Reinsurance Application Presented By Alice Shumba Head- Underwriting FBC Reinsurance

Training Objectives Define and understand the purpose of Reinsurance By the end of the course, we should be able to: Define and understand the purpose of Reinsurance Identify Types and Forms of reinsurance Appreciate Application of Facultative Reinsurance Appreciate Application of Treaty Reinsurance Design a reinsurance Program

What is reinsurance?...... The business of insuring an insurance co. or underwriter against suffering too great a loss from their insurance operations. Robert & Stephen Kiln- Reinsurance in Practice Transfer of part of the hazards or risks that a direct insurer assumes by way of insurance contract or legal provision on behalf of an insured, to a second insurance carrier, the reinsurer, who has no direct contractual relationship with the insured.’ M Grossmann, Reinsurance – An Introduction A relationship between two consenting adults.

……What is reinsurance? The Insurance Chain Insured Retail Broker Insurer/Cedant Reinsurance Broker Reinsurer/ Retrocedant Retro

What is reinsurance PURPOSE OF REINSURANCE Spreading risks recall the insurer’s risk transfer options Increasing Capacity Stabilizing results Managing Accumulations Providing Expertise Facilitating entry into new lines or territories Tax advantage Providing Security Increasing stakeholder confidence Managing Solvency to meet regulatory requirements Cash-flow advantages- proportional treaties

Types of Reinsurance Facultative Reinsurance Treaty Reinsurance Facultative Obligatory Business can be place on a proportional or Non Proportional basis

FORMS OF REINSURANCE REINSURANCE FACULTATIVE PROP QUOTA SHARE NON- PROP EXCESS OF LOSS TREATY SURPLUS NON PROP STOP LOSS

Types of Reinsurance FACULTATIVE It’s the oldest form of reinsurance Optional Ideally preserved for individual reinsurance of large or hazardous single risks lets examine the following Motor? Engineering Plant? House owners? Mine assets? Risks usually ceded on original terms. Traditionally placed on proportional basis but non- prop now more common.

Types of Reinsurance FACULTATIVE We opt for Fac when: Original risk is hazardous- pollution The risk exceeds the insurer’s treaty capacity- Large risk The risk is excluded from insurer’s treaty- territorial scope, hazardous, more specifically insured elsewhere E.G Terrorism A risk has been accepted by the cedant for unique commercial, financial or political reasons. Otherwise it would be unacceptable because of its nature and size. THINK OF SUCH RISKS

ADVANTAGES OF FAC DISADVANTAGES OF FAC FACULTATIVE ADVANTAGES OF FAC DISADVANTAGES OF FAC Freedom on whether or not to offer risk to a reinsurer of choice Insurer can’t be certain of placement if there is no automatic cover. There can be delays in confirming cover until placement is done Opportunity for reinsurer and cedant to build a relationship and understand each other’s underwriting styles Reinsurer may require too much detail where if they are a competitor, insurer may be uncomfortable Insurer may gain expertise on underwriting particular risks Labor intensive & high admin costs- Errors (you may forget to place risk) Protects treaty performance Reinsurer may take over control of underwriting and claims processes. Warranties, Surveys, appointment of assessors etc. Fac Reinsurer may eventually get accepted as a treaty security Reinsurer may exercise influence on the insurer’s standard assessment of risk. Insurer rates Motor 3% but reinsurer rates it 10%.

Types of reinsurance TREATY REINSURANCE Treaty reinsurance is obligatory in nature for both parties to the contract Business is placed as a bouquet unlike fac where placement is on a single risk Limits, terms and conditions are set for the whole bouquet. Terms are agreed in advance usually at the beginning of the year. Sometimes labeled blind cover

Types of reinsurance TREATY REINSURANCE Insurers use treaty when: Risks are homogenous or have similar exposures……not hazardous There is a large number of such risks – volume S/I can be confidently placed within range of each other…..size there is reinsurance capacity for the types of risk…..terrorism treaty

