1 DEVELOPING REINSURANCE STRATEGY FOR ENERGY BUSINESS Seminar Paper presented by: AGHOGHOVBIA, K. African Reinsurance Corporation

2 Contents  Introduction  Designing A R/I Programme  Energy Business & Reinsurance  Arranging the desired Programme  Negotiating Terms  Reviewing Programmes

3 Introduction  Insurance and Reinsurance  Insurers seek to develop a reinsurance strategy that is capital-efficient to enable them achieve their corporate goals.  The objective of this paper is to highlight the necessary ingredients in the design of a Reinsurance programme, particularly for the Energy class, that would satisfy, sometimes, conflicting goals.

4 Designing a Reinsurance Programme  A reinsurance programme is the combination of Reinsurance Contracts that an Insurer obtains to meet its reinsurance needs.

5 Designing …  The Management of an insurance company, in formulating its reinsurance programme, must aim at:  Protecting its net retained account from abnormally large losses, and  Providing itself with a greater acceptance capacity than what his financial resources would ordinarily allow.

6 … continues  The purpose of a reinsurance programme is therefore to form a bridge between two aims; in the sense that it enables the company to write the former and achieve the latter.

7  The designing of a reinsurance programme involves coordinating an insurer’s needs and the functions performed by reinsurance.  It is therefore essential to start the process by determining insurer’s needs that reinsurance can meet and these including the issues of retentions and limits, are influenced by the business strategy, financial resources and management attitude towards risks. Issues for Consideration in Designing a R/I Programme

8  As reinsurance cannot meet some of the insurer’s needs; the designing of a reinsurance programme focuses on the functions of reinsurance viz:  Increasing capacity,  Providing stability,  Providing catastrophe protection,  Providing relief to shareholders funds, and  Providing underwriting expertise. Continues …

9 Business Strategy and R/I Functions Reinsurance needs based on business strategy can be summarized below: CapacityStability Cat. Protec- tion Relief to S/holders Funds U/W Expertise Growth Plans XXX Lines of Business XXXX Portfolio Size XX Company Structures XX Geographic Spread XX

10 Financial Resources and R/I Functions CapacityStability Catastrophe Protection Relief to S/holders Funds Limited Liquidity XXX Limited Access to Capital XXX Limited Shareholders Funds XXXX Reinsurance needs based on insurer’s financial resources can be summarized below:

11 Retentions  Primary decision here is how much can be retained for the insurers own account. The retention considerations will be : a) Amount of single loss b) Amount of Accumulated loss c) Frequency of (a) and (b) d) Likely future trends “The U/W circle”.

12 Continues …  Again business strategy, financial resources and management attitude influence the retentions and limits that the insurer selects.  Other factors that influence retentions include:  Types and cost of reinsurance;  Size of portfolio;  Premium income and profitability;  Type and spread of risks and pattern of losses;  Reinsurer requirements;  Retentions of similar insurers and co-insurance contributions.

13 Limits  The limits of reinsurance contract are the maximum amounts of liability that the reinsurer can accept as defined in the reinsurance contract.  Factors considered in setting treaty limits vary by the kind of treaty and include:  - Maximum Policy limits  - Catastrophe exposure Note Extra Contractual Obligations, Excess of Policy limits Exposure …

14 Analyse the Business  After identifying the insurer’s needs, historical information on portfolio premium, losses, rate changes and reinsurance limits must be gathered and analysed to determine whether the proposed reinsurance programme meets the insurers needs.

15 Having analysed its portfolio of business and in the light of its proposed retention limits, it is clear that some form of reinsurance will be required, a decision will then be made on whether to arrange a Facultative or Treaty or a combination of both on either a pro – rata or excess of loss basis. Technical Selection of Appropriate Form of Reinsurance

16 Selecting Types of Reinsurance Increase Risk Capacity Provide Stability Provide Cat. Protection Provide Relief to S/holders Provide U/W Expertise FacultativeXX Quota Share X Surplus/ Fac Oblig XX Excess of Loss XXX Types of Reinsurance and R/I Functions

17 Facultative Reinsurance This could be Proportional or Non- proportional and is useful where: The risk is highly hazardous or of an unusual nature; Additional capacity is required ; The insurer wishes to protect the Treaty; The risk is excluded from the Treaty; and Underwriting advise is required.

