reinsurance by GarrettPendergast

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									REINSURANCE 101
      MODERATOR

JOHN KLINE, CPCU, ARM
      (YUM! Brands)

        SPEAKER

GEORGE BUDD, CPCU
  (GEORGE A. BUDD, LLC)
      REINSURANCE 101
• OBJECTIVES:
 – EXAMINE SOME BASIC CONCEPTS
 – SHOW HOW THESE ARE APPLIED
 – REVIEW NEW TRENDS
   • GLOBALIZATION
   • SECURITIZATION
   • COMPUTER MODELS
 – REVIEW RISK MANAGER’S CHOICES
REINSURANCE GLOSSARY
FOUR WEB SITES (all start with www.):

Raanet.org/abouttheraa/glossary.html

Captive.com/newstand/articles/
 GlosRein.html

Malaysian-re.com.my/mnrb-docs/
 html-dir/glossary.html

iii.org (click “insurance tools”)
     REINSURANCE?

THE INSURANCE OF INSURANCE
COMPANIES. THE SAME WAY
BOOKIES LAY OFF BETS…AND FOR
THE SAME REASON.
          REINSURANCE
• “Reinsurance is a contract of insurance
  whereby one insurer (called the
  reinsurer or assuming company)
  agrees, for a portion of the premium, to
  indemnify another insurer (called the
  reinsured or ceding company) for
  losses paid by the latter under
  insurance policies issued to its
  policyholders.”
      WHY REINSURE?

FOR THE SAME REASON YOUR
 BUSINESS BUYS INSURANCE:

TO PROTECT THE CORPORATE
 ASSETS
   TRANSFERRING RISK

             INSURANCE

                   RISK
Policyholder              Insurance Co.

 - Insured                     - Insurer

 - Underlying Insured
    TRANSFERRING RISK

        REINSURANCE
                 Risk
• Insurance Co.         Reinsurer
   - Ceding Co.         -Assuming Co.
   - Cedent
   - Primary Insurer
  – Direct Company
     TRANSFERRING RISK

         RETROCESSION
                Risk
Reinsurer              Reinsurer
- Retrocedent          -Retrocessionaire
         ELEMENTS OF
         REINSURANCE
• Reinsurance is a form of
  Insurance.
• There are only two parties to the
  reinsurance contract - the
  Reinsurer and the Reinsured - both
  of whom are empowered to insure.
 ELEMENTS OF REINSURANCE
                 (continued)
• The subject matter of a reinsurance
  contract is the insurance liability the
  Reinsured has assumed under
  insurance policies issued to its own
  policyholders.
• A reinsurance contract is an indemnity
  contract.
   What Reinsurance Does
• It redistributes the risk of loss
  which a reinsured incurs under
  the policies it issues according
  to its own needs.
• It redistributes the premiums
  received by the reinsured
  according to its own needs.
What Reinsurance Does Not Do!


 IT IS NOT A MAGIC POTION
What Reinsurance Does Not Do!
                  (continued)
•   Convert an uninsurable risk into an
    insurable one.
•   Make loss either more or less likely to
    happen
•   Make loss either greater or lesser in
    magnitude
•   Convert “bad” business into “good
    business”
  BASIC RULE

  IN REINSURANCE,
ALMOST ANYTHING IS
     NEGOTIABLE
  THE HOUSE OF REINSURANCE

• FACULTATIVE
 – INDIVIDUAL RISKS



• TREATY
 – GROUPS OF RISKS
  The House of Reinsurance
• THE FACULTATIVE SIDE:
 – Single Policy or Risk
 – Reinsurer evaluates each risk and
   establishes or agrees to accept
   Coverage Form and Price.
 – Automatic and Semi-Automatic Facilities
  The House of Reinsurance
• THE TREATY SIDE:
 – Covers classes or entire
  “books” of business.


 – Reinsurer accepts as written by Insurer
   as to Form, Price and Risk.
          LET’S DEFINE
           BOOK OF BUSINESS
ANY segment of an insurance company’s
portfolio.
It does not have to equate with a known
geographic area, a line of business, a
marketing segment or any combination of
these.
It is a segment of the portfolio the
company wants to protect for a variety of
reasons. WE define it!
          LET’S DEFINE
                   A LINE
1. A line of business such as Fire, Multi-
  Peril, General Liability, etc.
2. An amount retained by the insurer on a
  risk.
  This can be the amount after
  subtracting all facultative and treaty
  reinsurance or which includes them; it
  depends on the purpose.
          LET’S DEFINE

