AGENDA FACULTATIVE REINSURANCE Overview Uses Of Facultative Reinsurance Advantages and Disadvantages Of Facultative Good Practices In Facultative Reinsurance

AGENDA

Facultativ

e Reinsurance

Treaty

Reinsurance

Reinsurance

Programming

Reinsurance

Applicatio

ns

FACULTATIVE REINSURANCE

Overview

Uses Of Facultative Reinsurance

Advantages and Disadvantages Of Facultative

Good Practices In Facultative Reinsurance

Global Developments in Facultative

Overview – What Is Facultative Reinsurance?

Arrangement in which individual risks are offered by an insurer to a reinsurer, who has the right (in other words the “faculty”) to accept or reject each individual risk

Key issues

Oldest form of reinsurance. Optional reinsurance of individual risks.

Usage of facultative business to complement treaty reinsurances.

Involves cession of individual risks to reinsurers.

Cedents must provide all material facts

Reinsures considers risks on merits

Overview The facultative market

Buyers of Fac Reinsurance

Insurance Companies

Intermediaries

Reinsurance Brokers

Sellers Of Facultative Reinsurance

Professional Reinsurance Companies

OtherInsurance Companies

Overview – Types Of Facultative Reinsurance

Facultative

Proportional

Non ProportionalExcess of Loss

Stop Loss /Aggregate XL

Pro rata arrangements

Fixed portion of risk accepted

Premium and claims shared in the same proportions

“follow the fortunes”

Points to note

Errors ( calculations, account details)

Failure to secure cover

Non placement of business

Achieving system/filling

Communication with reinsurer

Non Proportional facultative

Reinsured chooses to retain the “First” or “Primary” part of the risk

Reinsurer charges lower premium than proportional percentage

Reinsured retains all claims up to the excess point

Premium is shared between deductible and limit of excess layer . Higher deductibles result in higher premium being retained.

TYPICAL FIRST LOSS SCALE% “First Loss” to Declared Full SI

Premium as a % of OG ( Cedant Share)

Premium as % of OG) R/I share

10% 54% 46%

20% 66% 34%

30% 75% 25%

40% 80% 20%

50% 83% 17%

60% 85% 15%

70% 87% 13%

80% 91% 9%

90% 95% 5%

Reasons for Placing Non Proportional Facultative

Where cedant intends to retain more premium

Where original rating is insufficient to attract reinsurance support proportionally.

Frequency of losses is high.

Large risks and risks in cat prone areas

The most effective way to reduce an insurers exposure in the least expensive way-removes volatility

Why Facultative Reinsurance?The traditional View

Additional Capacity

When reinsurance is not required on a regular basis e.g. space project.

When portfolio does not justify treaty ( few risks, little experience etc.)

Utilization of underwriting expertise

To protect treaty results- reduction of exposure on higher risk business.

Fronting

Excluded risks

Commercial Financial Strategic

Facultative Reinsurance TodayTo improve risk profile via carve out of particular perils, locations, or coverages to allow you to write a larger line, or help you become more price competitive

To gross up participation on a program you would like to write in order to take the lead on it

To remove a particular layer of exposure, such as the first layer in the event that the account has a loss frequency issue

To purchase a deductible buy-back, in the event that the deductibles do not meet underwriting standards, reinsurance could cover the gap and allow the account to be written

Managing volatility

Accessing attractively priced, flexible capital

Not tied to 12 month standard policy periods

To reduce reinsurance premium spend

To maintain or improve reinsurance protection

To achieve optimum cost of capital levels

To pursue growth opportunities

ADVANTAGES OF FACULTATIVE REINSURANCE

individual risk consideration

competitive edge

freedom to offer

improving treaty results

fac. reinsurer’s knowledge

developing relationship

DISADVANTAGES OF FACULTATIVE REINSURANCE

lack of certainty

labour intensive

disclosure

influence on underwriting

lack of control

Good Practices In Transacting Facultative Reinsurance

Maintain a cordial working relationship with reinsurers.

Involve reinsurers as early as possible on risks that will require Fac support( on complex risks invite quotes from reinsurers.)

Utilize the reinsurance technical support –engineers, agronomists, underwriters

Keep proper record of all facultative transactions

Properly record all reinsurance arrangements made. (especially verbal acceptances)

Good Practices In Transacting Facultative Reinsurance

Only confirm cover to client when reinsurance arrangements are complete.

