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PROJECT ON:

RE-INSURANCE

UNIVERSITY OF MUMBAI

K.P.B. HINDUJA COLLEGE OF COMMERCE


T.Y.B.COM (BANKING &INSURANCE) SEMESTER VI
SUBMITTED BY:

JYOTI GHADI
PROJECT GUIDE:

PROF. HEMAT BHATTI


ACADEMIC YEAR 2012-2013

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DECLARATION BY THE STUDENT

I, Ms. JYOTI GHADIstudent of T. Y. B. Com., Banking and Insurance, Semester VI, Roll No. 26, hereby declare that this Project Report entitled RE-INSURANCE is being submitted as a partial fulfilment of the course, which is a necessary requirement to pass the Semester VI examination. I further declare that the Report is the output of my personal research and all the information contained herein is correct to the best of my knowledge.

Name JYOTIGHADH

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CERTIFICATE
This is to certify that Ms. JYOTI GHADIof B.Com (Banking and Insurance), Semester V [2011-2012] has successfully completed the Project on RE-INSURANCE under the guidance of Prof. JYOTI GHADI.

Project Guide

________________

Course Coordinator

________________

Internal Examiner

________________

External Examiner

________________

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ACKNOWLEDGEMENT

With a deep sense of gratitude I express we thanks to all those who have been instrumental in the development of the project report. I am also grateful to all the co-coordinator and professors of my college who gave me a valuable opportunity of involving me in real live business project. I am thankful to all the professors whose positive attitude, guidance and faith in my ability spurred me to perform well. I am also indebted to all lecturers, friends and associates for their valuable advice, stimulated suggestions and overwhelming support without which the project would not have been a success.

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OBJECTIVES: To understand the importance of the RE-INSURANCE To set out the main structural features of the reinsurance industry. To briefly portrait the industry, including its scale, recent performance and approach to risk management. SOURCES OF DATA: The secondary data has been collected from the internet and books RESEARCH METHODOLOGY: The methodology adopted in preparing this project involves a lot of secondary data as well as the use of World Wide Web for the updated information.

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(((CONTENT)))
CHAPTE R NO. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. SUBJECT COVERED
HISTORY OF REINSURANCE REINSURANCE DEFINITION & INTRODUCTION REINSURANCE NEEDS THE FORMS OF RE-INSURANCE TYPES OF RE-INSURANCE FUNCTIONS OF RE-INSURANCE PARTICIPANTS OF THE REINSURANCE INDUSTRY REINSURANCE IN INDIA -GENERAL INSURANCE CORPORATION OF INDIA TOP 10 GLOBAL REINSURANCE COMPANIES CHALLENGES FOR REINSURANCE MARKET RESEARCH/PUBLICATIONS REINSURANCE SUPERVISION CONCLUSIONS BIBLIOGRAPHY

Pg. No 07-09 10-12 13-16 17-21 22-26 27-30 31-33 34-37 38-39 40-41 42 43 44 45

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HISTORY OF RE-INSURANCE
Insurance and reinsurance contracts had their origin in Marine transportation activities, way back in the XIV century. Initially, the Insurer would transfer a certain portion of a given risk to some other party, thus fractionating possible losses, with such operation determining that the reinsurance would then be characterized as just another type of insurance contract. Such a conceptualization, thus conceived and disseminated, does not keep the whole truth, as the reinsurance encompasses several other functions. A typical reinsurance contract is not just intended to transfer or assign part of the risk insured by one Insurer to Reinsurers. It also involves some other functions constructed over the centuries, according to the evolution experienced by this particular system of concentrated pulverization of risks and interests. Certain trips were only insured, in fact, should a reinsurance contract be available for its most hazardous portion, i.e., from a point of origin to a given port - an insurance contract would be established and, from that port to another port - with reinsurance coverage. Such sharing model does not configure, in itself, a mere parcelling of liabilities over one single risk. In other words, it presents and operates other equally differentiated situations and interests. In the XVII and XVIII centuries the first judicial sentences have been sculpted about reinsurance, highlighting the independent nature of this contract.
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REINSURANCE The development of European societies has dictated the need for organizing reinsurance companies, not only for the Marine risks, but also for the urgent demand of fire insurers. In 1846, the first independent reinsurers - Klnishe Rckversicherungs-Gesellschaft - obtained the necessary permit to operate in

