Risk management tools (1) (disadvantages of reinsurance (profit is passed…
Risk management tools (1)
reasons for reinsurance (SAD LIFE)
disadvantages of reinsurance
profit is passed from cedant to reinsurer
reinsurance premium is likely to exceed cost of benefits
liability may not be fully matched by reinsurance
possible liquidity issues
reinsurer may default
reinsurance may not be available on terms sought
claims split between the cedant and the reinsurer in pre-defined proportions
does not cap the claim paid by the cedant
written by treaty.
two types are quota share and surplus
Quota share- split is the same by all risks
surplus- proportion can vary by risk. Treaty specifies a retention level and maximum level of cover available.
reinsurer may also pay the cedant a reinsurance commission which an be used to provide financial assistance.
non-proportional reinsurance (or excess of loss)
cendant specifies a retention level. Cedant pays claims amount up to retention level, reinsurer pays the claim amount over the retention level
covers losses from a single claim from one insured risk
covers the aggregate losses from several insured risks, sustained from a defined peril (or perils) over a defined period, usually one year.
form of aggregate XL reinsurance
pays out if a "catastrophe" as defined in the contract occurs
form of aggregate XL
cove r based on aggregate losses, from all perils, arising on a company's whole account over a specified period, usually one year.
factors influencing the type of reinsurance products used
type of business
size and volatility of claims
does the insurer have lots of free assets or does it need financial assistance?
mutual (worried about financial assistance) or proprietary (worried about smoothing profits)?
does the insurer need expertise in a new or unusual product or new territory?
does the insurer want diversification through reciprocal arrangements (quota share)?
basic operation of the 5 ART products
integrated risk covers
multi-year, multi-line reinsurance contracts
avoids buying excess cover
lock into attractive terms
post loss funding
guarantees in exchange for a commitment fee funding will be provided on the occurrence of a specific loss. The funding is often a loan on pre-arranged terms or equity.
commitment fee will be lower than the equivalent insurance cost
transfer of insurance risk to the banking and capital markets
catastrophe and weather options
organisations with matching but uncorrelated risks can swap packages of risk so that each organisation has a greater risk diversification
reasons for ART (DESCARTES)