Hold cover instructions to be sent and valid for 14days( market practice)

Confirm telephonic placements (e.g. through email)

Prepare slip and premium bordereau expeditiously.(24 hours) and get them duly signed by reinsurers.

GLOBAL Market overview

An interesting trend in the facultative market is the way independent facultative brokers have been able to compete very effectively on a global basis with much bigger rivals.

Independent yet well established brokers have been able to offer speed of delivery, agility and regional expertise, which are all key attributes in the facultative market, particularly at times when customers are expecting more for less.

GLOBAL Market overview The most striking observation about the facultative reinsurance

landscape has to be the emergence of two new hubs: Singapore and Dubai through the Dubai International Financial Centre (DIFC).

These two markets, which have focused initially on capturing business from their own regions, have begun to compete with the London market in the facultative arena.

GLOBAL Market overview

London still offer a better all-round service and expertise especially on wordings and claims issues but of late Dubai has attracted some major players, which also have a presence in the Lloyd’s and the London markets.

There is a growing trend towards globalization of facultative risk placement

It is mainly driven by tax considerations and operating costs as well as the flexibility of regulations at the DIFC as compared to its European counterparts.

African case In Nigeria and Morocco organizations seeking to insure large risks on a

facultative reinsurance basis must place a significant amount with the local insurance market—70 percent in Nigeria’s case.

Multinational corporations in those countries, such as those involved in the oil business, have argued that they would rather seek rated international capacity.

Global Developments Facultative Reinsurance

Advent of online reinsurance trading – Ereinsure and Inreon (Swiss & Munich Re)

Upsurge in non proportional placements/ Layering arrangements.

‘Rent a captive arrangements’

Multi-line reinsurance

Non Standard Risk modeling

TREATY REINSURANCE

Types Of Treaties and Their Uses

Q U O TAS H A R E

S U R P L U SS H A R E

F A C U L TA TIV EO B L IG A TO R Y

P R O P O R TIO N A L

P E R R IS K(P E R P O L IC Y )

P E R O C C U R E N C E(C A TA S TR O P H E )

A G G R E G A TEE X C E S S

X O L

TR E A TY R E IN S U R A N C E

Types Of Treaties & Their Uses

Proportional Reinsurance

Reinsures accepts a fixed share of liabilities assumed by a primary insurer under original contract of insurance . Reinsurer accepts the proportionate share of premium and pays a proportionate share of the claims costs.


Quota Share Treaty

It is the simplest of all forms of reinsurance

The reinsure agrees to reinsure a fixed proportion of every risk accepted by the ceding company, sharing proportionately in all losses and receiving in return the same proportion of all direct premium, less the agreed reinsurance commission.

$1,000,000Primary Insurer Retention

Ceded to Reinsurer

$100,000

$0$100,000 policy $1,000,000 policy

20% 80%

20% 80%

QUOTA SHARE TREATY

$100,000$1,000,000Policy Policy

LimitsPrimary Insurer Retained Limit (20%) 20,000 200000Limit Ceded to Reinsurers (80%) 80,000 800,000

$10,000 LossRetained by Primary Insurer 2,000 2,000Ceded to Reinsurer 8,000 8,000

$50,000 LossRetained by Primary Insurer 10,000 10,000Ceded to Reinsurer 40,000 40,000


Needs Met By Quota Share

• Ceding company can safely accept larger risks

• Reducing the risk when entering new geographical

• Areas or lines of business

• No adverse selection to reinsurers

• Entering or withdrawal from a line of business or

• Geographical area - lessens risk as you learn

• With 100% quota share you exit

• Simplicity In administration & accounting

• Provides Surplus Releif


Other Uses For Quota Share Treaties

For classes of business where it is difficult to define a single risk e.g Crop hail insurance

For reducing a ceding company exposure under policies covering natural perils

For classes of business where the incidence and size losses are uncertain e.g liability business .


Surplus Treaties

• Similar to quota share

The most commonly used

Arranged in lines

Reinsured reinsures that portion of a risk which exceeds its own retention limit.

