1. PowerPoint Slides for Professors Spring 2010 Version PowerPoint Slides for Professors Spring 2010 Version This file as well as all other PowerPoint files for the book, “Risk Management and Insurance: Perspectives in a Global Economy” authored by Skipper and Kwon and published by Blackwell (2007), has been created solely for classes where the book is used as a text. Use or reproduction of the file for any other purposes, known or to be known, is prohibited without prior written permission by the authors. Visit the following site for updates: http://facpub.stjohns.edu/~kwonw/Blackwell.htmlhttp://facpub.stjohns.edu/~kwonw/Blackwell.html. To change the slide design/background, [View]  [Slide Master] W. Jean Kwon, Ph.D., CPCU School of Risk Management, St. John’s University 101 Murray Street New York, NY 10007, USA Phone: +1 (212) 277-5196 E-mail: Kwonw@stjohns.eduKwonw@stjohns.edu

2. Risk Management and Insurance: Perspectives in a Global Economy 23. Reinsurance Click Here to Add Professor and Course Information

3. Correction – Figure 23 3 One in each category of this column has to be non-proportional!

4. Study Points  Worldwide risk sharing  Reinsurance demand  Reinsurance fundamentals and operations  Reinsurance markets  Reinsurance regulation 4

5. Worldwide Risk Sharing Through Reinsurance 5

6. Fundamentals  Insurance vs. reinsurance vs. retrocession  Retention vs. cession  Privity of contract vs. cut-through provision  Reciprocal agreement 6 Refer also to Chapter 1 for the basic concepts.

7. Worldwide Risk Sharing (Figure 23.1) 7 Insured  Primary Insurer (Canada) Insured  Primary Insurer (China) Reinsurer (U.S) Reinsurer (Germany) Reinsurer (Japan) Reinsurer/ Retrocessionaire (France) Retrocessionaire (Italy) Retrocessionaire (Bermuda) Reinsurer (Singapore) Reinsurer (Mexico) Retrocessionaire (U.S.) Retrocessionaire (Korea) Retrocessionaire (Brazil) Another version in next page

8. Worldwide Risk Sharing (Figure 23.1) 8

9. Rationales for Reinsurance Demand  Ownership structure  Cost of financial distress  Capital market imperfections  Real service efficiency  Reduction of tax liability  Volatility control  Regulatory constraints 9 Refer to “Insurance Demand” in Chapters 2 and 19.

10. Reinsurance Fundamentals 10

11. Reinsurance is...,  Risk financing arrangements between insurance firms; e.g., Between direct insurer and reinsurer  Transfer of part of the risks that the direct insurer assumes by way of insurance contract to another insurance carrier (the reinsurer) which has no direct contractual relationship with the insured. 11

12. Key Terms and Concepts  Cedant, reinsured, primary insurer, ceding company  Reinsurer, assuming company  Retrocessionaire  Retention The amount of risk retained by cedant  Cession Alternative term to “reinsurance” The amount of risk transferred  Retrocession 12

13. Suppliers of Reinsurance  Professional reinsurers Munich Re, Swiss Re, Berkshire Hathaway…, Mega-mergers and acquisitions internationally  Reinsurance departments (of insurance companies) Directly Through underwriting agents 13

14. Suppliers of Reinsurance  Pools For national/regional cover of large risks (e.g., nuclear power or space shuttle projects) For nonstandard risk pooling in automobile and workers’ compensation insurance  Lloyd’s associations  Captives For holding company and sister companies May function as either insurer or reinsurer Little or no provision of insurance to others 14

15. Reinsurance Distributions  Direct writing reinsurer  Reinsurance brokerage firm  Slip  Lead (leading underwriter)  Broker’s cover  Characteristics Represent the client (cedant, not reinsurer) Act as consultant to the client Spread the risk using multiple reinsurers to ensure security for the client  Other services/business Captive management services Alternative risk transfer arrangement 15

