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Chapter 6 Summary: Quota Share

The document discusses different types of reinsurance products including quota share, surplus, excess of loss, stop loss, finite risk, run-off, and capital market products. Quota share splits premiums and claims proportionally. Surplus varies the proportion covered based on risk size. Excess of loss covers above defined layers. Stop loss covers against bad whole account experience. Finite risk focuses on improving accounting position over risk transfer. Run-off transfers reserve development risks. Capital market products provide contingent capital or securitize risks.

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203 views

Chapter 6 Summary: Quota Share

The document discusses different types of reinsurance products including quota share, surplus, excess of loss, stop loss, finite risk, run-off, and capital market products. Quota share splits premiums and claims proportionally. Surplus varies the proportion covered based on risk size. Excess of loss covers above defined layers. Stop loss covers against bad whole account experience. Finite risk focuses on improving accounting position over risk transfer. Run-off transfers reserve development risks. Capital market products provide contingent capital or securitize risks.

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SP8-06: Reinsurance products – types Page 49

Chapter 6 Summary
Quota share
Quota share is proportional reinsurance whereby the premiums and claims for all risks
covered by the treaty are split in a fixed proportion. The reinsurer pays return and override
commission to the insurer. Profit commission may also be payable.

The cedant’s experience (in terms of loss ratios) will be the same before and after
reinsurance. The reinsurer will have proportionately the same underwriting experience as
the cedant.

Quota share:
+ spreads risk, increasing capacity and encouraging reciprocal business
+ directly improves the solvency ratio (without losing market share)
+ is administratively simple
+ may provide commission that helps with cashflow
– cedes the same proportion of low and high variance risks
– cedes the same proportion of risks, irrespective of size
– passes a share of any profit to the reinsurer
– is unsuitable for unlimited covers.

Surplus
Surplus is proportional treaty reinsurance whereby the proportion of risk covered varies
from risk to risk depending on the size and type of risk.

The EML for a risk is used in assessing the proportion of the risk to reinsure, defined in terms
of ‘lines’. If k lines are used for a risk then premiums and claims are split in the proportion
1:k.

The width of one line represents the amount the insurer would pay if a claim equal to the
EML occurred. This amount is called the retention (r). Therefore: EML  (1 k) r .

A surplus treaty will usually specify a maximum number of lines and a minimum and
maximum retention. Higher levels of cover can be obtained by purchasing a second (and
third, and fourth) surplus treaty.

The cedant and reinsurer will have different experience: smaller risks may be retained in full
by the cedant, whereas larger risks may be covered primarily by the reinsurer.

The Actuarial Education Company © IFE: 2019 Examinations


Page 50 SP8-06: Reinsurance products – types

Surplus:
+ enables the insurer to fine-tune its exposure
+ enables the insurer to write larger risks
+ is useful for classes where wide variation can occur in the size of risks
+ helps to spread risks
+ may provide commission that helps with cashflow
– requires more complex administration
– is unsuitable for unlimited covers and personal lines cover.

Excess of loss
The reinsurer covers the risk (or a proportion of it) between defined layers, the limits of
which are often indexed for inflation (using a stability clause). The insurer may choose to
have a number of layers of cover with different reinsurers.

Once the layer of cover has been ‘burnt through’, it will need to be reinstated, which might
require a further reinsurance premium to be paid.

The cedant’s and reinsurer’s experience will be different and will depend on the distribution
of large losses.

There are three main types of excess of loss reinsurance:


 Risk XL – this relates to individual losses and is usually written by treaty
 Aggregate XL – this relates to cumulative losses, where the aggregation may be by
event, by peril or by class
 Catastrophe XL – this is a form of aggregate XL covering severe losses within the
hours clause that result from a specified event.

Excess of loss:
+ allows the insurer to accept risks that could lead to large claims
+ reduces the risk of insolvency from a large claim, an aggregation of claims or a
catastrophe
+ reduces claim fluctuations (and so smooths results)
+ helps to make more efficient use of capital.

© IFE: 2019 Examinations The Actuarial Education Company


SP8-06: Reinsurance products – types Page 51

Stop loss
Stop loss is a specific type of aggregate XL, which covers against very bad experience across a
whole account over a defined time period. The limits are usually defined as loss ratios (ie as
percentages of premiums).

Finite risk (or financial) reinsurance


The main feature of a financial reinsurance contract is that it involves only a small element, if
any, of transfer of insurance risk from the cedant to the reinsurer. Financial reinsurance was
devised primarily as a means of improving the apparent accounting position of the cedant.

The following are examples of finite risk reinsurance products:


 time and distance policies – the insurer pays the reinsurer a premium and in return,
the reinsurer pays an agreed schedule of claim payments; this has the effect of
discounting the reserves of the insurer for the time value of money
 spread loss covers – the insurer pays an annual or single premium to the reinsurer
for the coverage of specified claims; these may be used to provide liquidity and
security to the insurer and may be used for catastrophes
 financial quota share – this is quota share (as described above) purchased in order to
obtain reinsurance commissions for financing assistance
 structured finance – these often provide the insurer with a credit enhancement,
which lowers the cost of borrowing
 industry loss warranties – these are a type of reinsurance that pay out based on
industry losses rather than losses to individual insurers.

Run-off reinsurance
Run-off reinsurance solutions focus on the full-scale risk transfer of reserve development
risks.

Adverse development covers involve the purchase of reinsurance cover for the ultimate
settled amount of a block of business above a certain pre-agreed amount. Reserves are
maintained by the insurer.

Loss portfolio transfers are not a form of reinsurance. They involve the transfer of liability
for a specified book of business from one insurer to another. Reserves are transferred to the
new insurer along with all remaining exposure to the business.

The Actuarial Education Company © IFE: 2019 Examinations


Page 52 SP8-06: Reinsurance products – types

Capital market products


Committed (or contingent) capital is a contractual commitment to provide capital to an
insurer should a specific adverse event occur that causes the insurer financial distress.

Securitisation may be used to manage risk or capital. Examples of securitisation include:


 insurance-linked securities (ILSs) – often in the form of catastrophe bonds, where the
issuer can default on the interest and capital payments on the bond if the catastrophe
occurs
 credit securitisation – these may enhance the creditworthiness of debt instruments
and provide capital relief to banks / credit protection to companies
 motor securitisation – certain aspects of a motor insurer’s portfolio risks are passed to
the investment market.

© IFE: 2019 Examinations The Actuarial Education Company

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