ascertain reinsurer’s level of response and service.
FACULTATIVE
Disadvantages
Administratively cumbersome as each risk has to be placed
individually.
Time consuming and acceptances may not be obtained within
the required time frames.
The Error Factor inherent in hasty facultative placements.
Cover can not be confirmed until Reinsurance placement has
been confirmed (faculty).
Lower commission levels available as compared to those
offered under treaties (proportional).
FACULTATIVE
EXCESS OF LOSS/NON PROP
A term describing a reinsurance transaction that, subject
to a specified limit, indemnifies a ceding company
against the amount of loss in excess of a specified
retention
Advantages
Good protection against frequency/severity potential
depending upon the retention size
Allows a greater net premium retention
More economical in terms of reinsurance premium and
the cost of administration
FACULTATIVE OBLIGATORY
•Provides an automatic coverage for ceding companies and
reinsurers is obligated to accept risk offered but cedant has
option to cede or not to cede.
•Ceeded risks should be within the confines of the terms and
conditions of the treaty
•Offers additional reinsurance capacity with existing
programmes.
•Normally is unbalanced from premium liability standpoint.
•Capacity should be related to the level of retention and
liability expressed as multiple of retention.
FACULTATIVE
Underwriting Considerations?
Fire Risk
Engineering
Conclusion
FACULTATIVE
Facultative reinsurance is the oldest form of reinsurance.
It is the offer from one insurer to another / reinsurer to accept
part of an individual risk.
The reinsurer reserves the right (faculty) to accept, decline or
offer alternative terms.
Time consuming and expensive.
A reinsurer reserves the right to accept or decline ex-gratia
request (s), any form of ex-gratia payment has to be in
concurrence with reinsurers.
TYPES OF TREATY REINSURANCE
Types of Reinsurance
Non Proportional
Proportional
Quota Share
Surplus
XOL
Working Cover
Stop Loss
Catastrophe
TREATY REINSURANCE
An automatic agreement between the cedant and the reinsurer by
which the reinsurer is bound to accept all risks ceded to it.
Cessions to treaty do not require negotiation provided that the risk
falls within the class of business and limits covered by the treaty.
There are two forms of treaty reinsurance
(1)Proportional Treaty
•Quota share
•Surplus
•Facultative Obligatory / Automatic facultative
(2)Non Proportional Treaty
•Working / Single Risk XL
•Catastrophe XL
•Stop Loss / Aggregate XL
TREATY REINSURANCE
Proportional Treaty
•Proportional reinsurance is based on the original sum
insured
•Proportional reinsurance shares liabilities.
•The proportion in which the liability is shared
determines the sharing of premiums and claims.
•Liability of the reinsurer begins simultaneously with
that of the ceding company.
•Premium received by the reinsurer begins
simultaneously with that of the ceding company.
•Ceding company is paid a reinsurance commission that
covers the acquisition costs, premium taxes, and the cost
of servicing the business.
QUOTA SHARE REINSURANCE
The reinsurer agrees to reinsure a fixed proportion (fixed
percentage) of every risk accepted by the ceding
company, sharing proportionately in all losses and
receiving in return the same proportion of all direct
premium, less the agreed reinsurance commission.
Reinsurer’s liability is limited by an absolute sum
insured. This is called the treaty limit. Up to this sum
insured risks are shared between direct insurer and
reinsurer according to the percentages agreed.
QUOTA SHARE TREATY
1,200
Risk remaining
with insurer after
cession to the
reins treaty
(retention)
1,000
800
600
400
200
risk 1
risk 2
risk 3
risk 4
risk 5
risk 6
QUOTA SHARE REINSURANCE
Risk and claim allocation example
$1,000,000
Primary Insurer Retention
Ceded to Reinsurer
20%
80%
$100,000
20%
80%
$0
$100,000 policy
$1,000,000 policy
$100,000$1,000,000
Policy
Policy
Limits
Primary Insurer Retained Limit (20%)
Limit Ceded to Reinsurers (80%)
20,000
80,000
200000
800,000
$10,000 Loss
Retained by Primary Insurer
Ceded to Reinsurer
2,000
8,000
2,000
8,000
$50,000 Loss
Retained by Primary Insurer
Ceded to Reinsurer
10,000
40,000
10,000
40,000
QUOTA SHARE REINSURANCE
Provides for:
Immediate capital increase.
Risk reduction when entering new geographical area or new
line of business.
Risk spreading.
Simplified administration and accounting.
Loss recoveries irrespective of size.
Major Draw back
Cede too much premium away and therefore transfer too
much profit to reinsurers.
QUOTA SHARE TREATY REINSURANCE
ADVANTAGES
DISADVANTAGES
Cedant recovers on all losses irrespective
of original size of loss.
