REINSURANCE 101

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REINSURANCE 101
MODERATOR JOHN KLINE, CPCU, ARM (YUM!
Brands) SPEAKER GEORGE BUDD, CPCU (GEORGE A.
BUDD, LLC)
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REINSURANCE 101

• OBJECTIVES
• EXAMINE SOME BASIC CONCEPTS
• SHOW HOW THESE ARE APPLIED
• REVIEW NEW TRENDS
• GLOBALIZATION
• SECURITIZATION
• COMPUTER MODELS
• REVIEW RISK MANAGERS CHOICES

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REINSURANCE GLOSSARY

• FOUR WEB SITES (all start with www.)
• Raanet.org/abouttheraa/glossary.html
• Captive.com/newstand/articles/
• GlosRein.html
• Malaysian-re.com.my/mnrb-docs/
• html-dir/glossary.html
• iii.org (click insurance tools)

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REINSURANCE?

• THE INSURANCE OF INSURANCE COMPANIES. THE
  SAME WAY BOOKIES LAY OFF BETSAND FOR THE SAME
  REASON.

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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.

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WHY REINSURE?

• FOR THE SAME REASON YOUR BUSINESS BUYS INSURANCE
  
• TO PROTECT THE CORPORATE ASSETS

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TRANSFERRING RISK INSURANCE
RISK Policyholder Insurance Co.
- Insured - Insurer - Underlying
Insured
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TRANSFERRING RISKREINSURANCE

• Risk
• Insurance Co. Reinsurer
• - Ceding Co. -Assuming Co.
• - Cedent
• - Primary Insurer
• Direct Company

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TRANSFERRING RISKRETROCESSION

• Risk
• Reinsurer Reinsurer
• - Retrocedent -Retrocessionaire

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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.

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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.

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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.

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What Reinsurance Does Not Do!
IT IS NOT A MAGIC POTION
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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

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BASIC RULE

• IN REINSURANCE,
• ALMOST ANYTHING IS
• NEGOTIABLE

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THE HOUSE OF REINSURANCE

• FACULTATIVE
• INDIVIDUAL RISKS
• TREATY
• GROUPS OF RISKS

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The House of Reinsurance

• THE FACULTATIVE SIDE
• Single Policy or Risk
• Reinsurer evaluates each risk and establishes or
  agrees to accept Coverage Form and Price.
• Automatic and Semi-Automatic Facilities

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The House of Reinsurance

• THE TREATY SIDE
• Covers classes or entire
• books of business.
• Reinsurer accepts as written by Insurer as to
  Form, Price and Risk.

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LETS DEFINE

• BOOK OF BUSINESS
• ANY segment of an insurance companys portfolio.
  
• It does not have to equate with a known
  geographic area, a line of business, a marketing
  segment or any combination of these.
• It is a segment of the portfolio the company
  wants to protect for a variety of reasons. WE
  define it!

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LETS DEFINE

• 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.
• This can be the amount after subtracting all
  facultative and treaty reinsurance or which
  includes them it depends on the purpose.

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LETS DEFINE

• Example 5 million risk
• Facultative 3mm xs 2mm
• Net Line2mm
• Example Same as above except
• Line can also be defined as 5mm

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FORMS OF REINSURANCE

• PROPORTIONAL (OR PRO-RATA)
• PAY PREMIUM ON A SHARE BASIS
• COLLECT LOSSES ON SAME SHARE
• EXCESS OF LOSS
• PAY PREMIUM ON NEGOTIATED PRICE
• COLLECT LOSSES ONLY WHEN RETENTION IS EXCEDED.

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The Forms of Reinsurance

• Pro-Rata or Proportional
• Reinsurer receives a percentage share of premium
  and pays that same percent of each loss.
• Reinsurer pays cedent a Commission to Reimburse
  for Expenses
• Can be Flat Percentage
• Can Include Profit Commission
• Can be Swing-Rated

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The Forms of Reinsurance

• Pro-Rata or Proportional (cont.)
• Can be Quota Share or Surplus
• Quota Share
• Reinsurer takes same on each risk.
• Of vs. Part Of

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The Forms of Reinsurance

• Pro-Rata or Proportional (cont.)
• Surplus Share
• Reinsurers share varies for each risk based on
  type and/or size of risk.
• Whatever that percentage share is, reinsurer
  receives same percent of premium and losses.

