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3) Principles and Practice of Reinsurance
1. (3) PRINCIPLES AND PRACTICE__________________________________________________
3.PRINCIPLES AND PRACTICE OF
REINSURANCE
1. The reinsurance 1
needs of direct insurers
2. (3) PRINCIPLES AND PRACTICE__________________________________________________
1. The reinsurance needs of direct insurers
2. Forms and methods of placing reinsurance
3. Reinsurance practices and problems
1. The reinsurance 2
needs of direct insurers
3. (3) PRINCIPLES AND PRACTICE__________________________________________________
1. The reinsurance needs of direct
insurers
1. The reinsurance 3
needs of direct insurers
4. (3) PRINCIPLES AND PRACTICE__________________________________________________
1. Why do Insurers purchase reinsurance?
1. The reinsurance 4
needs of direct insurers
5. (3) PRINCIPLES AND PRACTICE__________________________________________________
• The need to protect solvency
1. The reinsurance 5
needs of direct insurers
6. (3) PRINCIPLES AND PRACTICE__________________________________________________
2. What determines any deviation in
outcomes from R0 to Rn?
1. The reinsurance 6
needs of direct insurers
7. (3) PRINCIPLES AND PRACTICE__________________________________________________
Deviation of outcomes from line R0Rn will depend upon:
1. Accurancy of Premium calculation.
Estimate of loss expectancy may differ from the true loss expectancy
because:
a) Sampling error (function of sample size)
b) Failure to identify or allow for changing risk conditions
2. The fluctuation of actual outcomes around the mean. (function of
sample size)
Reserves can be substantially reduced because of a random occurrence of
• LARGE INDIVIDUAL losses or
• ACCUMULATION of losses
1. The reinsurance 7
needs of direct insurers
8. (3) PRINCIPLES AND PRACTICE__________________________________________________
Fluctuation of actual outcomes
1. The reinsurance 8
needs of direct insurers
15. (3) PRINCIPLES AND PRACTICE__________________________________________________
3. The occurence of fluctuations in the basic probabilities.
Distribution of yearly outcomes on an unchanging portfolio
1. The reinsurance 15
needs of direct insurers
16. (3) PRINCIPLES AND PRACTICE__________________________________________________
3. The occurence of fluctuations in the basic probabilities.
Insurer´s overall operating result
Figure3.4
1. The reinsurance 16
needs of direct insurers
17. (3) PRINCIPLES AND PRACTICE__________________________________________________
3. The occurence of fluctuations in the basic probabilities.
The insurer´s need of reinsurance in order to reduce it´s probability of
ruin, will vary according to:
The SIZE OF ITS PORTFOLIO
• sample size ->The larger the portfolio, the smaller will tend to be
the variability of outcomes
AND THE TYPE OF BUSINESS UNDERWRITTEN
• The variation in the size of the individual units exposed to loss
• The degree of interdependece between loss exposures
1. The reinsurance 17
needs of direct insurers
18. (3) PRINCIPLES AND PRACTICE__________________________________________________
Therefore , in examining an insrurer‘s need of reinsurance
protection the facts to be considere are:
1. The premiums (no protection against under-pricing)
2. Characteristics of the class of buisness insured and the
composition of the company´s portfolio.
An other aspect is not only the probability of the aggregate claims in
any one year exceeding some predetermined tolerable amount,
but also the degree of variability in possible outcomes
1. The reinsurance 18
needs of direct insurers
19. (3) PRINCIPLES AND PRACTICE__________________________________________________
2. Forms and methods of placing
reinsurance
2. Forms and methods 19
of placing reinsurance
20. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurance
Proportional Reinsurance. Non-proportional Reinsurance.
Quota Share Surplus Excess of loss Stop loss, or loss ratio
Risk basis Occurence basis
2. Forms and methods 20
of placing reinsurance
21. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurance
QUOTA SHARE: A fixed
Proportional Reinsurance. proportion accepted by the
primary insurer and ceded to the
reinsurer is the same for all risks
Quota Share Surplus (in premium, costs, and claims)
SURPLUS: The ceding
company reinsures only the
balance of those risks beyond it
´s own retention (line).
2. Forms and methods 21
of placing reinsurance
22. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurances
Diffrerences between the reinsurer´s loss experience on the total
portfolio of business ceded and the primary insruer´s net retained
account migth be the cause of:
1. A badly balanced account leaving the reinsurance portfolio heavely
exposed to random fluctuations in loss experience from year to
year.
2. Although a reasonable spread of risks may be ceded, the reinsurer´s
portion may be prove to be subject to either larger random
fluctuations in losses or to a poorer experience than the retained
part.
3. The primary insurer may cede a larger proportion of the poorer
risks it has written.
2. Forms and methods 22
of placing reinsurance
23. (3) PRINCIPLES AND
PRACTICE____________________________________________________________________
TODAY….
Because of the heavy underwriting losses incurred during the 1980
´s, reinsurers pay more attention to the types of risks they accept.
They also place lower limits on treaty capacity (table of limits and
lines to provide) involving ceding companies more in their losses
experience.
The Increase in the number and severity of claims following natural
disasters has changed practice in regards to natural perils und
property treaties. Therefore proportional reinsurers are no longer
prepared to accept potentially unlimited liability for accumulations of
natural perils losses, and at the extrem they even may totally
exclude cover for natural prils, thats why the insurer requires a CAT
XL
2. Forms and methods 23
of placing reinsurance
24. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurance
Non-proportional Reinsurance.