Can cede too much premium away and
therefore transfer too much profit to
reinsurers.
Overrider to cover acquisition costs
(sometimes more!)
Simple to administer
Cost of reinsurance always reflects
original rates.
More balanced premium/limit ratio –
therefore more attractive to reinsurer and
easier to place.
SURPLUS TREATY REINSURANCE
Reinsurer takes a share of only those risks that exceed
the direct insurer’s retention line. This line is expressed
as an amount in dollars.
Risks with sums insured lower than the direct insurer’s
line are not ceded.
SURPLUS TREATY REINSURANCE
Percentage or proportions shared depend on retention levels.
The line vary by class of business, risk, construction, occupancy and
protection (Table of limits).
Capacity is expressed as number of lines subject to a maximum
dollar amount.
The maximum single risk capacity is equal to number of lines plus
One.
Number of lines and cession Percentages vary by class of risk.
SURPLUS TREATY REINSURANCE
Part of risk taken
on by reinsurer
1.200
1,000
800
600
400
200
risk 1
risk 2
risk 3
risk 4
risk 5
risk 6
MECHANICS OF SURPLUS TREATIES
Group of Risks and
Policies defined by the treaty terms and conditions
Liability amount less
than or equal to
retention (=1 line)
Liability amount greater
than retention and less
than or equal to
retention plus treaty
limit
Allocation to treaty - No
Allocation to treaty - Yes
Retention
Retention plus
Allocation to treaty
Liability amount greater
than retention plus
treaty limit
Allocation to treaty - Yes
Retention plus
Treaty and unplaced Share
SURPLUS TREATY REINSURANCE
PRIMARY POLICY LIMIT
RISK 1
100,000
RISK 2
500,000
RISK 3
1,000,000
MAXIMUM LINE
100,000
100,000
100,000
RETENTION FROM TABLE OF
LIMITS
100,000
100,000
100,000
NUMBER OF LINES CEDED
0
4
5
LIMITS CEDED TO SURPLUS
REINSURER
0
400,000
500,000
% OF LOSSES AND PREMIUM
RETAINED BY INSURER
100
20
10
% OF LOSSES AND PREMIUMS
CEDED TO REINSURER
0
80
50
SURPLUS TREATY REINSURANCE
Provides for
Increased capacity
Homogeneity of retained risks
Capital / surplus relief
Lower impact from large losses
Limit the retained risk on volatile lines of business
SURPLUS TREATY REINSURANCE
Disadvantages
(1)There is only very limited protection against a catastrophe that causes an
accumulation of losses. This is because in a portfolio with a normal
distribution of sums insured most risks will fall within the retention and will
not be ceded.
(2) Because of the proportionality between retention and reinsurance capacity,
in order to obtain a large amount of reinsurance cover the retention may have
to be higher than the direct insurer may wish. This problem can be solved if
there are several surpluses, however.
3)Surplus reinsurance involves more administration than is the case with
quota share. This is because the proportion shared between the reinsurer and
the direct insurer has to be calculated for each individual risk ceded.
(
(4) The level of reinsurance commission that the direct insurer
receives will be less than in the case of a quota share – all other things being
equal – because the reinsurer will participate in fewer risks. Furthermore, they
will be larger and less well balanced than the risks retained entirely by the
direct insurer and its retention on those risks ceded. Thus the lower level of
commission reflects the fact that in the case of surplus reinsurance the
principle of ”follow the fortunes” does not operate on a one to one basis.
QUOTA SHARE VS SURPLUS TREATIES
CESSION OBLIGATION
CESSION PERCENTAGE
QUOTA SHARE
SURPLUS SHARE
OBLIGATORY FOR
INSURER AND
REINSURER
FIXED AND CERTAIN
FOR EVERY RISK UNDER
THE TREATY
STATED AS A
PERCENTAGE
SAME
SIZE OF RISKS
SMALLER
VARIABLE FOR EACH
RISK UNDER THE
TREATY
STATED AS A NET
RETENTION AMOUNT
AND NUMBER OF LINES
LARGE ,MORE COMPLEX
TYPE OF RISK
CASUALTY AND SOME
PROPERTY
ALMOST EXCLUSIVELY
PROPERTY
ADMINISTRATION
RELATIVELY EASY
COMPLEX
CESSION LIMIT
PROPORTIONAL TREATY REINSURANCE
Basis of Underwriting
Underwriting Year basis
Liability attaches to policies issued during treaty period but claims
may still occur after treaty expiry.
Treaty left to run until outstanding liabilities have been settled
unless both parties agree to “loss commutation”.
