Introduction to Reinsurance

Presented by: Paul J. McGee, Mike Cass & Tom Pavelko

The Reinsurance Marketplace

Where to Go!!
Professional Reinsurance Companies

Primary Insurance Companies With

Reinsurance Departments
Specialty Companies

Distribution System
How To Get There!

The Direct Market

The Intermediary Market

Buyers Decision-Making Process

The Whys of Choice! Advantages and Disadvantages

Definitions
What Do These Words Mean?

The language of Reinsurance

Reinsurance :

A form of insurance whereby one insurer (the reinsurer) indemnifies another insurer (the reinsured) for losses under insurance policies issued by the reinsured to the public.
A Primary Company, Direct Company, all known as the Reinsured transferred

Ceding Company:

Reinsurer: The Company to whom the risk is

More of The Language of Reinsurance

Retrocession: Reinsurance of Reinsurance Retrocessionaire and Retrocedent:

The parties to a Retrocession

Treaty: An automatic contract Facultative: Risk reinsurance

And,More of the Language of Reinsurance

Pro Rata Reinsurance: A term describing a form of

reinsurance whereby the reinsurer shares a predetermined, proportional share of the premiums and losses of the reinsured.

Excess of Loss: A form of reinsurance whereby the

insurer retains all losses up to a predetermined amount, and is then indemnified beyond that amount, to a predetermined amount, by reinsurers. Also known as non-proportional
Retention: The amount of risk not being reinsured

Function of Reinsurance
A Need Fulfilled
Financial Stabilize Results Capacity Protection From the Almost

Immeasurable Other, More Obscure Needs

Method of Reinsurance
Treaty - Facultative

Two Disciplines With Common Goals

Key Distinctions
TREATY
A Block or Class of

FACULTATIVE
One Risk At a Time Underwriter Can

Business Usually Obligatory Reinsurer Not Involved In Risk Decisions Long Term Relationship

Accept or Reject Risk Underwriting Short Run (Usually one Year)

Why Treaty? When Facultative?

Treaty Exclusions

Protect Treaty

Capacity

Forms of Reinsurance
Pro-Rata

Quota Share and Surplus Share

Excess of Loss

Per Risk, Per Occurrence, Aggregate

Pro Rata Reinsurance

A Partnership through SHARING

Quota Share

KEY TERMS AND CONDITIONS

Quota Share

75% Cession
$0

25% Retention
$1 M

Proper Identification of Reinsured Parties

All Companies in a Group A Single Company Only Named Companies in a Group MGA-produced business for a Company Includes Quota Share Reinsurers

Interest and Liabilities Contract

Such participation shall be several and not joint with the participation of other subscribing reinsurers and the Subscribing Reinsurer shall under no circumstances participate in the interests, (if any) of the other reinsurers in said instrument

ARTICLE 1 Business Covered:

A. The Company shall cede to the Reinsurer and the Reinsurer

shall accept from the Company ___% quota share participation

of the net retained insurance liability of the Company on each risk insured under policies in force at ____, Standard Time,

_____, 20__ and new and renewal policies becoming effective

after (or on and after) said date, as respects losses occurring after (or on and after) ___, Standard Time _____, 20__,

covering the Lines of Business set forth below, except as

excluded in the Exclusion Article, subject to the limits set forth in the Limits of Cover Article.

ARTICLE II Term and Cancellation

A. This Agreement will apply to losses occurring after (or on and after) ___ ___ Local Time _____, 20 __ as respects policies in force at said date and new and

renewal policies becoming effective after (or on and

after) said date and will be of unlimited duration. This Agreement may be terminated as of _____ any , of

any year by either the Company or the Reinsurer giving

not less than __ days prior written notice by Certified Mail to the other party.