Germany, with the first reinsurance contract being entered into by that company in 1852. The Swiss Reinsurance Company was established in Zurich, in 1863; and the Mnchener Rckversicherungsgesellschaft in 1880, in Germany. Lloyd's underwriter, which also operates with reinsurance, was constituted in London as early as 1688. In the USA, reinsurance companies started to be organized just before the end of the year 1900. As of the growing evolution of the insurance markets in the world, along the timeline, even modifying risk conditions and economic interests, the Ceding Insurers were forced to retain part of the risks. The function related to the portfolio homogeneity of the Insurer, through a reinsurance operation, was certainly aggregated at much more modern times. The uncontrolled widespread of the productive system created disparate risks, not always properly conducted toward the same parameter, for which reason Insurers have had to limit their losses. The Insurers have to homogenize their results, eliminating the volatility they are absorbing from their insured customers. Upon absorbing such Insurer volatility, Reinsurers are, in turn, capable of homogenizing their portfolios by combining a certain number of portfolios comparable to each other and particularly in view of the internationality of their operations. Two or more catastrophic events would hardly occur within the same period and in one single place, let alone the possibility of occurring at the same time the world over, although, on a probabilistic basis, this could happen under certain conditions (pandemic diseases, for example).
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REINSURANCE In many countries, the insurance industry and, more specifically, Reinsurers are being faced with new impact scenarios not caused by natural catastrophes. Terrorist attacks, anthropic climatic changes and also financial market crises have all been disturbing societies and their institutions. Such a problematic constitutes new challenges for the insurance and reinsurance industry. At

present, one should imagine what was previously unimaginable, in the search for more remote loss events scenarios. The due appraisal of risks, the adjustment of coverages and prices, in addition to establishing adequate underwriting controls and policies, are the essential requirements at a time when a sustainable corporate planning is being required with a view into a future. In view of such new scenarios, always in evolution, the reinsurance acquired the modernity status of a financial product, to the extent of allowing Insurers to be more capable of underwriting risks, increasing the offer of insurance products and reducing capital costs. It then propitiates the guaranteed financial strength of the system, for stabilizing direct insurance markets and other intermediary entities, as well as institutional investors. A reinsurance operation is international by excellence, to the extent of being healthy for local markets to have their liabilities spread over different countries, thus diluting claimed losses, particularly those of a catastrophic nature. In a very brief manner, and consolidating the whole theory described in the previous paragraphs, the chief function of a reinsurance agreement (treaty) is to guarantee the indemnity to the Insurer resulting from a claim. All other underlying functions will be subject to changes over the time and according to the interests and even requirements of each insurance market. And, for being

REINSURANCE dynamic, it will then require constant adaptations of all those integrating the system.

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DEFINITION OF 'REINSURANCE' The practice of insurers transferring portions of risk portfolios to other parties by some form of agreement in order to reduce the likelihood of having to pay a large obligation resulting from an insurance claim. The intent of reinsurance is for an insurance company to reduce the risks associated with underwritten policies by spreading risks across alternative institutions. Also known as "insurance for insurers" or "stop-loss insurance". INTRODUCTION Reinsurance is a form of insurance. A reinsurance contract is legally an insurance contract. The reinsurer agrees to indemnify the cedant insurer for a specified share of specified types of insurance claims paid by the cedant for a single insurance policy or for a specified set of policies. The terminology used is that the reinsurer assumes the liability
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REINSURANCE ceded on the subject policies. The cession, or share of claims to be paid by the reinsurer, may be defined on a proportional share basis (a specified percentage of each claim) or on an excess basis (the part of each claim, or aggregation of claims, above some specified dollar amount). The nature and purpose of insurance is to reduce the financial cost to individuals, corporations, and other entities arising from the potential occurrence of specified contingent events. for part An of insurance the company losses sells insurance from policies these guarantying that the insurer will indemnify the policyholders financial stemming contingent events. The pooling of liabilities by the insurer makes the total losses more predictable than is the case for each individual insured, thereby reducing the risk relative to the whole. Insurance enables individuals, corporations and other entities to perform riskier operations. This increases innovation, marketplace. The nature and purpose of reinsurance is to reduce the financial cost to insurance companies arising from the potential occurrence of specified insurance claims, thus further enhancing innovation, competition, and efficiency in the marketplace. The cession of shares of liability spreads risk further throughout the insurance system. Just as an individual or company purchases an insurance policy from an insurer, an insurance company may purchase fairly comprehensive reinsurance from one or more reinsurers. competition, and efficiency in a capitalistic

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REINSURANCE There are many reasons for an insurance company to seek reinsurance for all or part of its liability, which could include but not limited to the followings:

Risk Transfer
The main purpose of reinsurance is to allow the ceding insurance company to write and assume individual risks that are greater than its capital size would allow, thus offering larger limits of protection to policyholders than otherwise possible. Reinsurance also protects insurers against catastrophic losses.