Clean cut Basis
Involves calculation of unexpired / unearned premium, withdrawn
from outgoing reinsurers and credited to incoming reinsurers (1/8
method, 1/24th method) Premium Portfolio Transfer.
Similarly, there will be outstanding losses at the expiry of the treaty
and outgoing reinsures will be requested to settle based on
outstanding loss figures (normally 90%) and funds will be credited
to Incoming reinsurers who assume liabilities for outstanding losses
plus those to occur in the following year. Outstanding Loss Portfolio
Transfer.
NB: Calculation with reasonable accuracy unexpired portion of
premium and outstanding losses is key.
PROPORTIONAL TREATY REINSURANCE
Loss Advice / Cash Loss Limit: a pre-agreed loss amount whereby
the cedant is expected to advise reinsurers of potential claims likely
to exceed the given amount. Should the claim materialise the cedant
can call upon (Cash Call) reinsurers to immediately pay their share
of the loss. However the cedant is required to refund Reinsurers the
advance payments on submission of their quarterly statement of
accounts.
Follow the fortunes – All cessions under this Treaty shall be subject
to the same terms and conditions as those binding upon the
Reinsured under the original acceptances.
The Reinsurers shall, subject to the terms and conditions of this
Treaty, follow the underwriting fortunes of the Reinsured. Clause
has been contentious as to whether Reinsurers should follow
“blindly”.
PROPORTIONALTREATY REINSURANCE
Table of limits application:
Risk classification according to exposure levels
i.e Low, Medium or High exposure and
Construction Type.
Cessions should therefore be based according to
table of retention to avoid over exposure.
NON PROPORTIONAL TREATY REINSURANCE
A reinsurance contract under-which the reinsurer is obligated to
automatically assume all or a large share of all losses up to a
specified limit when the losses exceed the ceding company’s
deductible or priority. The deductible can apply on a per risk or
occurrence basis:
Excess of loss is only applied after all other recoveries e.g. fac. R/I,
proportional treaties and salvage disposal (Net Retained Loss).
Ultimate Net Loss – defines what Reinsured is allowed to claim from
XOL Programme
Reinsurers premiums and losses involvement are
dis-proportionate.
Aggregate coverage is limited by the number of reinstatements
allowed/AAL.
NON PROPORTIONAL TREATY REINSURANCE
Basis of cover is not directly proportional to the
original policies written.
No regular periodical accounts.
Premium payable – Deposit, Minimum Deposit
Premium, and Adjustment Premiums at the end of
Treaty Period.
Losses Payable – Paid as and when due.
No commissions payable as rate is net.
Premium Reserve Deposits will not normally apply.
Portfolio Premiums will not normally apply.
Loss Reserve Deposits can apply.
Profit Commissions can apply but very rare.
NON PROPORTIONAL REINSURANCE
USD 12,500,000
Excess of loss
Reinsurers
exposure
(USD 7,500,000).
Excess point
(Deductible)
}
USD 5,000,000
}
Reinsured’s retention
(USD 5,000,000)
BASIC NON PROP REINSURANCE STRUCTURE
USD 15,000,000
Second layer USD 2,500,000
USD 12,500,000
First layer USD 7,500,000
USD 5,000,000
Reinsured’s retention
NON PROPORTIONAL TREATY TYPES
The per risk working excess of loss (WXL/R) gives
protection against losses on any one risk.
The per event catastrophe excess of loss cover (Cat XL)
gives protection against losses on any one accumulation
event.
The per risk and per event excess of loss WXL/E is a
combination between WXL/R and a Cat XL cover.
Stop loss /an aggregate excess of loss treaty- covers
against the accumulation of all subject losses during a
specified time period, usually one year. It usually covers
all or part of the net retention of the cedant and protects
net results, providing very strong stabilisation.
NON PROPORTIONAL TREATY REINSURANCE
Needs that are met by Per Risk & CAT XOL
•Increased risk capacity.
•Provides stability from losses that accumulate from single
occurrence.
•Smoothing results for quarterly / annual reporting.
•Severity protection.
NON PROPORTIONAL TREATY REINSURANCE
Needs met by stop loss / aggregate XOL
•Protection of / stabilisation of net results
•Reduction of a primary insurer’s costs for other XOL
reinsurance by allowing the insurer to increase its per
risk or per occurrence retentions on those treaties.
NON PROPORTIONAL TREATY REINSURANCE
Stop loss / aggregate XOL
Directly related to the Premium and Loss Exposure, ie
ultimate loss ratio.
Deductible and Cover fixed each year, mostly as
percentages of Retained Premium Written.
Recoveries can only be made after final Income & Loss
ratio has been determined.
Very limited market.
Expensive.
