Page 24 - Insurance Times JUNE 2022

of the ITRMO process. The goal is to identify the optimal the cost of risk [this being the sum of (retained losses) +
structure for the risk financing programme, against which (reinsurance premiums ceded less reinsurance
reinsurance coverage can be overlaid. commission and profit commission) + (cost of capital
including statutory reserves) and (taxes)]
This stage is focused not only on identifying optimum
reinsurance arrangements, but also in determining the This helps insurers to establish the cost benefit of each of the
amount and type of risk that can be retained by the insurer. options generated in relation to the current basis - for each
Typical considerations in this stage include: class of risk (mono-line) and as an integrated risk (multi-line)
Technically reviewing current coverage, limits and ex- financing programme. It then prioritises the options to define
clusions, in order to stress-test the adequacy of existing the optimum programme design.
reinsurance arrangements against the risks identified in
Stage 1. Stage 3 - Designing and placing insurance risk financing
solutions
Calculating risk tolerance: insurers must evaluate whether
Work done in the above two stages will now help determine
changes to their business, its strategy and its financial
the appropriate reinsurers to approach. Any work an insurer
strength could mean that current levels of reinsurance no
has done to identify its exposures, build an integrated risk
longer represent the best form of capital for financing
financing strategy and potentially managing down the causes
risk. This stage will help determine the insurer's material-
of claims, should help it obtain better terms in the reinsurance
ity threshold and transfer 'strike points'. A variety of indi-
market.
cators can be followed to determine risk appetite and the
willingness or ability of the insurer to pay for losses from
Cessions to reinsurers should contain detailed and relevant
their own liquid reserves. These include credit ratings,
data on the extent of the risks, the performance of controls
materiality thresholds, industry benchmarked retention
and their correlation with losses and the insurer's
levels or 'rules of thumb'. Besides ensuring more effective
commitment to improving risk profile. Given such available
deployment of capital, this process can help insurers re-
and transparent information and performance metrics,
duce the volatility attached to reinsurance market cycles,
reinsurers will often offer financial incentives to insurers who
by buying potentially protection at higher levels.
implement a programme of ongoing risk improvement, by
Using the analysis on risks, existing reinsurances and
either increasing reinsurance commissions or contributing to
optimal retention levels, insurers are then in a position
risk management initiatives.
to develop actuarial models - sometimes called
'integrated loss models' -that enable them to design
The reinsurance placement will be complemented by the
various programme structures, balancing a range of
structure of alternative risk financing and transfer solutions
theoretical transfer and retention costs. The objective
to ensure the overall return on capital invested in risk is
at this stage is to identify the lowest TCOR, allowing for
optimised for the company.
self-reinsured volatility.
Analysis of Alternative Risk Financing options, including Summary
captive feasibility studies: If a company has concluded
As stated earlier, what is true between an insurer and a
that it is potentially overspending on reinsurance, then
reinsurer is also true between a reinsurer and a
it might consider setting up a captive reinsurance vehicle
retrocessionaire and so on. A unique domain-technical
to self-finance some of its risk.
solution incorporating elements of financial modelling,
actuarial science and insurance market methodologies,
For each class of exposure under consideration, it is further customized for each specific insurer, is the all-
necessary to define (for any level of per occurrence encompassing holistic solution to optimizing insurers' return
deductible): on capital employed on insurance technical risk management.
the appropriate aggregate stop loss
The net result of this would be sustained financial and business
the retained risk fund required at a given confidence
benefits. Needless to add, the solution needs to be reviewed
level
for adequacy and optimality on a regular basis and changes,
reinsurance pricing if required, incorporated.

24 The Insurance Times, June 2022