NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

ASSIGNMENT 2 : REINSURANCE

1. Discuss how the various methods of facultative reinsurance operate. Answer Facultative

Proportionate Quota Share

Non-Proportionate Excess of Loss

The features of Facultative Contracts are as follows :1. 2. 3. 4. The original insurer is not obliged to offer the risk and the reinsurer is not obliged to accept. Facultative means optional, both parties have a choice as to whether to enter into a contract or not. Each risk is considered individually. Each risk is a separate reinsurance contract.

FACULTATIVE PROPORTIONAL REINSURANCE An insurer cede a certain percentage to reinsurer(s) and in the event of a loss, insurer will recover the same share on the loss amount. The ceding company would be limiting its exposure to its retained share. For example :Sum Insured Net Retention Cede to Insurer A Cede to Insurer B Cede to Insurer C RM1,000,000 RM100,000 (10%) RM400,000 (40%) RM300,000 (30%) RM200,000 (20%)

Total share - 100%

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

Loss RM500,000. Claim Recoveries are as follows :Net Rentention pay RM50,000 (10%) Insurer A - pay RM200,000 (40%) Insurer B - pay RM150,000 (30%) Insurer C - pay RM100,000 (20%)

FACULTATIVE OBLIGATORY REINSURANCE Facultative Obligatory arrangement of a contract combine some of the principles of both facultative and treaty methods of proportional reinsurance. The details of the reinsurance contract are concluded in advance between insurer & reinsurer. The insurer has the freedom to decide whether to cede to the treaty or not. Reinsurer is obligated to accept the cessions once they have been made to the facility. In a similar way to Surplus Treaty, the capacity is a multiple of the ceding companys gross retention. FACULTATIVE EXCESS OF LOSS The reinsured selects a fixed monetary amount to retain on a particular risk and arranges excess of loss protection with reinsurers for any claim amounts which might exceed the fixed monetary retention. Net Retention RM500,000 XOL 1st Layer RM1,000,000 in excess of RM500,000 2nd Layer RM3,000,000 in excess of RM1,500,000

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

2. Differentiate between the premium and claims calculations for proportional and excess of loss reinsurance. Answer PROPORTIONAL BASIS When a risk is reinsured on a proportional basis, the premium and claims are shared between the insured and reinsurer by a certain fixed percentage. For example, the reinsured retained 50% of the risk and cede out 50% under proportional reinsurance, reinsurer will assume 50% of the liability, 50% of the claim and also 50% of the premium. The share must be equal to 100%. EXCESS OF LOSS As compared to reinsurance on a proportional basis, the premium, claims and liability will not be shared in an equitable manner. Non-proportional reinsurance is based on the size of loss and the reinsurers share in the risk. The Reinsured agree to assume loss up to a certain limit variously known as retention, deductible, first loss or excess. The balance of the risk, reinsured would purchased a Excess of Loss (XOL) cover. For example :A risk value at RM10 Million Net Retention : RM500,000 XOL : RM9.5 Million Xs of RM500,000 The loss must exceed RM500,000 before a claim can be made against an Reinsurer. The reinsurer would indemnify the reinsured once a loss exceeded RM500,000 but up to a maximum limit of RM9,500,000 (contractual limit).

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

3. Explain the operation of the main types of proportional treaties. Answer Treaty

Proportionate Quota Share Surplus Treaty

Non-Proportionate Excess of Loss Stop Loss

OPERATION OF PROPORTIONAL TREATIES A) The insurer is obligated to cede a fixed percentage of all their risks and the reinsurer is obliged to accept all the cessions made, usually up to a maximum amount any one claim. For example, under Fire Insurance, insurer retained 40% of all risks under Fire Class and reinsured 60%. The liability, claims and premium will be shared on the percentage stated. The Reinsurer agrees to give reinsurance commission to insurer for the cost of acquiring and managing the original business. Quota Share treaties carry the highest percentage of ceding commission compared with other types of proportional reinsurance arrangements. The disadvantage of a quota share involves the cession of all business within the retention patterns, large amounts of income are ceded away.

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

SURPLUS TREATIES B) The capacity of the Surplus Treaty is always a multiple of the ceding companys retention and referred as lines. For example :Net Retention - RM500,000 Ten lines surplus treaty - 10 x RM500,000 = RM5,000,000 If the sum insured is within the retention limit, no cession is made to the treaty.