STOP LOSS REINSURANCE
1ST LAYER
UNDERLYING NET RETENTION (PRIORITY) - 100% OF GNPI
EXCESS LIABILITY
- 35% OF GNPI (CAN SPECIFY MONETARY VALUE)
2ND LAYER
UNDERLYING NET RETENTION (PRIORITY) - 135% OF GNPI
EXCESS LIABILITY
- 50% OF GNPI (CAN SPECIFY MONETARY VALUE)
EXERCISE
FROM THE FOLLOWING ADDITIONAL INFORMATION CALCULATE THE REINSURERS LIABILITY
GNPI - 5,000,000
LOSS - 7,500,000
STOP LOSS REINSURANCE
ANSWER
GNPI
-
5,000,000
LOSS
-
7,500,000
LR
-
150%
1ST LAYER
LOSS RATIO
150%
LESS PRIORITY
100%
EXCESS
50% ( 35 % FROM 1ST LAYER)
REINSURERS LIABLE FOR
35% OF GNPI
REINSURERS LIABLE FOR
35% OF 5,000,000
REINSURERS LIABLE FOR
1,750,000
2ND LAYER
15% : 750,000
NON PROPORTIONAL TREATY REINSURANCE
Treaty Period: issued normally for a period of 12 calendar
months:
Cover Basis: determines the reinsurer(s) who is liable;
Losses Occurring During - date of occurrence of an event
giving rise to a claim must be within the treaty period (no
coverage before and after)
Risk Attaching - original policy of insurance must have been
issued or renewed during the treaty period (Inclusion of Run
Off Clause)
Claims Made - caters for losses that become known during the
treaty period irrespective of the above.
NON PROPORTIONAL TREATY REINSURANCE
Class of Business - types of risks protected by the treaty
Territorial scope - certain areas are excluded.
Loss occurrence - per risk protects the cedant’s net
retained account and catastrophe excess of loss protects
cedant against an accumulation arising from a single
event.
Reinstatement Premium - normally do not provide
unlimited cover. Can be free or at an additional premium
pro-rata to amount only or and to time. (R/I need to
know how many losses they are likely to pay and
expected premium).
NON PROPORTIONAL TREATY REINSURANCE
Reinstatement premium calculation takes the
following formula:
Loss Amount to Treaty X Mindep = R/Premium
Treaty cover
(if pro-rata to time the above is multiplied by the
following)
number of days the treaty is left to run
365 days
NON PROPORTIONAL TREATY REINSURANCE
Clauses to note:
Ultimate Net Loss: refers to the actual amount payable by
cedant after accounting for co-insurances, facultative,
proportional treaty reinsurance and any proceeds from the
salvage disposal.
Hours: defines in terms of time what constitutes a single
event under Cat. X.O.L e.g 72 consecutive hours - riots, civil
commotion, cyclone, earthquake e.t.c.
Indexation / Stability: Protects reinsurers from severe
effects of inflation. Ensures that that the effects of inflation
as they impact on the judicial awards or out of court
settlement on third party bodily injuries are shared by both
the insurer and the reinsurer.
NON PROPORTIONAL TREATY REINSURANCE
Deductible & layer limits increase in ratio to the rate of
inflation. A franchise or cut off inflationary %age is
sometimes allowed before adjustment is applied:
Amount of payment X Base Index = Adjusted payment value
Index @ date of payment
All actual payments and adjusted payment values shall be
separately totaled and the deductible and treaty cover shall be
multiplied by the following:
Total Actual Payments
Total Adjusted Payment Values
If the results in %age change in cover and deductible is less than
the franchise then no adjustments are done.
NON PROPORTIONAL TREATY
Currency Fluctuation – seeks to establish fixed exchange rates at
the inception of the contract. Normally for the reinsured with a
worldwide portfolio (advent of Global programmes).
NON PROPORTIONAL TREATY
Pricing methods:
Experience rating - use of historic losses hence the term. (Pure
Burning Cost - where there are losses
Total Incurred (Paid and outstanding losses to XL Layer
Total Protected Premium Income for Account
Adjusted for Inflation + loadings for acquisition costs, profit
margins, IBNR losses, management expenses, brokerage and
reinsurer’s retrocession costs.
Exposure rating - determined based on an analysis of the
exposure inherent in the business to be covered and not on the
loss experience the business has demonstrated in the past.
Rate on line – over what period will premium quoted equal 1
total loss to the layer in question.
RISK MEASUREMENT
E.M.L
P.M.L
M.P.L
Estimated Maximum Loss
Probable Maximum Loss
Maximum Possible Loss
RISK MEASUREMENT
Estimated Maximum Loss (EML)
The maximum loss in respect of material damage which could be
sustained from the perils under consideration as a result of a
single incident considered to be within the realms of probability.
