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INTRODUCTION TO REINSURANCE

NOLAN ASCH CAS RATEMAKING SEMINAR MARCH 10-11, 2005

INT-6

INSURANCE
The insurer insures the individual or the corporation

REINSURANCE
The REINSURER insures the insurance company

REINSURANCE PLACEMENT MECHANISMS

DIRECT

BROKER

INSURANCE vs. REINSURANCE


BOTH concerned with future contingencies BOTH require underwriting skills (risk) BOTH involve transfer of risk BOTH require payment of premium BOTH provide protection BOTH subject to (some) regulation

REINSURANCE
Buyers assumed to be knowledgeable Responds to actual loss Provides indemnification only Reimburses for payments already made Usually Global

FUNCTIONS OF REINSURANCE

CAPACITY

CAPACITY
Single Risk (Fac - Sears Tower) PORTFOLIO (Treaty)

CAPACITY MECHANISMS
Excess-of-Loss Quota Share

FUNCTIONS OF REINSURANCE
CAPACITY CATASTROPHE

CATASTROPHE
QUOTA SHARE EXCESS OF LOSS SECURITIZATION

FUNCTIONS OF REINSURANCE
CAPACITY CATASTROPHE STABILIZATION

STABILIZATION
Reduction in Variance (swings)

STABILIZATION
Extreme contractual case STOP-LOSS Aggregate Excess

FUNCTIONS OF REINSURANCE
CAPACITY CATASTROPHE STABILIZATION FINANCING

FINANCING
Reducing Liabilities
Ceding Commissions Overrides

FINANCING
May increase PHS due to transaction

FINANCING
Finite Reinsurance...... Pre-Elliott Spitzer ALL Reinsurance is Financial Post Elliott Spitzer I dont think so.

FUNCTIONS OF REINSURANCE

CAPACITY CATASTROPHE STABILIZATION FINANCING ENTER AND EXIT MARKETS

ENTER OR EXIT MARKETS


Lessens risk as you learn With 100% Q/S you exit

FUNCTIONS OF REINSURANCE
CAPACITY CATASTROPHE STABILIZATION FINANCING ENTER AND EXIT MARKETS UTILIZE REINSURER EXPERTISE

USING REINSURER EXPERTISE


Large or unusual claims Large or unusual risks Special relationships and/or knowledge

LIMITATIONS OF REINSURANCE
Will NOT make bad business profitable Transaction Costs Rating Agency Impacts (Gross/Net)

How Reinsurance Is Priced in Practice


Hypothetical Examples

NO PRICE REGULATION

(virtually)

CASE BY CASE

NEGOTIATION

FLEXIBILITY IN STRUCTURE Contractual

EXCESS OF LOSS

LAYERING

$19.75 Mill xs $0.25 Mill


(sounds like a wide layer)

TYPICAL LAYERING
10M xs 10M 5M xs 5M 3M xs 2M 1M xs 1M 500 xs 500 250 xs 250 Price Price Price Price Price Price F E D C B A

High Frequency/ Low Severity


Buffer layers ie 250 xs 250
Price A
250 xs 250

Low Frequency/ High Severity


10M xs 10M Price F

Capacity Layers i.e. 10m xs 10m

CLIENT/BROKER NEGOTIATION
Change or re-subdivide the layering

LAYER TRAP MANY PERMUTATIONS

Pricing for 500 xs 500

Later, request the 250xs 250

LAYER TRAP

at last minute Ask for 150 xs 100 --Requires more data

PRICING TRAPS

AGGREGATE ANNUAL DEDUCTIBLES

ASSUME A 10% RATE


Request a 1% AAD Request a 2% AAD Request an 8% AAD NOW the risk/variance becomes LARGE vs a 2% rate

INFORMATION FOR PRICING


NO standards

WHAT THE REINSURER WANTS


EVERYTHING

WHAT THE BROKER/CLIENT MAY WISH TO SUPPLY


NOTHING

POSSIBLE OUTCOMES

GIGO
Garbage-In Garbage-out

EL NIO

NINO
Nothing-in Nothing-out

EXPERIENCE RATING
Using losses of the risk to price the risk.

STANDARD
All losses at half the attachment point & up

ACTUARIAL APPROACH
DETRENDED LOSSES Varies with age of claim BEGINS to show ACTUAL CLAIMS as a sample outcome

EXPOSURE RATING
Attempt to rate Reinsurance based upon the TRUE underlying exposures Proxies for TRUE exposures:
Limits Profiles = Subject Premium by policy limit Exposures by policy limit (still not the TRUE exposure)

LIMITS PROFILE
$100,000 Policy Limit
Yr 1997 10% of exposures at $100,000 Yr 1998 25% of exposures at $100,000 Yr 2002 90% of exposures at $100,000

loss was atypical in 1997 layer is effective 7/1/04

Include 97 and 98 losses at $100,000

LIMIT LOSS

limit loss to 1997 policy limits or trend and develop loss beyond policy limits

WE DONT DO THIS ANYMORE


Throw out claims from MGAs, classes or states we no longer write

QUOTA SHARE ISSUES


Moral hazard and Retention - 1% net Ceding Commission Overrides Sliding Scales Loss Corridors

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