Example: $5 million risk
          Facultative: $3mm xs $2mm
          Net Line=$2mm
Example: Same as above except
  Line can also be defined as $5mm
 FORMS OF REINSURANCE
• PROPORTIONAL (OR PRO-RATA)
 – PAY PREMIUM ON A SHARE BASIS
 – COLLECT LOSSES ON SAME SHARE
• EXCESS OF LOSS
 – PAY PREMIUM ON NEGOTIATED PRICE
 – COLLECT LOSSES ONLY WHEN
   RETENTION IS EXCEDED.
  The Forms of Reinsurance
• Pro-Rata or Proportional:
  – Reinsurer receives a percentage share of
    premium and pays that same percent of
    each loss.
  – Reinsurer pays cedent a Commission to
    Reimburse for Expenses
     • Can be Flat Percentage
     • Can Include Profit Commission
     • Can be “Swing-Rated”
  The Forms of Reinsurance

• Pro-Rata or Proportional (cont.)
  – Can be Quota Share or Surplus:

  – Quota Share
     • Reinsurer takes same % on each risk.
     • “Of” vs. “Part Of”
    The Forms of Reinsurance
• Pro-Rata or Proportional (cont.)
  – Surplus Share
     • Reinsurer’s share varies for each risk
       based on type and/or size of risk.
     • Whatever that percentage share is,
       reinsurer receives same percent of
       premium and losses.
   The Forms of Reinsurance
• EXCESS OR NON-PROPORTIONAL:
  – Per Risk (property), Per Occurrence
    (casualty) or Claims Made
  – Per Occurrence: Catastrophe
  – Aggregate or Stop Loss Excess
  The Forms of Reinsurance
• Per Risk or Occurrence Excess
  – Responds to Losses Excess of a
    Predetermined Retention
  – No Proportional Sharing of Premium
    or Loss
  – Premium is Negotiated
  – Written in Layers
  – Normally has Occurrence Limit
  – Reinstatements are Negotiated
        REINSTATEMENTS
•   PROPORTIONAL -- DOES NOT APPLY
•   “FULL”
•   AT A PRICE
•   FREE AND UNLIMITED
•   FREE BUT LIMITED
•   COMBINATION OF ABOVE
   RISK EXCESS PRICING
• LOSS RATING
 – BURNING COST
 – LOADED PRICE
 – TREND & DEVELOPMENT FACTORS
• EXPOSURE RATING
 – RATING SCALES
• UNDERWRITER’S JUDGEMENT
    OCCURRENCE LIMITS
• PER RISK EXCESS
 – MULTIPLE OF RISK SIZE
• PROPORTIONAL
 – CHANGES SINCE 1992
 – NEGOTIATED
   • FLAT DOLLAR AMOUNT
   • PERCENT OF PREMIUM
   • MULTIPLE OF RISK SIZE
     Forms of Reinsurance
• Catastrophe Excess of Loss
  – Covers all losses in an event
  – Occurrence is defined as a geographic
    area (flood and Riot) or a time period
    (wind, quake, fire and winter storm)
  – Usually Limited to two Occurrences
     • Additional Cover Needed
  – Sold in Layers
  – Usually has two risk warranty
  CATASTROPHE CHANGES
• No Reinstatement in Same Event

• Reinstatement at 100%

• ECO/XPL Excluded

• Deposits at 100%
      SURPLUS TREATY

• READS LIKE AN EXCESS
 – ELIGIBILITY RULES vis-a-vis PAYMENT,
   I.e., SIZE OF RISK vs. SIZE OF LOSS
• WORKS PROPORTIONALLY
 – PAY PROPORTIONAL PREMIUM
 – COLLECT PROPORTIONAL LOSSES
• WHY HAVE IT?
     SURPLUS TREATY
• WHY HAVE IT?
   • CAN AFFORD TO KEEP MORE LOSSES
   • WANT TO KEEP PREMIUM FOR GROWTH
     PURPOSES
   • OPTIONS:
     –   CARRY IT ALL NET
     –   REDUCE AMOUNT OF QUOTA SHARE
     –   ADD OR SUBSTITUTE WITH AN EXCESS TREATY
     –   ADD A SUPLUS TREATY
     –   COMBINATIONS OF THE ABOVE
      SURPLUS TREATY

• THE FIRST CONCEPT:
 – MINIMUM SIZE RISK
   EXAMPLE: ALL RISKS GREATER THAN $1
    MILLION MUST BE CEDED TO REINSURER.
    SURPLUS TREATY

   SIZE IS AN ELIGIBILITY RULE

 RISK IS CEDED PROPORTIONALLY
PREMIUM IS PAID PROPORTIONALLY
     LOSSES ARE COLLECTED
          PROPORTIONALLY
SURPLUS TREATY


       HOW DO

         WE

      DO THAT???
   SURPLUS TREATY
           EXAMPLE
      $5 MILLION VALUES
  BUILDING, CONTENTS, ETC.

