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6 Principle Functions of Reinsurance
- 1. Increase large line capacity
- 2. Provide catastrophe protection
- 3. Stabilize loss experience
- 4. Provide surplus relief
- 5. Facilitate withdrawal from a market segment
- 6. Provide underwriting guidance
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4 Functions of Facultative Reinsurance
- 1. Provide large line capacity for exposures that exceed limits of treaty agreements
- 2. Reduce the primary's exposure in a given geographic location
- 3. Insure an exposure with a typical hazard characteristics
- 4. Insure particular classes of exposures that are excluded under treaty reinsurance
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Treaty vs. Facultative Reinsurance
- 1. Treaty:
- a) Reinsurance of an entire class or portfolio of loss exposures
- b) Obligatory: all of primary's individual loss exposures that fall within the treaty are automatically reinsured
- 2. Facultative:
- a) Reinsurance of individual loss exposures
- b) Primary insurer chooses which exposures to submit to reinsurer
- c) Non-Obligatory: Reinsurer can accept or reject any loss exposure submitted
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2 Hybrids of Treaty & Facultative Reinsurance
- 1. Facultative Treaty
- a) Used when a class of business has insufficient loss exposures to justify treaty reinsurance
- b) Has sufficient number of loss exposures to determine the details of future individual placements
- 2. Facultative Obligatory Treaty
- a) Primary has option of ceding, but reinsurer is obligated to accept
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3 Reinsurance Professional and Trade Associations
- 1. Intermediaries and Reinsurance Underwriters Association (IRU)
- a) Publishes Journal of Reinsurance which discusses concepts and research affecting market
- b) Conducts claims seminars and conferences
- 2. Brokers & Reinsurers Markets Association (BRMA)
- a) Described as a forum for treaty reinsurance professionals
- b) Seeks to identify and address industry-wide operational issues (e.g., contract wording)
- 3. Reinsurance Association of America (RAA)
- a) Provides information on reinsurance issues to interested parties outside the industry
- b) Analyzes aggregate data and conducts seminars
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4 Factors A Primary Insurer Should Consider When Determining a Line on a Single Loss Exposure
- 1. Maximum amount of insurance or limit of liability allowed by insurance regulations
- 2. Size of potential loss or losses that can be retained without impairing insurer's earnings or surplus
- 3. Specific characteristics of a particular loss exposure (e.g.,property attributes)
- 4. Amount, types, and cost of available reinsurance
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3 Ways Reinsurance Can Stabilize Loss Experience
- 1. Limit liability for a single loss exposure
- 2. Limit liability for several loss exposures affected by a common event
- 3. Limit liability for loss exposures that aggregate claims overtime
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Novation vs. Portfolio Reinsurance
- 1. Novation
- a) Completely eliminates liabilities of the primary insurer
- 2. Portfolio Reinsurance
- a) Primary is still responsible for paying claims, but gets reimbursed by reinsurer
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3 Options a Primary Insurer May Have When It Decides To Withdraw From A Market
- 1. Stop selling new policies and continue insurance until all policies expire (runoff)
- 2. Cancel all policies (if regulations permit), and refund unearned premiums to insureds
- 3. Withdraw from market segment by purchasing portfolio reinsurance
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3 Common Types of Ceding Commissions in Reinsurance
- 1. Flat commission is a ceding commission that is a fixed percentage of the ceded premiums
- 2. Profit-sharing commission: is a ceding commission that is contingent on the reinsurer realizing a predetermined percentage of excess profit on ceded loss exposures
- 3. Sliding scale commission is a ceding commission based on a formula that adjusts the commission according to the protability of the reinsurance agreement
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7 Characteristics of Finite Reinsurance
- 1. Limited transfer of insurance risk to the reinsurer
- 2. Anticipated investment income is expressly acknowledged as an underwriting component
- 3. Used with a combo of traditionally insurable and traditionally uninsurable loss exposures
- 4. Usually provided for a multi-year term
- 5. Reinsurer premium can be a substantial percentage of there insurance limit
- 6. Designed to cover high severity losses
- 7. Reinsurer commonly shares profits with the primary isnurer when it has favorable loss experience
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2 Ways of Treating Loss Adjustment Expenses in Reinsurance