Treaty reinsurance PROPORTIONAL TREATIES Two main types in use are Quota Share and Surplus. Prop treaties directly compensate acquisition costs through commissions. Reinsurers cap liability using cession limit as well as event limit. Reinsurers follow usually original terms Accounting usually done in arrears and on an offset basis through submission of a monthly or quarterly return with or without a bordereaux

Treaty reinsurance Proportional treaty Contents of a bordereaux Insured’s Name Period of Insurance & Period of Reinsurance Sum Insured Reinsurer’s proportion /Retention Reinsurer’s amount /Ceded risk Gross Premiums allocated by class of business Premium split between cedant and reinsurer Deductions

Proportional treaties COMMISIONS Pricing of prop treaties is basically on the commission level. The more profitable and balanced an account is the more the commission. Types of commission Flat commission Sliding scale commission- Linked to loss ratio Profit commission

Quota Share Risk, premiums, and losses are allocated between cedant and reinsurer in the same fixed share. Reinsurers participates in every risk and loss Note - a quota share is usually named by the amount ceded i.e a 60% quota share means 60% has been ceded and 40% retained. Mostly used when the S/I in a portfolio are relatively uniform e.g in motor or households Quota shares carry the highest ceding commissions More ideal when fronting, entering new lines or territory Most ideal for reciprocal business Ideal example of follow the fortunes.

Quota Share COMPONENTS OF QUOTE

Surplus Cessions only done for risks that exceed the set retention level (line size) Cessions will be done in multiples of the line up to the agreed cession limit Reinsurers only participates on losses from the ceded risks i.e cedant carries all losses coming out from the retained risks Usually subjected to table of retentions Ideal when portfolio contains a mixture of large, medium and small size risks Cedant retains more premium than under Quota share The risk of unbalanced treaty is high

Surplus Treaty COMPONENTS OF QUOTE

Comparison of Q/S & Surplus Q/S generally has higher commissions More premium is usually ceded under Q/S You cannot vary the retention % on a Q/S Reinsurer & cedant’s fortunes are similar under Q/S but may be different under Surplus i.e one can make profit while the other makes a loss Surplus treaty has better cat protection With surplus, the insurer either stands or falls by the retention level chosen

Some Maths +÷×- SUM INSURED PREMIUM LOSS 1 LOSS 2 RISK A 10,000,000 100,000 12,000,000 8,000,000 RISK B 120,000 200,000 RISK C 4,000,000 400,000 800,000 1,500,000 RISK D 80,000 600,000 2,500,000 DO THE ALLOCATION OF RISK, PREMIUM AND LOSSES UNDER THE FOLLOWING PROGRAMES 90% QUOTA SHARE ARRANGEMENT WITH $9M CESSION LIMIT 9 LINE SURPLUS TREATY WITH A RETENTION OF $1,000,000

Risk A answer Retained Risk % Retained Risk Amt Ceded Risk % Ceded Risk Amt 90% Q/S 10% $1,000,000 90% $9,000,000 9 Line Surplus Premium allocation Q/S retention= 10% X $100,000= $10,000 Q/S cession= 90%X $100,000=$9,000,000 Surplus retention= 1/10 X $100,000= $10,000 Surplus cession= 9/10 X $100,000=$9,000,000 Loss Allocation Q/S retention= 10% X $10,000,000 (limit) = $1,000,000 Q/S cession= 90%X $10,000,000=$9,000,000 Surplus retention= 1/10 X $10,000,000= $1,000,000 Surplus cession= 9/10 X $10,000,000=$9,000,000 The risk is for $10m so there maybe underinsurance The same calculation applies for 2nd loss

Risk B answer 90% Q/S 9 Line Surplus Retained Risk% Retained Risk Amt Ceded Risk % Ceded Risk Amt Fac % Fac Amt 90% Q/S 8.33% $1,000,000 75% $9,000,000 16.67% $2,000,000 9 Line Surplus Note the inclusion of facultative. Risk is above treaty capacity ( More when we do designing) How did we get 75% on a 90% quota share treaty??? If quota share did not have cession limit which is highly unlikely, then the Q/S contribution will remain 90% Premium allocation Straight forward Loss Allocation Use the same % distribution even for the $200k claim. Note fac reinsurers still participate on the $10m claim with 16.67% share

