Reinsurance

Nigel Davies

December 2, 2008.

ReinsuranceSession 1

Introduction & Overview. Case Study, Round 1.

Session 2Case Study Feedback. Life Reinsurance. Finite Reinsurance. Failure of Reinsurance.

Session 3Catastrophe Insurance. Securitization. Case

study – Round 2.

Session 4Case Study Feedback. Supervisory Issues.

ReinsuranceSession 1

Introduction & Overview.

• Reinsurance Market

• Definitions and Types of Contract

Reinsurance

Insured

Insurance

Company

Reinsurance

Company

Reinsurance

Company

Broker, Agent, Phone,

Online, In person.

Broker, Direct.

Broker, Direct.

Reinsura

nce

Retroce

ssion

Direct

Insu

rance

Reinsurance

Insurance

Company

Reinsurance

Company

Broker, Direct.

Reinsura

nceUS$ billion

Growth in 2007

Growth in 2006

Life 2,393 5.4% 4.1%

Non-life 1,668 0.7% 3.9%

Total 4,061

Global Premiums in 2007

Source: Swiss Re, Sigma 3/2008.

How much of this is

reinsurance?

…and why do we

measure it by

premium?

Reinsurance

Gross Reinsurance

Premium Assumed

Risk “Located” In:

Net “Risk”

Europe 88,989 (64,653) 24,336

North America 81,946 (90,306) (8,360)

Asia & Australasia 1,989 (11,219) (9230)

Africa, Near & Middle East

(2,614) (2,614)

Latin America (4,132) (4,132)

Total 172,924 (172,924) NIL

Destination & Source of Reinsurance Premium (US$ million)

Source: IAIS Global Reinsurance Market Report, December 2007Data Source:- 59 Reinsurers: Bermuda 8; Europe 21; Japan 2; USA 28.

ReinsuranceReinsurance Premiums Assumed by Class of Business & Contract Type

(US$ million)

Source: IAIS Global Reinsurance Market Report, December 2007

Proportional Reinsurance

Ceding insurer and assuming reinsurer share an agreed portion or percentage of original premiums and subsequent losses in respect of the reinsured business.

Non-proportional Reinsurance

Reinsurer assumes the part of the ceding insurer’s claims that exceed a certain amount. The premium is a specially calculated amount.

Reinsurance

68%4176132005

62%2413912004

70%2683822003Other

12%625202005

10%505012004

10%545572003Property

89%5245882005

85%4214962004

85%3744402003Motor

Non-life

97%399340972005

98%458946682004

98%408041662003

Life

Retention RatioNet PremiumGross Premium

Reinsurance Profile – Trinidad & Tobago (TT$million)

Reinsurance

Non-Life Life

Reinsurance Market Dynamics – How do reinsurers make money?

Reinsurance

Non-Life1. High returns in low cat.

years attracts capital.2. New capital creates

overcapacity and reduces prices (market softens).

3. Cats wipe out capital and prices increase (market hardens).

4. Hard market attracts capital.

Life1. Information asymmetry.

Reinsurers have annually updated loss experience – better than (time-lagged) mortality tables.

2. Risk profile: pandemics vs. advances in medical science.

3. Life vs. Pensions products hedge mortality and longevity risks.

4. Primary market trend for savings products reduces need for life reinsurance.

Reinsurance Market Dynamics – How do reinsurers make money?

HIGHLY CYCLICAL INCREASING LONGEVITY

ReinsuranceCapital Movements in a Major Reinsurers – 2007

(Overall 7% increase)

Source: Global Reinsurance Market Review 2007. Benfield. www.benfieldgroup.com

ReinsuranceNon-life Reinsurance

Prices

For expected loss of 1%, premium was 4% of sum insured in 2008 (2007, 5.5%).

For expected loss of 4%, premium was 11% of sum insured in 2008 (2007, 13%).

Reinsurance

Increasing Longevity in the Caribbean

For 18 age-group cohorts.

Source: Caribbean Epidemiology Centre. October 2000. www.carec.org

ReinsuranceStory so far……….

1. Reinsurance activity, measured by premium, is substantial but impossible to make cross-sectoral comparisons

2. Reinsurance risk tends to migrate to large European reinsurers.

3. Non-life RI >> Life RI.4. Proportional & non-proportional reinsurance5. Non-life RI highly cyclical – 7% increase in capital

in 2007 led to price drops of 10%-20% in ROL for 2008.

6. Life primary market driven by increasing longevity…..

7. ….. growing due to savings products, but this has little effect of Life RI. Life RI based on information asymmetry.

Reinsurance

• Prioritize Non-life reinsurance over Life reinsurance.

• Cover Proportional & Non-proportional contracts equally.

Reinsurance

Classification of Reinsurance Contracts

Reinsurance

TREATY REINSURANCE

FACULTATIVE REINSURANCE

Reinsures bundles of

primary policies

Reinsures individual primary policies

Reinsurance Contracts

Non-life / Life.Proportional / Non-

proportional.Obligatory / non-

obligatory.

}

Reinsurance

TREATY REINSURANCE

FACULTATIVE REINSURANCE

Reinsures bundles of

primary policies

Reinsures individual primary policies

Reinsurance Contracts

Non-life / Life.Proportional / Non-

proportional.Obligatory / non-

obligatory.

