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6/12 M97/February 2018 Reinsurance

Again, if a loss of £4m occurs:

Retained loss £200,000 5%
Surplus treaty loss £2.4m 60%
Additional retained loss £1.4m 35%
£4m 100%

This time the net exposure would be £1.6m, resulting in an ultimate cedant retention of £100,000, a total
loss to the layer of risk excess of loss reinsurance and a claim of £1.1m to the facultative excess of loss
reinsurance.

Activity
Show that the largest loss which will not result in a claim on the latter contract is £1.25m.

B Pricing programmes

Once designed, a reinsurance programme must be priced. So far as non-proportional is concerned, the
price of each treaty is derived from the following factors:
• risk premium, which is the cost of claims including a loading for fluctuations;
• external costs, which include acquisition expenses and agents’ commission;
• internal costs, such as administration and staff costs; and
• desired profit or return.
In basic terms, for each treaty, the risk premium – that is, the expected losses to the particular contract
for the prospective treaty year – is estimated using a variety of, largely, actuarial techniques. Typically,
6 the premium is modelled by a reinsurer’s pricing actuary and we take a brief look at the main techniques
Chapter used to do this in section B1. Next, the loss cost is adjusted for any policy features which vary with Reference copy for CII Face to Face Training
losses (for example, aggregate retentions, reinstatements and profit commissions).
To complete the process, the premium is then loaded for expenses and profit and any other factors
considered appropriate in the light of the particular circumstances.

B1 Pricing techniques

There are three
main approaches
to reinsurance
(3)
pricing:
(1)
experience rating frequency and
severity rating

(2)
exposure rating

B1A Experience rating
Experience rating is the use of experience (losses and exposure) to project or estimate average future
Use of experience to
project or estimate loss costs. This approach takes contract-specific historical loss and exposure data (for instance,
average future premium), developing and/or adjusting it to reflect current exposures and uses this as a basis for
loss costs
selecting your expected losses and hence the required premium rate, or risk premium, for the
reinsurance contract.
Depending on what data are available, historical premium may be projected to reflect rate changes up to
the prospective period. Similarly, incurred losses are developed to ultimate, using one or more reserving
methods, such as the loss development (or Chain Ladder) method, or the expected loss ratio method, or
a combination of the two (Bornhuetter-Ferguson method), and a measure of claims inflation is applied.
This technique may be used for proportional and non-proportional treaties.