16. Types and Nature of Reinsurance Contracts  Facultative vs. treaty reinsurance Facultative-obligatory (fac-oblig) reinsurance  Proportional (pro-rata) vs. non-proportional (excess-of-loss or XL) reinsurance  Financial reinsurance 16

17. Facultative vs. Treaty Facultative  Placement in the reinsurance market “on or after” writing risk  Per risk or policy Treaty  Placement via re existing contract  Bulk contract for all risks falling into (e.g., property risks < $1 million in Manhattan 17

18. Proportional vs. Non-proportional (Excess-of-Loss) Proportional  Equal share of risk, premium and loss Excess-of-Loss (XL)  Sharing of loss not in proportion to sharing of premium 18

19. How to Utilize Reinsurance  Single reinsurance contract  Reinsurance program For a line For a group of lines  umbrella For all businesses of the insurer  whole account 19

20. Classification of Reinsurance Contracts (Figure 23.2) 20 Facultative The contract is on individual risk basis; that is, there is no pre-existing reinsurance contract. The insurer decides whether to cover a risk alone, or cede part of it to a reinsurer. When offered, the reinsurer may accept it, decline it or counteroffer the insurer. Treaty The contract commonly is annual on a line of business and territory basis. The insurer and the reinsurer are bound to a contract that dictates what risks are to be shared and how they are shared. Therefore, the insurer must transfer all risks subject to the agreement and the reinsurer must accept all ceded risks. Facultative-Obligatory (Fac-Oblig) Commonly used as the top layer of a treaty reinsurance program, this type of contract gives the insurer an option to retain a risk fully or cede part of it to the reinsurer. When ceded (a facultative element), the reinsurer must assume the risk (an obligatory element). Reinsurance Contract Proportional Non-proportional Proportional Non-proportional Source: Kwon (1999)

21. Forms of Reinsurance (Figure 23.3) 21 Proportional (Pro-rata) Sharing the amount of insurance, premium and loss on a proportional basis Quota Share Surplus Facultative-Obligatory Excess-of-loss (Non-proportional) Reinsurance coverage only when loss exceeds the retained loss at lower layer(s) Facultative Excess Risk (working) Excess Catastrophic (Cat) Excess Stop Loss Umbrella Excess..... Financial Retrospective Financial Reinsurance Prospective Financial Reinsurance Forms of Reinsurance Source: Kwon (1999)

22. Proportional Reinsurance – Quota Share (Table 23.1) 22

23. Proportional Reinsurance – Surplus (Table 23.2) 23

24. Illustrative Proportional Treaty (Figure 23.4) 24

25. Non-proportional (Excess-of-Loss) Reinsurance  Facultative XL  Risk (working) XL  Common account XL  Per occurrence XL Hours clause  Stop loss XL  Aggregate XL  Umbrella XL  Whole account XL  Reinstatement provision (page 608) 25

26. Excess-of-loss Reinsurance (Figure 23.5) 26

27. Reinsurance Program Design  Factors to consider in designing a program Risk and loss portfolios over several years Types of reinsurance contracts Apportionment of risks or losses by layer Availability of reinsurers specializing in each type of reinsurance and their ancillary services Prevailing conditions in the reinsurance market and in the economy Profitability (including the size of ceding and other commissions from reinsurers) The insurer’s own capacity to retain losses 27

28. Reinsurance Program Design  Commissions Types Ceding commissions Profit commissions Not all reinsurance contracts offer commissions 28 You may use the example in pages 609-610 to describe the relief from ceding commissions. Ceding commissions differ from reinsurance brokerage fees.

