THE REINSURANCE PRINCIPLES

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1 THE REINSURANCE PRINCIPLES

2 Contents 1. Concepts of Insurance and Reinsurance 2. Functions of Reinsurance 3. Types & structures of Reinsurance 4. Introduction to Pricing 5. Introduction to Portfolio Strategy 6. Functions of a Reinsurance broker 2

3 Definitions of Insurance Why does a company insures itself? Material and Immaterial assets are exposed to various risks The shareholders are willing to carry the Entrepreneurial Risks; hence all other Risks must be dealt with by a Third Party (Insurance or State) What is insurable? A risk that is Unpredictable, External and Irresistible A risk that is Quantifiable in order to Sell it A risk that is Financially bearable by an Insurer How does a company insures itself? By transferring the Risk to a third party, the Insurer By transforming a Variable cost (Risk) into a Fixed cost (Premium) 3

4 Insurance is Risk Diversification Insurance main Diversification is TIME For a given Risk, the probability of loss occurrence is below 1: there could be a claim or not In a given area, the risks are not correlated : a Fire on building A doesn t imply a Fire on building B elsewhere in the same town The probability of having all the Risks incurring a loss at the same time is low: 1 every 50, 100, 200 years Hence, a premium representing a fraction of the value of each Risk is enough to cover a Loss from time to time But an extreme event may correlate Risks which are normally Independent : here is the border of Insurance and the gateway to Reinsurance 4

5 Definitions of Reinsurance Why does an insurer buy Reinsurance? In case of exceptional event, i.e. accumulation of many small events or one extreme event that exterminate the Time diversification of the Insurer s portfolio (ex. Earthquake) What is reinsurance? Formally, it s a contract between an Insurer and a Reinsurer, upon which the Reinsurer commits to pay his share of a claim against a premium Risk wise, it s a way for the insurer to optimize and homogenize its portfolio of risks. How can reinsurance be viable? Time diversification is replaced by Geographical diversification: an Earthquake in Japan is not correlated to a Storm in Europe or a Terror act in New York. Reinsurance is written in various independent regions and also in various lines of business. Appropriate Pricing is important, but monitoring of Risk Accumulation is Vital: an error on pricing doesn t ruin the reinsurer. 5

6 Functions of Reinsurance Risk transfer Insurer can assume greater individual risks than assets allows Income smoothing Insurer s results are more predictable by absorption of large losses and reduction of capital needed Surplus relief Insurer s writings being limited by solvency margin, reinsurance allows insurer to keep writing without increasing its capital Reinsurer s expertise Insurer desires to benefit from the expertise and rating ability of the reinsurer Creating a manageable and profitable portfolio Insurer improves balance and homogeneity of its portfolio by getting rid of peak exposure and reducing volatility Managing cost of capital Reinsurance cost is less than capital cost and more convenient 6

7 Types of Risks and reinsurance Classes Type of risk exposures Natural perils (storm, cyclone, earthquake, tsunami ) Industrial & technological perils (product default, explosion ) Terrorism (correlation of risks : ex. World Trade Center) Pollution Nuclear (state or pools) Decenial Liabiliy following Constructions (Terminal E Paris) Reinsurance classes Property and consequential business interruption Liabilities : general, motor, professional, products Marine, Aviation and Spatial Accident, Life and Health Workmen s compensation 7

8 Types & structures of Reinsurance Facultative or Treaty Facultative: reinsurance of an individual policy or risk with the ability of the reinsurer to decline. Used for industrial, special and technological risks, on top or out of treaty capacities. Risk of anti selection and high administration costs Treaty: annual or multiyear contract upon which the insurer must cede all the risks concerned and the reinsurer can t decline. No anti selection and reduced administration. Proportional or Non Proportional Proportional: reinsurer takes a stated percent share of each policy the insurer writes and carries the same claims share Non-Proportional: reinsurer commits to pay claims in excess of a given amount and within a given limit ; and in exchange receives a premium 8

