REINSURANCE 101

MODERATOR

JOHN KLINE, CPCU, ARM

(YUM! Brands)

SPEAKER

GEORGE BUDD, CPCU

(GEORGE A. BUDD, LLC)
 REINSURANCE 101
• OBJECTIVES:
– EXAMINE SOME BASIC CONCEPTS
– SHOW HOW THESE ARE APPLIED
– REVIEW NEW TRENDS
• GLOBALIZATION
• SECURITIZATION
• COMPUTER MODELS
– REVIEW RISK MANAGER’S CHOICES
REINSURANCE GLOSSARY
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 REINSURANCE?

THE INSURANCE OF INSURANCE

COMPANIES. THE SAME WAY
BOOKIES LAY OFF BETS…AND FOR
THE SAME REASON.
 REINSURANCE
• “Reinsurance is a contract of insurance
whereby one insurer (called the
reinsurer or assuming company)
agrees, for a portion of the premium, to
indemnify another insurer (called the
reinsured or ceding company) for
losses paid by the latter under
insurance policies issued to its
policyholders.”
 WHY REINSURE?

FOR THE SAME REASON YOUR

BUSINESS BUYS INSURANCE:

TO PROTECT THE CORPORATE

ASSETS
 TRANSFERRING RISK

INSURANCE

RISK
Policyholder Insurance Co.

- Insured - Insurer

- Underlying Insured
 TRANSFERRING RISK

REINSURANCE
Risk
• Insurance Co. Reinsurer
- Ceding Co. -Assuming Co.
- Cedent
- Primary Insurer
– Direct Company
 TRANSFERRING RISK

RETROCESSION
Risk
Reinsurer Reinsurer
- Retrocedent -Retrocessionaire
 ELEMENTS OF
REINSURANCE
• Reinsurance is a form of
Insurance.
• There are only two parties to the
reinsurance contract - the
Reinsurer and the Reinsured - both
of whom are empowered to insure.
 ELEMENTS OF REINSURANCE
(continued)
• The subject matter of a reinsurance
contract is the insurance liability the
Reinsured has assumed under
insurance policies issued to its own
policyholders.
• A reinsurance contract is an indemnity
contract.
 What Reinsurance Does
• It redistributes the risk of loss
which a reinsured incurs under
the policies it issues according
to its own needs.
• It redistributes the premiums
received by the reinsured
according to its own needs.
What Reinsurance Does Not Do!

IT IS NOT A MAGIC POTION

What Reinsurance Does Not Do!
(continued)
• Convert an uninsurable risk into an
insurable one.
• Make loss either more or less likely to
happen
• Make loss either greater or lesser in
magnitude
• Convert “bad” business into “good
business”
 BASIC RULE

IN REINSURANCE,
ALMOST ANYTHING IS
NEGOTIABLE
 THE HOUSE OF REINSURANCE

• FACULTATIVE
– INDIVIDUAL RISKS

• TREATY
– GROUPS OF RISKS
 The House of Reinsurance
• THE FACULTATIVE SIDE:
– Single Policy or Risk
– Reinsurer evaluates each risk and
establishes or agrees to accept
Coverage Form and Price.
– Automatic and Semi-Automatic Facilities
 The House of Reinsurance
• THE TREATY SIDE:
– Covers classes or entire
“books” of business.

– Reinsurer accepts as written by Insurer

as to Form, Price and Risk.
 LET’S DEFINE
BOOK OF BUSINESS
ANY segment of an insurance company’s
portfolio.
It does not have to equate with a known
geographic area, a line of business, a
marketing segment or any combination of
these.
It is a segment of the portfolio the
company wants to protect for a variety of
reasons. WE define it!
 LET’S DEFINE
A LINE
1. A line of business such as Fire, Multi-
Peril, General Liability, etc.
2. An amount retained by the insurer on a
risk.
This can be the amount after
subtracting all facultative and treaty
reinsurance or which includes them; it
depends on the purpose.
 LET’S DEFINE

