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Reinsurance By Roar Rasten Gard AS The Nordic Association of Marine Insurers 1 Why a session on Reinsurance? • • • All marine insurers are heavily reliant on reinsurance in their operations Both underwriting and claims handling are effected by the company’s reinsurance program and philosophy Insurance is the art of spreading risks and reinsurance is an important part of this Goals for this session • Discover why companies use reinsurance ◦ Underwriting capacity ◦ Earnings volatility ◦ Capital protection • Understand different types of reinsurance ◦ Facultative reinsurance ◦ Treaty reinsurance; proportional and non-proportional ◦ Pool • Reinsurance in practice, understand the impact of reinsurance ◦ Quota Share ◦ Excess of loss with and without aggregate Definition of risk Risk is the potential for loss or failure to meet business objectives as a consequence of internal or external events Risk Capacity The ability to carry risks • Demands: ◦ Regulatory requirements ◦ Market requirements (i.e. Rating) ◦ Capital providers requirements ◦ Other? • Instruments: ◦ Capital ◦ Portfolio mixture ◦ Reinsurance ◦ Other? Risk appetite Risk appetite reflects the amount of risk taking that is acceptable to an organisation An organisations risk appetite will shape its attitude towards risk taking and define level of exposure to specific risks or risk groups that the organisation is able to tolerate Important factors for deciding the company’s risk appetite? Reinsurance • “Insurance of insurance companies” ◦ “Reinsurance is the transfer of parts of the hazards or a risk that a direct insurer assumes by way of insurance contracts or legal provision on behalf of an insured, to a second insurance carrier, the reinsurer, who has no contractual relationship with the insured.” (M. Grossmann) In distinction to co-insurance where the contractual relationship is between the insured and its co-insurers Why reinsurance? • Increase in underwriting capacity (maximum limit to be offered as risk transfer to a policyholder) • Reduction in portfolio volatility (better balanced portfolio) • Reduction in the economic effect of a catastrophe (accumulation of risks) • Removal of unwanted risks Reduced capital need A reinsurer balance their book of business by taking on the same types of risk from many insurers. Distribution of insurance risks Policy holders Insurance compromises Reinsurers Portfolio Exposure Exposure Peak exposures Max acceptable loss for own account No of cover Basic: Reinsurance Forms • Facultative reinsurance: ◦ Facultative reinsurance is reinsurance for individual risks • Obligatory Reinsurance ◦ Obligatory reinsurance is treaty reinsurance for portfolios • “Claims Pool” ◦ A pool is not reinsurance but sharing of claims costs among a group of insurers Source: Swiss Re Basic: Reinsurance Types • Proportional reinsurance • Non-proportional Reinsurance • Alternative risk transfer (ART) The reinsurer’s share of premium is directly proportional to his obligation to pay claims* The reinsurer obliges himself to pay all losses above the deductable/excess amount up to a contractually defined cover limit* Often organised as an instrument to smooth result over time *Source: Swiss Re Reinsurance instruments • Proportional reinsurance: ◦ Facultative proportional reinsurance ◦ Quota Share treaty reinsurance ◦ Surplus treaty reinsurance • Non-proportional reinsurance: ◦ Facultative non-proportional reinsurance ◦ Excess of Loss treaty reinsurance ◦ Stop Loss Facultative proportional Reinsurance per risk reinsurance 30% 80% 100% 70% 20% Buy out of top exposure “Fronting” of Captive Buy out of unwanted risks Three examples where facultative proportional reinsurance is used The proportion is used both when sharing premium and claims The insurance conditions are often discussed with lead reinsurer before the policy are written Quota Share Premium Reinsured share Own account Claims 50% 50% 50% 50% Quota Share • • • Treaty capacity 50 million (exposure per risk; sum insured or PML) Placed share 50% (every risk is ceded 50%) Overrider commission 10% (negotiable) Quota Share Reinsurance Premium written Incurred claims Brokerage Own expenses/overrider comm.10%* Technical result Gross figures 100.0 75.0 10.0 8.0 7.0 50 % Figures QS reins. for own share account 50.0 50.0 37.5 37.5 5.0 5.0 5.0 3.0 2.5 4.5 * Negotiable As long as the exposure of a risk is less than or equal to the treaty capacity the risk shall be ceded to the treaty and both premiums and claims are shared in the agreed proportions. Quota Share and Fac • • If single risks have and exposure greater than the QS capacity the risks have to be reduced to the max limit before entered to the treaty. Proportional fac. is often used for this purpose Quota Share Reinsurance Premium written Incurred claims Commissions Own expenses/overrider comm.