IS IT GREATER THAN $1 MILLION?
              YES!
       THEN IT’S ELIGIBLE
     SURPLUS TREATY
$5 MILLION TOTAL
REINSURED KEEPS $1 MILLION
CEDES (REINSURER ACCEPTS) $4
  MILLION   1/5 = 20%
             4/5 = 80%
 REINSURED PAYS 80% OF PREMIUM
ANY SIZE LOSS, COLLECTS 80% OF IT
SURPLUS TREATY


          ANY
          SIZE
         LOSS!
      SURPLUS TREATY

THE MINIMUM SIZE IS AN ELIGIBILITY
 RULE ONLY!
ONCE WE HAVE DETERMINED A RISK IS
 ELIGIBLE, IT BECOMES A QUOTA
 SHARE OF THE AMOUNTS CEDED vs.
 THE AMOUNTS RETAINED
    SURPLUS TREATY
HOW ARE CESSIONS DETERMINED?

          BY LINES
      SURPLUS TREATY

A LINE IS THE AMOUNT THE REINSURED
         IS KEEPING FOR ITSELF

THE CESSION IS NORMALLY BASED ON
      “X” NUMBER OF LINES AS
     NEGOTIATED IN THE TREATY
     SURPLUS TREATY
     THE $5 MILLION EXAMPLE
          (SPLIT 20%/80%)
ONLY WORKS IF THE TREATY ALLOWS
             FOR 4 LINES
            TO BE CEDED
    $1 MILLION EQUALLED 1 LINE
   $4 MILLION EQUALLED 4 LINES
     SURPLUS TREATY
             BUT
IF THIS WERE A THREE LINE TREATY,
 THE MOST THAT CAN BE CEDED IS 3X
    WHAT THE REINSURED KEEPS.
THEREFORE, THE $5 MILLION HAS TO
        BE DIVIDED BY 4 (3+1)
 SURPLUS TREATY
 $5,000,000 ÷ 4 = $1,250,000
 3 X $1,250,000 = $3,750,000
        = 75% CEDED
       25% KEPT NET
ALL PREMIUMS AND LOSSES
FOLLOW THE SAME DIVISION
            REMINDER
– Surplus Share
   • Reinsurer’s share varies for each risk
     based on type and/or size of risk.
   • Whatever that percentage share is,
     reinsurer receives same percent of
     premium and losses.
    SURPLUS TREATY
        NEXT CONCEPT:
      MINIMUM RETENTION

REINSURER WANTS REINSURED TO
 MAINTAIN RISK ON A PAR WITH ITS
              SIZE
      SURPLUS TREATY
MINIMUM SIZE: $1,000,000
MINIMUM RETENTION: $500,000
RISK SIZE: $1,500,000
(CONTINUE WITH 3 LINE TREATY)
     $1,500,000 ÷ 4 = $375,000
        DOES NOT WORK!
    CEDENT MUST KEEP $500,000!
   SURPLUS TREATY
              ERGO
         KEEP $500,000
        CEDE THE REST
$1,500,000 - $500,000= $1,000,000
    EQUALS 2 LINES CEDED
DIVISION OF RISK IS 1/3 AND 2/3
     SURPLUS TREATY
       NEXT CONCEPT:
      MAXIMUM CESSION

REINSURER IS WILLING TO ASSUME
 RISK BUT ONLY UP TO A CERTAIN
            AMOUNT
       SURPLUS TREATY
MINIMUM SIZE: $1,000,000
MINIMUM RETENTION: $500,000
MAXIMUM CESSION: $5,000,000
NEW RISK: $20,000,000
     $20,000,000 ÷ 4 = $5,000,000
     $5,000,000 X 3 = $15,000,000
    BUT MAX CESSION = $5,000,000
SURPLUS TREATY

        ERGO

CEDE $5,000,000 (25%)
KEEP $15,000,000 (75%)
     SURPLUS TREATY
WHAT PERCENTAGES WERE CEDED?


