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INTRODUCTION TO
REINSURANCE
NOLAN ASCH
CAS RATEMAKING SEMINAR
MARCH 12,2001
REI-46
INSURANCE
The insurer insures the individual or
the corporation
REINSURANCE
The REINSURER insures the
insurance company
REINSURANCE
PLACEMENT MECHANISMS
DIRECT
BROKER
INSURANCE
vs.
REINSURANCE
BOTH concerned with future contingencies
BOTH require underwriting skills (risk)
BOTH involve transfer of risk
BOTH require payment of premium
BOTH provide protection
BOTH subject to (some) regulation
REINSURANCE
Buyers assumed to be knowledgeable
Responds to actual loss
Provides indemnification only
Reimburses for payments already made
Usually Global
FUNCTIONS OF
REINSURANCE
CAPACITY
CAPACITY
Single Risk (FAC WTC)
PORTFOLIO (TREATY)
CAPACITY MECHANISMS
Excess-of-Loss
Quota Share
FUNCTIONS OF REINSURANCE
CAPACITY
CATASTROPHE
CATASTROPHE
QUOTA SHARE
EXCESS OF LOSS
SECURITIZATION
FUNCTIONS OF REINSURANCE
CAPACITY
CATASTROPHE
STABILIZATION
STABILIZATION
Reduction in Variance (swings)
STABILIZATION
Extreme contractual case
“STOP-LOSS”
Aggregate Excess
FUNCTIONS OF REINSURANCE
CAPACITY
CATASTROPHE
STABILIZATION
FINANCING
FINANCING
Reducing Liabilities
Ceding Commissions
“Overrides”
FINANCING
May increase PHS due to transaction
FINANCING
Finite Reinsurance......
but ALL Reinsurance is Financial
FUNCTIONS OF REINSURANCE
CAPACITY
CATASTROPHE
STABILIZATION
FINANCING
ENTER AND EXIT MARKETS
ENTER OR EXIT MARKETS
Lessens risk as you learn
With 100% Q/S you exit
FUNCTIONS OF REINSURANCE
CAPACITY
CATASTROPHE
STABILIZATION
FINANCING
ENTER AND EXIT MARKETS
UTILIZE REINSURER EXPERTISE
USING REINSURER
EXPERTISE
Large or unusual claims
Large or unusual risks
Special relationships and/or
knowledge
LIMITATIONS OF
REINSURANCE
Will NOT make bad business profitable
Transaction Costs
Rating Agency Impacts (Gross/Net)
How Reinsurance Is Priced
in Practice
Hypothetical
Examples
NO PRICE REGULATION
(virtually)
CASE BY CASE
NEGOTIATION
FLEXIBILITY IN STRUCTURE
Contractual
EXCESS OF LOSS
LAYERING
$19.75 Mill xs $0.25 Mill
(sounds like a wide layer)
TYPICAL LAYERING
10M xs 10M
5M xs 5M
3M xs 2M
1M xs 1M
500 xs 500
250 xs 250
Price
Price
Price
Price
Price
Price
F
E
D
C
B
A
High Frequency/ Low Severity
Buffer layers
ie 250 xs 250
Price A
250 xs 250
Low Frequency/ High Severity
10M xs 10M
Price F
Capacity Layers
ie 10m xs 10m
CLIENT/BROKER
NEGOTIATION
Change or re-subdivide
the layering
LAYER TRAP
MANY PERMUTATIONS
Pricing for 500 xs 500
Later, request the 250xs 250
LAYER TRAP
at “last minute”
Ask for 150 xs 100
--Requires more data
PRICING TRAPS
AGGREGATE ANNUAL DEDUCTIBLES
ASSUME A 10% RATE
Request a 1% AAD
Request a 2% AAD
Request an 8% AAD
NOW the risk/variance
becomes LARGE vs a 2% rate
INFORMATION FOR PRICING
NO standards
WHAT THE REINSURER
WANTS
EVERYTHING
WHAT THE BROKER/CLIENT
MAY WISH TO SUPPLY
NOTHING
POSSIBLE
OUTCOMES
GIGO
Garbage-In
Garbage-out
EL NIÑO
NINO
Nothing-in
Nothing-out
EXPERIENCE RATING
Using losses of the risk
to price the risk.
STANDARD
All losses at half the
attachment point & up
ACTUARIAL APPROACH
DETRENDED LOSSES
Varies with age of claim
BEGINS to show ACTUAL
CLAIMS as a sample outcome
EXPOSURE RATING
Attempt to rate Reinsurance based upon the
TRUE underlying exposures
Proxies for TRUE exposures:
Limits Profiles = Subject Premium by policy limit
Exposures by policy limit ( still not the TRUE exposure)
LIMITS PROFILE
$100,000 Policy Limit
Yr 1994 10% of exposures at $100,000
Yr 1995
25% of exposures at $100,000
Yr 2000 90% of exposures at $100,000
loss was atypical in 1994
layer is effective 7/1/01
Include ‘94 and ‘95 losses at $100,000
LIMIT LOSS
limit loss to 1994 policy limits
or
trend and develop loss
beyond policy limits
“WE DON’T DO THIS
ANYMORE”
“Throw out “ claims from
MGA’s, classes or states
we no longer write
QUOTA SHARE ISSUES
Moral hazard/ Retention 1% net
Ceding Commission
Overrides
Sliding Scales
Loss Corridors