9 Proportional Reinsurance Quota-Share: For a given line of business, the insurer cedes a fixed percentage of all the policies and receives the same percentage of all claims for this line of business. The reinsurer pays a commission to the insurer for underwriting and administration costs Interests of insurer and reinsurer are aligned, out of commission. Peak exposures are not cancelled, but reduced proportionally Surplus: The insurer cedes only the risks exceeding a given amount (retained line) and for each risk the proportion of premium corresponding to the ceded risk exposure. It allows the transfer of peak exposures and homogenizes the retained portfolio 9

10 Proportional Reinsurance Quota Share (30%/ 70%) a b c d e f g h i j k l m n o p 18 q r Retention Cession Surplus 0 a b c d e f g h i j k l m n o p q r Retention Cession 10

11 Non-Proportional Reinsurance Excess of Loss: Reinsurance attaches only for claims in excess of a certain amount (Priority) and up to a given amount (Limit) per claim. Sometimes it s unlimited (ex: Motor Liability for bodily injury). In exchange, the reinsurer receives a premium expressed as a percentage of the total ceded premium (Rate) or the Limit (ROL) An XoL may attach per Event or per Risk Stop Loss: Reinsurance attaches in excess of a total amount of claims per year, expressed as a percentage of Loss Ratio up to a given Loss Ratio, ex. 20% xs 110%. Loss ratio = Losses/ Premiums A SL protects the annual results of a given class of business A SL applies for classes of business for which an event is difficult to define. Ex: hail, water damages, drought 11

12 Non-Proportional Reinsurance Excess of Loss ( xs 3 000) Claim Priority Limit 140% Surplus (15% xs 110%) 120% 100% 80% 60% Loss Ratio Priority Limit 12

13 The diligence of a Reinsurance broker Broker s Role Translator of Cultural differences Mediator & Moderator Advisor Understand Client's needs and requirements Understand the prevailing environment, be it Market, Political, Economic or Social Assess the strengths and weaknesses of each risk carrier, understand their portfolio strategy Broker s Duties Ensure that Risk Exposure s data is well presented to underwriters Ensure that Client discloses its risk exposure to underwriters Adjust to Client s needs & requirements Ability to deliver a Tailor made product or service whenever needed Regional presence as to follow Client s geographical expansion Maintain a close relationship with underwriters Broker s Services Negotiate Competitive & Realistic terms Ensure fair Competition among the various underwriters in the market Provide the broadest Coverage available to match Client s needs Cope with Client s budget constraint Ensure diligent Claims settlement Anticipate market downturns Adjust Wordings in accordance to Client s risk exposure 13

14 Conclusion: Reinsurance is a shield against exceptional events Risk assessment is based on quantitative methodologies But statistics and modeling have their limits Market Knowledge, Pragmatism and Humility are also helpful tools, when dealing with randomness Beyond all technical issues, reinsurance is about trustbased, long term and balanced relation relationship Thank you for your kind attention, 14

15 Top 25 Globale Reinsurance Group Rank Rating as at Net Reinsurance Company Country 08/02/2010 Premium written AA- Munich Reinsurance Co Germany A+ Swiss Reinsurance Co Swizerland AA+ Berkshire Hathaway Re US AA- Hannover Rueckversicherung AG Germany A Scor SE France A+ LIoyd's UK AA- Reinsurance Group of America Inc US A+ Transatlantic Holdings Inc US AA- Partner Re Ltd Bermuda A+ Everest Reinsurance Co Bermuda AA Tokio Marine Group Japan A XL Re Ltd Bermuda A- Korean Reinsurance Co Korea A- Odyssey Re US AA- Transamerica Re (AEGON) US AA Mitsui Sumitomo Insurance Co Ltd Japan AA Mapfre Re Spain AA- Sompo Japan Insurance Inc Japan AAA Caisse Centrale de Reassurance France A+ Toa Re Co Ltd Japan A- White Mountains Re Group Ltd Bermuda A+ AXIS Capital holdings Ltd Bermuda NR General Ins Corp of India India A+ QBE Insurance Group ltd Australia A+ ACE Tempest Reinsurance Bermuda

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