- 1. Pro-rata in Addition
- a) Prorate expenses between the primary and the reinsurer based on same percentage share that each is responsible for the loss
- 2. Included in the limit
- a) Add the expenses to the amount of loss when applying the attachment point
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Working Cover
- 1. Definition: an excess of loss reinsurance agreement with alow attachment point
- 2. Characteristics:
- a) Enables primary insurer to spread losses over several years (profitable will offset unprofitable)
- b) Primary uses when selling line with little expertise until they better understand
- c) Usually require occurence limitation to prevent working cover from being exposed to catastrophic events
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Co-Participation Provision
- 1. Definition: Provision that requires the primary insurer to retain a specified percentage of the losses that exceed its attachment point
- 2. Purpose: Provides primary with financial incentive to efficiently manage losses that exceed attachment point
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5 Types of Excess of Loss Reinsurance
- 1. Per Risk Excess of Loss - Covers property insurance and applies separately to each loss occurring to each risk
- 2. Catastrophe Excess of Loss - Protects primary insurer from an accumulation of retained losses arising from single catastrophic event
- 3. Per Policy Excess of Loss - Applies the attachment point and the reinsurance limit separately to each policy issued by the primary regardless of number of losses per policy
- 4. Per Occurrence Excess of Loss - Applies the attachment point and the reinsurance limit the total losses arising from a single event affecting 1 or more of the primary's policies
- 5. Aggregate Excess of Loss - Covers aggregated losses that exceed the attachment point and occur over a stated period
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Clash Cover
- 1. Definition: Type of per occurrence XOL reinsurance for liability loss exposure that protects the primary against aggregations of losses from one occurrence that affects several insureds or several types of insurance
- 2. Characteristics:
- a) Can combine coverage for several lines of business
- b) Has high attachment point
- c) Retention is not in addition to the retention of other applicable per occurrence XOL reinsurance
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4 Basis of Attachment For Reinsurance Policies
- 1. Risks attaching basis - covers policies issued or renewed by the primary insurer on or after the reinsurance treaty's effective date
- 2. Losses occurring basis - covers the unearned portion of policies in force as well as policies issued or renewed by the primary insurer on or after the reinsurance treaty's effective date
- 3. Policies issued basis - convers only new policies issued on or after the reinsurance treaty's effective date
- 4. In-force policies basis - covers only the unearned portion of in-force policies
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Properties of Insolvency Clause
- 1. States that the reinsurer agrees to pay its reinsurance obligations if the primary insurer becomes insolvent, whether or not the primary insurer has paid its obligations to the underlying policyholders
- 2. Without diminution - reinsurer must pay full value of claims under the treaty
- 3. Liquidator must notify reinsurer of a pending claim so reinsuer has time to investigate
- 4. Reinsurer has right at own expense to defend a claim
- 5. With court approval, reinsuer's expenses to investigate and settle a claim can be wholly or partially reimbursable by the insolvent primary insurer
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4 Reasons to Modify Exposure Rated Excess Loss Premium for Property Per Risk Excess of Loss Treaty
- 1. Adequacy of underlying premiums
- 2. Composition of policies subject to the treaty and their deductibles
- 3. Quality of the primary's underwriting
- 4. Loading for the reinsurer's expenses
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2 Functions of Property Per Risk Excess of Loss Reinsurance
- 1. Increase large line capacity
- 2. Stabilize loss experience
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4 Steps of Experience Rating
- 1. Collect the required data
- 2. Trend losses
- 3. Develop the experience rate
- 4. Price the unused portion of the layer
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7 Clauses Designed or Adapted for Property Per Risk Excess of Loss
Treaties
- 1. Retention and limits clause
- 2. Loss notices and settlements clause
- 3. Reinsurance premium clause
- 4. Net retained lines clause
- 5. Ultimate net loss clause
- 6. Pools, Associations, and Syndicates Exclusion Clause
- 7. Total Insurance Value Exclusion Clause
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5 Characteristics of Property Per Risk Excess of Loss Treaties