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The Forms of Reinsurance

• EXCESS OR NON-PROPORTIONAL
• Per Risk (property), Per Occurrence (casualty) or
  Claims Made
• Per Occurrence Catastrophe
• Aggregate or Stop Loss Excess

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The Forms of Reinsurance

• Per Risk or Occurrence Excess
• Responds to Losses Excess of a Predetermined
  Retention
• No Proportional Sharing of Premium or Loss
• Premium is Negotiated
• Written in Layers
• Normally has Occurrence Limit
• Reinstatements are Negotiated

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REINSTATEMENTS

• PROPORTIONAL -- DOES NOT APPLY
• FULL
• AT A PRICE
• FREE AND UNLIMITED
• FREE BUT LIMITED
• COMBINATION OF ABOVE

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RISK EXCESS PRICING

• LOSS RATING
• BURNING COST
• LOADED PRICE
• TREND DEVELOPMENT FACTORS
• EXPOSURE RATING
• RATING SCALES
• UNDERWRITERS JUDGEMENT

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OCCURRENCE LIMITS

• PER RISK EXCESS
• MULTIPLE OF RISK SIZE
• PROPORTIONAL
• CHANGES SINCE 1992
• NEGOTIATED
• FLAT DOLLAR AMOUNT
• PERCENT OF PREMIUM
• MULTIPLE OF RISK SIZE

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Forms of Reinsurance

• Catastrophe Excess of Loss
• Covers all losses in an event
• Occurrence is defined as a geographic area (flood
  and Riot) or a time period (wind, quake, fire and
  winter storm)
• Usually Limited to two Occurrences
• Additional Cover Needed
• Sold in Layers
• Usually has two risk warranty

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CATASTROPHE CHANGES

• No Reinstatement in Same Event
• Reinstatement at 100
• ECO/XPL Excluded
• Deposits at 100

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SURPLUS TREATY

• READS LIKE AN EXCESS
• ELIGIBILITY RULES vis-a-vis PAYMENT, I.e., SIZE
  OF RISK vs. SIZE OF LOSS
• WORKS PROPORTIONALLY
• PAY PROPORTIONAL PREMIUM
• COLLECT PROPORTIONAL LOSSES
• WHY HAVE IT?

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SURPLUS TREATY

• WHY HAVE IT?
• CAN AFFORD TO KEEP MORE LOSSES
• WANT TO KEEP PREMIUM FOR GROWTH PURPOSES
• OPTIONS
• CARRY IT ALL NET
• REDUCE AMOUNT OF QUOTA SHARE
• ADD OR SUBSTITUTE WITH AN EXCESS TREATY
• ADD A SUPLUS TREATY
• COMBINATIONS OF THE ABOVE

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SURPLUS TREATY

• THE FIRST CONCEPT
• MINIMUM SIZE RISK
• EXAMPLE ALL RISKS GREATER THAN 1 MILLION
  MUST BE CEDED TO REINSURER.

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SURPLUS TREATY

• SIZE IS AN ELIGIBILITY RULE
• RISK IS CEDED PROPORTIONALLY
• PREMIUM IS PAID PROPORTIONALLY
• LOSSES ARE COLLECTED PROPORTIONALLY

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SURPLUS TREATY

• HOW DO
• WE
• DO THAT???

