What is Reinsurance?

“Insurance for Insurance Companies”.

More precisely, Reinsurance transfers insurance underwriting risk to third-party organizations.

Introduction

(Re)Insurance Financial Strategies

Pooling

• large number of small risks, where individual premiums inadequate to cover individual losses

Funding

• Individual risks’ premiums set high enough to cover likely losses (plus expenses and profit)

Speculating

• Large, unique exposure; low chance of loss; potential loss is very high


• Low enough likelihood that expected return greater than cost of capital

Basic Strategy	Insurance Example	Reinsurance Example	Business Constraints	Low-Cost Providers
Funding	• Dental insurance • WC retro	• Net account quota share	• Processing • Leverage	• Class of business specialists
Pooling	• HO fire • Auto BI	• Working layers	• Line size limits • Spread	• Diversified multi-line underwriters
Speculating	• Trophy properties • EQ shake	• Property cat • EQ quota share	• Aggregate exposure • Volatility	• High capital • Tolerant of volatility • Price-setters

Reinsurance and Holborn’s Role

Reinsurance - Other Characteristics

Reinsurance contracts derive value from insurance polices (although reinsurance transactions rarely involve original policyholders).

For a premium, an insurance company cedes portions of its insurance risk to a reinsurance company to transfer possible loss.

Reinsurance rates and forms are unregulated; however, the parties to a reinsurance transaction must be licensed (or reinsurers’ liability collateralized) for the reinsurance transaction to be fully recognized by insurance regulators (and, thus, for insurance companies to receive statutory accounting benefit from the transaction).

Types of Reinsurance - Summary

There are two types of reinsurance

• Facultative


• Treaty

Each type of reinsurance can be structured in one of two ways

• Excess of Loss (i.e., limit and retention)


• Pro Rata (a/k/a, “proportional”)

Treaty excess of loss reinsurance can apply on one of the three basis:

• Per Risk


• Per Occurrence (a/k/a, “Catastrophe”)


• Aggregate (a/k/a, “Stop Loss”)

Facultative Reinsurance

Facultative reinsurance applies to an individual risk, i.e., one commercial fire policy or even only one location. Insurer and reinsurer agree to the reinsurance terms on each individual agreement. It is generally used to reinsure:

1. extra-hazardous or unusual risks which might be excluded from treaty reinsurance agreements.


2. high valued risks with policy limits exceeding maximum treaty parameters.

For Property risks, specific information about construction, usage, contents, fire protections and other safety attributes will be assessed by the underwriter. For Casualty exposures, revenue, coverage type, and claims history are key underwriting considerations.

Both pro rata and excess of loss forms are used.

Facultative premiums are usually based on the ceding company’s exposures, not it’s premium. So, $25 per car, not 2% of Automobile premiums

Treaty Reinsurance

Treaty reinsurance applies to an insurance company’s entire book of business, such as all commercial fire polices, all automobile policies, all workers’ compensation policies, all homeowners policies, or, more generally, any combination of the above.

Certain risks are inevitably excluded to help define the exposure for the treaty underwriter, who must rely on the capabilities of the ceding carrier in determining the worth of any particular risk.

Both pro rata and excess of loss forms are used.

Treaty reinsurance premiums is usually set as a percentage of the ceding companies original premiums.

Pro Rata (or Proportional) Reinsurance

Insurer shares with the reinsurer all of the premiums and losses in a certain percentage.

Two forms of pro rata: Quota Share and Surplus Share.

Example: 80% Homeowners Quota Share. Insurer retains 20% of each and every policy; the reinsurer accepts 80%.

Surplus Share: The insurer and reinsurer share a variable percentage of loss and premium for each risk (not a fixed percentage, like a quota share).

Example: $4Mn home, subject to a surplus share contract with a minimum retention of $1Mn and maximum cession of $3Mn.

• In this situation, the Reinsured can choose to cede anywhere from 0% to 75% of the risk (being $3Mn. of $4Mn. value).


• Given no maximum retention, the Reinsured can keep the entire risk net.


• If the risk is deemed undesirable, the Reinsured can cede a maximum of $3Mn, and retain $1 Mn. In this instance, 75% of the loss and premium is ceded to the reinsurer.

Other examples (same surplus share structure)

• $2Mn. Home Up to 50% cessions (being $1Mn. of $2Mn.)


• $1.5Mn. Home Up to 33% cession (being $500,000 of $1.5Mn.)

Pro Rata Pricing Mechanism: Ceding commission.

Two Options:

• Flat: Fixed percentage.


• Sliding Scale: Fluctuates with actual loss experience, subject to a minimum and maximum.

Why buy pro rata protection?

• To reduce net written premiums and underwriting leverage (i.e., Finance, “surplus relief”)


• Capacity for individual risks


• Catastrophe protection

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