Introduction To Reinsurance: Presentation by Holborn Corporation November 11, 2004

Introduction to Reinsurance
Presentation by Holborn Corporation

November 11, 2004
What is Reinsurance?
“Insurance for Insurance Companies”
More precisely
Reinsurance transfers insurance

underwriting risk to third-party
organizations.
2 Intro-Reinsurance.ppt
Introduction
(Re)Insurance Financial Strategies
¾ Pooling
Large number of small risks, where individual premiums inadequate
to cover individual losses
¾ Funding
Individual risks’ premiums set high enough to cover likely losses
(plus expenses and profit)
¾ Speculating
Large, unique exposure; low chance of loss; potential loss is very
high
Low enough likelihood that expected return greater than cost of
capital
Introduction
(Re)Insurance Financial Strategies
Insurance Reinsurance Business Low-Cost

Basic Strategy
Example Example Constraints Providers
Funding • Dental insurance • Net account quota • Processing • Class of business

• WC retro
share • Leverage
specialists
Pooling • HO fire • Working layers • Line size limits • Diversified

• Auto BI • Spread
multi-line
underwriters
Speculating • Trophy properties • Property cat • Aggregate • High capital

• EQ shake • EQ quota share
exposure • Tolerant of
• Volatility volatility
• Price-setters
Reinsurance and Holborn’s Role
Agents
Reinsurance
Insurance Insurance Companies
Policyholders Companies Example:
Lloyd’s Of London,
Berkshire Hathaway
Brokers
Reinsurance Intermediaries
*Holborn*
Risk Takers Transfer of Risk

“Middle Persons”
Reinsurance - Other Characteristics
¾ Reinsurance contracts derive value from insurance polices

(although reinsurance transactions rarely involve original
policyholders).
¾ For a premium, an insurance company cedes portions of its

insurance risk to a reinsurance company to transfer possible loss.
¾ Reinsurance rates and forms are unregulated; however, the parties

to a reinsurance transaction must be licensed (or reinsurers’ liability
collateralized) for the reinsurance transaction to be fully recognized
by insurance regulators (and, thus, for insurance companies to
receive statutory accounting benefit from the transaction).
Types of Reinsurance - Summary
¾ There are two types of reinsurance

Facultative
Treaty
¾ Each type of reinsurance can be structured in one of two ways
Excess of Loss (i.e., limit and retention)
Pro Rata (a/k/a, “proportional”)
¾ Treaty excess of loss reinsurance can apply on one of the three basis:
Per Risk
Per Occurrence (a/k/a, “Catastrophe”)
Aggregate (a/k/a, “Stop Loss”)
Facultative Reinsurance
¾ Facultative reinsurance applies to an individual risk, i.e., one commercial fire
policy or even only one location. Insurer and reinsurer agree to the
reinsurance terms on each individual agreement. It is generally used to
reinsure:
a) extra-hazardous or unusual risks which might be excluded from treaty
reinsurance agreements.
b) high valued risks with policy limits exceeding maximum treaty parameters.
¾ For Property risks, specific information about construction, usage, contents,
fire protections and other safety attributes will be assessed by the
underwriter. For Casualty exposures, revenue, coverage type, and claims
history are key underwriting considerations.
¾ Both pro rata and excess of loss forms are used.
¾ Facultative premiums are usually based on the ceding company’s exposures,
not it’s premium. So, $25 per car, not 2% of Automobile premiums
Treaty Reinsurance
¾ Treaty reinsurance applies to an insurance company’s entire book of

business, such as all commercial fire polices, all automobile policies, all
workers’ compensation policies, all homeowners policies, or, more
generally, any combination of the above.
¾ Certain risks are inevitably excluded to help define the exposure for the
treaty underwriter, who must rely on the capabilities of the ceding carrier
in determining the worth of any particular risk.
¾ Both pro rata and excess of loss forms are used.
¾ Treaty reinsurance premiums is usually set as a percentage of the ceding

companies original premiums.
Pro Rata (or Proportional) Reinsurance
¾ Insurer shares with the reinsurer all of the premiums and losses in a
certain percentage.
¾ Two forms of pro rata: Quota Share and Surplus Share.
¾ Example: 80% Homeowners Quota Share.

