Finance 431: Property-Liability Insurance Lecture 8: Reinsurance

Reinsurance Introduction Types of Reinsurance Types of Reinsurers Uses of Reinsurance New Developments

Introduction to Reinsurance What is reinsurance? Insurance for insurance companies How reinsurance is used CapacityStability Catastrophe protectionFinancial strength Entry and exitAccounting 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) Policyholder pays premium to insurer Insurer indemnifies against loss Insurer “cedes” part of premium to reinsurer Reinsurer “assumes” responsibility for part of loss

Types of Reinsurance Facultative versus treaty Facultative - specific risks Treaty - book of policies Proportional versus non-proportional (excess) Proportional Quota share - all policies on same basis Surplus share - basis varies by policy limits Non-proportional Excess 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 Reinsurance Capacity 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)