         S IZ E               % CEDED

    $ 5 ,0 0 0 ,0 0 0      7 5 % (3 L IN E S )

    $ 1 ,5 0 0 ,0 0 0     6 6 .7 % (2 L IN E S )

    $ 2 0 ,0 0 0 ,0 0 0   2 5 % (1 /3 L IN E )
Properties of Surplus Treaties
• Risk Must be of a Minimum Size to
  Qualify
• Amount Ceded is Based on Number
  of “Lines”
• Reinsured Must Retain a Minimum
  Amount Called “Minimum Retention”
• There is a “Maximum Limit”
• Normally Obligatory
       THE PRIORITIES

The Order of Collecting Losses:
• Facultative
• Proportional (Q/S and Surplus)
• Per Risk
• Catastrophe
• Aggregate or Stop Loss
  COLLECTING THE LOSS
          $240 MILLION RISK
• $76 MILLION LOSS
  – $30 MILLION FACULTATIVE
  – 20% QUOTA SHARE
  – 3 LINE SURPLUS TREATY
        $30 MILLION MAXIMUM CESSION
         (12.5% OF TOTAL SCHEDULE)
  – $65 MILLION XS $10 MILLION RISK XS
   COLLECTING THE LOSS
• LOSS $76 MILLION
  – COLLECT THE FACULTATIVE
    $30 MILLION
• REMAINDER $46 MILLION
  – COLLECT THE QUOTA SHARE
    20% x $46 MILLION = $9.2 MILLION
• REMAINDER $36.8 MILLION
    COLLECTING (cont.)


• REMAINDER = 36.8 MILLION
  – COLLECT THE SURPLUS TREATY
    $30 MILLION MAXIMUM CESSION?
    REMEMBER THE PERCENTAGE
    $46 MILLION X 12.5% = $5.75 MILLION
      COLLECTING (cont.)

• REMAINDER = $31.05 MILLION
  – COLLECT THE RISK EXCESS TREATY
    $21.05 MILLION


• CEDENT KEEPS $10 MILLION NET
     COLLECTING (cont.)
• RECAP
 FACULTATIVE PAID $30 MILLION
 QUOTA SHARE PAID $9.2 MILLION
 SURPLUS TREATY PAID $5.75 MILLION
 RISK XS TREATY PAID $21.05 MILLION

 (THE CEDENT KEPT $10 MILLION NET)
 The New Reinsurance Market
• “Securitization”
• Bermuda Commodities Exchange
  – Guy Carpenter & Co. Index
• Program Business
• eCOMMERCE
• Chicago Board of Trade (CBOT)
       SECURITIZATION
• PHYSICAL LOSS CAPACITY
 – NEW AND ADDITIONAL CAPACITY
 – TENDS TO BE EXPENSIVE
 – ONE LOSS SITUATION
• ASSET PORTFOLIO PROTECTION
 – WHAT HAPPENS AFTER LARGE LOSS
• NEEDS TO BE TESTED
           eCOMMERCE
•   LARGE FUTURE
•   MOSTLY PERSONAL LINES
•   CATEX
•   NEW EUROPEAN RISK INTERCHANGE
   COMPUTER MODELS
– AIR (CATMAP)
– RMS (IRAS)
– EQUICAT
– DAMES & MOORE
– CATALYST
– ISO (CAT TRADER)
– TILLINGHAST (RIPL)
    COMPUTER MODELS
• IMPORTANCE
 – RATE MAKING
 – FINANCIAL RATINGS
 – PORTFOLIO ANALYSIS, MANAGEMENT
   AND CONTROL
 – RISK AND LOCATION UNDERWRITING
   • EARTHQUAKE ANALYSIS
 UNDERWRITING TRENDS
 EMPHASIS ON MODELING

 INVOLVEMENT OF ACTUARIES AND
  FINANCIAL PEOPLE IN DECISION MAKING
  PROCESS.

 REDUCED RESPONSIVENESS

 CORPORATE SPECIALIZATION
       GLOBALIZATION
• WORLDWIDE CLIENTS
 – WORLDWIDE INSURANCE NEEDS
 – WORLDWIDE REINSURANCE NEEDS
• NATIONAL CLIENTS
 – WORLDWIDE INSURANCE/REINSURANCE
   NEEDS
• CORPORATE SOLUTIONS?
     RISK MANAGEMENT
• DO WE NEED AN INSURER?
 – CAPITAL REQUIREMENTS
 – EXPERTISE
 – CORPORATE CAPACITY
   • MONEY
   • TIME
 – LEVERAGING ABILITY
     !WARNINGS!
     DON’T DABBLE!

CONTROL YOUR RESERVES!

KNOW WITH WHOM YOU ARE
        DEALING!
ANY QUESTIONS

								
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