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SURPLUS TREATY

• EXAMPLE
• 5 MILLION VALUES
• BUILDING, CONTENTS, ETC.
• IS IT GREATER THAN 1 MILLION?
• YES!
• THEN ITS ELIGIBLE

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SURPLUS TREATY

• 5 MILLION TOTAL
• REINSURED KEEPS 1 MILLION
• CEDES (REINSURER ACCEPTS) 4 MILLION 1/5
  20
• 4/5 80
• REINSURED PAYS 80 OF PREMIUM
• ANY SIZE LOSS, COLLECTS 80 OF IT

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SURPLUS TREATY

• ANY
• SIZE
• LOSS!

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SURPLUS TREATY

• THE MINIMUM SIZE IS AN ELIGIBILITY RULE ONLY!
• ONCE WE HAVE DETERMINED A RISK IS ELIGIBLE, IT
  BECOMES A QUOTA SHARE OF THE AMOUNTS CEDED vs.
  THE AMOUNTS RETAINED

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SURPLUS TREATY

• HOW ARE CESSIONS DETERMINED?
• BY LINES

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SURPLUS TREATY

• A LINE IS THE AMOUNT THE REINSURED IS KEEPING FOR
  ITSELF
• THE CESSION IS NORMALLY BASED ON X NUMBER OF
  LINES AS NEGOTIATED IN THE TREATY

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SURPLUS TREATY

• THE 5 MILLION EXAMPLE
• (SPLIT 20/80)
• ONLY WORKS IF THE TREATY ALLOWS FOR 4 LINES
• TO BE CEDED
• 1 MILLION EQUALLED 1 LINE
• 4 MILLION EQUALLED 4 LINES

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SURPLUS TREATY

• BUT
• IF THIS WERE A THREE LINE TREATY, THE MOST THAT
  CAN BE CEDED IS 3X WHAT THE REINSURED KEEPS.
• THEREFORE, THE 5 MILLION HAS TO BE DIVIDED BY 4
  (31)

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SURPLUS TREATY

• 5,000,000 4 1,250,000
• 3 X 1,250,000 3,750,000
• 75 CEDED
• 25 KEPT NET
• ALL PREMIUMS AND LOSSES
• FOLLOW THE SAME DIVISION

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REMINDER

• Surplus Share
• Reinsurers share varies for each risk based on
  type and/or size of risk.
• Whatever that percentage share is, reinsurer
  receives same percent of premium and losses.

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SURPLUS TREATY

• NEXT CONCEPT
• MINIMUM RETENTION
• REINSURER WANTS REINSURED TO MAINTAIN RISK ON A
  PAR WITH ITS SIZE

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SURPLUS TREATY

• MINIMUM SIZE 1,000,000
• MINIMUM RETENTION 500,000
• RISK SIZE 1,500,000
• (CONTINUE WITH 3 LINE TREATY)
• 1,500,000 4 375,000
• DOES NOT WORK!
• CEDENT MUST KEEP 500,000!

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SURPLUS TREATY

• ERGO
• KEEP 500,000
• CEDE THE REST
• 1,500,000 - 500,000 1,000,000
• EQUALS 2 LINES CEDED
• DIVISION OF RISK IS 1/3 AND 2/3

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SURPLUS TREATY

• NEXT CONCEPT
• MAXIMUM CESSION
• REINSURER IS WILLING TO ASSUME
• RISK BUT ONLY UP TO A CERTAIN AMOUNT

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SURPLUS TREATY

• MINIMUM SIZE 1,000,000
• MINIMUM RETENTION 500,000
• MAXIMUM CESSION 5,000,000
• NEW RISK 20,000,000
• 20,000,000 4 5,000,000
• 5,000,000 X 3 15,000,000
• BUT MAX CESSION 5,000,000

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SURPLUS TREATY

• ERGO
• CEDE 5,000,000 (25)
• KEEP 15,000,000 (75)

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SURPLUS TREATY

• WHAT PERCENTAGES WERE CEDED?

