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Sometimes the structure of these transaction becomes which provides protection to the insurer/reinsurer. This is
extremely complicated with the captive being the insurer, done through traditional, indemnity reinsurance coverage
a reinsurer and/or a retrocessional. With many moving based on the insurer's ultimate net loss, or, more typically,
parts, it becomes difficult to assess the true nature of the a recovery is determined based on a derivative (or
transactions and to record all of the necessary accounting parametric) measure of the loss. For example, one is based
entries in an accurate and timely manner. This operational on the industry loss or the modeled loss from an event.
risk is one on which the Risk Officer's organization must
focus, ensuring that appropriate controls are in place to The SPV, in turn, develops its capitalization through the
mitigate the risk. issuance of bonds to investors. In the event the reinsurance
is triggered, the bondholder will not receive all or any of
For both commercial reinsurance and captive their principle at maturity. The parametric coverage
arrangements, training and oversight need to be approach, while more attractive to the investor in the
emphasized and sufficiently robust to ensure that there is catastrophe bonds as the investor doesn't have to
a significant degree of risk transfer (underwriting and underwrite the individual company, includes basis risk the
timing risk), any fees are reasonable, no side agreements, Risk Officer needs to evaluate. That is, it is possible that
verbal or written, the financial records of both parties the buyer could have a loss to which the coverage does not
reflect the transaction the same way, and similar measures. respond.
The Risk Officer needs to be comfortable that procedures
are in place so all such arrangements receive appropriate Industry loss warranty protections are structured similarly
oversight and monitoring. but the protection triggers are typically based on relatively
narrowly defined risks and regions and a resulting
Facultative reinsurance purchased locally to protect aggregate industry loss. Industry loss warranties are
individual policies and treaty reinsurance has significant attractive to investors for simplicity but include considerable
measures of operational risk. These include delays in basis risk for the insurer which needs to be evaluated.
agreeing policy wording and a resulting lack of contract Another alternative source of reinsurance capacity is
certainty, non-concurrent terms and a simple failure to reinsurance provided by thinly capitalized reinsurers backed
execute as intended. The Risk Officer needs to ensure that by hedge funds.
the operational risk measures developed enterprise-wide
extend to the placement of reinsurance. These reinsurers provide reinsurance on a fully
collateralized basis, meaning that the full limit of the
Alternative risk transfer: Large natural catastrophe reinsurance is collateralized at the inception of the
contract. Risks with these vehicles include operational
losses in 2004 and 2005 and enhancements to catastrophe risks, risks pertaining to the collateral and failure to satisfy
accumulation models have increased the demand for statutory requirements. The RM should also be aware that
reinsurance and retrocession protections. In turn, this these vehicles typically do not include the reinstatement
demand has led to increased utilization of alternative risk coverage available in traditional reinsurance.
transfer mechanisms to supplement the traditional
reinsurance markets. Finally, so-called "side cars" are special purpose reinsurance
vehicles similar to those vehicles that facilitate Catastrophe
In particular catastrophe bonds, industry loss warranty Bonds. These vehicles are funded by both debt and equity
protections, hedge funds and so-called "side-cars" have and typically provide quota share reinsurance to the
grown in popularity. These facilities provide much needed, sponsor (re)insurer.
fully collateralized capacity to insurers and reinsurers but
may include basis risk which must be included in risk capital The SPV has limited capital resources and this limitation acts
determinations. to cap the quota share coverage provided by the facility.
This structure has the potential of "tail risk", which is the
Catastrophe bonds typically involve a special purpose vehicle
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12 June 2015 Life Insurance Today
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