RISK MEASUREMENT
Probable Maximum Loss (PML)
The maximum loss that can be reasonably foreseen after making
appropriate allowances for approved structural features and
separation, fire fighting facilities and fixed protection.
RISK MEASUREMENT
Maximum Possible Loss (MPL)
The maximum loss that may occur under extraordinary
coincidences (worst case scenario).
RISK MEASUREMENT
Term
Abbreviation
Main Assumptions
Estimated Maximum Loss
EML
Fire protection systems, including
automatic fire alarm & sprinkler are
not effective, Fire fighting is
delayed & damage limited by
adequate separation
Probable Maximum Loss
PML
No fire protection systems are
effective including fire fighting &
damage limited by separation of
structure.
Maximum Possible Loss
MPL
No fire protection & effective fire
fighting, Fire stopped due to non
supply of combustible material.
RISK MEASUREMENT
Consequences of EML or MPL use:
•They are likely to affect:
•Underwriter’s acceptance
•Underwriter’s retention
•Cession to reinsurance
•Rating of the risk
RISK MEASUREMENT
Sum Insured vs EML or MPL
Sum insured: theoretically you cannot lose more than agreed full
value sum insured.
Instead of ceding full value sum insured through reinsurances,
cede risk on the basis of EML assessment.
RISK MEASUREMENT
EML, PML & MPL assessments
Very important for Proportional, Risk Excess of Loss
(sometimes Catastrophe Excess of Loss).
Both reinsured and reinsurer must consider implications
- they vary between two parties.
Each must have trust in EML, PML & MPL - not a policy
or contract warranty for insurance or reinsurance.
If EML, PML OR MPL estimate goes wrong, full loss
value paid.
RISK MEASUREMENT
Error potential
100% Total Sum Insured = $10,000,000
Original Gross Premium = $ 10,000
40% EML
= $ 4,000,000****
OGP remains unchanged =
$ 10,000
EML Error Factor
= TSI/EML x 100/1
100%TSI/40% EML = 250% Error Factor
**** From now on $4,000,000 EML becomes 100% for
purchase of any reinsurances.
RISK MEASUREMENT
Please remember - the lower the EML estimate, the
higher the EML Error Factor (neg co-relation)
Reinsurers impose minimum EML estimate (in Zim
market 50%) on risks ceded to proportional treaties
This restricts EML Error potential, for example:
100% TSI / 50% EML
=
100% TSI / 30% EML
=
100% TSI / 25% EML
=
100% TSI / 20% EML
=
Why use of EML, PML or MPL?
200% Error Factor
333% Error Factor
400% Error Factor
500% Error Factor
RISK MEASUREMENT
Allows ceding companies to retain bulk of the premium.
Reinsured could effectively safeguard their surplus
reinsurers by protecting EML Error Potential.
Would probably purchase Facultative Excess of Loss to
cover the difference between EML and Full Value Sum
Insured.
RISK CESSION
Reinsured retains maximum $1,000,000 EML any
one risk.
First Surplus Treaty has capacity 4 lines, each line
being a maximum of $1,000,000 EML a.o. risk =
$4,000,000.
Reisured therefore has 5,000,000 EML automatic
underwriting capacity a.o. risk.
Automatic underwriting capacity is reinsured’s own
retention ($1,000,000 EML) plus maximum First
Surplus capacity ($4,000,000 EML).
RISK CESSION
Full Value S/I
$5,000,000
Original Premium Rate
0.3%
Original Premium
$15,000
EML assessed at 40%
$2,000,000 EML
Reinsured’s own retention
$1,000,000 EML
(50%)
Cession to Surplus
$1,000,000 EML (50%)
EML Error Factor
$3,000,000
EML Error XL
$3,000,000 xs $2,000,000
EML Error XL in pct(%)
150% xs 100%
SURPLUS CESSION & EXCESS OF LOSS
• Risk One: TSI to EML
2,000,000
or
100% EML
5,000,000
EML Error
XL
2,000,000
EML
TSI
for 100%
SI
EML
40%
0
3,000,000
xs
2,000,000
150% EML
xs
100% EML
Surplus
1,000,000
Retention
1,000,000
Not to
Scale
RISK CESSION
Full Value
$10,000,000 SI
Original Premium Rate
0.4%
Original Premium
?
EML assessed at 50%
? EML
Reinsured’s own retention
$1,000,000
No of lines
5
EML Error Factor
?
EML Error XL
?
EML Error XL in pct(%)
?
RISK CESSION
Reinsured’s own retention
Cession to Surplus
Facultative
Premium due Surplus Treaty
Facultative premium
?
