REINSURANCE ALLOCATING RISK

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Milo Daniels
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1 6REINSURANCE Reisurace is a risk maagemet tool used by isurers to spread risk ad maage capital. The isurer trasfers some or all of a isurace risk to aother isurer. The isurer trasferrig the risk is called the cedig isurer. The isurer acceptig the risk is called the assumig isurer or reisurer. For life isurers, the risk trasferred may be mortality, logevity or morbidity risk, surreder or expese risk, ivestmet risk, or a combiatio of these risks. Reisurace has made possible the protectio of a wider array of idividuals ad groups tha would otherwise be feasible. A isurer who is approached by a applicat who presets a uusual risk or who eeds a amout of life isurace policy that is larger tha the isurer s retetio limit (the amout of risk a isurer has determied it ca judiciously retai) may still be able to offer the policy to the cosumer if part of the risk is trasferred to a reisurer. A cedig isurer also uses reisurace to limit its risk o a group of policies to avoid fluctuatios i claim levels or to lower the risk of claims ivolvig multiple deaths from sigle evets. Virtually all life isurers buy reisurace to improve their risk profile. I 2017, 87 percet of life isurers with life premiums ceded at least some of those premiums as reisurace. Amog isurers with accidet ad health premiums, 83 percet ceded accidet ad health premiums as reisurace. Forty seve percet of isurers doig auity busiess i 2017 ceded auity cosideratios, excludig deposit-type fuds. The Society of Actuaries aually publishes more detailed data o the life reisurace marketplace i the Reisurace News. ALLOCATING RISK I order for families to have peace of mid ad for ecoomies to thrive, there must be a mechaism to deal with large fiacial risk. Life isurers provide that fiacial security. Reisurace spreads the risk of loss betwee two isurace compaies. The risk ca be spread eve further if the cedig isurer uses more tha oe reisurer, or the reisurer i tur trasfers some of that risk to aother reisurer, or retrocessioaire. I the most basic reisurace arragemet, a sigle isurer issuig policies to the public cedes busiess to a sigle reisurer, usually a idepedet firm operatig i the ope marketplace. Isurers sometimes cede busiess to affiliates to aggregate similar risks i oe etity for efficiet risk maagemet. Isurace groups also use captive reisurers to reisure risks exclusively from affiliated compaies to access capital markets. Whe reisurace exists, the cedig isurer trasferrig the risk retais its fiacial relatioship with, ad legal obligatio to pay claims to, the policyholder. The policyholder will ot eve be aware that part of the risk i their policy is covered by a reisurer. The reisurer idemifies, or reimburses, the cedig isurer for losses icurred o the reisured policies. Reisurace is ow a global busiess. Of the $221 billio total reisurace premiums paid by U.S. life isurers i 2017, 63 percet was paid to reisurers domiciled i the U.S. ad 37 percet to reisurers domiciled i other coutries.

2 REINSURANCE RELATIONSHIP Uderwritig Stregth A closely related motivatio for reisurace is obtaiig the reisurer s uderwritig assistace ad proficiecy. Reisurers review ad maitai policy ad claim records o a large volume of risks from may cedig compaies whose policyholders are diverse ad geographically distributed. The risk pool from which they develop ad provide uderwritig kowledge is larger ad wider tha is ormally available to a sigle primary isurer. Uderwritig is further stregtheed whe risk is spread to more tha oe reisurer or retrocessioaire, because of the exposure to a eve broader rage of policies ad claims. Cofidece that uderwriters are competetly ad professioally meetig its uderwritig eeds allows a cedig isurer to cocetrate o other activities to expad its busiess. Product Flexibility Aother reaso to reisure is the opportuity it gives a cedig isurer to exit from some product lies ad eter others. If a isurer has issued policies i a particular product lie that it wishes to discotiue, the isurer ca reisure most or all of the risk o those policies. TYPES OF REINSURANCE Various reisurace plas are available based o cedig compaies eeds ad their reasos for reisurig. Plas ca be broadly classified as either proportioal reisurace, specifyig i advace the amouts or percetages of risk for which the reisurer is liable, or oproportioal, specifyig istead the loss limits, time limits, or coditios beyod which a reisurer will reimburse some or all of the cedig isurer s beefit paymets. Proportioal Reisurace Specified amouts or percetages are shared betwee cedig compaies ad reisurers i proportioal reisurace. Excess of retetio allocates risk by amout. The cedig isurer establishes a dollar amout beyod which it is uwillig to retai risk, ad the reisurer assumes risk over this amout, up to the reisurer s retetio limit. I cotrast, quota share allocates by percetage, where the cedig isurer ad reisurer establish the percetage of risk for which each will retai or assume resposibility. Proportioal plas, commoly used i life isurace iclude: Coversely, if a isurer wats to eter a particular product lie, reisurers ca help with product developmet ad assume some of the product s risk. Later, as the primary isurer gais more cofidece i its ability to uderwrite ad develop the product, the isurer might retai more of the risk o ew busiess ad recapture provisios i the reisurace treaty might allow it to take back some of the risk the reisurer assumed. Capital Maagemet Reisurace also helps a cedig isurer maage its capital efficietly. This is especially helpful to a life isurer issuig ew policies because iitial costs (expeses plus reserves) are ofte higher tha premiums received. Sharig those iitial costs ad risks with a reisurer helps the cedig isurer maage its cash flows. Yearly reewable term (YRT) I this type, mortality risk is the oly risk trasferred to the reisurer. The reisurace premium varies each year with the age of the isured. YRT reisurace allows a cedig isurer to trasfer mortality risk, but it leaves the isurer resposible for establishig reserves for the remaider of the policy beefits. Despite its ame, YRT is ot yearly reewable. The reisurer may ot termiate coverage util the origial isurace policy termiates. 58 America Coucil of Life Isurers

