1. Reinsurance Nigel Davies December 2, 2008.

2. Reinsurance Session 1 Introduction & Overview. Case Study, Round 1. Session 2 Case Study Feedback. Life Reinsurance. Finite Reinsurance. Failure of Reinsurance. Session 3 Catastrophe Insurance. Securitization. Case study – Round 2. Session 4 Case Study Feedback. Supervisory Issues.

3. Reinsurance Session 1 Introduction & Overview. Reinsurance Market Definitions and Types of Contract

4. Reinsurance Insured Insurance Company Reinsurance Company Reinsurance Company Broker, Agent, Phone, Online, In person. Broker, Direct. Reinsurance Retrocession Direct Insurance

5. Reinsurance Insurance Company Reinsurance Company Broker, Direct. Reinsurance US$ billion Growth in 2007 Growth in 2006 Life2,3935.4%4.1% Non-life1,6680.7%3.9% Total4,061 Global Premiums in 2007 Source: Swiss Re, Sigma 3/2008. How much of this is reinsurance? …and why do we measure it by premium?

6. 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) Latin America (4,132) Total 172,924(172,924)NIL Destination & Source of Reinsurance Premium (US$ million) Source: IAIS Global Reinsurance Market Report, December 2007 Data Source:- 59 Reinsurers: Bermuda 8; Europe 21; Japan 2; USA 28.

7. Reinsurance Reinsurance 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.

8. 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)

9. Reinsurance Non-Life Life Reinsurance Market Dynamics – How do reinsurers make money?

10. Reinsurance Non-Life 1.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. Life 1. 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 CYCLICALINCREASING LONGEVITY

11. Reinsurance Capital Movements in a Major Reinsurers – 2007 (Overall 7% increase) Source: Global Reinsurance Market Review 2007. Benfield. www.benfieldgroup.com

12. Reinsurance Non-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%).

13. Reinsurance Increasing Longevity in the Caribbean For 18 age-group cohorts. Source: Caribbean Epidemiology Centre. October 2000. www.carec.org

14. Reinsurance Story 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 reinsurance 5.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.

15. Reinsurance Prioritize Non-life reinsurance over Life reinsurance. Cover Proportional & Non-proportional contracts equally.

16. Reinsurance Classification of Reinsurance Contracts

17. 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. }

18. 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. }

19. Reinsurance Non-life Treaty Reinsurance Non-proportionalProportional 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

20. Reinsurance 1. 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!

21. Reinsurance 1. Excess of Loss Contracts $10m $50m $40m $30m $20m $5m Line of Business ALine of Business B 1 st Layer, $10m xs $10m 1 reinstatement 2 nd Layer, $10m xs $20m 1 reinstatement 3 rd Layer, $20m xs $30m No reinstatements 1 st Layer, $5m xs $5m 3 reinstatements 2 nd Layer, $20m xs $10m 1 reinstatement

22. Reinsurance 1. Excess of Loss Contracts $10m $50m $40m $30m $20m $5m Line of Business ALine of Business B 123 Claims & RI Recoveries ($m) Claim 1Claim 2Claim 3Loss Scenario Gross Claim552530110 R/I Rec. Layer 1(10) NIL(20) R/I Rec. Layer 2(10)(5) (20) R/I Rec. Layer 3(20)N/A (20) Net Claim15102550 } *} * *

23. Reinsurance 2. Stop Loss Contracts Aggregate Losses / Claims of Insurer 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 Aggregate Premiums

24. 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

25. 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

26. 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.

27. 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.

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

29. Reinsurance Time Amount Property Catastrophe Household Fire & Contents (Non- catastrophe) MotorWorkers’ Compensation What type of reinsurance contract suits the loss scenarios in these lines of business?

30. Reinsurance Time Amount Motor Property Catastrophe Workers’ Compensation Household Fire & Contents (Non- catastrophe)

31. Reinsurance Claims Arranged by Line of Business Amount 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.

32. 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.