powerpoint slides for professors spring 2010 version
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PowerPoint Slidesfor Professors
Spring 2010 Version
This file as well as all other PowerPoint files for the book, “Risk Management and Insurance: Perspectives in a Global Economy” authored
by Skipper and Kwon and published by Blackwell (2007), has been created solely for classes where the book is used as a text. Use or
reproduction of the file for any other purposes, known or to be known, is prohibited without prior written permission by the authors.
Visit the following site for updates:http://facpub.stjohns.edu/~kwonw/Blackwell.html.
To change the slide design/background,[View] [Slide Master]
W. Jean Kwon, Ph.D., CPCUSchool of Risk Management, St. John’s University
101 Murray StreetNew York, NY 10007, USAPhone: +1 (212) 277-5196
E-mail: [email protected]
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Risk Management and Insurance: Perspectives in a Global Economy
23. Reinsurance
Click Here to Add Professor and Course Information
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Correction – Figure 23
One in each category of this column has to be non-proportional!
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Study Points
Worldwide risk sharing
Reinsurance demand
Reinsurance fundamentals and operations
Reinsurance markets
Reinsurance regulation
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Worldwide Risk Sharing Through Reinsurance
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Fundamentals
Insurance vs. reinsurance vs. retrocession
Retention vs. cession
Privity of contract vs. cut-through provision
Reciprocal agreement
Refer also to Chapter 1 for the basic concepts.
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Worldwide Risk Sharing (Figure 23.1)
Insured Insured Insured Insured
Primary Insurer(Canada)
Insured Insured Insured Insured
Primary Insurer(China)
Reinsurer(U.S)
Reinsurer(Germany)
Reinsurer(Japan)
Reinsurer/Retrocessionaire
(France)
Retrocessionaire(Italy)
Retrocessionaire(Bermuda)
Reinsurer(Singapore)
Reinsurer(Mexico)
Retrocessionaire(U.S.)
Retrocessionaire(Korea)
Retrocessionaire(Brazil)
Another version in next page
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Worldwide Risk Sharing (Figure 23.1)
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Rationales for Reinsurance Demand
Ownership structure
Cost of financial distress
Capital market imperfections
Real service efficiency
Reduction of tax liability
Volatility control
Regulatory constraints
Refer to “Insurance Demand” in Chapters 2 and 19.
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Reinsurance Fundamentals
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Reinsurance is...,
Risk financing arrangements between insurance firms; e.g.,• Between direct insurer and reinsurer
Transfer of part of the risks that the direct insurer assumes by way of insurance contract to another insurance carrier (the reinsurer) which has no direct contractual relationship with the insured.
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Key Terms and Concepts
Cedant, reinsured, primary insurer, ceding company
Reinsurer, assuming company
Retrocessionaire
Retention• The amount of risk retained by
cedant
Cession• Alternative term to “reinsurance”• The amount of risk transferred
Retrocession
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Suppliers of Reinsurance
Professional reinsurers• Munich Re, Swiss Re, Berkshire Hathaway…,• Mega-mergers and acquisitions internationally
Reinsurance departments (of insurance companies)• Directly• Through underwriting agents
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Suppliers of Reinsurance
Pools• For national/regional cover of large risks (e.g., nuclear power or
space shuttle projects)• For nonstandard risk pooling in automobile and workers’
compensation insurance
Lloyd’s associations
Captives• For holding company and sister companies• May function as either insurer or reinsurer• Little or no provision of insurance to others
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Reinsurance Distributions
Direct writing reinsurer
Reinsurance brokerage firm
Slip
Lead (leading underwriter)
Broker’s cover
Characteristics• Represent the client (cedant, not
reinsurer)• Act as consultant to the client• Spread the risk using multiple
reinsurers to ensure security for the client
Other services/business• Captive management services• Alternative risk transfer
arrangement
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Types and Nature of Reinsurance Contracts
Facultative vs. treaty reinsurance• Facultative-obligatory (fac-oblig) reinsurance
Proportional (pro-rata) vs. non-proportional (excess-of-loss or XL) reinsurance
Financial reinsurance
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Facultative vs. Treaty
Facultative Placement in the reinsurance
market “on or after” writing risk
Per risk or policy
Treaty Placement via re existing
contract
Bulk contract for all risks falling into (e.g., property risks < $1 million in Manhattan
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Proportional vs. Non-proportional (Excess-of-Loss)
Proportional Equal share of risk, premium and
loss
Excess-of-Loss (XL) Sharing of loss not in proportion
to sharing of premium
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How to Utilize Reinsurance
Single reinsurance contract
Reinsurance program• For a line• For a group of lines umbrella• For all businesses of the insurer whole account
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Classification of Reinsurance Contracts (Figure 23.2)
Facultative
The contract is on individual risk basis; that is, there is no pre-existing reinsurance contract. The insurer decides whether to cover a risk alone, or cede part of it to a reinsurer. When offered, the reinsurer may accept it, decline it or counteroffer the insurer.