Example: $5 million risk

Facultative: $3mm xs $2mm
Net Line=$2mm
Example: Same as above except
Line can also be defined as $5mm
 FORMS OF REINSURANCE
• PROPORTIONAL (OR PRO-RATA)
– PAY PREMIUM ON A SHARE BASIS
– COLLECT LOSSES ON SAME SHARE
• EXCESS OF LOSS
– PAY PREMIUM ON NEGOTIATED PRICE
– COLLECT LOSSES ONLY WHEN
RETENTION IS EXCEDED.
 The Forms of Reinsurance
• Pro-Rata or Proportional:
– Reinsurer receives a percentage share of
premium and pays that same percent of
each loss.
– Reinsurer pays cedent a Commission to
Reimburse for Expenses
• Can be Flat Percentage
• Can Include Profit Commission
• Can be “Swing-Rated”
 The Forms of Reinsurance

• Pro-Rata or Proportional (cont.)

– Can be Quota Share or Surplus:

– Quota Share
• Reinsurer takes same % on each risk.
• “Of” vs. “Part Of”
 The Forms of Reinsurance
• Pro-Rata or Proportional (cont.)
– Surplus Share
• Reinsurer’s share varies for each risk
based on type and/or size of risk.
• Whatever that percentage share is,
reinsurer receives same percent of
premium and losses.
 The Forms of Reinsurance
• EXCESS OR NON-PROPORTIONAL:
– Per Risk (property), Per Occurrence
(casualty) or Claims Made
– Per Occurrence: Catastrophe
– Aggregate or Stop Loss Excess
 The Forms of Reinsurance
• Per Risk or Occurrence Excess
– Responds to Losses Excess of a
Predetermined Retention
– No Proportional Sharing of Premium
or Loss
– Premium is Negotiated
– Written in Layers
– Normally has Occurrence Limit
– Reinstatements are Negotiated
 REINSTATEMENTS
• PROPORTIONAL -- DOES NOT APPLY
• “FULL”
• AT A PRICE
• FREE AND UNLIMITED
• FREE BUT LIMITED
• COMBINATION OF ABOVE
 RISK EXCESS PRICING
• LOSS RATING
– BURNING COST
– LOADED PRICE
– TREND & DEVELOPMENT FACTORS
• EXPOSURE RATING
– RATING SCALES
• UNDERWRITER’S JUDGEMENT
 OCCURRENCE LIMITS
• PER RISK EXCESS
– MULTIPLE OF RISK SIZE
• PROPORTIONAL
– CHANGES SINCE 1992
– NEGOTIATED
• FLAT DOLLAR AMOUNT
• PERCENT OF PREMIUM
• MULTIPLE OF RISK SIZE
 Forms of Reinsurance
• Catastrophe Excess of Loss
– Covers all losses in an event
– Occurrence is defined as a geographic
area (flood and Riot) or a time period
(wind, quake, fire and winter storm)
– Usually Limited to two Occurrences
• Additional Cover Needed
– Sold in Layers
– Usually has two risk warranty
 CATASTROPHE CHANGES
• No Reinstatement in Same Event

• Reinstatement at 100%

• ECO/XPL Excluded

• Deposits at 100%
 SURPLUS TREATY

• READS LIKE AN EXCESS

– ELIGIBILITY RULES vis-a-vis PAYMENT,
I.e., SIZE OF RISK vs. SIZE OF LOSS
• WORKS PROPORTIONALLY
– PAY PROPORTIONAL PREMIUM
– COLLECT PROPORTIONAL LOSSES
• WHY HAVE IT?
 SURPLUS TREATY
• WHY HAVE IT?
• CAN AFFORD TO KEEP MORE LOSSES
• WANT TO KEEP PREMIUM FOR GROWTH
PURPOSES
• OPTIONS:
– CARRY IT ALL NET
– REDUCE AMOUNT OF QUOTA SHARE
– ADD OR SUBSTITUTE WITH AN EXCESS TREATY
– ADD A SUPLUS TREATY
– COMBINATIONS OF THE ABOVE
 SURPLUS TREATY

• THE FIRST CONCEPT:

– MINIMUM SIZE RISK
EXAMPLE: ALL RISKS GREATER THAN $1
MILLION MUST BE CEDED TO REINSURER.
 SURPLUS TREATY

SIZE IS AN ELIGIBILITY RULE

RISK IS CEDED PROPORTIONALLY

PREMIUM IS PAID PROPORTIONALLY
LOSSES ARE COLLECTED
PROPORTIONALLY
SURPLUS TREATY

HOW DO

WE

DO THAT???
 SURPLUS TREATY
EXAMPLE
$5 MILLION VALUES
BUILDING, CONTENTS, ETC.