The cedant can adopt varying retention limits depending on risks exposure

Types Of Treaties And Their Uses

Percentage shared depends on retention

The line varies by class of risk, construction, occupancy and protection

Capacity is expressed as number of lines subject to a maximum dollar amount

The maximum single risk capacity is equal to number of lines plus one

Number of lines and cession percentages vary by class of risk


Operation Of Surplus Treaties Example

PRIMARY POLICY LIMIT RISK 1 100,000

RISK 2 500,000

RISK 3 1,000,000

MAXIMUM LINE 100,000 100,000 100,000

RETENTION FROM TABLE OF LIMITS

100,000 100,000 100,000

NUMBER OF LINES CEDED 0 4 5

LIMITS CEDED TO SURPLUS REINSURER

0 400,000 500,000

% OF LOSSES AND PREMIUM RETAINED BY INSURER

100 20 50

% OF LOSSES AND PREMIUMS CEDED TO REINSURER

0 80 50

Types Of Treaties & Their UsesSurplus Cessions By Class Of Risk

RISK POLICY LIMIT

INSURER’S RETENTION

NUMBER OF LINES

AMOUNT REINSURED

% CEDED

AMOUNT OVER TREATY LIMIT

A 85,000 20,000 3.25 65,000 76

- B

40,000 10,000 3.0 30,000 75 -

C 280,000 40,000 5.0 200,000 71 40,000

D 27,000 10,000 1.7 17,000 63

- E

25,000 30,000 - - - -

F 240,000 50,000 3.8 190,000 79

-


Uses Of Surplus Treaties

Almost exclusively used to reinsure property and

Homeowners policies

For liability exposures, few of the insurer’s criteria for Setting retentions are acceptable to the reinsurer

Generally,this adverse selection does not occur with property

Insurance because the line guide addresses loss severity

Potential , not risk desirability


Needs Met By Surplus Treaties

Increase capacity

Limit the retained risk on volatile lines of insurance

Reduce the risk when entering new geographical areas Or lines of business.

Limit the financial effect of large losses

Quota Share Vs Surplus Treaty

QUOTA SHARE SURPLUS SHARE

CESSION OBLIGATION OBLIGATORY FOR INSURER AND REINSURER

SAME

CESSION PERCENTAGE FIXED AND CERTAIN FOR EVERY RISK UNDER THE TREATY

VARIABLE FOR EACH RISK UNDER THE TREATY

CESSION LIMIT STATED AS A PERCENTAGE

STATED AS A NET RETENTION AMOUNT AND NUMBER OF LINES

SIZE OF RISKS SMALLER LARGE ,MORE COMPLEX

TYPE OF RISK CASUALTY AND SOME PROPERTY

ALMOST EXCLUSIVELY PROPERTY

ADMINISTRATION RELATIVELY EASY COMPLEX

Challenges of Proportional Treaties

Facultative inwards and Co-insurance

Capacity abuse

Tables of retentions

Adherence to treaty clause

manipulation of returns

Technical accounting issues

Cash call and cash call credits

accumulation challenges

Exgratia Settlements

Due to problems of proportional treaties, they have become less popular world over compared to Excess of loss treaties

Excess Of Loss Treaties In return of an agreed premium ,the reinsurer

accepts to pay losses incurred by the cedant reinsured in excess of the agreed amount subject to an upper limit .

• The reinsured decides upon a monetary limit which he is prepared to retain in a given loss situation - known as the priority, point or attachment point or deductible

Excess Of Loss Treaties Continued Characteristics

• Risks are not ceded to an XL

• Simple to administer

• Pricing of XL treaty/no direct relationship with original rating

• Placed in layers

Excess Of Loss Treaties Continued

Per Risk XL

For liability it is called per policy XL

Stabilizes insurers loss ratio

Per Event XL

Catastrophe XL for Property/ per occurrence XL for liability

Severity protection

2 risk warranty

Hours Clause

Advantages Of Excess Of Loss Treaties

Cedant gets only required protection

Low administration cost

The ceding company retains for its own account higher proportion of its gross premium income

AGGREGATE EXCESS OF LOSS TREATIES

Stop loss protects the insurer against its aggregate annual loss experience on a particular account

Under this kind of cover, the limit and retention are expressed as percentage of incurred losses with monetary limit.

E.G 120% of incurred losses xs 65% of incurred losses on GNPI subject to a maximum of USD 950,000.

