Finance 431: Property-Liability Insurance Lecture 8: Reinsurance

Finance 431:Property-Liability Insurance

Lecture 8:Reinsurance

Reinsurance

Introduction

Types of Reinsurance

Types of Reinsurers

Uses of Reinsurance

New Developments

Introduction to ReinsuranceWhat is reinsurance?

Insurance for insurance companies

How reinsurance is used

Capacity Stability

Catastrophe protection Financial strength

Entry and exit Accounting

Economic significance

Relationship with primary insurers and original policyholders

Problems and limitations

Insurance / Reinsurance Parallels

Insurer(policy limit)

Reinsurer (policy limit)

Insurer(pays “retention”)

Policyholder (pays deductible)

Policyholderpays premiumto insurer

Insurerindemnifiesagainst loss

Insurer “cedes”part of premiumto reinsurer

Reinsurer“assumes”responsibilityfor part of loss

Types of ReinsuranceFacultative versus treaty

Facultative - specific risksTreaty - book of policies

Proportional versus non-proportional (excess)Proportional

Quota share - all policies on same basisSurplus share - basis varies by policy limits

Non-proportionalExcess of loss

Types of Reinsurance (cont.)

• Forms of proportional reinsurance– Quota share: reinsurer pays a fixed percentage

of each policy’s losses, and receives a fixed percentage of the original premium

– Surplus share: reinsurer’s share varies by policy (according to policy limit)

Types of Reinsurance (cont.)• Forms of excess-of-loss reinsurance

– Per risk: covers individual losses from each policy or risk (common for property coverages)

– Per occurrence cover: covers losses from each event or occurrence, across all policies (common for casualty coverages)

• Working layer• Clash covers

– Per occurrence / catastrophe cover: covers a single large event (e.g., natural catastrophe)

– Stop-loss / aggregate excess: protects net results

An insurer writes a $100,000 liability policy for a premium of $10,000; a loss of $60,000 occurs on this policy. For a 50% Quota Share reinsurance policy, how much premium will the reinsurer collect and how much will they pay in losses?

Reinsurance Premium Loss

A) $1,000 $10,000

B) $5,000 $30,000

C) $10,000 $10,000

D) $10,000 $30,000

E) None of the above

Same primary policy as the prior slide. For a Surplus Share reinsurance policy with a retention of $40,000, how much premium will the reinsurer collect and how much will they pay in losses?

Reinsurance Premium Loss

A) $4,000 $24,000

B) $4,000 $40,000

C) $6,000 $30,000

D) $6,000 $36,000

E) None of the above

Same primary policy as the prior slide. For a per risk excess of loss reinsurance policy with a retention of $50,000, how much premium will the reinsurer collect and how much will they pay in losses?

Reinsurance Premium Loss

A) $1,667 $10,000

B) $5,000 $10,000

C) $8,333 $50,000

D) $10,000 $10,000

E) None of the above

An insurer writes a $40,000 liability policy for a premium of $6,000; a loss of $30,000 occurs on this policy. For a 50% Quota Share reinsurance policy, how much premium will the reinsurer collect and how much will they pay in losses?

Reinsurance Premium Loss

A) $3,000 $15,000

B) $3,000 $30,000

C) $5,000 $15,000

D) $6,000 $30,000

E) None of the above

Same primary policy as the prior slide. For a Surplus Share reinsurance policy with a retention of $40,000, how much premium will the reinsurer collect and how much will they pay in losses?

Reinsurance Premium Loss

A) $0 $0

B) $2,400 $12,000

C) $4,000 $36,000

D) $6,000 $30,000

E) None of the above

Same primary policy as the prior slide. For a per risk excess of loss reinsurance policy with a retention of $50,000, how much premium will the reinsurer collect and how much will they pay in losses?

Reinsurance Premium Loss

A) Cannot be determined $0

B) Cannot be determined $10,000

C) Cannot be determined $40,000

D) $0 $0

E) None of the above

Types of Reinsurers

Professional reinsurers

General Re (Berkshire Hathaway), Swiss Re

Reinsurance departments of primary insurers

Travelers, CIGNA

Underwriting organizations, pools and associations

Lloyd’s of London

Other Reinsurance Program Issues

• Pricing of reinsurance policies– Proportional: percentage of premium ceded (often with

a “ceding commission” paid back to the primary insurer to cover expenses)

– Excess: rate applied to primary insurer’s original premiums, in accordance with expected frequency and severity of losses to reinsurance layer

• Multiple reinsurers on a reinsurance contract• Retrocessions

– Reinsurance for reinsurers

Uses of ReinsuranceCapacity

Higher limits

More policies

Stability

Protection from catastrophes

Hurricanes, earthquakes

Enhanced financial strength (surplus strengthening)

Ease of entry and exit from a market

Accounting issues – can change timing of income and expenses

Alternatives to “Traditional” Reinsurance

• Reinsurance is one of many “risk management”

tools at the disposal of a primary insurer -- e.g.,

– Refuse to write certain risks

– “Co-insurance”

– Reinsurance

– Capital market / financial solutions

Beyond “Traditional” Reinsurance• “Newer” reinsurance products

– Portfolio reinsurance– Finite (financial) reinsurance

• Very recent advances– Integrated risk policies– Insurance securitization– Hedge funds writing reinsurance

• Although some of these recent advances might be considered competitors of traditional reinsurance, many reinsurers have themselves embraced these new techniques (Swiss Re)