6 questions = 8% of the exam Chapter 11 Managing Exposure 6 questions = 8% of the exam

Learning Objectives: After studying this chapter, you should be able to: Describe the basic factors influencing the market cycle Describe the principles of accumulation of risk Describe the basic considerations applicable in the purchasing of reinsurance

Market Cycle Transitional stage Soft market Transitional stage captial markets invest in insurance new insurers and underwriting vehicles emerge insurers' capacity increases insurers write more business competition lowers rates claims exceed premiums capital markets withdraw from insurance insurers' capacity reduces competition for restricted capacity increases rates premiums exceed claims Transitional stage Soft market Transitional stage Hard market

Market Cycle It is very difficult to identify the length of a market cycle, it can vary between 2 and 5 years. Things that can shorten or lengthen the cycle are… Economic changes Changes in legislation Weather related incidents Major disasters

Risk Accumulation Insurers must look at loss exposure from single risks and single events, Single risks: Property and business interruption risks: Consider a fire risk… The underwriter would try and work out the Estimated Maximum Loss (EML) sometimes called the Maximum Probable Loss (MPL) If the EML is more than the insurers acceptability limit they could reinsure the risk so they can take it all on or share the risk with other insurers (Co-insurance)

Risk Accumulation Single risks: Liability risks: Limit of liability rather than sum insured. It is common to encounter layering of limits i.e. one insurer may offer a 2 million limit and a second insurer cover the excess over 2 million up to say 5 million (Excess of Loss insurance) Single events: Many individual losses can occur as a result of a single catastrophe insurers are aware of this and can take out reinsurance to protect themselves.

Reinsurance What is reinsurance? Why would a company want to buy reinsurance? Who has to pay the customer’s claim when a risk is reinsured?

Types of Reinsurance There are two major types of reinsurance: Proportional Non proportional They can be further sub divided: Proportional Non-proportional Quota share Surplus Excess of loss Stop loss

Proportional Reinsurance Quota share: The reinsurer will take on an agreed % of all risk written by the insurer. e.g. if the insurer has a treaty covering 60% of its household portfolio the reinsurer would accept liability for 60% of every policy written What are the advantages and disadvantages to the insurer who buys this type of reinsurance? Who might buy this type of reinsurance?

Proportional Reinsurance Surplus: The reinsurer will cover amounts that go above the insurers retention limit (line). Policy Sum Insured Amount retained Amount reinsured Reinsured % Balance 1 £100,000   2 £300,000 £200,000 66.67% 3 £500,000 £400,000 80.00% 4 £600,000 83.33% 5 £700,000 71.43%

Non-proportional Reinsurance Excess of loss: written on a Per risk or Per event basis This table shows the reinsurers liability for £100,000 in excess of £50,000 (could be other layers): Loss Amount Insurers liability Reinsurers liability Balance 1 £25,000   2 £75,000 £50,000 3 £125,000 4 £200,000 £100,000

Non-proportional Reinsurance Stop loss (excess of loss ratio): With this type of reinsurance, the insurer is primarily concerned with protecting its loss ratio. If, for example an insurer wanted to prevent its maximum loss ratio from exceeding 80% it could obtain reinsurance for claims in excess of this figure. Reinsurers usually limit their maximum liability and would also generally insist that an insurer shares in any reinsured loss. Otherwise the insurer would be guaranteeing that they would not suffer an underwriting loss

What is an example of a non-proportional reinsurance? a. Quota share. b. Facultative. c. Excess of loss. d. Surplus.

What effective would you expect major disasters such as hurricanes to have on the market cycle? a. it will shorten it b. it won’t make any difference to it c. it will soften the market d. It will lengthen it

In respect of the insurance market cycle when would be the optimum time to write new business? a. When the market has softened. b. When reinsurance capacity is low. c. When the market has hardened. d. When the market is at its lowest.

At what stage in the market cycle will reinsurers want to increase investment? a. When capacity is being withdrawn. b. When higher profits are being made. c. When lower profits are being made. d. When lower prices are being charged.

Under a surplus reinsurance treaty how is the reinsurer's proportion of any claim settlement calculated? Total sum insured divided by the insurer's retention limit. Set proportion or percentage of all claims made. Sum insured in excess of insurer's retention limit divided by the total sum insured. A proportion agreed individually in respect of each risk.

Surplus reinsurance is a type of: quota share reinsurance. proportional reinsurance. non-proportional reinsurance. facultative reinsurance.

ABC Insurance has arranged excess of loss reinsurance for £1m in excess of £500,000 on a per risk basis. What is the reinsurer's liability, if any, of a claim agreed at £250,000? Nil £83,333 £125,000 £250,000

ABC Insurance has arranged excess of loss reinsurance for £1m in excess of £500,000 on a per risk basis. What is the reinsurer's liability, if any, of a claim agreed at £750,000? Nil £250,000 £500,000 £750,000