THE REINSURANCE PRINCIPLES

Contents

1. Concepts of Insurance and Reinsurance

2. Functions of Reinsurance

3. Types & structures of Reinsurance

4. Introduction to Pricing

5. Introduction to Portfolio Strategy

6. Functions of a Reinsurance broker

Definitions of Insurance

• Why does a company insures itself?

– Material and Immaterial assets are exposed to various risks

– The shareholders are willing to carry the Entrepreneurial

Risks; hence all other Risks must be dealt with by a Third

Party (Insurance or State)

What is insurable?

– A risk that is Unpredictable, External and Irresistible

– A risk that is Quantifiable in order to Sell it

– A risk that is Financially bearable by an Insurer

• How does a company insures itself?

– By transferring the Risk to a third party, the Insurer

– By transforming a Variable cost (Risk) into a Fixed cost

Insurance is Risk Diversification

• Insurance main Diversification is TIME

– For a given Risk, the probability of loss occurrence is

below 1: there could be a claim or not

– In a given area, the risks are not correlated : a Fire on

building A doesn’t imply a Fire on building B elsewhere

in the same town

– The probability of having all the Risks incurring a loss at

the same time is low: 1 every 50, 100, 200… years

– Hence, a premium representing a fraction of the value

of each Risk is enough to cover a Loss from time to time

– But an extreme event may correlate Risks which are

normally Independent : here is the border of Insurance

and the gateway to Reinsurance

Definitions of Reinsurance

• Why does an insurer buy Reinsurance?

– In case of exceptional event, i.e. accumulation of many small events or one extreme event that exterminate the Time diversification of the Insurer’s portfolio (ex. Earthquake)

• What is reinsurance?

– Formally, it’s a contract between an Insurer and a Reinsurer, upon which the Reinsurer commits to pay his share of a claim against a premium

– Risk wise, it’s a way for the insurer to optimize and homogenize its portfolio of risks.

• How can reinsurance be viable?

– Time diversification is replaced by Geographical diversification: an Earthquake in Japan is not correlated to a Storm in Europe or a Terror act in New York. Reinsurance is written in various

independent regions and also in various lines of business. – Appropriate Pricing is important, but monitoring of Risk

Functions of Reinsurance

• Risk transfer

– Insurer can assume greater individual risks than assets allows

• Income smoothing

– Insurer’s results are more predictable by absorption of large losses and reduction of

capital needed

• Surplus relief

– Insurer’s writings being limited by solvency margin, reinsurance allows insurer to keep

writing without increasing its capital

• Reinsurer’s expertise

– Insurer desires to benefit from the expertise and rating ability of the reinsurer

• Creating a manageable and profitable portfolio

– Insurer improves balance and homogeneity of its portfolio by getting rid of peak

exposure and reducing volatility

• Managing cost of capital

Types of Risks and reinsurance Classes

• Type of risk exposures

– Natural perils (storm, cyclone, earthquake, tsunami…)

– Industrial & technological perils (product default, explosion…)

– Terrorism (correlation of risks : ex. World Trade Center)

– Pollution

– Nuclear (state or pools)

– Decenial Liabiliy following Constructions (Terminal E Paris)

• Reinsurance classes

– Property and consequential business interruption

– Liabilities : general, motor, professional, products

– Marine, Aviation and Spatial

– Accident, Life and Health

– Workmen’s compensation…

Types & structures of Reinsurance

• Facultative or Treaty

– Facultative: reinsurance of an individual policy or risk with

the ability of the reinsurer to decline. Used for industrial,

special and technological risks, on top or out of treaty

capacities. Risk of anti selection and high administration costs

– Treaty: annual or multiyear contract upon which the insurer

must cede all the risks concerned and the reinsurer can’t

decline. No anti selection and reduced administration.

• Proportional or Non Proportional

– Proportional: reinsurer takes a stated percent share of each

policy the insurer writes and carries the same claims share

– Non-Proportional: reinsurer commits to pay claims in excess

of a given amount and within a given limit ; and in exchange

receives a premium

Proportional Reinsurance

• Quota-Share

– For a given line of business, the insurer cedes a fixed percentage of all the policies and receives the same percentage of all claims for this line of business.

