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Reinsurance
DEMYSTIFYING THE WORLD OF REINSURANCE
Size of
Risk
Reinsurer
Insurer
Insured
Policies
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.”
THE REINSURANCE MARKET
INSURANCE
COMPANIES
REINSURANCE REINSURANCE
COMPANIES BROKER
RETROCESSIONAIRES
Reinsurance
Reinsurance
Company
Reinsurance
Company Broker, Direct.
Insurance
Broker, Direct.
Company
Broker, Agent, Phone,
Insured
Online, In person.
MAJOR INSURANCE EVENTS
2006 INDEXED VALUES
• WTC US$ 21bn
• Katrina US$ 66bn
• Wilma US$ 12bn
• Rita US$ 10bn
• Australia Storm (last week) expected
to be largest natural catastrophe in
Australian history. AUS$ 2-3bn
• Hurricane Andrew US$ 23bn
• Northridge US$ 19bn
Reinsurance
…and why
do we
measure it
How much of this by premium?
is reinsurance?
Reinsurance
Global Premiums in 2007 Company
US$ Growth Growth
billion in 2007 in 2006
Life 2,393 5.4% 4.1%
Non-life 1,668 0.7% 3.9% Insurance Broker, Direct.
Company
Total 4,061
Source: Swiss Re, Sigma 3/2008.
Reinsurance
Destination & Source of Reinsurance Premium (US$ million)
Gross
Reinsurance Risk Net “Risk”
Premium “Located” In:
Assumed
Europe 88,989 (64,653) 24,336
North America 81,946 (90,306) (8,360)
Asia & Australasia 1,989 (11,219) (9230)
Africa, Near & Middle East (2,614) (2,614)
Latin America (4,132) (4,132)
Total 172,924 (172,924) NIL
Data Source:- 59 Reinsurers: Bermuda 8; Europe 21; Japan 2; USA 28.
Source: IAIS Global Reinsurance Market Report, December 2007
NEED FOR REINSURANCE
Most risks, both natural and man-made, are insured and yet the
likely losses are often beyond the capacity of any single
insurance company or even insurance market.
Reinsurance is therefore the means by which Insurance
Companies obtain the necessary protection.
NEED FOR REINSURANCE
An Insurance Company would therefore buy Reinsurance :
• To protect its Capital and its Shareholders
• To Stabilise its results from year to year by leveling claims
fluctuations
• To increase its Capacity to handle larger and more
complex risks of various classes
• To maintain any statutory minimum Solvency
requirements and provide Security
• To Spread risks throughout world markets, not just
locally, to lessen financial impact on any single
economy
• Limit concentration of risk
• Take advantage of risk expertise of reinsurers who have
grater experience of business (territory class)
Reinsurance Transactions
Reinsurance is a contractual agreement under which the primary
insurer transfers some or all of its loss exposures to a reinsurer.
?
Primary
Reinsurer Retrocessionaire
Insurer
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 even in life and personal accident
insurance, caused by insurance policy
obligations.
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”
Reinsurance in india
• After nationalisation in 1972, General Insuarance
Corporation became the Indian reinsurer.
• The main objective was to maximise aggregate
domestic retention of premium
• To secure best terms consistent with the quality
of business ceded
• To minimise the drain of foreign exchange
• However, Oil, satellites and financial risks have
always been reinsured in the range of 90% or
more
Reinsurance in india………
• Until GIC was notified as a National
Reinsurer,
• it was operating as a holding / parent
company of the 4 public sector companies,
controlling their reinsurance programmes.
• GIC would receive 20% obligatory cession
of each policy written in India.
Reinsurance in india……
• Since deregulation, GIC has assumed the role of
the market’s only professional re-insurer.
• In order to focus on reinsurance, both in India and
through its overseas offices and trading partners,
GIC has divested itself of any direct business that
it wrote prior to November 2000, with the
temporary exception of crop insurance.
• It currently manages Hull Pool on behalf of the
market, which receives a cession from writing
companies and after a pool protection the
business is retro-ceded back to the member
companies.
General insurance corporation
DOMESTIC
• As a sole reinsurer in the domestic reinsurance
market, GIC provides reinsurance to the direct
general insurance companies in the Indian
market.
• GIC receives statutory cession of 10% on each and
every policy subject to certain limits. It leads
many of domestic companies’ treaty programmes
and facultative placements.
General insurance corporation……
INTERNATIONAL
• A GIC is spreading its wings to emerge as an
effective reinsurance solutions partner for the
Afro-Asian region and has started leading the
reinsurance programmes of several insurance
companies in SAARC countries, South East Asia,
Middle East and Africa.
• To offer its international clientele an easy
accessibility, efficient service and tailor made
reinsurance solutions; GIC has opened
liaison/representative/branch offices in London
and Moscow.