IS IT GREATER THAN $1 MILLION?

YES!
THEN IT’S ELIGIBLE
 SURPLUS TREATY
$5 MILLION TOTAL
REINSURED KEEPS $1 MILLION
CEDES (REINSURER ACCEPTS) $4
MILLION 1/5 = 20%
4/5 = 80%
REINSURED PAYS 80% OF PREMIUM
ANY SIZE LOSS, COLLECTS 80% OF IT
SURPLUS TREATY

ANY
SIZE
LOSS!
 SURPLUS TREATY

THE MINIMUM SIZE IS AN ELIGIBILITY

RULE ONLY!
ONCE WE HAVE DETERMINED A RISK IS
ELIGIBLE, IT BECOMES A QUOTA
SHARE OF THE AMOUNTS CEDED vs.
THE AMOUNTS RETAINED
 SURPLUS TREATY
HOW ARE CESSIONS DETERMINED?

BY LINES
 SURPLUS TREATY

A LINE IS THE AMOUNT THE REINSURED

IS KEEPING FOR ITSELF

THE CESSION IS NORMALLY BASED ON

“X” NUMBER OF LINES AS
NEGOTIATED IN THE TREATY
 SURPLUS TREATY
THE $5 MILLION EXAMPLE
(SPLIT 20%/80%)
ONLY WORKS IF THE TREATY ALLOWS
FOR 4 LINES
TO BE CEDED
$1 MILLION EQUALLED 1 LINE
$4 MILLION EQUALLED 4 LINES
 SURPLUS TREATY
BUT
IF THIS WERE A THREE LINE TREATY,
THE MOST THAT CAN BE CEDED IS 3X
WHAT THE REINSURED KEEPS.
THEREFORE, THE $5 MILLION HAS TO
BE DIVIDED BY 4 (3+1)
 SURPLUS TREATY
$5,000,000 ÷ 4 = $1,250,000
3 X $1,250,000 = $3,750,000
= 75% CEDED
25% KEPT NET
ALL PREMIUMS AND LOSSES
FOLLOW THE SAME DIVISION
 REMINDER
– Surplus Share
• Reinsurer’s share varies for each risk
based on type and/or size of risk.
• Whatever that percentage share is,
reinsurer receives same percent of
premium and losses.
 SURPLUS TREATY
NEXT CONCEPT:
MINIMUM RETENTION

REINSURER WANTS REINSURED TO

MAINTAIN RISK ON A PAR WITH ITS
SIZE
 SURPLUS TREATY
MINIMUM SIZE: $1,000,000
MINIMUM RETENTION: $500,000
RISK SIZE: $1,500,000
(CONTINUE WITH 3 LINE TREATY)
$1,500,000 ÷ 4 = $375,000
DOES NOT WORK!
CEDENT MUST KEEP $500,000!
 SURPLUS TREATY
ERGO
KEEP $500,000
CEDE THE REST
$1,500,000 - $500,000= $1,000,000
EQUALS 2 LINES CEDED
DIVISION OF RISK IS 1/3 AND 2/3
 SURPLUS TREATY
NEXT CONCEPT:
MAXIMUM CESSION

REINSURER IS WILLING TO ASSUME

RISK BUT ONLY UP TO A CERTAIN
AMOUNT
 SURPLUS TREATY
MINIMUM SIZE: $1,000,000
MINIMUM RETENTION: $500,000
MAXIMUM CESSION: $5,000,000
NEW RISK: $20,000,000
$20,000,000 ÷ 4 = $5,000,000
$5,000,000 X 3 = $15,000,000
BUT MAX CESSION = $5,000,000
SURPLUS TREATY

ERGO

CEDE $5,000,000 (25%)

KEEP $15,000,000 (75%)
 SURPLUS TREATY
WHAT PERCENTAGES WERE CEDED?