Risk 1 2 3 4

Original Sum Insured (RM) 500,000 1,000,000 1,500,000 2,000,000

Company Retention (RM) 500,000 500,000 (50%) 500,000 (33.33%) 500,000 (25%)

Ceded to Surplus Treaty (RM) 500,000 (50%) 1,000,000 (66.67%) 1,500,000 (75%)

CLAIM RECOVERIES Risk 4 Claim Amount (RM) 1,000,000 Insurer (RM) 250,000 (25%) Surplus Treaty (RM) 750,000 (75%)

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

4. Discuss the various types of commission arrangements. Answer 1) FLAT RATE COMMISSION A flat rate commission is applied if a portfolio of business expected do have a very stable results. The commission will be shown as a percentage of the gross premium that will be ceded to reinsurers. This percentage differ on each class of business, type of reinsurance arrangement. The ceding commission should be sufficient to cover the companys own acquisition costs. 2) PROFIT COMMISSION The reinsured may seek an extra commission from reinsurers for giving them a share in a good risks. This payment would be allowed on a Quota Share and Surplus Treaty. In order to ascertain the profit commission, all components related to the profitability of the treaty need to be identified. The relevant details may form part of the profit commission calculations are :a) b) c) d) a) b) c) d) e) f) Income Premiums credited for the underwriting year Premium reserves from previous year Incoming premium portfolio Incoming loss portfolio Expenditure Losses and loss expenses paid during the underwriting year Outgoing loss portfolio Premium reserve at the end of the year Outgoing premium portfolio Ceding commission on premium, Fire Brigade charges, similar levies Allowance for reinsurers expenses

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

3)

SLIDING SCALE COMMISSION The sliding scale commission which not only automatically rewards the cedant for producing good result but also takes into consideration the possibility of imposing a penalty in the event of a poor performance. The reinsured debit the reinsurer a provisional commission on premiums paid during the year. This commission will be adjusted at the end of the year. The adjustment is determined in accordance with an agreed variable table of commission linked directly to the loss ratio achieved by the treaty.

4)

REVERSE PROFIT COMMISSION If a loss exceed an agreed loss ratio between reinsured & reinsurer, the cedant have to bear a certain portion of the loss amount rather than the reinsurers bearing the whole burden. For example, if the loss ratio of any treaty year exceed X % the reinsured shall bear Y % of the amount of by which the loss ratio exceed X %.

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

5. Distinguish between premium and claims reserves. Answer PREMIUM Premium is the gross written premiums equal to the premiums received for the year. For example :A Houseowner policy, risk value at RM100,000 Rate : 0.106% Total Gross Premium written = RM100,000 x 0.106% = RM106.00* Total premium received = RM106.00* * Excluding service tax & stamp duty CLAIMS RESERVE When a client of the insurer lodged a claim, the client have to inform the insurer the estimated claim amount. The insurer would set aside a claims reserve based on this estimated but take into consideration the duration of the claim, adjuster fee, other charges, administration cost etc.

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

6. What are the methods of calculating earned and unearned premium? Answer EARNED PREMIUM Written premium is premium registered on the books of an insurer or reinsurer at the time a policy is issued and paid for. Premium for a future exposure period is said to be unearned premium, i.e. the unexpired portion of the risk. For an individual policy, written premium minus unearned premium equals earned premium. UNEARNED PREMIUM The sum of all premiums representing the unexpired portions of the policies or contracts that the insurer or reinsurer has on its books as of a certain date. It is usually based on a formula of averages of issue dates and the length of term.

