Re Insurance

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Reinsurance
From Wikipedia, the free encyclopedia

Jump to: navigation, search Reinsurance is a means by which an insurance company can protect itself against the risk of losses with other insurance companies. Individuals and corporations obtain insurance policies to provide protection for various risks (hurricanes, earthquakes, lawsuits, collisions, sickness and death, etc.). einsurers, in turn, provide insurance to insurance companies.

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1 Functions of reinsurance o 1.1 Risk transfer o 1.2 Income smoothing o 1.3 urp!us re!ief o 1." #r$itrage 2 %&pes of reinsurance o 2.1 'roportiona! o 2.2 (on)proportiona! *e+cess of !oss, 3 -ontracts " .arkets / Retrocession 0 ee a!so 1 2+terna! !inks

[edit] Functions of reinsurance
!here are many reasons an insurance company will choose to reinsure as part of its responsibility to manage a portfolio of risks for the benefit of its policyholders and investors.

[edit] Risk transfer
!he main use of reinsurance is to allow the ceding company to assume individual risks greater than its si"e would otherwise allow, and to protect the cedant against catastrophic losses. einsurance allows an insurance company to offer larger limits of protection to a policyholder than its own capital would allow. If an insurance company can safely write only #$ million in limits on any one policy, it can reinsure (or cede) the amount of the limits in e%cess of #$ million to reinsurers. einsurance&s highly refined uses in recent years include applications where reinsurance was used as part of a carefully planned hedge strategy.

[edit] Income smoothing

einsurance can help to make an insurance company&s results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage.

[edit] Surplus relief
einsurance can improve an insurance company's balance sheet by reducing the amount of net liability, and thereby increasing surplus. (urplus, assets less liabilities, is roughly the same as shareholder equity on a balance sheet of a non)insurance company.

[edit] Arbitrage
!he insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than what they believe the cost is for the underlying risk.

[edit] Types of reinsurance
[edit] Proportional
*roportional reinsurance (mostly known as quota share reinsurance) involves one or more reinsurers taking a stated percent share of each policy that an insurer produces (+writes+). !his means that the reinsurer will receive that stated percentage of each dollar of premiums and will pay that percentage of each dollar of losses. In addition, the reinsurer will make an upfront payment called the +ceding commission+ to the insurer to compensate the insurer for the costs of writing and administering the business (agents' commissions, modeling, paperwork, etc.). !he insurer may seek such coverage for several reasons. First, the insurer may not have sufficient capital to prudently retain all of the business that it is capable of producing. For e%ample, it may only be able to offer #, million in coverage, but by purchasing proportional reinsurance it might double or triple that limit. *remiums and losses are then shared on a pro rata basis. For e%ample, an insurance company might purchase a $-. quota share treaty/ in this case they would share half of all premium and losses with the reinsurer. In a 0$. quota share, they would share (cede) 123th of all premiums and losses. !he reinsurance company usually pays a commission on the premiums back to the insurer in order to compensate them for costs incurred in sourcing and administering (e.g. retail brokerage, ta%es, fees, home office e%penses) the business (usually 4-)1-.). !his is known as the ceding commission. !he other (lesser known) form of proportional reinsurance is surplus share. In this case, a 5line6 is defined as a certain policy limit ) say #,--,---. In a 7 line surplus share treaty the reinsurer could then accept up to #7--,--- (7 lines). (o if the insurance company issues a policy for #,--,---, they would keep all of the premiums and losses from that policy. If they issue a #4--,--- policy, they would give (cede) half of the premiums and losses to the reinsurer (, line each). If they issue a #$--,--- policy, they would cede 8-. of the premiums

and losses on that policy to the reinsurer (, line to the company, 3 lines to the reinsurer 32$ 9 8-.) If they issue the ma%imum policy limit of #,,---,--- then the reinsurer would then get 7-. of all of the premiums and losses from that policy.

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on!proportional "e#cess of loss$