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Properties of Surplus Treaties

• Risk Must be of a Minimum Size to Qualify
• Amount Ceded is Based on Number of Lines
• Reinsured Must Retain a Minimum Amount Called
  Minimum Retention
• There is a Maximum Limit
• Normally Obligatory

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THE PRIORITIES

• The Order of Collecting Losses
• Facultative
• Proportional (Q/S and Surplus)
• Per Risk
• Catastrophe
• Aggregate or Stop Loss

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COLLECTING THE LOSS

• 240 MILLION RISK
• 76 MILLION LOSS
• 30 MILLION FACULTATIVE
• 20 QUOTA SHARE
• 3 LINE SURPLUS TREATY
• 30 MILLION MAXIMUM CESSION
• (12.5 OF TOTAL SCHEDULE)
• 65 MILLION XS 10 MILLION RISK XS

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COLLECTING THE LOSS

• LOSS 76 MILLION
• COLLECT THE FACULTATIVE
• 30 MILLION
• REMAINDER 46 MILLION
• COLLECT THE QUOTA SHARE
• 20 x 46 MILLION 9.2 MILLION
• REMAINDER 36.8 MILLION

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COLLECTING (cont.)

• REMAINDER 36.8 MILLION
• COLLECT THE SURPLUS TREATY
• 30 MILLION MAXIMUM CESSION?
• REMEMBER THE PERCENTAGE
• 46 MILLION X 12.5 5.75 MILLION

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COLLECTING (cont.)

• REMAINDER 31.05 MILLION
• COLLECT THE RISK EXCESS TREATY
• 21.05 MILLION
• CEDENT KEEPS 10 MILLION NET

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COLLECTING (cont.)

• RECAP
• FACULTATIVE PAID 30 MILLION
• QUOTA SHARE PAID 9.2 MILLION
• SURPLUS TREATY PAID 5.75 MILLION
• RISK XS TREATY PAID 21.05 MILLION
• (THE CEDENT KEPT 10 MILLION NET)

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The New Reinsurance Market

• Securitization
• Bermuda Commodities Exchange
• Guy Carpenter Co. Index
• Program Business
• eCOMMERCE
• Chicago Board of Trade (CBOT)

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SECURITIZATION

• PHYSICAL LOSS CAPACITY
• NEW AND ADDITIONAL CAPACITY
• TENDS TO BE EXPENSIVE
• ONE LOSS SITUATION
• ASSET PORTFOLIO PROTECTION
• WHAT HAPPENS AFTER LARGE LOSS
• NEEDS TO BE TESTED

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eCOMMERCE

• LARGE FUTURE
• MOSTLY PERSONAL LINES
• CATEX
• NEW EUROPEAN RISK INTERCHANGE

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COMPUTER MODELS

• AIR (CATMAP)
• RMS (IRAS)
• EQUICAT
• DAMES MOORE
• CATALYST
• ISO (CAT TRADER)
• TILLINGHAST (RIPL)

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COMPUTER MODELS

• IMPORTANCE
• RATE MAKING
• FINANCIAL RATINGS
• PORTFOLIO ANALYSIS, MANAGEMENT AND CONTROL
• RISK AND LOCATION UNDERWRITING
• EARTHQUAKE ANALYSIS

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UNDERWRITING TRENDS

• EMPHASIS ON MODELING
• INVOLVEMENT OF ACTUARIES AND FINANCIAL PEOPLE IN
  DECISION MAKING PROCESS.
• REDUCED RESPONSIVENESS
• CORPORATE SPECIALIZATION

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GLOBALIZATION

• WORLDWIDE CLIENTS
• WORLDWIDE INSURANCE NEEDS
• WORLDWIDE REINSURANCE NEEDS
• NATIONAL CLIENTS
• WORLDWIDE INSURANCE/REINSURANCE NEEDS
• CORPORATE SOLUTIONS?

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RISK MANAGEMENT

• DO WE NEED AN INSURER?
• CAPITAL REQUIREMENTS
• EXPERTISE
• CORPORATE CAPACITY
• MONEY
• TIME
• LEVERAGING ABILITY

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!WARNINGS!

• DONT DABBLE!
• CONTROL YOUR RESERVES!
• KNOW WITH WHOM YOU ARE DEALING!

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ANY QUESTIONS