SIZE % CEDED

$5,000,000 75% (3 LINES)

$1,500,000 66.7% (2 LINES)

$20,000,000 25% (1/3 LINE)

Properties of Surplus Treaties
• Risk Must be of a Minimum Size to
Qualify
• Amount Ceded is Based on Number
of “Lines”
• Reinsured Must Retain a Minimum
Amount Called “Minimum Retention”
• There is a “Maximum Limit”
• Normally Obligatory
 THE PRIORITIES

The Order of Collecting Losses:

• Facultative
• Proportional (Q/S and Surplus)
• Per Risk
• Catastrophe
• Aggregate or Stop Loss
 COLLECTING THE LOSS
$240 MILLION RISK
• $76 MILLION LOSS
– $30 MILLION FACULTATIVE
– 20% QUOTA SHARE
– 3 LINE SURPLUS TREATY
$30 MILLION MAXIMUM CESSION
(12.5% OF TOTAL SCHEDULE)
– $65 MILLION XS $10 MILLION RISK XS
 COLLECTING THE LOSS
• LOSS $76 MILLION
– COLLECT THE FACULTATIVE
$30 MILLION
• REMAINDER $46 MILLION
– COLLECT THE QUOTA SHARE
20% x $46 MILLION = $9.2 MILLION
• REMAINDER $36.8 MILLION
 COLLECTING (cont.)

• REMAINDER = 36.8 MILLION

– COLLECT THE SURPLUS TREATY
$30 MILLION MAXIMUM CESSION?
REMEMBER THE PERCENTAGE
$46 MILLION X 12.5% = $5.75 MILLION
 COLLECTING (cont.)

• REMAINDER = $31.05 MILLION

– COLLECT THE RISK EXCESS TREATY
$21.05 MILLION

• CEDENT KEEPS $10 MILLION NET

 COLLECTING (cont.)
• RECAP
FACULTATIVE PAID $30 MILLION
QUOTA SHARE PAID $9.2 MILLION
SURPLUS TREATY PAID $5.75 MILLION
RISK XS TREATY PAID $21.05 MILLION

(THE CEDENT KEPT $10 MILLION NET)

 The New Reinsurance Market
• “Securitization”
• Bermuda Commodities Exchange
– Guy Carpenter & Co. Index
• Program Business
• eCOMMERCE
• Chicago Board of Trade (CBOT)
 SECURITIZATION
• PHYSICAL LOSS CAPACITY
– NEW AND ADDITIONAL CAPACITY
– TENDS TO BE EXPENSIVE
– ONE LOSS SITUATION
• ASSET PORTFOLIO PROTECTION
– WHAT HAPPENS AFTER LARGE LOSS
• NEEDS TO BE TESTED
 eCOMMERCE
• LARGE FUTURE
• MOSTLY PERSONAL LINES
• CATEX
• NEW EUROPEAN RISK INTERCHANGE
 COMPUTER MODELS
– AIR (CATMAP)
– RMS (IRAS)
– EQUICAT
– DAMES & MOORE
– CATALYST
– ISO (CAT TRADER)
– TILLINGHAST (RIPL)
 COMPUTER MODELS
• IMPORTANCE
– RATE MAKING
– FINANCIAL RATINGS
– PORTFOLIO ANALYSIS, MANAGEMENT
AND CONTROL
– RISK AND LOCATION UNDERWRITING
• EARTHQUAKE ANALYSIS
 UNDERWRITING TRENDS
 EMPHASIS ON MODELING

 INVOLVEMENT OF ACTUARIES AND

FINANCIAL PEOPLE IN DECISION MAKING
PROCESS.

 REDUCED RESPONSIVENESS

 CORPORATE SPECIALIZATION
 GLOBALIZATION
• WORLDWIDE CLIENTS
– WORLDWIDE INSURANCE NEEDS
– WORLDWIDE REINSURANCE NEEDS
• NATIONAL CLIENTS
– WORLDWIDE INSURANCE/REINSURANCE
NEEDS
• CORPORATE SOLUTIONS?
 RISK MANAGEMENT
• DO WE NEED AN INSURER?
– CAPITAL REQUIREMENTS
– EXPERTISE
– CORPORATE CAPACITY
• MONEY
• TIME
– LEVERAGING ABILITY
 !WARNINGS!
DON’T DABBLE!

CONTROL YOUR RESERVES!

KNOW WITH WHOM YOU ARE

DEALING!
ANY QUESTIONS