}

Reinsurance

Non-life Treaty Reinsurance

Non-proportional Proportional

Excess of Loss

Stop Loss

Quota Share

Surplus Treaty

Excess of Loss and Quota Share Treaties are most common.

Stop Loss contracts are very rare nowadays

Reinsurance1. Excess of Loss Contracts -

Basics

$1m

$4m

$5m

$2m

$3m$3m xs

$1m

Limit

Attachment point

Reinsurance cover for specified line(s) of business

} Deductible / Risk retention

Claim: For a $5m claim, $3m is recoverable under this contract.

RI cover exhausted!

Reinsurance

1. Excess of Loss Contracts

$10m

$50m

$40m

$30m

$20m

$5m

Line of Business A Line of Business B

1st Layer, $10m xs $10m

1 reinstatement

2nd Layer, $10m xs $20m

1 reinstatement

3rd Layer, $20m xs $30m

No reinstatements

1st Layer, $5m xs $5m

3 reinstatements

2nd Layer, $20m xs $10m

1 reinstatement

Reinsurance

1. Excess of Loss Contracts

$10m

$50m

$40m

$30m

$20m

$5m

Line of Business A Line of Business B

1 2 3

Claims & RI Recoveries ($m)

Claim 1 Claim 2 Claim 3 Loss Scenari

o

Gross Claim 55 25 30 110

R/I Rec. Layer 1 (10) (10) NIL (20)

R/I Rec. Layer 2 (10) (5) (5) (20)

R/I Rec. Layer 3 (20) N/A N/A (20)

Net Claim 15 10 25 50

} *

*

Reinsurance

2. Stop Loss Contracts

Aggre

gate

Loss

es

/ C

laim

s of

Insu

rer

Attachment point (e.g. loss ratio of 110%)

Limit (e.g. loss ratio of 130%)

Stop loss covers a specified %age of losses

between attachment point and limit.

Attachment points and limits expressed as either:

1. Loss ratios, or

2. Absolute amounts

Aggre

gate

Pre

miu

ms

Reinsurance

3. Quota Share Contracts

Proportional Reinsurance

Ceding insurer and assuming reinsurer share an agreed portion or percentage of original premiums and subsequent losses in respect of the reinsured business.

Quota Share Contracts have 2 types of limits:

1.Per risk limit

2.Aggregate exposure limit

Reinsurance

3. Quota Share Contracts

$2m

$1m

$4m

$3m

$6m

$5m

}

75% Quota Share

Aggregate exposure limit

Reinsurer imposes a limit on aggregate exposure (total sums insured). A breach of this limit will mean an averaging down of the QS cover.

$4m per risk limit

Reinsurance

3. Quota Share Contracts

$2m

$1m

$4m

$3m

$6m

$5m

}

75% Quota Share

Aggregate exposure limit

Reinsurer imposes a limit on aggregate exposure (total sums insured). A breach of this limit will mean an averaging down of the QS cover.

$4m per risk limit

Profit Commission

With extensive reinsurance cover in the lower layers, insurers may allow underwriting standards to drop (in order to gain market share) & this reduces underwriting profit.

To counteract this, QS contracts typically allow a retroactive payment from the reinsurer of, say, 20% of its profit on the contract.

Reinsurance

4. Surplus Treaty Contracts

Surplus Treaty

Ceding insurer retains a specified amount – called the line.

The amount ceded to the reinsurer is defined as a specified number of lines.

Example: 4 line surplus treaty of $1m

$2m

$1m

$4m

$3m

$6m

$5m

Retention

Reinsurance cover for 4 x retention in a 4 line surplus treaty. NOTE – 100% COVER FOR THESE CEDED LINES.

Reinsurance

4. Surplus Treaty Contracts

Example: 4 line surplus treaty of $1m

$2m

$1m

$4m

$3m

$6m

$5m

1

2

1

2

Cedant retains all premiums and claims.

pre

miu

m

pre

miu

m

Cedant retains 25% of premiums and claims. Reinsurer assumes 75% of premiums and claims.

Reinsurance

Time

A

mou

nt

Property Catastrophe

Household Fire & Contents (Non-

catastrophe)

MotorWorkers’ Compensation

What type of reinsurance contract suits the loss scenarios in these lines

of business?

Reinsurance

Time

A

mou

nt

Motor

Property Catastrophe

Workers’ Compensation

Household Fire & Contents

(Non-catastrophe)

Reinsurance

Claims Arranged by Line of Business

A

mo

un

t

Motor

Property Catastrophe

Workers’ Compensation

Household Fire & Contents

(Non-catastrophe)

The Ideal Reinsurance Program?

Catastrophe XL.

2 reinstatements to cover 3 events in total.Casualty XL.

3 reinstatements on bottom layer to cover 4 events.Quota Share.

To cover attritional losses in all lines of business.

Reinsurance

CASE STUDY – ROUND 1.• Contract wordings are “standardized” throughout the industry.

• Terms & conditions can vary greatly.

• Wordings do vary in quality and are capable of misinterpretation.

• Wordings contain jargon……..

• Please read the handout which is about a

Non-life Casualty XL Program.

• Prepare questions for discussion & reasons for your questions

• Prepare suggestions on how this program can be improved upon.