3 Coisurace The cedig isurer trasfers a proportioate share of all the policy risks ad cash flows. The reisurer re-ceives its share of premiums, pays its share of beefits, sets up its share of reserves, ad pays a allowace to the cedig isurer to cover its share of the costs of admiisterig the policy. Modified coisurace The reisurer trasfers its share of reserves back to the cedig isurer while the risk remais with the reisurer. The cedig isurer, however, must pay iterest to replace what the reisurer would have eared had it retaied its share of the reserve. This arragemet allows the cedig isurer to reduce potetial credit risk ad to retai cotrol over ivestmets. The latter is particularly importat where the isurer is usig a uique ivestmet strategy. Noproportioal reisurace Noproportioal plas ca be used for all types of isurace. Commo uses iclude: Stop loss The reisurer remits some or all of a cedig compay s aggregate claims above a predetermied dollar amout (the attachmet poit), or above a percetage of premiums durig a specified period. Excess of time Most ofte used for disability or logterm care reisurace, this type of pla specifies the time after which a reisurer pays some or all of the claims. Catastrophe The reisurer covers claims that exceed a specified amout or umber of isureds due to a sigle evet resultig i more tha oe loss, as i a accidet or atural disaster. Reisurace 59

4 Table 6.1 Reisurace Assumed ad Ceded Premiums Millios Average aual percetage chage / /2017 PREMIUMS PAID ON CEDED BUSINESS Life isurace Idividual $77,542 $110,823 $97, Affiliates 61,905 51,229 51, No-Affiliates 15,637 59,594 46, Group 5,209 15,254 20, Affiliates 1,661 6,164 7, No-Affiliates 3,547 9,090 13, Credit Total 83, , , Auity cosideratios 1 Idividual 28,785 17,911 46, Affiliates 25,717 11,956 37, No-Affiliates 3,067 5,955 8, Group 1,004 10,298 8, Affiliates 197 5,911 5, No-Affiliates 807 4,387 2, Total 29,789 28,210 54, Accidet ad health isurace Idividual 10,758 14,279 16, Affiliates 1,983 7,123 11, No-Affiliates 8,775 7,156 5, Group 10,327 28,076 30, Affiliates 4,820 15,627 15, No-Affiliates 5,507 12,449 15, Credit Total 21,809 42,637 47, Aggregate total 135, , , PREMIUMS FROM ASSUMED BUSINESS Life isurace Idividual $34,734 $56,748 $61, Affiliates 2, , NC No-Affiliates 32,318 56,401 47, Group 3,769 7,441 9, Affiliates No-Affiliates 3,146 6,691 9, Credit Total 38,795 64,316 71, Auity cosideratios 1 Idividual 11,555 14,622 21, Affiliates 1,198 12,765 9, No-Affiliates 10,357 1,857 12, Group 755 5,450 3, Affiliates , No-Affiliates 608 4,889 1, Total 12,310 20,072 25, Cotiued 60 America Coucil of Life Isurers

5 Table 6.1 Reisurace Assumed ad Ceded Premiums cotiued PREMIUMS FROM ASSUMED BUSINESS cotiued Accidet ad health isurace Millios Average aual percetage chage / /2017 Idividual 6,410 9,158 10, Affiliates 1,191 4,003 6, No-Affiliates 5,218 5,156 4, Group 11,032 16,957 16, Affiliates 5,440 5,236 3, No-Affiliates 5,592 11,721 12, Credit Total 17,800 26,224 27, Aggregate total 68, , , Source: ACLI tabulatios of Natioal Associatio of Isurace Commissioers (NAIC) data, used by permissio. Notes: NAIC does ot edorse ay aalysis or coclusios based o use of its data. Codificatio effective with 2001 Aual Statemet filigs chaged the reportig of certai lies of busiess, particularly deposit-type cotracts, as explaied i umbered foototes. Data represet U.S. life isurers ad frateral beefit societies. 1 From 2001, excludes deposit-type fuds as icome due to codificatio, makig data icomparable with previous years. Table 6.2 Life Reisurace Assumed (face amout) Millios Average aual percetage chage / /2017 Face amout (millios) Idividual $1,028,874 $1,608,595 $1,077, Group 102,364 1,029, , Credit 8,572 7,251 7, Total 1,139,810 2,644,948 1,880, Policies (uits) Idividual 11,949,687 11,635,469 12,151, Group 3,985,456 46,021,604 14,359, Credit 1,462, , , Total 17,397,437 57,935,381 26,780, Source: ACLI tabulatios of Natioal Associatio of Isurace Commissioers (NAIC) data, used by permissio. Notes: NAIC does ot edorse ay aalysis or coclusios based o use of its data. Data represet U.S. life isurers ad frateral beefit societies. Reisurace 61

CHAPTER 2 PRICING OF BONDS

CHAPTER 2 PRICING OF BONDS CHAPTER SUARY This chapter will focus o the time value of moey ad how to calculate the price of a bod. Whe pricig a bod it is ecessary to estimate the expected cash flows ad