Insurer retains 20% of each and every policy;
the reinsurer accepts 80%.
Pro Rata Reinsurance
¾ Surplus Share: The insurer and reinsurer share a variable percentage of loss and
premium for each risk (not a fixed percentage, like a quota share).
¾ Example: $4Mn home, subject to a surplus share contract with a minimum retention of
$1Mn and maximum cession of $3Mn.
In this situation, the Reinsured can choose to cede anywhere from 0% to 75% of
the risk (being $3Mn. of $4Mn. value).
Given no maximum retention, the Reinsured can keep the entire risk net.
If the risk is deemed undesirable, the Reinsured can cede a maximum of $3Mn,
and retain $1 Mn. In this instance, 75% of the loss and premium is ceded to the
reinsurer.
¾ Other examples (same surplus share structure)
$2Mn. Home Up to 50% cessions (being $1Mn. of $2Mn.)
$1.5Mn. Home Up to 33% cession (being $500,000 of $1.5Mn.)
Pro Rata Reinsurance
¾ Pro Rata Pricing Mechanism: Ceding commission.

¾ Two Options:
Flat: Fixed percentage.
Sliding Scale: Fluctuates with actual loss experience, subject to
a minimum and maximum.
¾ Why buy pro rata protection?
To reduce net written premiums and underwriting leverage (i.e.,
Finance, “surplus relief”)
Capacity for individual risks
Catastrophe protection
Excess of Loss Reinsurance
¾ Reinsurer indemnifies reinsured (up to a stated limit) once a loss(es)

exceeds a pre-determined level (i.e., the deductible or retention).
¾ Excess of Loss reinsurance is expressed as, for example, $400,000

excess $100,000. (If the insurer incurs a $500,000 loss, it is
responsible for the first $100,000 of paid loss, and is reimbursed for the
next $400,000).
¾ Pricing: Percentage rate applicable to insurer’s original premium (i.e.,

“subject premium”) for policies covered by reinsurance.
¾ Three types of Excess of Loss Reinsurance:
Per Risk
Retention and limit apply to each and every policy, individually
(usually subject to an occurrence limit).
Catastrophe (or Occurrence)
Retention and limit apply to one or many policies in the same event.
Aggregate (or “Stop Loss”)
Retention and limit apply to all losses from all covered policies, in
the aggregate, over a specified timeframe – usually no more than
one year.
¾ Functions:
Per Risk: Capacity for Individual Risks
Catastrophe: Protection against accumulation of loss

Aggregate: Stabilization – i.e., net income protection
(Finance, Catastrophe)
Functions of Reinsurance
¾ There are four main functions of reinsurance

Finance
Capacity
Stabilization (net income protection)
Catastrophe (surplus protection)
¾ Another reason may include product expertise held

by the reinsurer, not by the reinsured.
Functions: i) Finance
¾ An insurance company’s growth may be limited because of unearned premium reserve
requirement(s). A company is forced to put all written premium into a UEP reserve account
while still paying business (acquisition) costs, (agents’ commissions must be paid on written
premium). The premium on an annual policy is earned at the rate of 1/12th per month.
Because acquisition costs must be paid immediately, there can be a substantial drain on
surplus, particularly when premium volume is expanding rapidly.
¾ The accounting system used by insurance companies is designed to enhance financial

strength, with state insurance regulators monitoring such items as the ratio of written
premium to surplus. A general rule of thumb used to be 3 to 1, but now 2 to 1 is more often
used. A ratio above 2.5 to 1 (varies by Company) could result in a company being viewed as
over extended, leading to rating agency action.
¾ Pro rata reinsurance enables a company to continue to write polices without draining capital
and surplus. It reduces written premium and increases the surplus, by means of a ceding
commission recouping pre-paid acquisition expenses.
Functions: ii) Capacity
¾ The ability to offer significant capacity on any given risk allows an insurance
company to compete in the market. Most companies require greater capacity than
their own resources can provide. By reinsuring portions of risk, through pro rata
and/or excess of loss, a company can compete in the market.
¾ A company writing to a maximum policy limit of, say, $10,000,000 could double
that capacity by arranging a surplus share reinsurance treaty. Thus, a $20,000,000
policy can be written with 50% of $10,000,000 ceded to a surplus share
reinsurer(s).
¾ Alternatively, a per risk excess of loss contract of $10,000,000 excess $10,000,000

has similar effect. On a $20,000,000 policy, all losses over $10,000,000 are paid by
the reinsurers for a predetermined premium.
Functions: iii) Stabilization
¾ Insurance companies generally prefer stable year-to-year underwriting