18 Treaty Reinsurance Forms of Treaty R/I Proportional Non-Proportional QS Surp Fac Oblig XOL XOL Loss Ratio or Stop Loss Risk Occurrence Basis Basis

19 Factors in Selecting Appropriate Type(s) of Reinsurance Treaties Factors In Selecting Appropriate (Type(s) of Reinsurance Treaties) ♪ The nature of business ♪ Administrative costs and ease or otherwise of operation ♪ The effect on the company’s retained account ♪ Whether the reinsurance is being sought solely to control exposures or for other purposes too, such as easing the financing strains of solvency ♪ Whether company wishes to engage in reciprocity

20 Energy business reinsurance programme design follows the same principles as other lines. In selecting appropriate reinsurance therefore, cognizance must be taken of the risk characteristics. Energy Risk Characteristics: High value (billions of Dollars) Often long tailed High concentration of risks Few policies, high premium Highly hazardous business Due to above characteristics, particularly the unbalanced nature of energy portfolio and exposure to accumulation, treaty reinsurance is not fashionable. Reinsurers prefer to have discretion to accept/decline business and under terms and conditions acceptable to them, thus fac, Line Slip & Pools. Energy Business & Appropriate Reinsurance

21 Facultative Proportional Reinsurance Advantages: Cedant recovers part of all losses, Over-rider covers acquisition costs, Simple to administer, Cost reflects original rates, Attractive to reinsurer as premium/limit ratio is balanced. Disadvantages: Insurer may cede too much premium. NB: This type of reinsurance is good for increased market share, capacity and limitation of net exposure Reinsurance Options Available on Energy Business

22 Facultative Non Proportional Reinsurance Advantages: Simplest form of reinsurance, Maximizes retained income through retention mechanism, Ideal against accumulations through CAT event coverage, Easy to place with reinsurers. Disadvantages: Volatile if claims experience is not satisfactory, Affect cash flow as premium is paid in advance, Rates do not follow original terms, and could be expensive, No over-rider. R/I Options Available on Energy Business

23 Line Slip Reinsurer enters an agreement with broker to accept cessions of a given class of business, subject to acceptance by lead reinsurer, Not a treaty as it is not obligatory, Rarely used nowadays.

24 Pools Arrangement Available to members of an Energy Pool Formed on both National & Regional basis, Participants exposed to accumulation of risk from business attaching to pool, Balance in risk portfolio enables pool to reinsure to limit accumulation problems. Regional Pools spread risk wider than national ones, Premium in a region available for investment within regional economy, Realized profit for the benefit of members, Example of regional Energy pool is the African Oil & Energy Insurance Pool – the most successful pool in the continent of Africa, Companies that want the twin advantage of Capacity & Expertise may cede business and enjoy profit from the pool. Energy Reinsurance Pools

25 Arranging the desired Programme  Direct or Through Brokers  Selection of Markets & Reinsurer

26 Negotiating Terms  Information Required  Price  Proportional  Non-Proportional

27 Reviewing Programme o Reinsurance programmes are reviewed at renewal because conditions change, o Important aspect of review is to ensure that: - Company continues to enjoy adequate reinsurance, - Underwriters remain aware of treaty limits and exclusions, - Claims reporting procedures are continually observed, and - Cost of reinsurances remain competitive.

28 Responsibilities for Design of Programmes  1. The General Management  2. The Departmental Managers Underwriting Departments: Accounting and Administrative Dept Financial Department  3. The Reinsurance Manager