DATE SUBMITTED : 10/4/2007

NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

7. SENTOSA Insurance Company has the following reinsurance protection for its Fire portfolio. Net Retention: RM2 million. First Surplus Treaty Second Surplus Treaty : 15 Lines with per line of RM2, 000,000 : 10 Lines with per line of RM2, 000,000

The Company has further purchased a Catastrophe XOL cover as follows:Layer 1: RM750, 000 in excess of RM250, 000 Layer 2: RM5, 000,000 in excess of RM1, 000,000 a) Work out the sum insured of the following risks that will be ceded to the First Surplus,Second Surplus treaties and Facultative Reinsurance if any and also the claims recoveries respectively. Risk 1 2 3 4 5 Sum Insured RM70 mil RM50 mil RM20 mil RM10 mil RM35 mil Losses RM25,000,000 RM 5,000,000 RM15,000,000 RM10,000,000 RM30,000,000

b) Assuming that losses for items 1, 4 and 5 happened on the same day due to flood. What would be the amount recovered from the XOL reinsurers and what is the amount retained by Sentosa Insurance Company? RISK 1 2 3 4 5 SUM INSURED 70M 50M 20M 10M 35M RETENTION 2M 2M 2M 2M 2M 1ST SURPLUS 30M 30M 30M 30M 30M 2ND SURPLUS 20M 20M 20M 20M 20M

DATE SUBMITTED : 10/4/2007

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NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

Answer A) CESSION TO 1ST SURPLUS, 2ND SURPLUS & FAC RI RISK 1 2 3 4 5 SUM RETENTION INSURED (RM) (RM) 70M 2M (2.86%) 50M 20M 10M 35M 2M (4%) 2M (10%) 2M (20%) 2M (5.71%) 1ST SURPLUS (RM) 30M (42.86%) 30M (60%) 30M (90%) 30M (80%) 30M (85.71%) 2ND SURPLUS (RM) 20M (28.57%) 18M (36%) 3M (8.58%) FAC RI (RM) *18M (25.71%)

* REMARKS Insurer would cede RM18M to Facultative Reinsurer if such facility is arranged. Otherwise, the insurer have to bear RM18M. CLAIMS RECOVERY RISK 1 2 3 4 5 LOSSES (RM) 25M 5M 15M 10M 30M INSURER (RM) 715,000 (2.86%) 200,000 (4%) 1,500,000 (10%) 2,000,000 (20%) 1,713,000 (5.71%) 1ST SURPLUS (RM) 10,715,000 (42.86%) 3,000,000 (60%) 1,350,000 (90%) 8,000,000 (80%) 25,713,000 (85.71%) 2ND SURPLUS (RM) 7,142,500 (28.57%) 1,800,000 (36%) 2,574,000 (8.58%) FAC RI (RM) 6,427,500 (25.71%) -

DATE SUBMITTED : 10/4/2007

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NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

b) CATASTROPHE XOL RECOVERIES RISK SUM INSURE D (RM) 70M 10M 35M LOSSES INSURER INSURER (RM) RETENTION PAY (RM) (RM) 25M 10M 30M 715,000 2,000,000 1,713,000 250,000 250,000 250,000 1ST LAYER (RM) 465,000 465,000 465,000 2ND LAYER (RM) 1,250,000 963,000

1 4 5

DATE SUBMITTED : 10/4/2007

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NAME : CHONG KIM FOONG COMPANY : SIME DARBY LOCKTON SDN BHD

8.

Insurer B has the following treaties to protect its engineering portfolio: A 60% quota share treaty with limit of RM1, 000,000; and a ten line surplus treaty with gross retention of RM1,000,000. Insurer B pays the following separate losses under its engineering insurance account during the treaty year : Policy 1 2 Sum Insured (RM) 800,000 5,000,000 Losses Paid (RM) 500,000 3,000,000

Calculate the reinsurance recoveries from these reinsurers. Answer 60% Quota Share Gross Retention RM1,000,000 40% Net Retention 10 Lines Surplus Treaty RM10,000,000 POLICY 1 2 POLICY 1 2 SUM INSURED (RM) 800,000 5,000,000 SUM INSURED (RM) 800,000 5,000,000 NET RETENTION (RM) 320,000 (40%) 400,000 (8%) LOSSES PAID (RM) 500,000 3,000,000 SURPLUS TREATY (RM) 4,000,000 (80%)

QUOTA SHARE (RM) 480,000 (60%) 600,000 (12%)

CLAIMS RECOVERIES POLICY LOSSES PAID (RM) 1 500,000 2 3,000,000

NET RETENTION (RM) 200,000 240,000

QUOTA SHARE (RM) 300,000 360,000

SURPLUS TREATY (RM) 2,400,000

DATE SUBMITTED : 10/4/2007

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