Treaty
The contract commonly is annual on a line of business and territory basis. The insurer and the reinsurer are bound to a contract that dictates what risks are to be shared and how they are shared. Therefore, the insurer must transfer all risks subject to the agreement and the reinsurer must accept all ceded risks.
Facultative-Obligatory (Fac-Oblig)
Commonly used as the top layer of a treaty reinsurance program, this type of contract gives the insurer an option to retain a risk fully or cede part of it to the reinsurer. When ceded (a facultative element), the reinsurer must assume the risk (an obligatory element).
Rein
sura
nce
Cont
ract
Proportional
Non-proportional
Proportional
Non-proportional
Source: Kwon (1999)
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Forms of Reinsurance (Figure 23.3)
Proportional (Pro-rata)Sharing the amount of insurance, premium and loss on a proportional basis
• Quota Share• Surplus
• Facultative-Obligatory
Excess-of-loss (Non-proportional)Reinsurance coverage only when loss exceeds the retained loss at lower layer(s)
• Facultative Excess• Risk (working) Excess
• Catastrophic (Cat) Excess• Stop Loss
• Umbrella Excess. . . . .
Financial
• Retrospective Financial Reinsurance• Prospective Financial Reinsurance
Form
s of R
eins
uran
ce
Source: Kwon (1999)
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Proportional Reinsurance – Quota Share (Table 23.1)
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Proportional Reinsurance – Surplus (Table 23.2)
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Illustrative Proportional Treaty (Figure 23.4)
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Non-proportional (Excess-of-Loss) Reinsurance
Facultative XL Risk (working) XL Common account XL Per occurrence XL
• Hours clause Stop loss XL Aggregate XL Umbrella XL Whole account XL
Reinstatement provision (page 608)
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Excess-of-loss Reinsurance (Figure 23.5)
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Reinsurance Program Design
Factors to consider in designing a program• Risk and loss portfolios over several years• Types of reinsurance contracts• Apportionment of risks or losses by layer• Availability of reinsurers specializing in each type of reinsurance and
their ancillary services• Prevailing conditions in the reinsurance market and in the economy• Profitability (including the size of ceding and other commissions from
reinsurers)• The insurer’s own capacity to retain losses
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Reinsurance Program Design
Commissions• Types
• Ceding commissions• Profit commissions
• Not all reinsurance contracts offer commissions
You may use the example in pages 609-610 to describe the relief from
ceding commissions.
Ceding commissions differ from reinsurance brokerage fees.
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Financial Reinsurance
Risks involved• Underwriting (pricing) risk• Timing risk• Investment risk
Financial reinsurance explicitly considers the investment and timing risks and may provide little or no pricing risk transfer.