Reinsurance market
• A feature of reinsurance market is that because of
the way in which insurers and reinsurers operates
a company may be trading simultaneously as both
a buyer and a seller of reinsurance.
• So the organization of reinsurance markets range
from a group of local insurers placing all of their
reinsurance with a local monopoly reinsurance
corporation to something as complex as london
reinsurance
London market
Buyers :
• British and foreign direct writing companies
• Lloyd’s underwriting syndicates (group of
Underwriters)
• British and foreign reinsurance companies
Intermediaries:
Reinsurance brokers and all above
Lloyd’s market
Lloyd's is the world's best known - but probably least
understood - insurance brand. This is because Lloyd's is
not an insurance company but a society of members, both
corporate and individual, who underwrite in syndicates on
whose behalf professional underwriters accept risk.
Supporting capital is provided by investment institutions,
specialist investors, international insurance companies
and individuals.
Lloyd's brokers bring business to the market. The risks
placed with underwriters originate from clients and other
brokers and intermediaries all over the world. Together,
the syndicates underwriting at Lloyd's form one of the
world's largest commercial insurers and a leading
reinsurer.
Lloyd’s market……..
• Syndicates
Lloyd's members conduct their insurance business in syndicates, each of
which is run by a managing agent.
The syndicates operating within the market cover many speciality areas
including:
• Marine
• Aviation
• Catastrophe
• Professional indemnity
• Motor
Syndicates tailor solutions to respond to the specific risks of the client
base.
Syndicates compete for business, thus offering choice, flexibility and
continuing innovation. Syndicates cover either all or a portion of the
risk and are staffed by underwriters, the insurance professionals on
whose expertise and judgement the market depends.
Reinsurance Market-US
• Suppliers include both domestic U.S. reinsurers and
non-U.S. reinsurers; roughly split the U.S. market for
reinsurance.
• Some firms solely provide reinsurance; others provide
both primary and reinsurance.
• Reinsurance market subject to cycles & fluctuations in
supply or capacity and underwriting/pricing.
• Historically, long-term relationships between primary
insurers and reinsurers provided stability.
• As relationships have eroded, market has become
more volatile.
Buyers of reinsurance
• Direct writing companies
• Captive insurance companies
• Reinsurers
• State owned insurance corporations
• State reinsurance corporation
• Underwriting pools
• Regional reinsurer pools and corporations
Sellers of reinsurance
• Professional reinsurance companies
• Lloyd’s of London
• Direct insurance companies
• Underwriting agencies
• State insurance and reinsurance
corporation
• Insurance and reinsurance pools
• Regional reinsurance corporation
Reinsurance brokers
The role of the reinsurance broker
Advise clients:
• Proper retenton and adequate capacity
• Market knowledge
• Prepration of reinsurance contract
• Collection of premium
• Claim negotitation and collection
• Provision of informtion
• Code of conduct
BASIC RULE
IN REINSURANCE, ALMOST ANYTHING IS
NEGOTIABLE
THE REINSURER ONLY FOLLOWS THE CEDING
INSURER’S FORTUNE
Functions of Reinsurance
• Stabilization of loss experience (net income protection)
– i.e., hedging ( the risk of insurer is spread to re-insurer)
– Otherwise adverse claim ratio shall lead to increase in
premium rates and so shall affect business in the market
• Large-line capacity
– full retention of large exposures not feasible
– Can undertake more business of different nature
• Financing- large losses can endanger the financial stability if
not reinsured
– keep leverage reasonable, offset serious
or series of losses
– Timely availability of finance
• Catastrophe protection
• Underwriting assistance
• Withdrawal
– portfolio transfers
Stabilization of Loss Experience
Function: Finance
• Reinsurance enables an insurer
– to continue to write polices without draining capital
and surplus
– reduces written premium
– Increases surplus by recouping acquisition expenses
through RI commission
However :
– Acquisition cost is paid upfront
– Drain on surplus if volume is expanding rapidly
Function: Capacity
• Insurers require greater capacity than their own
resources
• Reinsuring risks brings in additional capacities
• An insurer with a policy limit of Rs. 10 crore
– Builds capacity of Rs. 20 crore
– Cedes 50 % to surplus share reinsurance treaty
– Alternatively, arranges an Excess of Loss
cover of Rs. 10 crore
Function: Stabilization
• Stable underwriting results vs. wide
fluctuations
• Through XoL enables insurer to
– Determine loss limits per risk or in aggregate
– Reinsurer pay above the loss limits
Stabilisation of Catastrophe
• Balance sheets protection against severity of
major catastrophe e.g., hurricanes, floods,
earthquakes etc.
