CLASSIFICATION OF REINSURANCE IN LIFE INSURANCE

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1 CLASSIFICATION OF REINSURANCE IN LIFE INSURANCE Kaarína Sakálová 1. Classificaions of reinsurance There are many differen ways in which reinsurance may be classified or disinguished. We will discuss briefly some of hem. Ceded/Assumed/Reroceded Ceded means he ransfer of an insurance risk from he company, which originally issued he policy, called he ceding company, o anoher insurance company, called he reinsurer. So he ceding company underwries and issues an original policy and conracually ransfers a porion of risk o an insurer. A reinsurer is no obligaed o reain all risks, which i has assumed. I may decide o rerocede o anoher company all or some porion of risks i has assumed. A ceding reinsurer is reinsurer, which ransfers a porion of he underlying reinsurance o a rerocessionnaire. Indemniy/Assumpion Assumpion means a form of reinsurance under which policy adminisraion and he conracual relaionship wih he insured, as well as all liabiliies, passes o he reinsurer. Indemniy reinsurance is a form of reinsurance under which he risk bu no he adminisraion is passed o he reinsurer which indemnifies he ceding company for losses covered by he reinsurance agreemen reay. The ceding company reains is liabiliy o and is conracual relaionship wih he insured. Proporional/Nonproporional Reinsurance may be conduced on eiher a proporional or a nonproporional basis. Proporional is a form of reinsurance where he amoun ceded is defined a he ime of cession so he reinsuring company knows, before a claim arises exacly wha is liabiliy is. There are many mehods of deermining he proporion of reinsurance ceded, and he

2 proporion may vary by policy duraion. Nonproporional is a form of reinsurance where he reinsurer s liabiliy is no fixed in advance, bu is dependen on he number or amoun of claims incurred in a given period. Auomaic/Faculaive A reinsurance reay may allow business o be ceded on eiher an auomaic or a faculaive basis. An auomaic reinsurance reay provides ha he ceding company is allowed o cede risks issued in excess of is reenion limi, o a specific reinsurer a a predeermined cos wihou submiing underwriing papers o he reinsurer for approval. A faculaive reinsurance reay provides ha a reinsurer mus approve each individual risk before i has any liabiliy. There exis also many variaions of hese wo mehods. Tradiional/Financial Tradiional reinsurance refers o reinsurance arrangemens where he primary purpose is he ransfer of risk. Financial reinsurance refers o reinsurance arrangemens where he primary purpose is he achievemen of a specific business objecive such as increasing sauory surplus, reducing axes, or acquiring blocks of business. The risk ransfer is secondary o he business purpose. 2. Proporional reinsurance conrac The main mehods of proporional reinsurance conrac may be caegorised on coinsurance (original erms) and risk premium. a) Coinsurance (original erms) If he company adop he coinsurance mehod of reinsurance, his can be o one of he following basis individual surplus arrangemens or quoa-share basis. These are wo ways in which he amoun o reinsured can be specified. Individual surplus arrangemen resuls in he reinsurance of ha par of original sum insured in excess of he ceding company s reenion on any individual life. Alernaively, he reinsurance may be on a quoa-share basis, in which case a specified percenage of each policy is reinsured. A company may adop a mixure of he above, reaining for iself a percenage of each policy

3 up o a maximum reenion. For example a company migh reinsure 25 % of every policy up o a maximum original sum assured of m.u., and whole of any amoun in excess of m.u. When he coinsurance mehod is used, he company se up acuarial reserves for he original sum assured and can hen deduc he acuarial reserves relaing o he reinsured porion. b) Risk premium (or Yearly renewable erm) mehod The ceding company reinsures par of he sum a risk, i.e. he excess of he benefi payable over he reserve, wih he reinsurer on a yearly renewable risk premium basis. Reinsured is only he moraliy elemen. Moraliy facor is S( ) q If a company reinsures an amoun of sum assured R, using he risk premium mehod, hen he reinsured amoun in each year is ( ) R 1, pre = 0,1,2,..., n 1. So if he reinsured person died in he firs year, he reinsurer pays an amoun ( 0 = 0 ) R o he ceding company. If deah occurs in he following years (because amoun paid o he ceding company by reinsurer is decreasing. is increasing) he There are wo approaches commonly used o deermine he amoun of he sum a risk each year ha is reinsured. In he case of he risk premium mehod he mehods corresponding o he mehods of coinsurance are he consan reenion mehod - he excess, if any, of he sum a risk above a specified amoun is reinsured he reducing reenion mehod - a specified percenage of he sum a risk is reinsured. Under he CRM he ceding company begins wih reaining a amoun decreases (as he reserves increase) ( S S ) ( S R) = ( R S ). S R and reinsured

