Reinsurance Presentation

25 and 26 October 2020

Discussion Questions

Q1: What advantages and disadvantages would an insurance company expect from ceding its risks (a)
facultative or (b) using a treaty?

Ans: Before talking about the advantages and disadvantages of both types of reinsurance, I would like to
make a first brief note about the role of reinsurance as a mechanism to control exposure.

As was mentioned in the training session and the supporting material, we can say that reinsurance is
'insurance for insurance companies', in other words, 'second level insurance'.

When the insurance companies underwrite a risk, it faces similar uncertainties to those that the policyholder
originally faced. The uncertainties pertain to the probability of a loss occurring in the first place, the financial
impact, and the moment of such a loss.

The insurance company is partially protected against these uncertainties by the common insurance practice of
pooling of risks; however, this does not protect the insurance company against a higher number (frequency) of
losses than expected or the occurrence of a larger loss than expected.

Confronted with such uncertainty, insurers seek protection from the reinsurer; where they can transfer part or
the whole of the risk.

So, reinsurance plays an important role by providing:

1. Protection against the unexpected claim, risk change, error of risk.

2. Maintains financial stability;
3. Provides capacity for larger and complex risks;
4. Provides expertise on certain complex class of business.

I. Facultative reinsurance

Answering the question, facultative reinsurance normally provides cover for large or unusual individual risks,
which are typically excluded from or exceed standard reinsurance treaties.
 As per the study material provided and CII study text, M80 Underwriting practice, 2018, using
facultative and have the following advantages and disadvantages

Advantages: Disadvantages:

 Individual risks are considered on their merits, so  As risks are considered individually, the reinsured
that an appropriate premium can be negotiated cannot be certain of the placement of facultative
rather than having to consider it as part of an reinsurance and this could affect its ability to
overall portfolio of risks. underwrite the underlying risk.

 There is freedom for the reinsured to cede any  The administration involved in facultative reinsurance
risk that may be accepted or declined by the is labour and cost intensive and any delay in issuing a
reinsurer. policy can create problems with clients

 Facultative insurance can increase the

competitive strength of the reinsured within his  If used extensively, facultative reinsurance can
market. undermine any potential profit in an account.

 The ceding company might benefit from the  The ceding company has to disclose full information
expertise and experience of the facultative regarding the original underwriting terms and
reinsurer. condition of the risk, which could be a problem if the
reinsurer is also a competitor in the market.
 There is an opportunity for both parties to
develop a successful and professional  The insurer may lose control over the handling of the
relationship. risk. For example, it may not be allowed to agree
policy amendments without receiving the prior
agreement of the reinsurer. Failure to advise the
reinsurer of changes in the risks could also potentially
invalidate the reinsurance protection.

 The reinsurer can exert a certain influence on the

insurer's underwriting by asking to improve the risk
offered or by unduly altering its assessment of the
premium on the original risk.

II. Treaty reinsurance

Under the terms of treaties of reinsurance, the reinsurer is obliged to offer/cede a fixed amount of his
business, which the reinsurer is obliged to accept. It’s fair to say that is treaty is an obligatory contract that
tending to protects a portfolio of risks, opposed to just a single risk with facultative ceding.

As per the study material provided and CII study text, M80 Underwriting practice, 2018, bellow is the
advantages and disadvantages of using a treaty.

Advantages: Disadvantages:
 The reinsured has automatic reinsurance cover  There is no freedom, since both parties are bound
and does not need to arrange individual contracts. by the contract, which cannot be cancelled,
before the end of the stipulated period.
 The reinsured receive ceding commission toward
brokerage and expenses cost under certain types  Too much premium can be ’lost’ by the reinsured
of treaties. to reinsurers on small good risks, which it would
otherwise retain entirely for its own account. But
 Some types of treaties provides profit this can sometimes be overcome by arranging
commission to the reinsured. specific types of treaty reinsurance.

 The administration of treaty reinsurance is

quicker and easier than that for facultative
 reinsurance.

 Accounting procedure can be simplified by the

use quarterly accounting.

Q2: Describe how premiums and losses are shared in (a) surplus treaty reinsurance and (b) working XL
reinsurance.

Ans:

a. Surplus treaty reinsurance

The surplus treaty reinsurance is a type of proportional or pro rata reinsurance treaty in which the
ceding company determines the maximum loss it can retain for each risk in the portfolio. For each
risk ceded to the treaty, losses and premium are shared in equal proportions.

b. Working XL reinsurance.
In XL reinsurance premium is specifically calculated.
Under an excess of loss reinsurance arrangement, the reinsurer agrees to pay the first amount AOA X
of losses arising and the reinsurer agrees to pay an amount AOA X in excess of amount AOA X, up
to an agreed limit.

Ex: A Reinsured may wish to retain the first AOA 300.000 of each and every loss arising from a
particular event and may purchase an excess of loss treaty to cover AOA 700.000 in excess of AOA
300.000.
In this case, if a loss amounting to AOA 500.000 occurs, the insurer would be liable for the retention
of AOA 300.00. The remainder of the loss is equal to AOA 200.000; this is lower than the maximum
coverage (AOA 700.000), so, the reinsurer is liable to pay AOA 200.000.

Q3: An author cited in this chapter wrote “reinsurance can be viewed as both leverage and a risk management
mechanism.” Explain.

Ans:

Firstly, it is essential to note the following: Reinsurance is one of the most important tools the insurer uses to
leverage and risk management.

Leverage tool: As I stated above, reinsurance provides to the insurer capacity and financial stability. Through
the purchase of reinsure, the insurer can avoid fluctuation in claim costs, and therefore underwriting results,
between one period and the next. Large variations in underwriting results can damage a company’s reputation
and cause shareholders and regulations concerns. So, reinsurance can smooth results by capping any large
losses that could destabilize the insurer.

Moreover, by buying reinsurance, the insurer can increase its capacity to underwrite more business and accept
larger, or more complex and unusual risks. Therefore, in my opinion, this is how reinsurance is seen as a
leverage tool for the insurer.

Risk management mechanism tool: Reinsurance can also be seen as a risk management mechanism or
alternative risk transfer mechanism because allows the transfer/spread of insurance risks to the capital
markets. By doing so, insurer uses it to reduce its underwriting risks and the volatility of its financial results,
stabilize its solvency, use its available capital more efficiently, and improve its ability to withstand disasters,
increase its underwriting capacity and draw on the experience of the reinsurer in respect of product
development.

· Q4: What are the reasons that some governments offer for subjecting domestic nonlife insurance companies
to compulsory cessions to a national or regional reinsurance company? In those countries, why do you believe
the cession commonly applies to treaty reinsurance only?

Ans: - This is the only way a national or regional reinsurer can have a client. Many of them under normal
market conditions would not be able to compete with others reinsurers.

Treaty reinsurance covers a range of risks through a single agreement. The result, apart from the convenience
mentioned above, is that many policies can be written for a period of time in a single agreement.

Reinsurer can make a lot of money on small good risks, which it would otherwise retain entirely for its own
account.

· Q5: Why are the world’s largest reinsurance firms located in Europe?

 I think this linked to the history of insurance and reinsurance industries.

 Europe has played a leading role in both insurance and reinsurance formation.
 Also the number of catastrophic events that have taken place in Europe,