:on)proportional reinsurance, also known as e%cess of loss reinsurance, only responds if the loss suffered by the insurer e%ceeds a certain amount, called the retention. ;n e%ample of this form of reinsurance is where the insurer is prepared to accept a loss of #, million for any loss which may occur and purchases a layer of reinsurance of #3m in e%cess of #, million ) if a loss of #1 million occurs the insurer pays the #1 million to the insured(s), and then recovers #4 million from their reinsurer(s). In this e%ample, the insurer will retain any loss e%ceeding #$ million unless they have purchased a further e%cess layer (second layer) of say #,- million e%cess of #$ million. <%cess of loss reinsurance can have two forms ) 5*er isk6 or 5*er =ccurrence6 (>atastrophe or 5>at6). In per risk, the cedant&s insurance policy limits are greater than the reinsurance retention. For e%ample, an insurance company might insure commercial property risks with policy limits up to #,million and then buy per risk reinsurance of #$ million in e%cess of #$ million. In this case a loss of #? million on that policy will result in the recovery of #, million from the reinsurer. In catastrophe e%cess of loss, the cedant&s insurance policy limits must be less than the reinsurance retention. For e%ample, an insurance company issues homeowner's policy limits of up to #$--,--- and then buys catastrophe reinsurance of #44,---,--- in e%cess of #1,---,---. In that case, the insurance company would only recover from reinsurers in the event of multiple losses in one event (i.e hurricane, earthquake, etc.) !his same principle applies to casualty reinsurance e%cept that in the case of >atastrophe e%cess the word 5>lash6 is used.

[edit] Contracts
@ost of the above e%amples concern reinsurance contracts that cover more than one policy (treaty). einsurance can also be purchased on a per policy basis, in which case it is known as facultative reinsurance. Facultative reinsurance can be written on either a quota share or e%cess of loss basis. Facultative reinsurance is commonly used for large or unusual risks that do not fit within standard reinsurance treaties due to their e%clusions. !he term of a facultative agreement coincides with the term of the policy. Facultative reinsurance is usually purchased by the insurance underwriter who underwrote the original insurance policy, whereas treaty reinsurance is typically purchased by a senior e%ecutive at the insurance company. einsurance treaties can either be written on a 5continuous6 or 5term6 basis. ; continuous contract continues indefinitely, but generally has a 5notice6 period whereby either party can give its intent to cancel or amend the treaty within 7days. ; term agreement has a built)in e%piration date. It is common for insurers and reinsurers to have long term relationships that span many years.

[edit] %arkets
@any reinsurance placements are not placed with a single reinsurer but are shared between a number of reinsurers. (for e%ample a #1-,---,--- %s of #4-,---,--- layer may be shared by 1- reinsurers with a #,,---,--participation each) !he reinsurer who sets the terms (premium and contract conditions) for the reinsurance contract is called the lead reinsurer/ the other companies subscribing to the contract are called following reinsurers (they follow the lead). ;bout half of all reinsurance is handled by reinsurance brokers who then place business with reinsurance companies. !he other half is with 5direct writing6 reinsurers who have their own production staff and thus reinsure insurance companies directly.

[edit] Retrocession
einsurance companies themselves also purchase reinsurance and this is known as a retrocession. !hey purchase this reinsurance from other reinsurance companies. !he reinsurance company who sells the reinsurance in this scenario are known as 5retrocessionaires.6 !he reinsurance company that purchases the reinsurance is known as the 5retrocedent.6 It is not unusual for a reinsurer to buy reinsurance protection from other reinsurers. For e%ample, a reinsurer that provides proportional, or pro rata, reinsurance capacity to insurance companies may wish to protect its own e%posure to catastrophes by buying e%cess of loss protection. ;nother situation would be that a reinsurer which provides e%cess of loss reinsurance protection may wish to protect itself against an accumulation of losses in different branches of business which may all become affected by the same catastrophe. !his may happen when a windstorm causes damage to property, automobiles, boats, aircraft and loss of life. !his process can sometimes continue until the original reinsurance company unknowingly gets some of its own business (and therefore its own liabilities) back. !his is known as a 5spiral6 and was common in some specialty lines of business such as marine and aviation. (ophisticated reinsurance companies are aware of this danger and through careful underwriting attempt to avoid it. In the ,78-s, the Aondon market was badly affected by the intentional creation of reinsurance spirals, which concentrated risks into the hands of a few reinsurance syndicates. ; series of catastrophic losses in the late ,78-s bankrupted these syndicates causing many ceding insurance companies to lose their effective coverage. It is important to note that the insurance company is obliged to indemnify its policyholder for the loss under the insurance policy whether or not the reinsurer reimburses the insurer. @any insurance companies have gotten into trouble by purchasing reinsurance from reinsurance companies that did not or could not pay their share of the loss. In a $-. quota share the insurance company could then be left with half the premium and the entire loss. !his is a genuine concern when purchasing reinsurance from a reinsurer that is not domiciled in the same country as the insurer. emember that losses come after the premium, and for certain lines

of casualty business (e.g. asbestos or pollution) the losses can come many, many years later. (tarting in the late ,77-s and especially following 7),, and Burricane Catrina, reinsurers began to seek substantial portions of their retrocessional protection through Industry Aoss Warranties (or +IAW's+, a form of standardi"ed insurance in which losses are paid based on industry losses rather than company losses), >atastrophe bonds and einsurance (idecars.

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