Reinsurance

DEMYSTIFYING THE WORLD OF REINSURANCE

Insurer

Insured

Reinsurer

Policies

Size of Risk

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 COMPANIES

RETROCESSIONAIRES

REINSURANCE BROKER

Reinsurance

Insured

Insurance

Company

Reinsurance

Company

Reinsurance

Company

Broker, Agent, Phone,

Online, In person.

Broker, Direct.

Broker, Direct.

Reinsura

nce

Retroce

ssion

Direct

Insu

rance

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 inAustralian history. AUS$ 2-3bn

• Hurricane Andrew US$ 23bn

• Northridge US$ 19bn

Reinsurance

Insurance

Company

Reinsurance

Company

Broker, Direct.

Reinsura

nceUS$ billion

Growth in 2007

Growth in 2006

Life 2,393 5.4% 4.1%

Non-life 1,668 0.7% 3.9%

Total 4,061

Global Premiums in 2007

Source: Swiss Re, Sigma 3/2008.

How much of this is

reinsurance?

…and why do we

measure it by

premium?

ReinsuranceGross

Reinsurance Premium Assumed

Risk “Located” In:

Net “Risk”

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

Destination & Source of Reinsurance Premium (US$ million)

Source: IAIS Global Reinsurance Market Report, December 2007Data Source:- 59 Reinsurers: Bermuda 8; Europe 21; Japan 2; USA 28.

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

PrimaryInsurer Reinsurer Retrocessionaire

Reinsurance is a contractual agreement under which the primaryinsurer transfers some or all of its loss exposures to a reinsurer.

?

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 companiesIntermediaries: 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 brokersThe role of the reinsurance brokerAdvise 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

• 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.

Risk Profile Impact on PL

Cost of Reinsurance

Capital Strength

Overall Decision

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 Treaty2.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.

75%

$50,000 Policy

25%

75%25%

$100,000 Policy

75%25%

$150,000 Policy

• Simple to rate & administer.• Does not stabilize underwriting results.• Can help reduce reported expenses.• Can cede profitable business.

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 retention stated in $ or INR; % of premiums & losses ceded varies by policy.

– Avoids cessions on small policies.

– Better at providing large-line capacity.

– More costly to administer.

– Used on property risks, rarely liability.

75%25%

$100,000 Policy

83%17%

$150,000 Policy

Example:$25,000 retention