1. Reinsurance
Session 2

2. Reinsurance Session 2 Finite Reinsurance Life Reinsurance
Securitization / Alternative Capital Sources
Reinsurance Failures
Session 2

3. Reinsurance
1. Finite Reinsurance

4. Finite Reinsurance Multi-year
Multi-class (mostly)
Limited indemnity risk transfer, mainly timing risk
Side letters to contract which serve to conceal the limited indemnity risk transfer
Dampens fluctuation of profit over term of contract.

5. Where would you most likely find Finite Reinsurance?
High level catastrophe XL cover
Likely location for Finite Reinsurance
Cover for fairly high claims whose level is predictable over 5-8 years
Low level QS cover

6. Finite Reinsurance
Dampens fluctuation of profit over term of contract.
Net asset value increases over time
Net asset value decreases over time
No Finite Re.
With Finite Re.
Little effect
Net asset value
Conceals serious problems
Time (years)

7. Finite Reinsurance Loss Portfolio Transfer (LPT)
Transfers loss portfolio to reinsurer, plus assets and plus premium. Protects against timing risk
Adverse Development Cover (ADC)
Losses stay with insurer but reinsurer smoothes any adverse development. Post-loss funding?
Message:
Please don’t be “blinded by science”
Spread Loss Treaty (SLT)
Pays “premium” into an “experience account” at reinsurer which is used to smooth results of cedant.
Finite Quota Share (FQS)
Transfers unearned premium in return for a reinsurance commission.
Counter-cyclical tool to smooth profits.
Source: Swiss Re. Sigma 1997, & Core Curriculum Module

8. Finite Reinsurance
Side letters to contract which serve to conceal the limited indemnity risk transfer
SEC vs. General Re & AIG (USA) – February 2008
A finite re contract to inflate AIG’s loss reserves by US$500million in (an immaterial amount for the AIG Group).
Securities Fraud, Conspiracy, False Statements to Regulators
4 Gen Re & 1 AIG executives guilty and each face up to a US$48million fine & between 150 and 200 years in prison.
SFO vs. Independent Insurance (UK) – October 2007
Jail sentences for CEO, CFO and In-house Counsel for conspiracy to defraud.
Dampens fluctuation of profit over term of contract.

9. Reinsurance
2. Life Reinsurance

10. Life Reinsurance Usually, transfers mortality and morbidity risk.
Each life company establishes a “retention per life” e.g. TT$300,000.
The more volatile the underwriting results the smaller the retention should be
The smaller the policy base the smaller the retention should be
The less homogeneous the policy base the smaller the retention should be
The lower the capital base the smaller the retention should be

11. Risk Transfer – Mortality & Morbidity
Life Reinsurance
Risk Transfer – Mortality & Morbidity
Little need to reinsure savings / unit linked products!!
Some anti-cyclical “finite reinsurance” transfers timing risk.
Main Types Reinsurance Contracts
Coinsurance
Modified Coinsurance
Yearly Renewable Term (YRT)
And
Treaty (large bundles of policies)
Facultative (individual policies)
Some contracts transfer timing risk to alleviate front-end strain.

12. Life Reinsurance -Types of Contract
YRT
Reinsurer assumes mortality and morbidity risk only, & annual premiums based on amount at risk. Premiums increase with age of insured. Investment risks and returns remain with primary insurer.
(Quota Share or Excess of Loss)
Coinsurance
Reinsurer shares a percentage of business including cash flows and reserves. Investment risks and returns are shared in proportion to the risk transfer.
Modified Coinsurance
As above, but ceding company retains assets and reserves and, therefore, investment risks and returns. Primary insurer pays a fixed rate of interest to reinsurer for the investments it “holds” in relation to the risk transferred.
Reference material:
American Council of Life Insurers (ACLI). Reinsurance Treaty Sourcebook
GLOC has YRT to reinsure mortality and morbidity in XS of $30k per life.
Discuss how life reinsurers make their money.
Point towards the treaty sourcebook.

13. 3. Securitization / Alternative Capital Sources
Reinsurance
3. Securitization / Alternative Capital Sources

14. Insurance Securitization
Transfers insurance risk to capital markets
Mechanism is same as for non-insurance securitization
Securitization is suited to catastrophe risk; most of the deals are in this line of business.
Reference:
See the Deal Directory
The website is up to date now.
History of securitization is well-known. Started with credit card receivables. Applied to insurance, but never formed a mass market. Only a way for the top reinsurers to fine tune their enormous capital needs. This technique became widely used to transfer credit risk between banks, enabling them to diversify. It was the means of systemic transmission of the sub-prime problem to banks worldwide.

15. Insurance Securitization - Basics
Insurance Market
Capital Market
Insurer
Investor
Investor
Insurer
Reinsurer
Risk gatherer
& transferor
Special Purpose Vehicle
Risk converter & bond issuer
Investor
Insurer
Investor
Insurer
Insurer
Investor
Conventional reinsurance contracts
Conventional bond issuance
See next slide for:
Risk transfer
SPV

16. Insurance Securitization - Basics
Risk Transfer from Reinsurer to SPV
Defined risk is transferred to SPV
Reinsurer is reimbursed by triggering a claim:
Indemnity-based (like a conventional claim)
Not popular with investors and now uncommon – too much moral hazard
Parametric trigger
Defined events at defined locations – quake of specified magnitude in specified location
Cash flow criterion – variance from pre-agreed cash flow budget
The Special Purpose Vehicle
Receives funds from
Transferor – reinsurance premium
Investors – purchase of bonds
If risk transfer claim is triggered, a payment is made to reinsurer.
If no payment to reinsurer, then on maturity the bondholders receive all cash in SPV:
Reinsurance premium
Refund of bond purchase price
Investment income on the above
Risk transfer
SPV
Cash flow criteria facilitate non-cat securitizations
SPVs in tax havens, because the accrual of tax free investment income improves the yield to investors.

17. Insurance Securitization - Basics
Investor
Investor
Reinsurer
Risk gatherer
& transferor
Special Purpose Vehicle
Risk converter & bond issuer
Investor
Investor
Parametric trigger
gives rise to basis risk,
sometimes covered by
a secondary reinsurer
A claim made before
bond matures may upset
investment profile,
sometimes covered
by a liquidity provider
Investor

18. Reinsurance Sidecars
Sidecar – a financial entity created to allow investors to take the risk & return (for a limited period) of a small and limited category of policies, usually property catastrophe. Sidecars do not take the longer term investment risk associated in buying shares whose value is affected by the entire book of business.
Source: AM Best

19. Reinsurance 4. Reinsurance Failures Insolvency of a reinsurer
BUT, before that happens…..
Cashflow problems in a reinsurer will quickly become the problem of the reinsured
Failure of Reliance National, a large US insurer caused by failure of reinsurers for whom it was fronting – “WORKERS’ COMPENSATION CARVE-OUT”
Even without failures, the biggest & best reinsurers are not immune to problems …..
Munich Re in 2002 … Too heavily invested in equities during a stock market crash.
Munich Re in 2008 … Hurricanes Gustav & Ike in the Caribbean wipe out 3Q profits.

20. Are failures likely? Catastrophe risk seems to be the major threat!
Reinsurance
Are failures likely? Catastrophe risk seems to be the major threat!
Source: Guy Carpenter LLC, 2008 Reinsurance Market Review