ARTICLE IV Exclusions
The following risks and kinds of insurance are excluded from coverage under this Agreement, and no loss or losses thereon shall be recoverable hereunder: 1. All lines of Business not specifically covered hereunder 2. Reinsurance assumed, but not to exclude local Agency reinsurance 3. Pools, Associations and Syndicates business as per POOLS, ASSOCIATIONS AND SYNDICATES EXCLUSION CLAUSE attached 4. Flood and Earthquake when written as such. 5. Hail on growing or standing crops or timber. 6. Nuclear Incident .. 7. War Risks .. Etc.

ARTICLE IX Reinsurance Premium

A. The Company shall pay promptly to the Reinsurer _____% of the Companys unearned premium on its net retained insurance liability in force at _____, Standard Time, _____, 20__ on the business covered hereunder.

ARTICLE XV Access to Records

The Company shall place at the disposal of the Reinsurer
at all reasonable times, and the Reinsurer shall have the right to inspect, through its authorized representatives, all books, records and papers of the Company in connection with the reinsurance hereunder or the

subject matter thereof.

ARTICLE XXIII Arbitration

A. Should an irreconcilable difference of opinion arise

between the parties to this Agreement, whether before

or after termination, as to the interpretation of this Agreement or transaction with respect to this

Agreement, such difference will be submitted to

arbitration upon the written request of one of the parties. One arbiter to be chosen by the Company and

one by the Reinsurer. An umpire will be chosen by the

two arbiters before they enter into arbitration etc.

ARTICLE XXIV Intermediary Clause

Reinsurance Intermediaries, New York, New York, 10038 is hereby recognized as the Intermediary negotiating this Agreement for all business hereunder. All communications (..) relating thereto will be transmitted to the Company or the Reinsurer through the office of..Reinsurance Intermediaries. Payment by the Company to the Intermediary will be deemed to constitute payment to the Reinsurer. Payments by the Reinsurer to the Intermediary will be deemed only to constitute payment to the company to the extent that such payments are actually received by the Company.

Pricing of Prorata Reinsurance

Commission = Price Alternatives Flat, Profit and Sliding

Scale

ARTICLE XI Commission
A. The Reinsurer shall make a commission allowance of % to the Company on the premiums ceded under this Agreement. On all return premiums the Company shall return to the Reinsurer the commission allowance of %. B. The commission allowance which the reinsurer makes to the Company on the business transacted under this Agreement includes provision for all taxes, assessments and any other expenses whatsoever, except loss adjustment expenses.

ARTICLE XII Contingent Commission

A. The reinsurer shall make a contingent commission allowance of % to the Company on the net profits accruing to the Reinsurer under this Agreement.

B. The net profits under this Agreement shall be calculated in accordance with the following formula: INCOME 1. Premiums earned .

OUTGO
2. Losses Incurred 3. Commission allowance

etc.

Profit Commission
Formula: 25% Ceding Commission subject to: 25% Profit Commission after: Incurred Losses, Expenses and a 5% Reinsurer Margin
$1,000,000 250,000 400,000 50,000 $ 300,000

Example: (a) Ceded Premiums (b) Commissions (25%) (c) Incurred Losses (d) Reinsurer Margin (e) Net Profit

(f) Profit Commission (25%) 75,000 (g) Original Commission (b) 250,000 (h) Total Commission 325,000 being 32.5% ($325,000/$1,000,000)

Sliding Scale Commission Arrangement

Provisional Commission 30% at a 65% Loss Ratio

Sliding Upwards % for Each 1% Improvement in Loss Ratio, To Maximum Commission of 40%

Sliding Downwards 1% for Each 1% Deterioration in Loss Ratio, To Minimum Commission of 25%

Sliding Scale (cont.)

Therefore;
If Loss Ratio develops at 70%, Company returns 5% points of commission to Reinsurer. Commission becomes 25% (1:1) If Loss Ratio develops at 60%, Reinsurer pays Company an additional 2.5% points of Commission. Commission becomes 32.5%. (1/2:1)

Surplus Share Agreement

Company selects amount of liability retained on each

risk.
Company transfers surplus amount in multiples of net,

known as lines.
Retention and amount ceded subject to treaty terms.