• Catastrophe XoL (Excess of Loss) specifically
addresses accumulation of small losses and
single major loss
Relationships & Insolvencies
• Typically, there is no contractual relationship between
primary insured and reinsurer.
– recourse only through receiver of insolvent insurer
• Exception: cut-through endorsements-A cut-through provision allows
a party not in privity with the reinsurer to have rights against the reinsurer
under the reinsurance agreement
• Offsets
– Typically, a reinsurer can offset any receivables from
insolvent insurer against reinsurer’s obligation to insolvent
insurer.
• If reinsurer goes insolvent, Primary insurer still obliged
to insured even if reinsurer fails to meet obligations.
Retention
• Management of a Ceding Insurer sets the
retention limit for different risks or class of
risk depending its capacity to retain/bear
the risks based upon the financial position,
underwriting experience, etc.
• The insurers therefore have set limits and
approved method for a decision for ceding
business through an approved form of
reinsurance
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 equivalent to its bearing capacity
3. To fix a retention line is a subjective
decision made with the help of computer
simulation of data
Retention
• Retentions are expressed in terms of S.I.
• But loss exposures - PML are also taken into
account- past claim experience & probability law
• Decision on Retention limit is standardized based
on risk factors (similar loss exposer per risk):
– Location
– Separation
– Process carried on
– Class of construction and fire protection
• In case of large risks- inspection of risk and PML
shall determine the retention limit individually
Measure -Retention ……
(Traditional approach - “As if”)
• -To estimate MPL based on the past records.
• -Applying past losses to the insured values that exist
now. Good to know simple as well as complex losses.
(Current approach – “Probabilistic”)
• -The computer simulation of all the possible losses
that could happen within a long period of time.
• -This type of model also makes it possible to
understand the relationship between loss potential
and occurrence frequency.
• Insurers are increasingly using these models. Some
have in-house models. Some depend on professional
companies.
Fixing Retention Level
• The Factors in the decision
Risk Profile Impact on PL
Overall Decision
Capital
Cost of
Strength
Reinsurance
• Management is fully involved in the decision process,
because how much they can/should retain those largest
risks is one of the most significant issues.
• Some insurers have their own model for the simulation
of their optimum retention.
Life Insurer’s retention Limit
• This study examines the relationship between ceding life insurers'
retention limits on an insured life basis and certain operational and
financial characteristics of the companies.
• Analysis is performed using 97 major U.S. insurers with 1987 assets
ranging from $108 million to $32 billion. Retention limits for these
insurers vary from $25,000 to $20,000,000 per insured life.
• Five factors are shown to have the greatest impact on life
insurer retention limits. These factors are
• (1) firm size is found to be the most important factor,
• (2) form of insurer organization (i.e., mutual or stock),
• (3) the firm's emphasis on new business,
• (4) average policy size, and
• (5) the company's emphasis on term insurance.
• Collectively, the principal components regression model
explains nearly 90 percent of the total variation in
retention limits for the sample insurers.
Types of Reinsurance
Types of Reinsurance
• Facultative Reinsurance
– Primary insurer and reinsurer negotiate a specific
agreement for a particular risk/exposure.
– Best suited for unique, large exposures.
– High transaction costs.
Facultative Obligatory Treaty (Facultative +Treaty)
– The insurer cede risks of any agreed class which
Reinsurer must accept if ceded
Types of Reinsurance ……..
• Treaty Reinsurance (agreement)
– Reinsurer is obligated to accept all business that falls
within the terms of the treaty.
– Lower transactions costs but greater potential for
adverse selection.
– Best suited for numerous, smaller exposures that are
more similar.
1. Quota Share Treaty
2. Surplus Treaty
Quota Share Treaties- Proportional
• Primary insurer cedes a fixed, predetermined % of premium
& losses on every risk it insurers within class(es) subject to
treaty.
• Simple to rate & administer.
• Does not stabilize underwriting results. $150,000 Policy
• Can help reduce reported expenses.
• Can cede profitable business.
$100,000 Policy
$50,000 Policy 25% 75%
25% 75%
25% 75%
Quota share treaty…….
• Every risk or policy is shared in the percentage
agreed in terms of sum insured subject to a
maximum limit and also the premium
• Profitable to reinsurer as he participate in every
risk or policy
• It is costly to ceding insurer and so a short term
arrangement or for new class of business
• Good for new Insurer with less capital in relation
to underwriting of insurance business
Surplus Share Treaties- Proportional
– Minimum limit of Example:
retention stated in $ or $25,000 retention
INR; % of premiums &
losses ceded varies by
policy. $150,000 Policy
– Avoids cessions on
small policies.
$100,000 Policy
– Better at providing
large-line capacity.
17% 83%
– More costly to
administer. 25% 75%
– Used on property risks,
rarely liability.
