PRINCIPLE OF REINSURANCE INS 701

1. PRINCIPLE OF REINSURANCEINS 701 Trimester 3 Lecture Hour – 5.00pm to 7.30pm Day : Tuesday @ B313

2. WELCOME Unit Coordinator Details of Unit Outline Objective of the Unit Lecture Outline Unit Assessment Grades Introduction to Reinsurance

3. AN OVERVIEW OF REINSURANCE INTRODUCTION WHAT IS REINSURANCE WHY REINSURE BENEFIT OF REINSURANCE THE REINSURANCE RISKS THE HISTORY OF REINSURANCE REINSURANCE INDUSTRY STRUCTURE THE REINSURANCE MARKET NOW

4. CONT- TYPES,FORMS AND METHOD OF REINSURANCE WHEN IS REINSURANCE REQUIRED SELF HELP QUESTION

5. INTRODUCTION Reinsurance is a way of ‘insuring the insurer’ against risks which it hasn’t the financial means to carry with security Reinsurance is insurance purchased by insurers from other insurers to limit the total loss an insurer would experience in case of a disaster.

6. CONT- Ordinarily, the business owner has little to be concerned with when it comes to reinsurance. However, recent events, such as the War in Iraq, the rise of terrorism, and recent natural disasters, have made it difficult for insurers to secure reinsurance and, as a result, insurers have left the market in some states or premiums for certain types of insurance have risen to an all-time high. Alan Cranfield - Address

7. Learning Outcomes Explain the benefits of reinsurance and describe the risks to the reinsurer Outline the history of reinsurance and explain how its current structure has been influenced both by its past, and by present economic and other forces Describe the various types, methods and forms of reinsurance, and explain the purpose of each in reinsuring various classes of business

8. What Is Reinsurance? Reinsurance is about spreading the risk? An insurer places part of the risk it has accepted with other insurers, and pays them either a share of the original premium paid by the insured In the event of a claim, the original insurer and the reinsurer(s) share the cost of the payout in accordance with their agreement For the amount of risk a company underwrite it calculate: How much of the risk it will retain itself How much of the risk it will transfer via reinsurance

9. Why Reinsure? Catastrophe Risk Large claim from one event can exceed the company capacity to pay R/I can give Insurer access to sufficient capital to satisfy all their obligations 1999 – typhoon in Hong Kong & Japan Earthquake in Taiwan Bushfire 2003 in Australia Sept 11 - Scenario Meeting Solvency Margins

10. Benefits Of Reinsurance R/I has the following benefit for the insurer: Stabilization or Smoothing of Results Stabilizes a co. underwriting result by minimizing the effects of fluctuation in claims Protection of the Capital Spreading of risk-locally & international market Catastrophe Protection Financing Access to R/I expertise

11. The reinsurer’s risks Reinsurer insure catastrophe risks and other severe risks that normal insured can’t accept because of the ruinous consequences of major loss. A reinsurer must be able to provide appropriate cover to insurers, while safeguarding its own business portfolio to ensure that it is not exposed itself to undue risk, and its able to make profit.

12. CONT- Reinsurer uses the following means to safeguard their business activities: Underwriting Policy Retro ceding [further reinsurance] Control of risk exposure

13. History of Reinsurance R/I, has its origin from Marine Commerce Increase in trading activity, the loss of a no. of vessels and their valuable cargoes at sea could ruin an insurer. Catastrophe fire in Hamburg between 1672 & 1676 indicate the need for reinsurance 19th Century the rise in Industrialization. 20th Massive increase in Industrialization

14. Reinsurance Industry Structure Professional Reinsurance Companies Set up for the sole purpose of transacting reinsurance business Lloyd’s Market Group of Names[Syndicate] Underwriter to accept business on behalf of the Names All business has to go through Lloyd’s Broker Reinsurance Pools Group of Insurer E.g. 4 Insurer will retain $100k, which means they can underwrite $400k business & they share the premium and claim