Excess of loss Stop loss, or loss ratio
Risk basis Occurence basis
2. Forms and methods 24
of placing reinsurance
25. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurance
Excess of loss: Usually placed in
layers.For Example, 3 separate XL Non-proportional Reinsurance.
risks basis:
Retain -> up to 1000 €
• XL layer-> Cover: 4000€ xs 1000€ Stop loss, or loss ratio
Excess of loss
• XL layer-> Cover: 5000€ xs 5000€
• XL layer-> Cover: 10000€ xs unlimited
Risk basis Occurence basis
2. Forms and methods 25
of placing reinsurance
26. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurance
Stop loss: (or excess of loss
ratio) protects a company Non-proportional Reinsurance.
against ist aggregate annual
net loss experience on a
particular underwriting account Excess of loss Stop loss, or loss ratio
exceeding some tolerable
figure. For Example, a stop
loss may cover 40% of the net
losses incurred during a year Risk basis Occurence basis
in excess of 70%,
2. Forms and methods 26
of placing reinsurance
27. (3) PRINCIPLES AND PRACTICE__________________________________________________
Forms and types of reinsurances
We have following conditions:
1. Retention of 1 Mio €, reinsured with a XL risks basis 900.000€ xs
100.000€.
2. Surplus : Capacity of 4 lines of each 1 Mio€
How would be the splitting a claim of 1 Mio € form a risk risk with a
sum insured of 4 Mio €?
2. Forms and methods 27
of placing reinsurance
28. (3) PRINCIPLES AND PRACTICE__________________________________________________
Methods of placing reinsurance
The facultative
• was the first method to be used.
• Each risk offered individually to reinsurers, who are free to accept
what share they decide or to reject.
• Mainly used for proportional reinsurances
Open cover (or facultative obligatory)
• A reinsurer agrees to accept obligatory a share of any business
confoming to predetemined conditions regarding class of insurance,
type of riks, country , etc. offered by a ceding company; or A broker
(brokers open cover)
• No obligation to offer any buisiness
• Mainly used for surplus
2. Forms and methods 28
of placing reinsurance
29. (3) PRINCIPLES AND PRACTICE__________________________________________________
Methods of placing reinsurance
Treaty
• Subject to terms and conditions agreed between the parties and set
out in the treaty.
• There is an obligation on the reinsured to cede and the reinsurer to
accept risks of a class falling within the limitations of the treaty.
Pool
• Take various forms but often a quota share or surplus reinsurance
arrangement between participating member.
• According to the rules agreed, insurance accepted by members are
ceded to the pool which in turn arranges retocessions to members.
• The pool may retain some part of each risk for ist own account
• Its used for proportional reinsurance, The pool may protect itself by
purchasing non-proportional reinsurance from outside reinsurers.
2. Forms and methods 29
of placing reinsurance
30. (3) PRINCIPLES AND PRACTICE__________________________________________________
3. Reinsurance practices and problems
3. Reinsurance 30
practices and problems
31. (3) PRINCIPLES AND PRACTICE__________________________________________________
Inflation
Problems of conducting reinsurance business on international scale
considerably increased since the end of the 1960‘s.
– DOMESTIC RATES OF INFLATION during the 1970‘s and 1980‘s
– INTERNATIONAL MONETARY FOND‘S SYSTEM of fixed parties
between currencies was abandoned
And then in the 1990‘s
– LOW LEVELS of INFLATION in the major western economies and
capital and funds did flow relatively unhindered across international
markets.
3. Reinsurance 31
practices and problems
32. (3) PRINCIPLES AND PRACTICE__________________________________________________
Inflation influences both Insurers and Reinsurers.
– Rising administrative expenses
– A tendency for INCREASES IN PREMIUM RATES to lag BEHIND THE RISE
of property, liability and mos non-life CLAIMS
Even though interest rates grow, the increase in investment earnings is
usually insufficient to offset fully the higher claimscosts.
-> Operating profits fall ,
-> FREE RESERVES can‘t increase in step with the premiums and
-> the solvency margin fall too,
-> affecting the financial stability and underwriting capacity.
3. Reinsurance 32
practices and problems
33. (3) PRINCIPLES AND PRACTICE__________________________________________________
Reinsurers are generally more exposed for 2 reasons:
– The average of settlement delays tend to be longer on reinsured
losses.
Generally under both SURPLUS and NON-PROPORTIONAL ,
reinsurers are involved in the larger losses, and larger losses tend to
be longer to settle than small claims.
2. Under EXCESS OF LOSS, inflation may a) take more claims above
the lower excess limit, and b) for losses within the excess of loss
reinsurance band, the reinsurer will bear the full impact of inflation.
3. Reinsurance 33
practices and problems
34. (3) PRINCIPLES AND PRACTICE__________________________________________________
Floating exchange rates
The effect of movements in exchange rates on the respective financial positions of a
ceding company and ist reinsurer(s) will depend upon:
1. The provisions regarding the currency(ies) in which accounts are to be
rendered and settled.
2. The abilitiy of the reinsurer to match liabilities with assets in the same
currency(ies). Problems:
1. Time lags between the recept of premiums and payment of the claims
2. Localisation of technical reserves or capital market conditions are unfavourable.
3. The degree of variability in claims costs
4. Freedom to move funds at will and to retain foreign currencies is restricted.
3. Reinsurance 34
practices and problems
