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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)
