Principal functions of reinsurance
- Increase large line capacity
- Provide catastrophe protection
- Stabilize loss experience
- Provide surplus relief
- Facilitate withdrawal from a market segment
- Provide UW guidance
Increase large line capacity - Example & impact on F.S.
- to limit exposure to losses when market demand greater coverage.
- SS treaty cedes prems/losses for high valued homes. ceding % = home value xs of 500k divided by total (home 625k, ceded % = 125/625 = 20%)
- Impact on F.S.:: no impact other than additional earnings
- Loss reserves: gross and net increase, due to increased premium and nature of NB (slower dev on larger claims)
- UEP: increase, but same % of premium
- Leverage ratios: Net increase slightly due to change in business model. Gross begin to differ materially from net, and reinsurance leverage becomes important
- I.S.: Little impact on net, but book getting riskier and reinsurance cost will change, which may increase volatility.
CAT protection - Example & impact on F.S.
- CAT treaty for 5% of gross prem, and pays for losses from a CAT in xs of 10% of prem
- Impact on F.S.:: if no cat, decreases; if cats, mitigate risk of significant drops
- Loss reserves: if no cat, no impact on net; if cats, gross increases significantly very quickly. Net will return to normal sooner than gross
- UEP: little to no impact (cat reinsurance is normally small portion of total)
- Leverage ratios: If no cat, increase due to reduced surplus. If cat, impact on gross and ceded
- I.S.: II reduced by cost of reins. But UW income protected if cat, with loss only from ceded prem, retention and reinstmt prem
Stabilize loss experience - Example & impact on F.S.
- Losses fluctuate from year to year more than desired (for capital provider)
- agg XOL for 10% of gross prem, that returns 90% of losses above LR 100%
- Impact on F.S.:: net expected value is lower, but with less period-to-period volatility
- Loss reserves: net stabilized
- UEP: net reduced
- Leverage ratios: net more stable but slightly higher (due to reduced surplus), assuming positive net cost from reins
- I.S.: UW results over time expected to be lower, due to net cost of reins, and II lower. But UW results from year-to-year more stable
Surplus relief - Example & impact on F.S.
- reins to reduce leverage ratios.
- 50% QS to reduce net PS and RS ratios. ceding commission 20% (consistent with gross expense ratio)
- Impact on F.S.:: Liabilities decrease as half of losses and UEP ceded; assets decrease due to reinsurance cost. net effect = small decline in surplus if ceded is profitable (Increase if unprofitable)
- Loss reserves & UEP: Net are fixed % of gross
- Leverage ratios: Net improved. ceded increased. solvency becomes more reliant on reins
- I.S.: UW income halved; II ignificantly reduced
Facilitate withdrawal from a market segment - Example & impact on F.S.
- to exit a market, and not willing to wait until runoff of existing obligations.
- cede 100% of remaining UEP and all losses after beginning of year.
- Impact on F.S.:: Liabilities down to $0; assets decrease due to reins cost. net effect = small decline in surplus if ceded is profitable. But surplus less volatile and less impacted by unexpected LLs during runoff
- Loss reserves: Gross unchanged, net disappear
- UEP: Gross disappear over the year as business runs off. Net disappear immediately when UEP is ceded
- Leverage ratios: Net = 0, only remaining insurance risk is reinsurance collectability risk. Hence, surplus supporting runoff now freed
- I.S.: UW results reflect a profit because ceding commission offsets expenses paid previous year. profit is slightly smaller than if business had not been ceded. But risk in results is now greatly reduced (only reinsurance collectability risk).
Provide UW guidance
want to enter a new market, but doesn't have expertise -> heavily reinsures its writings, relying on reinsurer’s expertise in pricing and UW