results, rather than wide fluctuations.
¾ Excess of loss reinsurance enables a company to determine the loss it will

assume on any one risk, in any one occurrence, or in the aggregate for the
entire year. Thus, losses are stopped at a certain level above which
reinsurers pay.
Functions: iv) Catastrophe
¾ Surplus needs to be protected against severity of major catastrophe, such as

hurricanes, tornadoes, floods, earthquakes, hail, etc.
¾ Most reinsurance arrangements provide some degree of coverage for these

occurrences, but catastrophe excess of loss specifically addresses the
accumulation of small losses, some or all or which would not be covered under
any of the company’s other reinsurance.
Holborn’s Role as Reinsurance Intermediary
¾ Advocate, consultant and advisor to insurance company clients.

¾ Maintain business relationships with reinsurers on a worldwide basis
¾ Structure cost effective reinsurance programs
¾ Canvass reinsurance market to determine interest

among intermediary market reinsurers in a given
program bearing in mind the financial strength of each
reinsurer
¾ Constant monitoring of reinsurers’ financial condition - ability
and “willingness” to pay claims
¾ Monitor effectiveness of reinsurance program – Increase
retention? Limit needs? Coverage Provided, etc.
¾ Provide other actuarial, modeling, claims, accounting
and contract wording services.
Actuarial Support
Our Mission
To offer the best combination of proprietary,
commercially available and common-sense
tools for our clients to systematically evaluate
all of their choices for reinsurance purchasing
and risk management.
Actuarial Support
¾ Founded in 1940’s
¾ Ahead of its time
¾ 7 employees (over 10% of our workforce)
¾ Customized models for each client
¾ Relationships with multiple vendors
¾ Proprietary original models to supplement weaknesses
in vendors’ models
Actuarial Support
¾ Catastrophe modeling
Mapping includes
• Concentration studies / “Concentrics”
• Deterministic storms / “Look-a-likes”
Vendor-developed cat models, which we license
Holborn’s proprietary Inland Wind Cat model
¾ Dynamic Financial Analysis (DFA)
¾ Optimization / risk selection
¾ Reinsurance benchmark pricing
¾ BCAR “What-if’s”
¾ Risk transfer testing
¾ Rating agency questionnaires

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Introduction to Reinsurance

Presentation by Holborn Corporation

“Insurance for Insurance Companies”

Reinsurance transfers insurance

Insurance Reinsurance Business Low-Cost

Funding • Dental insurance • Net account quota • Processing • Class of business

Pooling • HO fire • Working layers • Line size limits • Diversified

Speculating • Trophy properties • Property cat • Aggregate • High capital

Risk Takers Transfer of Risk

¾ Reinsurance contracts derive value from insurance polices

¾ For a premium, an insurance company cedes portions of its

¾ Reinsurance rates and forms are unregulated; however, the parties

¾ There are two types of reinsurance

¾ Treaty reinsurance applies to an insurance company’s entire book of

¾ Both pro rata and excess of loss forms are used.

¾ Treaty reinsurance premiums is usually set as a percentage of the ceding

¾ Two forms of pro rata: Quota Share and Surplus Share.

¾ Example: 80% Homeowners Quota Share.

¾ Pro Rata Pricing Mechanism: Ceding commission.

¾ Reinsurer indemnifies reinsured (up to a stated limit) once a loss(es)

¾ Excess of Loss reinsurance is expressed as, for example, $400,000

¾ Pricing: Percentage rate applicable to insurer’s original premium (i.e.,

¾ Three types of Excess of Loss Reinsurance:

 Per Risk: Capacity for Individual Risks

 Catastrophe: Protection against accumulation of loss

¾ There are four main functions of reinsurance

¾ Another reason may include product expertise held

¾ The accounting system used by insurance companies is designed to enhance financial

¾ Alternatively, a per risk excess of loss contract of $10,000,000 excess $10,000,000

¾ Insurance companies generally prefer stable year-to-year underwriting

¾ Excess of loss reinsurance enables a company to determine the loss it will

¾ Surplus needs to be protected against severity of major catastrophe, such as

¾ Most reinsurance arrangements provide some degree of coverage for these

¾ Advocate, consultant and advisor to insurance company clients.

¾ Structure cost effective reinsurance programs

¾ Canvass reinsurance market to determine interest

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Per Risk: Capacity for Individual Risks

Catastrophe: Protection against accumulation of loss