Risk C answer Retained Risk % Retained Risk Amt Ceded Risk % Ceded Risk Amt 90% Q/S 10% $400,000 90% $3,600,000 9 Line Surplus 25% $1,000,000 75% $3,000,000 Premium allocation Q/S retention= 10% X $400,000= $40,000 Q/S cession= 90%X $400,000=$360,000 Surplus retention= 25% X $400,000= $100,000 Surplus cession=75%X $400,000=$300,000 Loss Allocation Q/S retention= 10% X $800K = $80K And Loss 2 10% x $1m= $100k Q/S cession= 90%X $800k=$720k and Loss 2 90%x $1m=$900k Surplus rtn= 25% X $800k= $200k and loss 2 25% x $1m= $250k Surplus cession= 75% X $800k=$600k & loss 2 75%x $1m=$750k Note treaties have similar 100% capacities but operate differently because of movement in retention % on surplus

Risk D answer Retained Risk % Retained Risk Amt Ceded Risk % Ceded Risk Amt 90% Q/S 10% $80,000 90% $720,000 9 Line Surplus 100% $800,000 0% $0 Premium allocation Q/S retention= 10% X $80,000= $8,000 Q/S cession= 90%X $80,000=$72,000 Surplus retention= 100% X $80,000= $80,000 Surplus cession= NIL Loss Allocation Q/S retention= 10% X $600K = $60K And Loss2 10% x $800k= $100k Q/S cession= 90%X $600k=$540k and Loss 2 90%x $800K(limit) =$720k Surplus rtn= 100%X $600k= $600k and loss 2 100% x $2.5m= $2.5m Note- even if a claim is above the surplus retention point, The cession of the risk guides the allocation of losses.

Non Proportional Treaty Unlike prop treaties, premium paid is not proportionally related to risk carried. Premiums usually paid in advance as Minimum and/or Deposit Premium. There is no cession per risk rather the premium is for the whole portfolio. Distribution of Liabilities is based on losses rather than sum insured. So no need for cession bordereaux Losses only get paid once they exceed the excess point/deductible. Reinsurers limit their horizontal liabilities through Reinstatements. There is usually a limit on cover to cap reinsurers’ vertical liability. If the excess of loss is protecting a prop treaty, its maximum retention can be used as the cover limit for Excess of loss. No commissions paid under non proportional treaties

Non prop treaties PRICING Pricing of Non Prop treaties can be done using Exposure rating Size, volume and nature of book Average S/I in comparison with Cover Limit Level of deductible Volatility of claims in the reinsured class Experience rating Burning cost based on e.g - 5 year Loss Ratio + loading for inflation, costs and profit margin Claims experience can warrant an increase or reduction in loss ratio

Non Proportional treaties PRICING Resultant Rate is applied to EGNPI to get provisional premium/ MDP. An Adjustment premium is paid at the end of the year when the AGNPI is known. GNPI (Gross Net Premium Income) is the Gross premium before deducting commissions but net of other reinsurances. The treaty can be Layered and priced according to exposure to losses The 1st layer is usually the working layer hence will attract a higher rate.

Non Proportional Treaties Excess of Loss Excess of loss can be used to protect the following : Risk Exposure EML error exposure Catastrophe Exposure – Know definition of event e.g 72 hrs clause Clash Exposure- Accumulation of different risk classes in one event One program may offer all this protection

Non Proportional Treaties Components of XL Quote

Non Proportional Treaties ALLOCATION OF LOSSES In the quote above. Losses are paid once they exceed deductible. The Xl treaty covers the Ultimate Net loss to insured i.e loss that remains for the insured’s net account after other reinsurances have paid their proportions. Reinstatement premium is immediately deducted from the claim amount using this formula: (Loss to layer ÷ Cover Limit for layer) X Premium…..if it is 100% pro-rata to amount only X (days remaining in the year/365) ……if it is pro-rata amount and time