Surplus Share
Limit 4M
$2M Ceded to Surplus Share (50%)

Policy 1 $4M

Policy 2 $2M

Policy 3 $1M

2M

1M 500K

NET ($2M)

$1.5M Ceded to Surplus Share (75%)

$0 Ceded to Surplus Share NET ($1M)

NET ($500K)

Assume 3 Line Surplus, Min. Net 500K, $2M Limit to Treaty

Quota Share
Percentage ceded same on

Surplus Share
Percentage ceded varies at

every risk

risk level

Obligatory

Obligatory and non-

obligatory

Applies to all business

Used mainly for larger risks

subject to Treaty

EXCESS OF LOSS

Building Blocks

EXCESS OF LOSS
FOURTH LAYER

THIRD LAYER

SECOND LAYER

FIRST LAYER

RETENTION

Categories
Per Risk

Per Occurrence

Aggregate (aka Stop Loss and Loss Ratio)

An Example of Excess of Loss Reinsurance

TREATY LIMIT: EXCESS OF: Loss A: Reinsurer Pays: $150,000 $ 50,000 (Retention) $45,000 Loss B: $100,000

-o-

$50,000

Pricing Excess of Loss

A rate applied to a subject-premium base.

Normally, Deposit and Minimum premiums apply.

Per Risk Pricing Alternatives

Flat Formula a/k/a Burning Cost

Formula Method for Excess of Loss Rating

EXAMPLE:
Provisional Rate: Minimum Rate: Maximum Rate: Loading 9.00% 6.00% 12.00%

100/75 (1.333%)

Result
Year 2000 2001 2002 Premium $10,000,000 $11,000,000 $12,000,000 XS Losses $750,000 $550,000 $1,020,000 Loss Cost 7.5% 5.0% 8.5% Loading Rate 1.333 10.00 1.333 1.333 6.66 11.33

Total

$33,000,000

$2,320,000
=

7.03%

1.333

9.37

FINAL RATE X PREMIUM 2000 10.00 2001 6.66 2002 11.33 $10,000,000 $11,000,000 $12,000,000

REINSURANCE PREMIUM $1,000,000 $ 732,600 $1,359,600

CAN BE A ONE YR. PLAN OR IN 3-5 YEAR BLOCK

Important Points to be Considered

Treatment of Loss Adjustment Expenses Excess Policy Limits (XPL) Extra Contractual Obligations (ECO)

Catastrophe Reinsurance
Large Limit and Retention Type of event limited by hours clause Per Occurrence coverage rather than Per Risk

The Reinstatement issue

Catastrophe Reinsurance
Pricing Concepts

Pay-Back Rate-On-Line

A Treaty Reinsurance Program

Property
Per Risk
500k Net $400K excess of $100K 1st Excess of Loss $100k Per Risk SURPLUS SHARE 3 Lines $1,500,000 Limit 75% Quota Share (Net $25K max.) $0 $500K $2M Net Retention Per Occurrence $ 0 $4M xs $6M 2nd Layer Cat Excess of Loss $6M $4M xs $2M 1st Layer Cat Excess of Loss

Property Catastrophe
$10M

$2M

RISK SIZE

Balance Sheet at Dec. 31, Before Reinsurance

ASSETS Cash and other assets Total Assets LIABILITIES Unearned Premiums Loss and Expense Reserve Total Liabilities Policyholders Surplus

$25,000,000 $25,000,000 $10,000,000 $10,000,000 $20,000,000 $ 5,000,000

Balance Sheet on Jan. 1, After Reinsurance (Assume Company has arranged for a 75% quota share treaty on in-force business, receiving a 30% ceding commission.)

ASSETS Cash and Other Assets $19,750,000 Total Assets $19,750,000 (75% of $10,000,000 less 30% comm. Paid from assets)
LIABILITIES Unearned Premiums Loss and Expense Reserve Total Liabilities Policyholders Surplus $ 2,500,000 $10,000,000 $12,500,000 $ 7,250,000

(Increase represents 75% of $10,000,000 less 30% commission)

Thank You For Your Attention!