1 1 Understanding Agricultural Reinsurance Ramiro Iturrioz Insurance for the Poor The World Bank June, 2010
2 2 What is reinsurance? Reinsurance is insurance for insurers. It is an agreement between an insurer (cedent) and a reinsurer: the reinsurer agrees to indemnify the cedent against all or part of a loss which the ceding company may incur under certain policies of insurance that it has issued. In turn, the cedent pays a consideration, typically a premium, and discloses information needed to assess, price and manage the risks covered by the reinsurance contract.
3 3 What are the essentials of agriculture reinsurance? What is agricultural reinsurance? Agricultural reinsurance is a specialized sub-line of business of property reinsurance. Crops, livestock, forestry, aquaculture, bloodstock, greenhouses, and pets. Who offers agricultural reinsurance? Approximately 20 reinsurance companies are reinsuring agricultural risks. Leaders: Those who provide terms and conditions ( restricted to a group of 6 reinsurers) Followers: Those who provide capacity following the Leader s terms and conditions. Currently, it is estimated that between 15% to 20% of the agricultural insurance direct premiums (US$ 19.5 billon) are reinsured. Who purchase agricultural reinsurance? Agriculture Primary Insurers (majority) Reinsurance Intermediaries. Multinational Corporations. Captive insurers or banks.
4 4 Insured s business model defines the reinsurance needs Insurers whose agricultural risks portfolios are exposed to catastrophic events need more reinsurance. Small local agricultural insurers need more reinsurance coverage than larger international insurers. Multiline Insurers have a relatively better balanced portfolio than agricultural specialized insurers; therefore, need relatively less reinsurance cover. Portfolios with a small number of risks facing large exposures need more reinsurance than portfolios with a large number of small and homogenous risks Agricultural Insurers expanding into new products or entering new geographical regions often use reinsurance to benefit from reinsurers expertise and financing. How much business an agricultural insurer will reinsure depends on its business model, its capital strength, its risk appetite, and the prevailing market conditions
5 5 What are the benefits of agriculture reinsurance? Makes agricultural insurance more stable and attractive for insurers Reduces volatility of underwriting results Provides capital relief and flexible financing Allows agricultural insurers to benefit from the economies of scale. More business with the same amount of capital. Spread overheads over a broader base of business Access to reinsurers expertise and services, especially in the fields of product development, pricing, underwriting, and claims management Cross fertilization among markets. Underwriting tools, training for insurers underwriters and risks models Guidelines on claims assessment and training Reinsurance allows efficient risk and capital management Through protecting balance sheets against unexpected adverse losses, Through a better understanding of the assumed risks Through ensuring a correct risk assessment and pricing
6 6 How do agricultural reinsurers manage risks? Risk management is the core competence of any reinsurer The role of risk management is to identify, monitor and model the risks and their interdependencies and to ensure that risks are in line with what the reinsurer can bear. Risk Management is an interactive process which involves: Underwriting process Capital Management Asset Management Capital Management Underwriting Risk Management Asset Management
7 7 Diversification leads to a lower price for reinsurance Lines of business insured Optimum Better Diversification Lower capital needs and capital cost given the exposure Less expensive reinsurance cover Multiline Higher level of protection given the level of capital Geographical Distribution International National Mono-line Small Big Portfolio size
8 8 What framework is needed for agricultural reinsurance? Market Level Freedom of contract and legal security Market access and free flow of capital Adequate Insurance Regulations (Capital requirements) Client Level Expertise in agricultural business. Existence of underwriting and loss adjustment manuals. Availability of Information for risk assessments Insurers net retentions. Risk Level Experienced surveyors and loss adjusters. Adequate insurance policy wordings Minimum premium requirements Adequate terms and conditions.
9 9 PPPs from reinsurers perspective GOVERNMENT INTERVENITON Fully Intervened System High Insurance penetration levels Well Diversified Portfolios Social criteria prevail over Technical criteria Monopolies. Several issues with the service. Government assumes full liability (not reinsured) High Fiscal Cost High Insurance penetration levels Well Diversified Portfolios Technical criteria over commercial criteria The competition is for service. Government adds stability to the system Private Sector adds know how. Reasonable Fiscal Cost Pure Market Based Low to moderate penetration. Low risk diversification. Commercial prevail over technical criteria. The competition is on price No fiscal cost PLAYERS & PRODUCT DIVERSIFICATION
10 10 Conclusions The Insured s agricultural reinsurance needs depend on its business model, capital strength, risk appetite, and prevailing reinsurance market conditions. Agricultural reinsurance is not limited to providing financial capacity; market discipline and expertise transfer are also a plus of agricultural reinsurance. Portfolio risk management from a reinsurer perspective is based on three pillars: underwriting process, capital management, and asset management. Owing to specialization and capacity to diversify risks, reinsurance is one of the most efficient ways to transfer agricultural risks. Legal security, freedom of flow of capital, primary insurer partnership are preconditions for reinsurance. Size is important in agricultural reinsurance. Transaction cost for small reinsurance cessions can be too onerous. PPPs models in agricultural insurance are supported by reinsurers.
11 11 Appendix: Basic forms of agricultural reinsurance a) Proportional Quota Share Surplus Share Premiums and liabilities are divided equally RI closely linked to the original policies written Original terms + conditions are very important RI Commission is a pricing element Good structure on start up situations Cedant retains a share of those risks which are below a specific maximum termed line. Risks exceeding the cedant line are reinsured. RI s share is made up of a number of lines Good structure to homogenizing portfolios
12 12 Appendix: Basic forms of agricultural reinsurance b) Non Proportional: Stop Loss 150 Mio = 150% LR Upper Limit of Cover = 150% LR (150 Mio) Stop Loss Cover Stop Loss Cover = 50% xs 100% (50 Mio) 100 Mio = 100% LR Priority= 100% LR (100 Mio) Premium Income = 100% Deductible Reinsured Retention Commonly used in crops and livestock insurance. Objective: To protect primary insured retention over a certain aggregate period. Priority levels are selected carefully to avoid to guarantee primary insured's profits RI pays claims which fall between the limit and the priority (For this example: 50% LR xs. 100%) For claims below or above limits, insurer has to carry losses or buy additional RI RI premium is set independently of original business
13 13 Basic forms of agricultural reinsurance c) Non Proportional: Working Excess of Loss per Event and Cat XL Event Cat XL/ R Ceiling Cat XL Cover WXL/ R Ceiling Cat XL/ R deductible WXL/ R Cover WXL/ R Deductible WXL/ R deductible Cat XL Deductible Risks Cat XL is commonly used in Aquaculture and Forestry insurance (risk accumulation problems). Objective: To protect primary insured retention against catastrophic losses due to the same event. Two or more risk has to be affected due to the same insured event to trigger a Cat XL. Event definition (type, geographical extension and duration) is key for this coverage. RI pays claims which fall between the limit and the deductible (attachment point) For claims below or above limits, insurer has to carry losses or buy additional RI RI premium is set independently of original business
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