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Financial Reinsurance
Retrospective financial reinsurance
Time and distance contracts
Loss portfolio transfer• Run-off business
Prospective financial reinsurance• The primary focus of financial reinsurance in today’s market
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Prospective Financial Reinsurance
Length of coverage period
Finite term of contract (non-renewability)
Explicit profit sharing agreement
Limit on coverage
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Prospective Financial Reinsurance (Insight 23.1)
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Reinsurance Markets
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Reinsurance Premiums Globally (2005) (Figure 23.6)
North America50.4%
Europe34.2%
Asia10.3%
Rest of the World5.1%
Source: Datamonitor (2005)
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Reinsurance Global Market Share 1998 vs. 2008
Standard & Poor’s (2009)
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Cession Rate by Region (1998) (Table 23.3)
No recent updates are found regarding cession distribution.
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Top 20 Global Reinsurers (2007)
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Top 15 Global Reinsurers (2008)
Standard & Poor’s (2009) Total is for Top 40 companies.
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US Reinsurers (2009)
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Top 10 Global Reinsurance Brokers (2006)
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Reinsurance in Emerging Markets
Reinsurance is crucial, as domestic companies tend to have low levels of capitalization and keep low retentions (and a correspondingly high demand for reinsurance).
Insuring industrial infrastructure necessitates technical expertise.• Historically, large global reinsurers have provided risks assessment and
underwriting services
Most insurers in developing countries have proportional treaties as the basis of their reinsurance programs.
Fronting is common in developing countries.
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Reinsurance in Emerging Markets
Compulsory placement of reinsurance as a means of the local government’s attempt to:• Diversify the pools of risks from individual insurers to the national
reinsurer• Permit more favorable terms and prices when the national reinsurer
retrocedes risks internationally• The global trend is to abandon such practices, as compulsory
cessions usually harm markets relying on them.
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Compulsory Reinsurance Cessions (Table 23.5)
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Reinsurance Regulation
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Reinsurance Regulation
In general, reinsurance subject to less stringent regulation than is direct insurance• Even so, of critical concern because of its importance to the stability
and growth of insurance markets• Further, the market internationally dominated by a relatively small
number of very large reinsurers
Current initiatives largely the domain of advanced economies and intergovernmental organizations
Table 23.6
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Reinsurance Regulation
The IAIS Standard on Supervision of Reinsurers (2003)
• Principle One. Regulation and supervision of reinsurers’ technical provisions (loss reserving), investments and liquidity, capital requirements and policies and procedures to ensure effective corporate governance should reflect the characteristics of its business and be supplemented by systems for exchanging information among supervisors.
• Principle Two. Except as stated in Principle One, regulation and supervision of the legal forms, licensing and the possibility of withdrawing the license, fit-and-proper testing, changes in control, group relations, supervision of the entire business, on-site inspections, sanctions, internal controls and audit, and accounting rules applicable to reinsurers should be the same as those for primary insurers.
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Reinsurance Regulation
The E.U. Reinsurance Directive (2005)
• Supervisory power
• Single licensing
• Solvency provision
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Regulatory Developments in Reinsurance (Table 23.6)
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Reinsurance Issues (new for discussion)
Meaning and application of reinsurance
• Alternative risk transfers, especially insurance-linked securitizations
Taxation issues
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Discussion Questions
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Discussion Question 1
What advantages and disadvantages would an insurance company expect from ceding its risks (a) facultatively or (b) using a treaty?
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Discussion Question 2
Describe how premiums and losses are shared in (a) surplus treaty reinsurance and (b) working XL reinsurance.
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Discussion Question 3
What effect would you expect from continuing consolidation in the reinsurance market? Discuss its impact on competition, capacity and reinsurance market security.
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Discussion Question 4
An author cited in this chapter wrote “reinsurance can be viewed as both a leverage and a risk management mechanism.” Explain.
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Discussion Question 5
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?
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Discussion Question 6
In view of the trends in the reinsurance market, what is their likely impact on reinsurance distribution systems.
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Discussion Question 7
Why are the world’s largest reinsurance firms located in Europe?