Introduction to Reinsurance NLC-RISC Trustee Conference May 2011

1 Presentation Agenda Types of reinsurance and cost-sharing options The key doctrines of reinsurance Why to buy reinsurance How to evaluate reinsurers Reinsurance market overview How reinsurance is purchased

2 Reinsurance Contractual agreement Reinsurer agrees to indemnify the pool Some or all of certain losses covered by the pool

3 Types of Reinsurance Facultative Reinsurance Coverage for a specific exposure or risk Attaches to a specific risk Treaty Reinsurance Cover for entire class or portfolio Sharing of losses Excess Insurance Transfer of risk

4 Types of Reinsurance

5

6 Key Doctrines - Reinsurance Utmost Good Faith Pool has obligation to reinsurer to act in good faith for underwriting, pricing and claims handling Pool keeps reinsurer informed of developments that would materially impact the reinsurer Follow the Fortunes Reinsurer agrees to follow the fortunes of the pool

7 Key Doctrines - Reinsurance

8 Basis of Paying Losses Most arrangements are hybrid Quota share Fixed proportionate share Variable quota share Excess of Loss Above a stipulated dollar amount

9 Excess Insurance or Excess of Loss? The pool pays the first $250,000 The pool pays 50 percent of the next $250,000 ($125,000) RE pays the other 50 percent RE pays all loss amounts over $500,000

10 Other things out there… Aggregate policies Catastrophe policies Clash treaties …and more

11 Why Buy Reinsurance? Catastrophic relief Stabilize loss experience & reduce uncertainty Capacity to write larger (or more) risks Ability to better meet member needs Premium capacity & regulatory compliance

12 Why Buy Reinsurance?

13 Why Buy Reinsurance?

14 Choosing to Reinsure Risk factors should impact the decision process Size of potential loss Unpredictable frequencies Length of time for claim payments Volatility of loss outcomes

15 Evaluation of Reinsurers Cost Financial Security Coverage Relationship

16 Evaluation of Reinsurers Financial standing and capabilities Commercial ratings & performance tests Size, leverage, liquidity of balance sheets Commitment to line of business Degree of input (interference) Underwriting and claims Claim payment reputation Organizational structure and management philosophy

17 Evaluation of Reinsurers

18 Financial Rating Systems for Insurance Companies Why are they important? Reinsurance financials are complex Independent evaluations subject all insurers to the same criteria and provide benchmark Quantitative and qualitative review Balance sheet, operating performance Business profile Benchmarks even more important in an international market

19 Financial Rating Systems for Insurance Companies Why are they important?

20 Financial Rating Systems for Insurance Companies Why are they important? Perceived ability of a company to pay its claims Not a warranty of financial strength or ability to meet obligations 10 of 20 largest commercial insurance companies failed or were merged in the last 20 years All were rated A or better at the beginning of the period

21 Rating Agencies A.M. Best Primarily focused on insurance Standard & Poors An investor rating service Moodys An investor rating service Fitch An investor rating service

22 Ratings Considerations Claims payment rating A companys ability to pay its claims Investor ratings Risk-to-return ratio for investors Creates profit incentive that could lead to riskier behavior AIG Mortgage insurers

23 Ratings Considerations

24 Underneath it all… Reinsurers and excess insurers exist to make money for capital investors Expected to pay claims & expenses Must produce profit over time

25 Excess Risk Pool Pool of similar insurers who in part self- insure for risks typically reinsured Requires capital commitment Long-term financial focus Participatory governance and direction Regulatory credit for reinsurance recoverable Generally no rating agency help to evaluate

26 Excess Risk Pool

27 Key Factors for Evaluating an Excess Risk Pool Capital adequacy Competency of management Risk-taking philosophy Commitment level of other participants Pricing philosophy Coverage philosophy Willingness to pay claims Long-term viability By-Laws

28 Reinsurance Market ART - Alternative Risk Transfer Public Entity Risk Commercial Insurance CompaniesSpecialty Insurance Companies Reinsurance Companies

29 Reinsurance Market Public Entity Liability Small number of reinsurers Losses had been declining relative to expenditures Trends in public officials, land use, law enforcement Reinsurers looking to expand market share Flat or decreasing rates

30 Reinsurance Market Public Entity Property Small number of reinsurers May be hard for smaller pools to meet minimum premium requirements Coastal exposures difficult to place Large losses - global and U.S. Pricing generally flat, perhaps will begin to harden

31 Reinsurance Market Public Entity Work Comp Almost entirely made up of excess insurers Very few, at that Heavily competitive for good risks Soft pricing to increase market share Some market unknowns Impact of the recession Medicare as a Secondary Payer Presumption legislation

32 Reinsurance Market Reinsurance Association of America reinsurance companies (84 total members) reinsurance companies (40 total members)

33 Buying Reinsurance Apply Provide data Define terms and conditions Receive quote Agree Contract

34 Buying Reinsurance

35 Buying Reinsurance Direct Market Pool purchases direct from reinsurer Broker Market Pool must access reinsurer through a broker or intermediary

36 Buying Reinsurance

37 Buying Reinsurance Direct Market Might have more capacity for individual risks Traditional risk focus Direct relationship & communications Broker Market Increased pricing competition Specialty risk options Broker involved in communications & relationship management

38 Buying Reinsurance

39 Buying Reinsurance

40 Direct Market Reinsurers General Re Munich Re Swiss Re Excess Risk Pools

41 Broker Market Reinsurers ACE Arch Re Argo Re Aspen Re AXIS Employers Re Endurance Everest Re Hannover Re Harbor Point Hiscox Lloyds & Syndicates Partner Re Safety National Scor Re Transatlantic Re XL Re

42 Sample Reinsurance Structure

43 Sample Reinsurance Structure

44 Sample Reinsurance Structure