- 1. Used to protect against adverse financial consequences of large losses
- 2. Often purchased in layers so primary can obtain needed underwriting capacity
- 3. May only cover one type of insurance and only selected causes of loss
- 4. May contain exclusions that do not appear in the underlying insurance policies
- 5. Easier to administer than surplus share
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2 Characteristics of Flat Rate Covers
- 1. Fixed rate that is not adjusted for losses occurring under the reinsurance treaty and that is applied to the primary's prospective premiums
- 2. Amount of ultimate reinsurance premium determined once primary's final actual subject premium becomes known
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Characteristics of Loss Rated Cover
- 1. Loss Rate: Rate that is determined from the actual losses sustained under a reinsurance treaty
- 2. Usually has 3 rates: a provisional, a minimum, and a maximum rate
- 3. Provisional rate is generally set close to reinsurance rate for latest treaty term or loss cost rate after loadings
- 4. Rate is adjusted retrospectively based on the loss experience actually realized during the treaty term
- 5. Retro rate adjustment includes a provision for the reinsurer's profit, expenses, and contingencies, subject to the maximum and minimum rates
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Loss Notices and Settlements Clause
Requires the primary insurer to notify the reinsurer of any loss amount that exceeds or is likely to exceed the primary insurer's retention
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Pools, Associations, and Syndicates Exclusion Clause
- 1. Excludes from coverage any liability emanating from the primary's participation directly or indirectly, through pools, associations, and syndicates
- 2. Exluded in order to control reinsurers accumulation of pool liabilities since they already participate in many
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Total Insurance Value Exclusion Clause
- 1. Excludes very large loss exposures from automatic coverage
- 2. Exceptions, including if the loss is 100% insured by the primary
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Loss Rated Cover
- 1. Rate that is determined from the actual losses sustained under a reinsurance treaty
- 2. Generally set close to reinsurance rate for latest treaty term or loss cost rate after loadings
- 3. Adjusted retrospectively based on the loss experience actually realized during the treaty term
- 4. Retro rate adjustment includes a provision for the reinsurer's profit, expenses, and contingencies, subject to the maximum and minimum rates
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3 Functions of Casualty Excess of Loss Treaties
- 1. Increase Large Line Capacity - Helps primary compete by allowing them to write higher limits
- 2. Stabilize Loss Experience - Reduce fluctuation in experience which aids in financial planning, supports growth, and strengthens investors' confidence
- 3. Provide Catastrophe Protection - Protects primary's earnings and surplus
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3 Features of Claims-Made Policies
- 1. Retroactive date - Date on or after which BI or PD must occur in order to becovered
- 2. Prior acts coverage - Extension of coverage for claims that would otherwise not be covered because they occurred prior to the retroactive date of the current claims-made policy
- 3. Extended reporting period - Additional period following the expiration of a C-M policyduring which the expired policy covers claims made against the insured, provided the injury occurred on or after the retroactive date and before policy expiration
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Reinstatement Clause For Casualty Excess of Loss Treaties
1. Reinstates treaty's original per occurrence limit after a loss occurrence for a predetermined premium, subject to a maximum recovery for the contract year
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Sunset and Sunrise Clauses
- 1. Sunset clause - limits the time after the treaty's expiration during which occurrences can be reported to the reinsurer
- 2. Sunrise clause - restores the coverage lost because of the operation of a sunset clause
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Commutation Clause
- 1. Allows primary and reinsurer to close out liability for claims under the treaty after a stated time period from treaty expiration
- 2. Establishes earliest point at which a commutation request can be made
- 3. Defines how actuary or appraiser can determine ultimate costs and whether recommendation is binding
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Clauses Designed or Adapted For Casualty Excess of Loss Treaties
- 1. Retention and limits clause
- 2. Reinstatement clause
- 3. Claims and loss adjustment expense clause
- 4. Declaratory judgment expense clause
- 5. Sunset and sunrise clauses
- 6. Commutation clause