Very effective in stabilizing a primary Insurer’s net results

XL Treaties: Financial Implications for ceding company

Premium outgo in advance or quarterly installments, enables cash flow planning.

Many times claims free experience.

Catastrophe claims develop over long time, hence reserves need to be estimated correctly to show the true picture in the accounts.

Credit risk exists as there is substantial time gap between premium payment and claim recovery.

Less cash outgo in comparison to Proportional reinsurance.

Stabilizes the reinsurance results and solvency ratio.

XL Treaties: Financial Implications for Reinsurers

Definite cash inflow in the form of M & D Premiums. However efficient system control required to monitor the inflow.

In case claims free experience, 100% profit.

When claim arises, the cash outflow is comparatively more.

Premium generated through XL acceptances is lesser than Proportional acceptances.

Need to maintain enough liquidity for any big claim.

Additional provisioning made in the form of IBNR.

Challenges of Non-Proportional Treaty Reinsurance

New insurance companies do not find this method profitable and advisable as only a strong Balance sheet can provide the capacity of bearing the claims up to certain limit.

Reinsurance costs go up due to catastrophe events, which do not directly relate to the claim experience of buyer of such protection.

Difficult to assess the exact applicable rate. Use of complex financial models.

Takes long time for claim recovery, hence in case of claim, account need to be serviced for many years and documentation is involved

Challenges of Non-Proportional Treaties

Delays in settlement of MDPs

Treaty adjustments

Exhaustion of Cover

In accurate claim recovery calculations

• reinstatement premium

Reinsurance Programming

Reinsurance Programme Objectives

• Aligning to corporate needs (Growth?,Consolidation? Exit?)

• Efficiency

• Stability

• Cost effectiveness

• Administrative simplicity

• Continuity


Reinsurance programming objectives

Factors affecting reinsurance decisions

Information requirements

The programming process

Choosing reinsurance counter-parties

Role of intermediaries

Reinsurance Programming Reinsurance Programming refers to the planning and arrangement of

reinsurance facilities for future risks.

The Major tenets of reinsurance programming are as below:-

Fixing RetentionsCreation Of Automatic Capacity

Arranging Protection For net account


Important Considerations

• A reinsurance programme is a strategic issue and therefore there is need for liaison with the different functions in the business e.g. get the input of marketing, finance, technical etc.

• A good programme should give a good chance for the reinsurer and the cedant to make a profit.

• Reinsurance is a cost every dollar of reinsurance paid contains an element of profit for the reinsurer.


Important Considerations

• A reinsurance programme should be set with long term considerations in mind. Do not be overly motivated by short term issues.

• Reinsurance programme cannot correct poor underwriting, general management or poor investment performance.


A Good Reinsurance Programme should meet the following criteria:-

• Provide the company with a large enough capacity to write business and enable it to maximise its retention.

• The reinsurance costs should be reasonable

• Reinsurers should be financially strong

• Other business considerations like continuity, a mutually compatible business philosophy with reinsurance partners and a good relationship with counter parties.

• A reinsurance programme should be technically viable, stable and administratively simple.

• It should Provide reinsurers as fair a chance of making a profit as the ceding company.


Input required For Reinsurance Programming

• Company Strategy

• Risk and Loss Profiles

• Financial Information (Balance Sheet, income statements etc

• Financial projections

• An understanding of prevailing insurance and reinsurance market conditions.

• The investment strategy

• Underwriting philosophy of the business

• Risk appetite of the company.


A good programme should be tailored to a ceding company’s corporate needs without having to adapt underwriting policy to match reinsurance availability.

The cheapest reinsurance programme is not neccesarily the best for the business.


Steps In Reinsurance Programming

Determine Net Retention

Limits(For each class, type of risk

and Per event

Develop maximum

automatic facility ( Through proper mix of Prop, non

prop and autofac .

Select Good Intermediaries and Security.


Risk Retention

Amount a company is willing to put at stake for its own account when underwriting a single risk or group of risks.