15. Type, forms and Method of Reinsurance Type of Reinsurance Proportional Non-Proportional

16. Proportional R/I The reinsurer share of the premium is directly proportional to its obligation to pay any losses Agrees to accept a set proportion of the risk (or risks) being offered for reinsurance R/I accept 50% risk, entitled to 50% of the original insurance premium, contribute to 50% to all claims Oldest form of R/I and is possibly most common one. It is primarily used in classes of insurance where there is a known sum at risk, such as property The prime purpose –to increase the capacity available on a per risk basis for an insurer Used to lessen the effects that negative results will have on the overall portfolio in these classes

17. Non Proportional Reinsurance Arrange on Excess of Loss basis, whereby the insurer pays the losses up to a certain amount and the reinsurers those over that amount. The prime function of NPR is to smooth the result of the insurance by removing the fluctuations of an insurer’s result in areas such as individual property risks and liability risks caused by an extraordinary event or series of events such as natural catastrophe. It increase the capacity for insurer to underwrite higher sum insured/LOI than would otherwise possible

18. Methods of Reinsurance 2 distinct Method Facultative R/I – individual risks are submitted to reinsurer to accept or decline Treaty R/I – the insurer agrees to pass on and accept risks within pre-arranged limits, terms and conditions This is carried out under the terms of a contract with the reinsurer which is called a “treaty”.

19. REINSURANCE DIAGRAM

20. Facultative Reinsurance Deals with each risk individually Insurer must approach the reinsurer with a proposal and advise the reinsurer of all the information available, incl. terms & condition Reinsurer can Accept or Decline. Similar practice of direct insurance Reinsurer accepting an additional Non-Proportional Cover over and above the facilities automatically available to the insurer in PUB – in form as XOL R/I. The reinsurer agrees to indemnify the insurer if there is a claim that exceeds an agreed limit

21. Treaty Reinsurance A treaty is a written contract between an insurer and reinsurer under which the insurer obtains reinsurance protection for all the risks within a defined class of business. The treaty sets pre –arrangement terms and limits for the protection The reinsurer has to rely very much on the integrity of the insurer to whom any treaty is granted. In a treaty arrangement the reinsurer maintains a contractual right to inspect the books and record of an insurer relating to any risks ceded to or claims made on a treaty

22. Methods of Treaty R/I PROPORTIONAL TREATIES Quota Share Surplus Treaty Facultative Obligatory Treaty NON PROPORTIONAL TREATIES Excess of Loss Treaty Stop Loss Treaty

23. CONT Quota share treaty This type of treaty applies to a whole class of business. The reinsurer accepts a fixed proportion of every risk in that class E.g.. Retain 25%, cede 75%. The reinsurer will receive the same proportion of the premium received for that class and will pay that same proportion of the loss Advantages & Disadvantages Surplus Treaty Only amount in excess of the insurer’s retention are passed to the reinsurer, in direct proportion that the amount over the gross retention has to the sum insured (up to the agreed limit). Under the ST, the insurer automatically accept a risk that is many time the size of its retention Eg Sum Insured - 4500k Insurer retention -$100k (1/5th S/I) Surplus Treaty - $400k (4/5th ) Claim - $120k Insurer Pays 1/5 = $24k S/T pays 4/5th = $96k

24. CONT- Facultative obligatory Treaty A combination of a surplus treaty & facultative R/I hybrid between facultative reinsurance and treaty reinsurance where the ceding company may elect to assign certain risks that the reinsurer is obligated to accept. Excess of Loss Treaty Most commonly used treaty This form of R/I arrangement is not dependent on the sum insured but rather the size of the claim under the original insurance – the reinsurer agrees to indemnify the insurer if there is an individual claim that exceeds an agreed limit

25. CONT- Stop Loss Treaty A less commonly used form of Non Prop. R/I Reinsurance is based on Claim Not on a single individual or occurrence BUT against the losses incurred under a particular portfolio exceeding a previous agreed loss ratio (the ratio of premium income to claims incurred). If claim payments exceed a loss ratio of , say 70% of premium income, then the reinsurer takes care of the difference or an agreed % of the difference. Eg, reinsurer may be liable for 90% of all losses after the ratio of the company has reached 70% (capped at an upper limit of 120%)

26. When is R/I Required? TO BE CONTINED NEXT LECTURE