Page 49 - CFPA-SCR-Award in General Insurance W01_2018-19_Neat

Chapter 2 The insurance market 2/11

H Reinsurance

You will remember from chapter 1 that just as individuals, corporations and public bodies may feel the
need to transfer risk, so too do insurers. They achieve this by using the services of reinsurers that Chapter
specialise in accepting business originally underwritten by insurers. Reinsurance may be on an
individual risk basis, an event basis or on a portfolio (wide range) of risks. 2

H1 Purpose of reinsurance
We could start by asking ‘Why reinsure at all?’ Each insurer could decide to insure only those risks that
they were able to accept within their own defined limits. However, if we consider this for a moment we
can see problems:

• What about several losses to different insured risks that are all connected in some way, e.g. storm
damage to many insured properties at once?
• What about very large losses, e.g. a massive explosion or terrorist attack?
• What about the cumbersome nature of risk sharing if it is all is done by means of each insurer taking a
small direct share or even sharing by means of co-insurance?

An insurer is able to reinsure a risk that it holds because it stands to lose financially as a result of a
claim. Although in theory the whole of an individual risk could be reinsured, this would make no sense,
so insurers reinsure only part of a risk that they hold. In this way reinsurance may be used to share
losses on a risk-by-risk basis. One of the big differences between co-insurance and reinsurance is the
fact that when an insurer places part of a risk with a reinsurer, the policyholder will not normally know
that this has happened. It follows therefore that there is no contractual relationship between the original
policyholder and the reinsurer. If a claim occurs the policyholder will look to the insurer to meet the loss
in full; any subsequent recovery of reinsurance monies is entirely a matter for the insurer to pursue.
In summary, reinsurance exists to:
• smooth peaks and troughs in the claims experience;
• protect the portfolio (essentially the balance sheet);
• provide improved customer service; and
• provide support for insurers entering new areas of business.
Let us look at these now in greater detail.

Question 2.1

What type of catastrophe perils might an insurer wish to reinsure against?

H1A Smoothing peaks and troughs

Insurers are keen to ensure that their trading results each year show gradual trends, rather than huge
peaks or deep troughs. Investors prefer to see stability in insurance companies. Reinsurance helps by
spreading the cost of very large losses over a period of time. In their pricing, reinsurer(s) will certainly
require increases where there are adverse trends, but will not try to recoup a very large payment all at
once. Instead they will spread the cost over a number of years so this has the effect of smoothing out the
highs and lows.

H1B Protecting the portfolio
It is possible to arrange reinsurance on a single known risk. When insurers do this it is known as
facultative reinsurance. However, it is equally important for insurers to protect the pool of accumulated
funds from the effects of very large losses or a series of losses arising from a single cause. This is a type
of catastrophe reinsurance and could apply to, for example, weather-related claims.
Insurers arrange facilities to enable them to place a range of risks that fall within agreed criteria. These
These arrangements
arrangements are called treaties. It is also possible for reinsurance to be effected to protect the portfolio are called treaties
as a whole. Some specialist treaties pay out if the overall loss ratio (premiums v. claims) exceeds a
certain figure. There are many different types of arrangement, some of which provide a means of sharing
risks in agreed proportions and others that protect against losses exceeding agreed amounts. The detail
of these goes beyond the scope of the syllabus for this subject.