29. Financial Reinsurance  Risks involved Underwriting (pricing) risk Timing risk Investment risk  Financial reinsurance explicitly considers the investment and timing risks and may provide little or no pricing risk transfer. 29

30. Financial Reinsurance  Retrospective financial reinsurance  Time and distance contracts  Loss portfolio transfer Run-off business  Prospective financial reinsurance The primary focus of financial reinsurance in today’s market 30

31. Prospective Financial Reinsurance  Length of coverage period  Finite term of contract (non-renewability)  Explicit profit sharing agreement  Limit on coverage 31

32. Prospective Financial Reinsurance (Insight 23.1) 32

33. Reinsurance Markets 33

34. Reinsurance Premiums Globally (2005) (Figure 23.6) 34 Source: Datamonitor (2005)

35. Reinsurance Global Market Share 1998 vs. 2008 35 Standard & Poor’s (2009)

36. Cession Rate by Region (1998) (Table 23.3) 36 No recent updates are found regarding cession distribution.

37. Top 20 Global Reinsurers (2007) 37

38. Top 15 Global Reinsurers (2008) 38 Standard & Poor’s (2009) Total is for Top 40 companies.

39. US Reinsurers (2009) 39

40. Top 10 Global Reinsurance Brokers (2006) 40

41. Reinsurance in Emerging Markets  Reinsurance is crucial, as domestic companies tend to have low levels of capitalization and keep low retentions (and a correspondingly high demand for reinsurance).  Insuring industrial infrastructure necessitates technical expertise. Historically, large global reinsurers have provided risks assessment and underwriting services  Most insurers in developing countries have proportional treaties as the basis of their reinsurance programs.  Fronting is common in developing countries. 41

42. Reinsurance in Emerging Markets  Compulsory placement of reinsurance as a means of the local government’s attempt to: Diversify the pools of risks from individual insurers to the national reinsurer Permit more favorable terms and prices when the national reinsurer retrocedes risks internationally The global trend is to abandon such practices, as compulsory cessions usually harm markets relying on them. 42

43. Compulsory Reinsurance Cessions (Table 23.5) 43

44. Reinsurance Regulation 44

45. Reinsurance Regulation  In general, reinsurance subject to less stringent regulation than is direct insurance Even so, of critical concern because of its importance to the stability and growth of insurance markets Further, the market internationally dominated by a relatively small number of very large reinsurers  Current initiatives largely the domain of advanced economies and intergovernmental organizations 45 Table 23.6

46. Reinsurance Regulation  The IAIS Standard on Supervision of Reinsurers (2003) Principle One. Regulation and supervision of reinsurers’ technical provisions (loss reserving), investments and liquidity, capital requirements and policies and procedures to ensure effective corporate governance should reflect the characteristics of its business and be supplemented by systems for exchanging information among supervisors. Principle Two. Except as stated in Principle One, regulation and supervision of the legal forms, licensing and the possibility of withdrawing the license, fit-and-proper testing, changes in control, group relations, supervision of the entire business, on-site inspections, sanctions, internal controls and audit, and accounting rules applicable to reinsurers should be the same as those for primary insurers. 46

47. Reinsurance Regulation  The E.U. Reinsurance Directive (2005) Supervisory power Single licensing Solvency provision 47

48. Regulatory Developments in Reinsurance (Table 23.6) 48

49. Reinsurance Issues (new for discussion)  Meaning and application of reinsurance Alternative risk transfers, especially insurance-linked securitizations  Taxation issues 49

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54. Discussion Questions 54

55. Discussion Question 1  What advantages and disadvantages would an insurance company expect from ceding its risks (a) facultatively or (b) using a treaty? 55

56. Discussion Question 2  Describe how premiums and losses are shared in (a) surplus treaty reinsurance and (b) working XL reinsurance. 56

57. Discussion Question 3  What effect would you expect from continuing consolidation in the reinsurance market? Discuss its impact on competition, capacity and reinsurance market security. 57

58. Discussion Question 4  An author cited in this chapter wrote “reinsurance can be viewed as both a leverage and a risk management mechanism.” Explain. 58

59. Discussion Question 5  What are the reasons that some governments offer for subjecting domestic nonlife insurance companies to compulsory cessions to a national or regional reinsurance company? In those countries, why do you believe the cession commonly applies to treaty reinsurance only? 59

60. Discussion Question 6  In view of the trends in the reinsurance market, what is their likely impact on reinsurance distribution systems. 60

61. Discussion Question 7  Why are the world’s largest reinsurance firms located in Europe? 61