– The reinsurer pays a commission to the insurer for underwriting and administration costs

– Interests of insurer and reinsurer are aligned, out of commission. – Peak exposures are not cancelled, but reduced proportionally

• Surplus

:

– The insurer cedes only the risks exceeding a given amount (retained line) and for each risk the proportion of premium corresponding to the ceded risk exposure.

– It allows the transfer of peak exposures and homogenizes the retained portfolio

Proportional Reinsurance

Non-Proportional Reinsurance

• Excess of Loss:

– Reinsurance attaches only for claims in excess of a certain amount (Priority) and up to a given amount (Limit) per claim. Sometimes it’s unlimited (ex: Motor Liability for bodily injury).

– In exchange, the reinsurer receives a premium expressed as a percentage of the total ceded premium (Rate) or the Limit (ROL) – An XoL may attach per Event or per Risk

• Stop Loss:

– Reinsurance attaches in excess of a total amount of claims per year, expressed as a percentage of Loss Ratio up to a given Loss Ratio, ex. 20% xs 110%. Loss ratio = Losses/ Premiums

– A SL protects the annual results of a given class of business

– A SL applies for classes of business for which an event is difficult to define. Ex: hail, water damages, drought…

Non-Proportional Reinsurance

The diligence of a Reinsurance broker

• Broker’s Role

– Translator of Cultural differences – Mediator & Moderator

– Advisor

– Understand Client's needs and requirements

– Understand the prevailing environment, be it Market, Political, Economic or Social

– Assess the strengths and weaknesses of each risk carrier, understand their portfolio strategy • Broker’s Duties

– Ensure that Risk Exposure’s data is well presented to underwriters – Ensure that Client discloses its risk exposure to underwriters – Adjust to Client’s needs & requirements

– Ability to deliver a Tailor made product or service whenever needed – Regional presence as to follow Client’s geographical expansion – Maintain a close relationship with underwriters

• Broker’s Services

– Negotiate Competitive & Realistic terms

– Ensure fair Competition among the various underwriters in the market – Provide the broadest Coverage available to match Client’s needs – Cope with Client’s budget constraint

– Ensure diligent Claims settlement – Anticipate market downturns

Conclusion:

• Reinsurance is a shield against exceptional events

• Risk assessment is based on quantitative

methodologies

• But statistics and modeling have their limits

• Market Knowledge, Pragmatism and Humility are also

helpful tools, when dealing with randomness

• Beyond all technical issues, reinsurance is about

trust-based, long term and balanced relation relationship

Top 25 Globale Reinsurance Group

1 AA- Munich Reinsurance Co Germany 29 077 2 A+ Swiss Reinsurance Co Swizerland 24 296

3 AA+ Berkshire Hathaway Re US 12 123

4 AA- Hannover Rueckversicherung AG Germany 10 196

5 A Scor SE France 7 500

6 A+ LIoyd's UK 6 702

7 AA- Reinsurance Group of America Inc US 5 349 8 A+ Transatlantic Holdings Inc US 4 108

9 AA- Partner Re Ltd Bermuda 3 989

10 A+ Everest Reinsurance Co Bermuda 3 505

11 AA Tokio Marine Group Japan 2 778

12 A XL Re Ltd Bermuda 2 403

13 A- Korean Reinsurance Co Korea 2 227

14 A- Odyssey Re US 2 031

15 AA- Transamerica Re (AEGON) US 1 928

16 AA Mitsui Sumitomo Insurance Co Ltd Japan 1 705

17 AA Mapfre Re Spain 1 684

18 AA- Sompo Japan Insurance Inc Japan 1 661 19 AAA Caisse Centrale de Reassurance France 1 653

20 A+ Toa Re Co Ltd Japan 1 640

21 A- White Mountains Re Group Ltd Bermuda 1 607 22 A+ AXIS Capital holdings Ltd Bermuda 1 533

Rank Company Country Net Reinsurance

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