?
?
?
?
CLAIM RECOVERY
Assume cedant of the above risk has the following XL/ EML Error
programme with the following limits and conditions effective
01/01/2016:
1st layer $1,750,000 XS $250,000
Mindep $50,000 Reinstatements 2 @ 100% Additional Premium –
Pro-rata to Amount & Time.
2nd Layer $8,000,00,00 XS $ 2,000,000
Mindep $125,000 Reinstatements 1 @ 50% Additional Premium –
Pro-rata to Amount & Time
A total loss of $ 8M is suffered on 01/01/2016. Calculate amount
due from
Surplus Treaty,
Facultative and
Excess of Loss Treaty
CONCLUSION
•Treaty Reinsurance provides automatic cover provided risk falls
within the pre-agreed terms and conditions.
•Two forms of Treaty – Proportional and Non Proportional.
•The basis on which the treaty is Underwritten determines the
Reinsurer responsible for loss payment.
•Proportional – Underwriting Year basis and Clean Cut basis.
•Non Proportional – Risk Attaching, Losses Occurring / Claims
Made basis.
•Cash Call recovered from Reinsurer needs to Credited upon
submission of Treaty returns.
REINSURANCE PROGRAMME
A reinsurance programme is a combination of
reinsurance contracts that an insurer obtains to
meet its reinsurance needs. Reinsurance
programme design coordinates the insurer’s
needs and the functions performed by
reinsurance.
REINSURANCE PROGRAMME
Objectives
Automatic cover – provided by obligatory treaties in order to meet normal
demands.
Facultative – to provide additional capacity over and above that obtained
from obligatory treaties. To enable acceptance of risks excluded from
obligatory treaties
Adequate limits (capacity) – this will depend on the company’s business
plan and stage of development.
Economic advantage – ability to obtain reinsurance commissions exceeding
acquisitions costs and administration expenses of business ceded.
Good security – reinsurers who are financially viable after big catastrophe
losses and who are willing to support the ceding company should it be
unfortunate to produce negative results.
REINSURANCE PROGRAMME
Deciding how to construct a Reinsurance Programme or
how to modify an existing one, can be a very time
consuming and detailed task.
Before embarking on the planning process the cedent
must have a firm grasp of the fundamental philosophies
of Reinsurance and a sound knowledge of its principle
and practices.
The functions of Reinsurance – why reinsure at all?
The forms of Reinsurance – how is reinsurance effected?
The Reinsurance Markets – who are the Reinsurers?
Reinsurance Security – where to place the Reinsurance?
REINSURANCE PROGRAMME
The planning and implementation of the programme
addresses the other basic questions:
1. Retentions and Deductibles to be carried –
When do we reinsure?
2. The classes of Business to be protected – What
are we reinsuring?
3. The scope and Extent of cover?
4. The Types or Reinsurance to be used – Which
•
Reinsurance to adopt?
REINSURANCE PROGRAMME DESIGN
Buy less reinsurance?
Buy more reinsurance?
• We have excess capital • It’s cheap
• Keep net premiums up • Everyone else is grabbing this
deal
• Eliminate unnecessary
expenses and transaction • Let the reinsurers share the
costs
coming unprofitable results
• Why share profits?
• Predictions of future
catastrophes
• Maximize investable
assets
• Support the higher limits
we’re selling
• We can’t lose on this latest
reinsurance proposal
• Better safe than sorry
REINSURANCE PROGRAMME
Programme Design stages:
Business Strategy
Growth Plans
Lines of business written
Size of the Company
Company structure
Geographic spread
Company’s financial resources
Gathering information
Selecting the reinsurance programme
Programme monitoring
REINSURANCE NEEDS BASED ON BUSINESS STRATEGY
FACTOR
CAPACITY
STABILITY CAT
PROTECTION
CAPITAL
RELIEF
GROWTH
X
X
X
LINES OF
BUSINESS
X
X
SIZE
X
X
STRUCTURE
X
GEOGRAPHIC
SPREAD
X
U/W
EXPERTISE
WITHDRAWAL
X
X
X
X
REINSURANCE PROGRAMME
Financial Resources
Asset liquidity
Access to capital
Capital strength
REINSURANCE NEEDS BASED ON FINANCIAL RESOURCES
CAPACITY STABILITY CAT
CAPITAL
PROTECTION RELIEF
LIMITED
ASSET
LIQUIDITY
LIMITED
ACCESS
TO
CAPITAL
LIMITED
CAPITAL
X
X
X
X
X
X
X
X
X
X
WITHDRAWAL
U/W
EXPERTISE
REINSURANCE PROGRAMME
Management decides to buy reinsurance or not. Although
statistical data and financial models might support the decision,
the decision also reflects the executives’ level of comfort. Senior
management must be comfortable with the degree of risk taken,
particularly when setting retentions and changing the reinsurance
programme.
