Reinsurance
Session 2
Reinsurance
Session 2
1. Finite Reinsurance
2. Life Reinsurance
3. Securitization / Alternative Capital
Sources
4. Reinsurance Failures
Reinsurance
1. Finite Reinsurance
Finite Reinsurance
• Multi-year
Dampens fluctuation
of profit over term of
contract.
• Multi-class (mostly)
• Limited indemnity risk transfer, mainly timing risk
• Side letters to contract which serve to conceal the
limited indemnity risk transfer
Finite Reinsurance
Where would you most likely find Finite Reinsurance?
High level catastrophe XL cover
Likely location for Finite Reinsurance
Cover for fairly high claims whose
level is predictable over 5-8 years
Low level QS cover
Finite Reinsurance
Dampens fluctuation of profit over term of contract.
No Finite Re.
Net asset value increases over
time
Net asset value
Conceals serious
problems
Little effect
With Finite Re.
Time (years)
Net asset value decreases over
time
Finite Reinsurance
Loss Portfolio Transfer (LPT)
Transfers loss portfolio to reinsurer, plus
assets and plus premium. Protects against
timing risk
Adverse Development Cover (ADC)
Losses stay with insurer but reinsurer
smoothes any adverse development. Postloss funding?
Message:
Spread Loss Treaty (SLT)
Please don’t be “blinded by science”
Pays “premium” into an “experience
account” at reinsurer which is used to
smooth results of cedant.
Finite Quota Share (FQS)
Transfers unearned premium in return for a
reinsurance commission.
Counter-cyclical tool to smooth profits.
Source: Swiss Re. Sigma 1997, & Core Curriculum Module
Finite Reinsurance
• Side letters to contract which serve to conceal the
limited indemnity risk transfer
SEC vs. General Re & AIG (USA) – February 2008
• A finite re contract to inflate AIG’s loss reserves by
US$500million in 2001. (an immaterial amount for the AIG Group).
• Securities Fraud, Conspiracy, False Statements to Regulators
• 4 Gen Re & 1 AIG executives guilty and each face up to a
US$48million fine & between 150 and 200 years in prison.
SFO vs. Independent Insurance (UK) – October 2007
• Jail sentences for CEO, CFO and In-house Counsel for conspiracy
to defraud.
Dampens fluctuation of profit over term of contract.
Reinsurance
2. Life Reinsurance
Life Reinsurance
• Usually, transfers mortality and morbidity risk.
• Each life company establishes a “retention per life” e.g.
TT$300,000.
• The more volatile the underwriting results the smaller the
retention should be
• The smaller the policy base the smaller the retention should be
• The less homogeneous the policy base the smaller the retention
should be
• The lower the capital base the smaller the retention should be
Life Reinsurance
• Risk Transfer – Mortality & Morbidity
• Little need to reinsure savings / unit linked products!!
• Some anti-cyclical “finite reinsurance” transfers timing risk.
• Main Types Reinsurance Contracts
• Coinsurance
• Modified Coinsurance
• Yearly Renewable Term (YRT)
And
• Treaty (large bundles of policies)
• Facultative (individual policies)
Life Reinsurance -Types of Contract
YRT
Reinsurer assumes mortality and morbidity risk only, & annual
premiums based on amount at risk. Premiums increase with age
of insured. Investment risks and returns remain with primary
insurer.
(Quota Share or Excess of Loss)
Coinsurance
Reinsurer shares a percentage of business including cash flows and
reserves. Investment risks and returns are shared in proportion
to the risk transfer.
Modified Coinsurance
As above, but ceding company retains assets and reserves and,
therefore, investment risks and returns. Primary insurer pays a
fixed rate of interest to reinsurer for the investments it “holds”
in relation to the risk transferred.
Reference material:
American Council of Life Insurers (ACLI). Reinsurance Treaty Sourcebook
http://www.acli.com/ACLI/Issues/GR02-216.htm
Reinsurance
3. Securitization / Alternative Capital Sources
Insurance Securitization
• Transfers insurance risk to capital markets
• Mechanism is same as for non-insurance
securitization
• Securitization is suited to catastrophe risk;
most of the deals are in this line of
business.
Reference:
www.artemis.bm See the Deal Directory
Insurance Securitization - Basics
Insurance Market
Capital Market
Insurer
Investor
Investor
Insurer
Reinsurer
Insurer
Special Purpose
Vehicle
Risk gatherer
& transferor
Investor
Insurer
Insurer
Conventional
reinsurance contracts
Investor
Risk converter & bond
issuer
Investor
See next slide for:
•Risk transfer
•SPV
Conventional bond
issuance
Insurance Securitization - Basics
Risk transfer
SPV
Risk Transfer from Reinsurer to SPV
1. Defined risk is transferred to SPV
2.
•
Reinsurer is reimbursed by
triggering a claim:
Indemnity-based (like a
conventional claim)
•
•
•
Not popular with investors and
now uncommon – too much
moral hazard
Parametric trigger
•
Defined events at defined
locations – quake of specified
magnitude in specified location
Cash flow criterion – variance
from pre-agreed cash flow budget
The Special Purpose Vehicle
1.
Receives funds from
•
•
2.
3.
Transferor – reinsurance premium
Investors – purchase of bonds
If risk transfer claim is triggered, a
payment is made to reinsurer.
If no payment to reinsurer, then on
maturity the bondholders receive all
cash in SPV:
•
•
•
Reinsurance premium
Refund of bond purchase price
Investment income on the above
Insurance Securitization - Basics
Investor
Investor
Reinsurer
Risk gatherer
& transferor
Special Purpose
Vehicle
Investor
Risk converter & bond
issuer
Investor
Investor
Parametric trigger
gives rise to basis risk,
sometimes covered by
a secondary reinsurer
A claim made before
bond matures may upset
investment profile,
sometimes covered
by a liquidity provider
Reinsurance Sidecars
Sidecar – a financial entity created to allow investors to take the risk & return
(for a limited period) of a small and limited category of policies, usually
property catastrophe. Sidecars do not take the longer term investment risk
associated in buying shares whose value is affected by the entire book of
business.
Source: AM Best
Reinsurance
4. Reinsurance Failures
Insolvency of a reinsurer
BUT, before that happens…..
Cashflow problems in a reinsurer will quickly become the problem of
the reinsured
Failure of Reliance National, a large US insurer caused by failure of
reinsurers for whom it was fronting – “WORKERS’ COMPENSATION
CARVE-OUT”
Even without failures, the biggest & best reinsurers are not immune
to problems …..
Munich Re in 2002 … Too heavily invested in equities during a stock
market crash.
Munich Re in 2008 … Hurricanes Gustav & Ike in the Caribbean wipe
out 3Q profits.
Reinsurance
Are failures likely? Catastrophe risk seems to be the major threat!
Source: Guy Carpenter LLC, 2008 Reinsurance Market Review