4 So a he beginning (reserve is zero) he reained sum is consan S R and is consan, bu he reinsured amoun is decreasing (and posiive) ill i reaches zero (reserves increase) a which ime he reinsurance ceases. Under he RRM insurer reinsures from sum a risk he par reained sum is ( S S ) ( R R ) = ( S R) ( ) 1. R R and he So a he beginning (reserve is zero) is reinsurers reenion limi decreases over he full erm of he policy as he reserve increases. S R consan and In summary, he reained sum a risk under RRM decreases a he same rae as he sum a risk under he reained porion. Under he CRM, he reinsured sum a risk decreases a he same rae a which he reserves under he original policy increase. CRM RRM Toal sum a risk S S S S Reinsured amoun max { R S, 0 } R R Reained sum a risk min { S R, S S } ( S R)( 1 ) Risk premiums are usually paid annually, irrespecive of he frequency of paymen of premiums under he original policy, bu monhly risk premiums may be paid for cerain uniised policies. The risk premium paid will reflec he probabiliy of a claim arising in ha year associaed wih he expeced value of he benefis payable under ha claim.

5 Risk premium wih financing commission. The risk premium reinsurance mehod can be associaed wih a financing arrangemen whereby he reinsurer relieves he ceding company of par of is new business financing requiremen. 3. Non-proporional mehods The non-proporional reinsurance is used primarily o reduce flucuaions in oal claims. Under each of hese forms, he reinsurance risk and coverage applies o a block of risks, no o individual risks. a) Caasrophe reinsurance The aim of caasrophe reinsurance is o reduce he poenial loss - o he ceding company - due o any non-independence of he risk insured. So i proecs he ceding company agains muliple single claims from a single even such as a plane crash, a fire or some oher acciden or naural disaser. The cover is usually only available on a yearly basis and has o be renewed each year. The covered evens mus be carefully defined and may exclude epidemics, wars, nuclear hazards or cerain specified evens. Reinsurance proecs he company from unplanned random concenraions of risks or claims. The reinsuring company will agree o pay ou if a caasrophe - as defined in he reinsurance conrac - occurs. There is no sandard definiion of wha consiues a caasrophe, bu ypically o qualify here needs o be a minimum number - say 5 - deahs from a single inciden wih he deahs occurring wihin a specified ime - say 48 hours - of ha inciden. The reinsurance conrac will also specify how much he reinsuring company will pay if a caasrophe occurs. b) Sop loss Sop loss coverage provides proecion agains an excessive number or amoun of claims in any given conrac period. I is a form of reinsurance under which he reinsurer pays some of all of a ceding company aggregae claims in excess of a predeermined amoun (aachmen poin). For life insurance sop loss applies o a block of policies, no jus o one life. I is used more commonly in conjuncion wih proporional reinsurance.

6 c) Spread loss Spread loss is a form of reinsurance under which premiums are paid during good years o build up a fund from which losses are recovered in bad years. This agreemen provides coverage if a company s losses in a given year exceeded a specified aachmen poin. Which ogeher wih reinsurer s paricipaion can be defined in a manner similar o ha used for sop loss. If a claim occurs, he reinsurer would pay he ceding company and he ceding company would he repay he amoun of claim wih ineres over a period of years, hus spreading he loss. In his radiional form, spread loss reinsurance is no really a form of reinsurance, bu is more a means of changing he iming of cash flows. In essence spread loss reinsurance is a ype of loan. References. 1. LIFE INSURANCE. Modul F. Insiue of Acuaries, Oxford, Neill, A.: Life Coningencies. The Insiue and he Faculy of Acuaries, Oxford Sakálová, K., Peller, F.: ýznam a meódy zaisenia v živonom poisení. Ekonomický časopis SA, Braislava 3/2004, s Sakálová, K.: Oceňovanie produkov v živonom poisení. Ekonóm. Braislava Spedding, A.: Life reinsurance. The Insiue of Acuaries, Oxford Tiller, J., E., Fagerberg, D.: Life, healh and annuiy reinsurance. ACTEX Publicaions, Connecicu, 1995.

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