XL Losses worked Example Using Risk A Loss 1: details were as follows Retained Risk $1m which is the cover limit on XL Retained loss was $1m. Using the above XL program Recovery will be calculated as follows: Loss to 1st layer $1,000,000- $350,000= $650,000 Reinstatement Premium ($650,000/$1,650,000) X $267 300= $105 300 When paying the claim deduct reinstatement premium i.e ($650k- $105,3k)= $544 700

Work to do Using the above XL program. Calculate amount paid to insurer on the following losses UNL. Assume Limit per risk of $4million Sum Insured $3m Loss $200,000 D.O.L. 05/01/14 Sum Insured $2m Loss $1,500,000 D.O.L 25/01/14 Sum Insured $4m Loss $2,500,000 D.O.L 30/03/14 Sum Insured $8m Loss $4,000,000 D.O.L 28/08/14* how far are you with reinstatement premium? Sum Insured $700k loss $600,000 D.O.L 15/10/14* do you still have enough cover?

Stop Loss & Aggregate XL Stop Loss operates on pre agreed % while Aggregate XL cover is expressed as fixed limits. They are used to protect losses in a particular class or an aggregation of an event. The insurer’s loss ratio is limited to a particular level and reinsurer will kick in up to the agreed limit. Most suitable in businesses where losses can have unpredictable spikes e.g in weather related covers like Hail insurance. Losses are only recoverable when the aggregate exceeds the deductible

Stop Loss QUOTATION EXAMPLE

Basis of Reinsurance Treaties can be placed using any of the following Basis: Risk attaching during- Reinsurance in force when policy commenced and received the ceded premium will pay claim. Losses Occurring During- Reinsurance in force at date of loss Claims made during- reinsurance in force when the insurer is first made aware of the claim will respond.

REINSURANCE DESIGNING CONSIDERATIONS You want to determine whether you buy fac, prop or non prop treaty or a combination of all. Look at: Nature of the portfolio Volume- Do you have sufficient numbers to have a treaty Mix- Is there homogeneous exposure in your book, it may all be motor but 50% could be excluded risks in your treaty Size- Can you chose XL or quota share- Are the sums insured within same range or vary significantly Are there policies with unlimited Liability Is portfolio subject to wide fluctuations in its annual results

Considerations Capacity required- Do you really need it, is there automatic reinsurance capacity for your risks. A treaty should at least cover the majority of risks written. Retention- your capital and risk appetite can determine this. Market norms can be a guide. No retention at all poses moral hazard Reinsurance costs- For XL you pay upfront, for prop you may cede more premiums How claims will be shared. Exposure to accumulations Loss experience Cost of operating the reinsurance program

Considerations Reinsurers will require the following information to make a judgment on required cover as well as to price it. Risk profiles 5 year losses statistics Required capacity/ Cat Limits Estimated Income Desired retention level by cedant Classes of business covered Potential accumulation for Reinsurer- Fac Inwards

Consideration Reinsurer will also make a judgment on Standard of Management style Experience of underwriters Geographical distribution of business written Financial standing of cedant Past underwriting results Exclusions, terms and conditions on the requires treaty.

Lets Design Using Risk Profile

Designing Reinsurer May insist on deductible of at least $250,000. Insurer may want treaty cover up to $6,000,000 Is insurer willing to pay upfront XL premium for $6 million cover in that case $5.75m Xs $250K. Will reinsurer be able to give you that and at what price? Note deductible is 4% of limit. Insurer may combine XL , Surplus and Fac. So you have 5 line surplus with retention of $1m. Giving total treaty capacity of $6m. Retention will be protected by XL of $750k Xs $250k. All risks above $6m will be placed on Fac basis

Another Example

This example consists of balanced spread of small risks This example consists of balanced spread of small risks. An XL might be ideal There may be need for proportional cover protected by an XL. However, will the deductible amount remain reasonable? There really isn’t much need for Fac except for the 4 risks above $200k Most likely a motor account

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