Loss Retention

Maximum amount a company is prepared to pay on any loss affecting a policy, risk or group of risks


Factors Affecting Net Retentions

• Premium volumes

• Portfolio structure

• Liquid assets

• Market conditions

• Regulatory requirements (e.g. solvency requirements and retention requirements)

• Estmated premium,profits and investment income

• Financial position – Capital + Free reserves(Shareholders funds)

• Cost of Reinsurance

• Risk and Loss Profiles


Fixing Retentions

Types Of Retentions

Risk Retention

Loss retention


Fixing Retentions Empirical Rules

Measure Empirical Rule

Net Retention as % of Shareholder Funds

1% to maximum 5%

Loss retention as a percentage of liquid assets

1% to maximum 10%

Loss retention as % of liquid assets <20% in the company’s most important class of business

Per risk loss Retention 2 – 5% of ENPI (Class)&/or1 to 3% of shareholder funds

Cat Loss Retention 5 – 10% of ENPI (Class)

Reinsurance Programming It is important to note that these parameters are not used in isolation

but are combined in order to generate a range from which management can decide based on risk appetite.

As an example the following information for XYZ Insurance company is available. Using this information decide at what level the company can set its per risk retention based on empirical rules of thumb.


Assets (US$)

Fixed Assets 900,000

Long Term Investments 200,000

Other Current Assets 700,000

Cash & Cash Equivalents 600,000

Total Assets 2,400,000

Equity & Liabilities

Share Capital 1,000,000

Retained Income 500,000

Current Liabilities 500,000

Non Current Liabilities 400,000

Total Equity & Liabilities 2,400,000


Measure Calculation Retention Range

Shareholder Funds Min $1,500,000 X 1%Max $1,500,000 X 5%

$15,000 – 75,000

Liquid Assets Min 1% X $600,000Max 10% X 600,000

$6,000 – 60,000


Selecting Retention Levels

An Insurance company is faced with the challenge of setting retentions at the following levels.

Per Risk •Net Sum Insured Retention Per Risk

Per Area •The aggregate sum insured retention per conflagration area or catastrophe peril exposure zone

Per Event •The net Loss Retention to Bear under the net account catastrophe cover protection


Maximum Risk Retention (Usd millions) A

Net Retained Premium (USD millions) B

Ratio A:B

1,000 40,000 1:40

2,000 75,000 1:37.5

3,000 100,000 1:33.3

4,000 115,000 1:29

5,000 110,000 1:22

10,000 140,000 1:14


Fixing Retention

• In fixing the net retention it is imperative that one determines the optimal level and not necessarily the maximum level.

• The example below illustrates the point aptly

• The table shows the net retained premium at different maximum sum insured retentions as extrapolated from the company’s risk profile.


1000

2000

3000

4000

5000

6000

7000

8000

9000

1000

00

20000

40000

60000

80000

100000

120000

140000

160000

Net Retained

Net Retained


As evidenced above with successive increases in retention the retained premium response diminishes.

In fact the balance on the retained portfolio deteriorates as the risk retention level increases.

Thus in the above example even if the business has a capacity to carry a retention of up to $5,000,000 say, it may peg it at the more optimal level of $3,000,000 and thus maintain a more balanced portfolio in line with its internal benchmarks.


Developments In retentions management

• Insurance companies often develop retentions further by developing schedules of retentions so that retentions are further optimised. Factors influencing schedule of retentions include location, separation, processes carried out ,class of construction and fire protection structures.


Creation Of Automatic Capacity

• The operation of the various proportional treaties and their uses have already been expounded on above.

• There are however other considerations that a ceding company has to contend with in finalising proportional reinsurance arrangements. These include the commission terms. Commission terms over time are dictated by the long term profitability of the treaty.


Protecting The Net Account

• The net account needs to be protected on a per loss basis as well as on a per event basis, in certain instances protection on an aggregate basis is also required.

• This is done through working excess of loss covers and catastrophe excess of loss covers and stop loss covers respectively.

Reinsurance Programming• While the amount of working excess of loss required is often

straightforward ceding companies are often faced with the problem of determining the optimal catastrophe cover to buy.

• A technical assessment of the extent of cover necessary and the proper rate for the covers requires a wealth of data


Catastrophe protection is designed by considering the extent of conflagration hazard to risks in the portfolio. With advances in ICT it is possible to accurately calculate the aggregate net exposure within each conflagration area.

For natural catastrophes the problem is more difficult to visualise. Cedants must decide which areas can be considered to be exposed to one event.

Reinsurance Programming Additional to Catastrophe cover it has also become

imperative in light of the use of PMLs for reinsurance arrangements to ensure that cover can also adequately cover losses due to PML error.