Senior management must be confident that other stakeholders are
also comfortable with reinsurance programme changes, which should
also encompass various stakeholders:-Board of Directors
-Shareholders
-Senior management
REINSURANCE PROGRAMME
RISK AVERSE
Very small retentions. Cedant relies on significant pro rata
reinsurance capacity. The majority of risks are transferred
to reinsurers.
Small retentions should be easy to protect. If the portfolio
is large enough result should be stable and profits
guaranteed.
However this needs careful underwriting. If the gross
result is poor the insurer may loose pro rata capacity as
reinsurers will be unwilling to provide capacity. Shows
how confident the cedant is with the risk.
REINSURANCE PROGRAMME
RISK SEEKING
Very large gross retention.
Little or no pro rata capacity. Gross retention is
reduced down to technically viable level by excess of
loss.
Excess of Loss usually unbalanced. Is prone to
swings in price from year to year.
Company dependent on excess of loss. At mercy of
reinsurers/market conditions either soft or hard.
DETERMINING RETENTIONS
Retentions
Retention is the amount of risk that an insurer keeps
for its own account.
Business strategy, financial resources and
management attitudes influence the retentions and
limits that an insurer selects.
In addition consideration should be given to the
following:
REINSURANCE PROGRAMME
Reinsurer requirements
Cost and type of reinsurance
Capital (and free reserves) and solvency
Level of premium income
Portfolio size and results
Types of reinsurance contract employed.
The class of business
The reinsurance market
Catastrophe exposures
REINSURANCE PROGRAMME
Information for programme design
Premium by class of business
Risk profiles
Loss and loss adjustment expenses incurred
Individual losses by class of business
Rate change histories by class of business per
town/city.
Outline of existing reinsurance program.
SELECTING THE REINSURANCE PROGRAM
INCREASED
CAPACITY
FACULTATIVE
STABILITY
CAT
PROTECTION
CAPITAL
RELIEF
X
X
QUOTA SHARE
X
SURPLUS
X
XOL
X
U/W
EXPERT
ISE
X
X
X
BUSINESS
WITHDRA
WAL
X
X
REINSURANCE PROGRAMME
Factors determining the choice of treaty
How much premium will be ceded?
Commission
Claims settlement
Amount of cover
Classes of business
Accumulation exposure
Relationship with the Reinsurer
Cost of reinsurance
REINSURANCE PROGRAMME
Reinsurance programmes are reviewed at renewal
because conditions change
Important aspect of review is to ensure that:
Company continues to enjoy adequate reinsurance.
Underwriters remain aware of treaty limits and
exclusions.
Claims reporting procedures are continually
observed.
Cost of reinsurances remain competitive.
REINSURANCE ACCOUNTING
Non proportional – Deposit or Minimum Deposit
Premium payable calculated based on EGNPI and
adjusted at the end of year once AGNPI has been
established.
Premiums payable at inception of the treaty either in
advance or in arrears.
Reinstatement premiums are chargeable on claims
collected and calculated using Mindep. Require
adjustment should this be necessary.
REINSURANCE ACCOUNTING
Proportional Treaty
Underwriting Year – accounts will be submitted until all liabilities
and accounts entries have ceased.
Clean cut – Premium portfolio Entry and Withdrawal as well as Loss
portfolio Entry and Withdrawal assists in cutting out the number of
accounts.
Premium Portfolio – amount of money passed from one year’s
reinsurers to the next to cover any Unexpired policy period still
running.
Loss portfolio – an amount of money paid from (by) this year’s
reinsurers to incoming reinsurers based on outstanding loss figures
(normally 90%) due to insurer’s tendency of over reserving.
REINSURANCE ACCOUNTING
Portfolios
Most accurate – Pro Rata , less Treaty Commissions
Treaty period 12 months 01/01/2015
Treaty commissions 30%
Policy 1 – 01/07/15 to 30/06/2016 Premium $ 1,000
Unexpired premium (182/365 X $1000) = $ 498
Policy 2 – 01/10/15 – 30/09/2016 – Premium $ 4,000
Unexpired premium (273/365 X $ 4,000) = $ 2,992
Total premium (1+2)
Less commission @ 30%
Portfolio premium
$ 3,490
$ 1,047
$ 2,443
Though accurate is time consuming.