* Technical result Gross Ceded figures Fac. 110.0 10.0 82.5 7.5 11.0 1.0 8.8 7.7 1.5 Figures after Fac. 100.0 75.0 10.0 8.8 6.2 50 % Figures QS reins. for own share account 50.0 50.0 37.5 37.5 5.0 5.0 5.0 3.8 2.5 3.7 * Negotiable It is not seldom that facultative reinsurers are not paying overrider commission Exercise 1 QS • Program: 50% quota share with treaty capacity 50 million • Brokerage Nil • Overrider commission 10% • Portfolio: 1. Exposure 50 million, premium 300.000 What will be the net* ceded premium to reinsurers? The risk has a claim of 1 million , what is the claim recovery from reinsurers? * Premium net of commissions Exercise 1 QS A 50% Quota share With a treaty capasity 50 million Overrider 10% Premium Gross 300,000 Ceded Premium Overrider Net ceded Gross Ceded claim - Claim 1,000,000 Exercise 2 QS • Program: 80% quota share with treaty capacity 50 million • Brokerage Nil • Overrider commission 10% • Portfolio of 5 risks: 1. Exposure 75 million, premium 750.000 2. Exposure 50 million, premium 300.000 3. Exposure 30 million, premium 200.000 4. Exposure 2 million, premium 20.000 5. Exposure 50.000, Premium 1.000 Do we need to use Fac to reduce the exposure to the treaty? What will be the net ceded premium to reinsurers? Risk 2 has a claim of 1 million and risk 4 has a claim of 50.000. What is the total claims recovery from reinsurers? Exercise 2 QS Exercise 2 80 % Quota Share with capasity 50 mill Brokerage nil, overrider commission 10 % Ceded premium Risk Sum Gross Treaty Share ceded Share Exposure premium limit to Fac to treaty 1 75,000,000 750,000 50,000,000 2 50,000,000 300,000 50,000,000 3 30,000,000 200,000 50,000,000 4 2,000,000 20,000 50,000,000 5 50,000 1,000 50,000,000 1,271,000 Premium to QS - Recovery from reinsurers Risk Sum Gross Exposure Claims 1 75,000,000 2 50,000,000 3 30,000,000 4 2,000,000 5 50,000 - Treaty Share limit to treaty 50,000,000 50,000,000 50,000,000 50,000,000 50,000,000 Claims to QS - Reinsurers 80% share - Reinsurers Less Net ceded share of prem. overrider premium - - - Surplus treaty • Each risk is ceded with an individual share ◦ Max retention for each risk is a fixed amount ◦ Ceded share is the share of the risk exceeding max retention Example: A risk with exposure (PML) 100 Insurance company’s max retention 25 Ceded share to reinsurers (100-25)/100 = 75% • • • Treaty capacity is often expressed in number of lines where one line in the company’s max retention Brokerage is ceded and claims recovered in the same per cent as premium Overrider is to be agreed The Nordic Association of Marine Insurers 22 Surplus treaty Each risk is ceded with an individual share Exposure 140 120 Fac. reinsurance 100 25% 14% 10% 80 Reinsurance 2 lines = 60 50% 57% 60% 67% 60 62% 57% 40% 40 Own retention 1 lines = 30 20 0 25% 29% 30% 33% 38% 43% 25% 60% 75% 100% Facultative non-proportional reinsurance Excess of Loss (XL) per risk reinsurance Exposure 100 Reinsured 50 Deductable Expressed as: Cover is 50 in excess of 50 (deductable) The treaty covers claims in excess of deductable. For this the cedent pays an agreed premium. Excess of loss treaty. Cover all claims in an agreed portfolio for a limit in excess of underlying 120 100 80 60 Reinsured 40 20 Own retention 0 This treaty is expressed as a treaty 80 excess of (xs) 20 Excess of Loss premium • Premiums are agreed and are not directly linked to portfolio premium ◦ Often expressed as a RoL, meaning premium divided by cover limit multiplied by 100. If you pay 300 for a limit of 1.000 the rate is 30 on line. ◦ Premiums are usually adjustable to portfolio premium. The premiums are agreed on a bases of an Estimated Premium Income (EPI). If the premium income increases in excess of EPI, the treaty premium increases with the same percentage. ◦ A minimum and deposit premium is often agreed Excess of Loss Reinstatement premium • When buying a XL-treaty you buy the right to draw on the reinsurers for claims in excess of underlying up to a full agreed limit. ◦ The treaty 80 xs 20 gives you the right to collect 80 from the reinsurers if the claim is 100 or more, or you can collect 20 from each of 5 claims which are 40, then the cover is exhausted. • Usually it is agreed that after a claim you reinstate the cover by paying an additional premium (reinstatement premium). This can be expressed as: ◦ 2 reinstatement at 100, meaning that you have the right and the obligation to reinstate the cover two times by paying an additional premium equal to the original agreed premium for each reinstatement. The reinstatement premiums shall also be adjusted. There are also treaties with the wording: free and unlimited reinstatement meaning that no additional premium is charged and there are no restrictions to how many times you can use the limit. Layered XL - program 120 100 80 3rd layer 50 xs 50 2nd layer 30 xs 20 1st layer 10 xs 10 60 40 20 0 Retention Layered XL - program 160 140 120 4th layer 50 xs 100 with 1 reinstatement at 100 3rd layer 50 xs 50 with 2 reinstatement at 100 2nd layer 30 xs 20 with 2 reinstatement at 100 1st layer 10 xs 10 XS 30 in the aggregate* with 2 reinstatement at 100 100 80 60 40 20 0 Retention *In the aggregate; you can not collect from reinsurers before claims to layer exceeds the agreed aggregated amount Exercise 3a XL-program • 2 layered program: ◦ ◦ ◦ • 1st layer 10 xs 10 with 2 reinstatement at 100. Rate on line (RoL) is 25. 2nd layer 30 xs 20 with 2 reinstatements at 100. RoL is 15. Minimum and deposit premium is equal to estimated premium What is estimated premium for layer 1 and 2? Premium cost per layer Layer limit 1 2 Sum RoL M&D Prem. - Exercise 3b XL-program • 2 layered program: ◦ ◦ ◦ ◦ 1st layer 10 xs 10 with 2 reinstatement at 100. Rate on line (RoL) is 25. 2nd layer 30 xs 20 with 2 reinstatements at 100. RoL is 15. Total premium written is 66 million at the end of the year There are no claims to the program The program is adjustable at an Estimated Premium Income (EPI) of 60. • What is the total adjusted premium for layer 1 and 2? Premium cost per layer Layer limit 1 2 Sum RoL Adjustment Adjusted M&D Prem. rate premium - - Exercise 4 XL-program • 2 layered program: ◦ ◦ ◦ 1st layer 10 xs 10 with 2 reinstatement at 100. Rate on line (RoL) is 25. 2nd layer 30 xs 20 with 2 reinstatements at 100. RoL is 15. Minimum and deposit premium is equal to estimated premium The program is adjustable at an EPI of 60. • • What is estimated premium for layer 1 and 2? There are 3 large claims in the year: one is 30, the 2nd one is 12 and the third is 15. Calculate the claim recovery from each layer. Claims recovery per layer Retention Claim 1 Claim 2 Claim 3 Sum - Layer 1 10 xs 10 - Layer 2 30 xs 20 - Total 30.0 12.0 15.0 57.0 Exercise 5 XL-program • 2 layered program: ◦ ◦ ◦ • • • 1st layer 10 xs 10 with 2 reinstatement at 100. Rate on line (RoL) is 25. 2nd layer 30 xs 20 with 2 reinstatements at 100. RoL is 15. Minimum and deposit premium is equal to estimated premium The program is adjustable at an EPI of 60. What is estimated premium for layer 1 and 2? There are 3 large claims in the year: one is 30, the 2nd one is 12 and the third is 15. Calculate the claim recovery from each layer. What will be the reinstatement costs and the net recoveries from reinsurers? Reinstatement premium per layer ReinstateLayer ment Claim 1 Retention Layer 1 2 at 100% Layer 2 2 at 100% Total - Reinstatement payable Claim 2 Claim 3 - - Total - Net recovery - Exercise 6 XL-program • 2 layered program: ◦ ◦ • • • • 1st layer 10 xs 10 with 2 reinstatement at 100. Rate on line (RoL) is 25. 2nd layer 30 xs 20 with 2 reinstatements at 100. RoL is 15. The program is adjustable at an EPI of 60. Minimum and deposit premium is equal to estimated premium. What is estimated premium for layer 1 and 2? There are 3 large claims in the year: one is 30, the 2nd one is 12 and the third is 15. Calculate the claim recovery from each layer. What will be the reinstatement costs? The total premium income for the portfolio under the program has reached 66. Recalculate the premium for the program and the reinstatement premium (adjusted premium). Exercise 6 XL-program Adjustment premium Actual EPI premium Layer M&D Prem. 1 2 Sum - Adj. rate Reinst. Prem. Pre adj. Prem - The Nordic Association of Marine Insurers Adj. Rate Adj. Prem - Tot. Prem - 35 Combination of Quota Share and Excess of Loss • • • A Quota Share treaty will often leave the insurer with a possibility for unacceptably large losses. It is therefore common to protect the portfolio for own account after the Quota Share treaty by an Excess of Loss program. Example: A 50% Quota Share with capacity 100 where own retention is protected by an excess of loss program 40 xs 10. Reinsurance security • Ability and willingness to pay claims ◦ Rating ◦ Market approach (long term player or? History?) ◦ Long tail business? ◦ Ability to pay (Risk of default) ◦ Willingness to pay The right reinsurance panel is important Have we achieved? • Discovering why companies use reinsurance ◦ Underwriting capacity ◦ Earnings volatility ◦ Capital protection • Understanding different types of reinsurance ◦ Facultative reinsurance ◦ Treaty reinsurance; proportional and non-proportional ◦ Pool • Reinsurance in practice, understanding the impact of reinsurance ◦ Quota Share ◦ Excess of loss with and without aggregate The Nordic Association of Marine Insurers 39