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3 Considerations for Exposure Rates
- 1. Accuracy and credibility of projected distribution of subject premium by policy limits
- 2. Accuracy of ILF in excess of retention
- 3. Possible LAE, ECO, XPL, and Clash not contemplated by ILF
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5 Considerations for Experience Rates
- 1. Accuracy of estimates of claims cost inflation trend
- 2. Accuracy of estimates of excess loss development
- 3. Accuracy of current value of subject premium
- 4. Adequacy of statistical sampling
- 5. Stability of estimated excess loss costs
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3 Areas Addressed By Claims & LAE Clause
- 1. Reporting claims
- 2. Binding the reinsurer to the primary insurer's settlement
- 3. Sharing loss adjustment expenses (pro-rate or included in loss)
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Arguments Supporting Coverage for Declaratory Judgment Expenses When Treaty Does Not Include a Declaratory Judgment Expense Clause
- 1. Declaratory judgment expenses are like any other claim related loss adjustment expense
- 2. Reinsurer benefits from successful declaratory judgment actions
- 3. "Follow the fortunes" doctrines requires coverage for declaratory judgment expenses
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Arguments Against Coverage for Declaratory Judgment Expenses When Treaty Does Not Include a Declaratory Judgment Expense Clause
- 1. Not the result of claim handling but of an adversarial proceeding and therefore not LAE
- 2. Treaty does not explicitly state that expenses are covered
- 3. "Follow the fortunes" doctine cannot create coverage where none exists
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5 Factors That Modify The Reinsurance Rate When Exposure Rating is Used to Price Casualty XOL Treaties
- 1. Allocated loss adjustment expenses
- 2. Reinsurer's expenses
- 3. Extra contractual obligations
- 4. Clash cover
- 5. Policy limit mix
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4 Functions of Catastrophe Reinsurance
- 1. Provide catastrophe protection
- 2. Limit financial consequences of catastrophic events
- 3. Primary can limit losses to a predetermined retention per loss occurrence which stabilizes loss experience
- 4. Help avoid large fluctuations in earnings per share and wide swings in profits and losses
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Reinstatement Clause For Catastrophe Treaties
- 1. Provides for an automatic reinstatement of the reinsurance limit
- 2. Typically only one reinstatement - immediate and mandatory
- 3. Typically reinsurer charges a pro rata amount of the original reinsurance premium
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Considerations for Catastrophe Treaties
- 1. Attachment point
- 2. Layers and limits
- 3. Underlying insurance analysis
- 4. Inuring reinsurance
- 5. Payback of prior losses
- 6. Reinsurance limit
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Payback Period vs. Rate on Line (ROL)
- 1. 'Payback Period' and 'Rate on Line' are inverses
- 2. Payback period is the number of years a treaty needs to continue at the present reinsurance premium for the reinsurer to recoup the payment of the reinsurance limit under the treaty
- a) Fomula: Payback period = Reinsurance limit / Reinsurance premium paid
- 3. Rate on line is a measure of the appropriateness of the reinsurance premium relative to the reinsurance limit
- a) Formula: ROL = Reinsurance Premium Paid / Reinsurance Limit
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4 Alternatives to Traditional Catastrophe Reinsurance
- 1. Lines of Credit
- 2. Catastrophe Bonds
- 3. Catastrophe Options
- 4. Catastrophe Risk Exchanges
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Uses of Catastrophe Models in Reinsurance
- 1. Primaries use cat models to
- a) Analyze the cat exposure
- b) Develop marketing plans
- c) Establish underwriting acceptability of individual loss exposures
- 2. Reinsurers use cat models to
- a) Determine how program will respond under various cat scenarioes
- b) Establish rates for cat coverage
- c) Manage cat exposure reinsurers have assumed
- d) Aid in determining cat retrocessional needs
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2 Key Outputs of Catastrophe Modeling
- 1. Probably maximum loss (PML)
- a) the amount of loss expected
- 2. Average annual loss (AAL)
- a) long-term average loss expected in any one year that represents
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4 Issues Associated With Use of Catastrophe Modeling
- 1. Cat models typically do not rely heavily on historical losses
- 2. Different models produce different outcomes because of variation in assumptions in models
- 3. Cat models place signicant demands on primary's information systems
- 4. Difficult to evaluate because developers unlikely to share proprietary information
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