REINSURANCE ACCOUNTING
1/8ths (quarterly)
1/24ths (monthly)
-Less commissions
Assumes policies issued evenly quarterly or monthly
Eighths system
1st Qtr $ 35,000
X
1/8
=
$ 4,375
2nd Qtr $ 70,000
X
3/8
=
$ 26,250
3rd Qtr $ 125,000
X
5/8
=
$ 78,125
4th Qtr $ 190,000
X
7/8
=
$166,250
$420,000
$ 275,000
Less commission @ 30%
$ 82,500
Unearned premium
$ 192,500
1/24ths assumes policies are evenly distributed over each month.
REINSURANCE ACCOUNTING
50% less treaty commissions
Assumption that all policies run for 12months and that they are
issued evenly throughout the year (50% of liability in year 1 and 50%
liability in year 2).
Premium for the year
$ 1,500,000
50%
$ 750,000
Less treaty commission @ 30% $ 225,000
Unearned premium
$ 525,000
REINSURANCE ACCOUNTING
Premium / Loss reserve deposit
For security and cash flow reasons cedants retain from reinsurers an
amount of premium each quarter (premium reserve deposit) and in
addition a portion equivalent to known outstanding losses (loss
reserve deposit).
1st Quarter
Cedant retains 40% of premiums due
2nd Quarter
Cedant retains 40% of premiums due
3rd Quarter
Cedant retains 40% of premiums due
4th Quarter
Cedant retains 40% of premium due
5th Quarter
Refund 1st Quarter retained plus interest
Retain 40% of 5th Quarter premiums
REINSURANCE ACCOUNTING
Commissions – deductions
To obtain business cedant incurs acquisition costs and therefore the treaty
wording will describe the percentage of the commission payable under
contract. But takes into account treaty performance, whether cessions are
gross or net of local deductions and acquisition costs since these vary by
class.
Flat / fixed commissions – remains the same irrespective of treaty
performance.
Sliding scale – the better the loss ratio the higher the commission
(Incurred losses (paid + outstanding) / Earned Premium).
Sliding scale 30% - 50%
Incurred loss ratio 47% and above and to below 20%. Subject to
Payment of provisional commission
Calculation of Incurred Loss Ratio
Review of Incurred Loss Ratio against sliding scale commission table
Payment of actual commission due subject to minimum and maximum
REINSURANCE ACCOUNTING
Profit commission – If treaty has been profitable an additional
commission is payable but depending on treaty terms this might be
payable after 3 years from inception though in the interim
provisional commission is payable.
Sliding Scale Adjustment after year 1
Premium
$ 70,000
Losses paid
$ 17,000
Outstanding losses
$ 22,000
Incurred
$ 39,000
Provisional comm. @ 30%
$ 21,000
Adjusted @ 38%
$ 26,600
Bal due to ceding Co.
$ 5,600
Loss ratio 55.71%
Commission 38%
REINSURANCE ACCOUNTING
Sliding Scale Adjustment after year 2
Premium
$ 80,000
Losses paid
$ 27,000
Outstanding losses
$ 21,000
Incurred
$ 48,000
Provisional comm. @ 30%
$ 24,000
Adjusted comm. @ 35%
$ 28,000
Less previously paid
comm.
$ 26,600
Bal due to ceding Co.
$ 1,400
Loss ratio 60%
Commission 35%
REINSURANCE ACCOUNTING
Profit Commission Adjustment after year 3
Premium
$ 70,000
Outgo
Losses paid
$ 17,000
Outstanding losses
$ 22,000
Commission
$21,000
5% Reinsurer expenses
$ 3,500
$ 70,000
$ 63,500
Excess Income over Outgo
$ 6,500
15% Profit commission
$ 975
REINSURANCE ACCOUNTING
Profit Commission Adjustment after year 4
Premium
$ 80,000
Outgo
Losses paid
$ 27,000
Outstanding losses
$ 21,000
Commission
$ 24,000
5% Reinsurer expenses
$ 4,000
$ 80,000
$ 76,000
Excess Income over Outgo
$ 4,000
15% Profit commission
$ 600
Cedant repays
$375 ($975-$600)
REINSURANCE ACCOUNTING
Conclusion
Non Proportional – Mindep are payable in Advance or Arrears, In
full, Once an year, Quarterly or Half Yearly.
Mindep is based on EGNPI and subject to Adjustment at the expiry
of treaty period once AGNPI has been established.
Proportional Treaty – basis of underwriting Underwriting or Clean
Cut.
Underwriting basis – accounts are tendered until all out outstanding
liabilities have been extinguished unless loss commutation is agreed.
Clean cut – in coming reinsurers assumes liabilities of outstanding
losses but receives loss portfolio entry as well as un-expired portion
of the underwritten premium.
The method for calculation unearned premiums.
Commission payable – Flat, Sliding scale and or Profit.
REINSURANCE PROGRAMME
Thank You