In this regard it is common therefore in the layering of excess of loss treaties to incorporate a layer catering for this ahead of the catastrophe layers.

In areas not normally prone to catastrophe attacks preparation for this cover can be done by estimating the number of risks that can be affected by one event e.g. catastrophe cover with a value of 10 times the per risk cover.

Reinsurance Programming• As part of the reinsurance design process the decision on whether to

use an intermediary or not needs to be addressed. An insurance company has an option to approach markets directly or to go via a reinsurance broker.

• It is recommended to use reinsurance broker especially where the programme has a fairly wide geographical spread.

Reinsurance Programming Good brokers provide the following benefits:-

– Regular flow of marketing intelligence about markets dealt with.

– Track the financial position of markets dealt with.

– They are able to handle tough negotiations on behalf of both parties.

– However brokers also add a cost to the portfolio and affect its profitability.


Programme Finalisation Issues to Bear In Mind

• In spite of ensuring technical viability advantage should be taken of market conditions .E.g. in soft market conditions. However where the market terms harden this should also be taken gracefully. Also importantly watch out for new brokers coming with lower than current terms from other markets. This could be due to lack of market knowledge and penetration strategies.This is unstable and defeats the long term objective of treaties. Switching reinsurers compromises goodwill and results in loss of the reserves built up with existing reinsurers.

• Terms and structure should be under constant review. Company should collate andanalyse data on their portfolio structure . This allows for data driven and tailor made programme.


• A good programme should progressively increased self reliance in the company and progressively increase retention. Even for special classes with time efforts should be made to secure greater freedom.

• Communication of the programme. Ensure the whole company especially underwriters are comfortable and understand how to use programme. Especially familiarity with limits, exclusions and conditions.

Counter-Party Analysis

Willingness To Pay• Degree of

difficulty In collecting recoverableFrom a solvent reinsurer

Solvency• Ability to

discharge maturing

Obligations as they fall due

Is settlement prompt and efficient?

Disputes increasing?

“Willingness to pay” may not be correlated to “ability to pay”

Counter Party Analysis

Management and corporate

strategy

Competitive position

Capitalisation

ERMInvestments

Liquidity

Operating performance

Financial flexibility

Capital model

Industry Risk

Counter-Party Analysis

Mitigating Credit Risk

Spread and diversification

Multiple sources of information

Cancellation clauses

Don’t rely solely on rating agencies

Cedants should perform own due diligence

Counterparty Analysis

Basic Checklist

Financial strength

Country of origin

Government supervision and regulation

Currency regulations

Ultimate ownership and inter-company relationships

Reinsurance arrangements

Management

Type of business written

Agency arrangements

Market intelligence

Other Factors Affecting Selection Of Securities

• Financial Strength

• Technical Expertise

• Strategic Fit

• Accessibility

• Reciprocity arrangements

• Strategic Alliances

Role Of Intermediaries Broker’s role was established under English Law as an agent of the

insured with a legal duty to carry out his client’s instruction.

Broker however paid by the reinsurer.

Utmost Good Faith / Duty of Care imperative in all dealings whether verbal or written

Why Use Intermediaries?

• The specific nature of insurance terminology and procedures

• Frequent changes affecting the position of insurers

• The complex character of an insurance contract

• Insufficient knowledge of the markets by client

• Direct relationships often breakdown – usually at 2nd or 3rd renewal

Benefits Of Using Intermediaries• Represents the Reinsured and provides independent advice

• Market knowledge and experience

• Access to market information, including ‘soft’ information

• Protects the relationship between the Reinsured and the reinsurer

• Reduces the Reinsured's administrative burden – ‘Outsourcing Outwards’

Intermediary Services

• Price – negotiate best terms available

• Safe Security – monitor the quality & ratings of insurers and reinsurers worldwide

• Placing Service – Negotiate, Place, Cover Note, Policy Wording and other documents

• Claims Service – Negotiate, Collect funds, Pay to client

• Technical Consulting Services – –insurance strategy

–new products

–market developments

–analysis and modelling

END OF PRESENTATION

Documents

AGENDA FACULTATIVE REINSURANCE Overview Uses Of Facultative Reinsurance Advantages and Disadvantages Of Facultative Good Practices In Facultative Reinsurance