Income Smoothing
In taking all or part of the risks, reinsurance helps to smooth out the financial results of an insurance company, making them more predictable by absorbing larger losses. This enables easier business planning and financial projections.

Surplus Relief
Under some typical reinsurance arrangments, insurance companies are allowed to reduce the amount of net liability they need to hold on its balance sheet by an amount equals to the reserve credit. Very often, reinsurers offer an initial commission or rebate to the insuance companies, thus further helping them to reduce the strain of writing new business.
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Product Development
In many circumstances, reinsurers are able to provide expertise about development of the more sophisticated product types. They work closely together with the insurance companies actuarial team to design the best tailor made products.

Source of Profit
Although more of an enhanced benefit instead of a core driver, insurance companies may be motivated by the fact that they are able to reap arbitrage profits by purchasing reinsurance coverage at a lower rate than what they believe the cost is for the underlying risk. This is achievable because reinsurers are more specialised in certain types of risks, allowing them to attain critical mass and hence a good economy of scale.

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REINSURANCE NEEDS
There are several reasons for an insurance company to use reinsurance. We will discuss here the most important ones. Increasing underwriting capacity Insurance companies are often offered risks that may surpass their financial strength. Ceding part of the risk may allow them to accept the full risk thus satisfying clients needs. For this purpose insurance companies may also use coinsurance. However in this case the insur- ance company will have to contact competitors to share part of the risk which might not be to its best interest, especially in a competitive market. Another disadvantage to the use of coinsurance is the burden put on the insured that will need to deal with each one of the participating insurance companies with regard to premium payments and claim settlements. Risk capital improvement and diversification Insurance companies having a more diversified portfolio of risks will tend to have more stable financial results. Using reinsurance will allow insurance companies to participate in a diversity of risks using the same working capital by ceding part of the risk and keeping a smaller portion of each risk. This reduction in the concentration on risk will diminish the volatility of the annual results. Figure 2 illustrates this reinsurance effect. Here, without reinsurance the companys capital commitment allows its participation in only one risk. Using reinsurance, the same committed capital allows the
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REINSURANCE company to participate in four different risks with a total higher sum insured.

Surplus relief The use of reinsurance allows insurance companies to partially transfer risks off their balance sheet. While the ultimate responsibility to the policy holders still remains with the insurance company, most jurisdictions recognize reinsurance as a risk managing tool that allows a reduction of statutory surplus requirements. The guarantee implicit on a reinsurance contract to pay the reinsured claims is recognized in the capital insured requirements premium net for of the cedant. Hence it is not thus uncommon to base the prudential requirements on the reinsurance. Reinsurance removes a technical risk but it introduces a counterparty risk since, as mentioned above, the ultimate responsibility to the policy holders still remains with the insurance company. To offset the counterparty risk additional surplus is usually required. This additional capital will vary depending on the solvency rating of the reinsurer. Also the amount of surplus relief granted will depend on that rating. Catastrophic protection Well run insurance companies accept risk exposure according to their financial strength. However, the risks may also be exposed to extreme infrequent events, like earthquakes,
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REINSURANCE floods, plane crashes and other mayor catastrophic events. Holding enough capital for those extreme events would make the insurance operation economically unviable or at least very expensive. Transferring this exposure to catastrophic events to the reinsurers is a more effective way to address very infrequent events. Reinsures offer catastrophic protection in a more economic feasible way than insurance companies by participating in catastrophic exposures through out the world and thus geographically better diversifying the risk. Usually reinsurers are also more capitalized than insurance companies. They also operate dedicated

departments that have gained substantial knowledge of the physical characteristics and history of catastrophic events thus allowing them to price and underwrite properly the exposure and accept those risks. Expertise transfer Through the reinsurance activity reinsurers acting in several markets with different insurance companies have the ability to acquire significant knowledge of the different products, markets and insurance techniques like underwriting, administration of the policies and claims assessment. This is particularly important when entering a new market, a new line of business or simply launching a new product. Transferring the risk through reinsurance may also include the shift of the underwriting, administration, or other activity related to the
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REINSURANCE risk transferred to the reinsurer. Such a reinsurance

agreement allows insurers to focus in their core business outsourcing to experts the non core activities. Financing new business As discussed in Module 1 a rapidly growing insurance activity can require upfront financing. This is particularly true in the case of Life Insurance business. Here the insurance company has to finance the agents or brokers commissions that can be as high as the full first years premium as well as the underwriting costs that may include medical examinations and financial assessments. Reinsuring part of the business can provide a source of financing especially if the reinsurer agrees to advance the future expected profits of the business in the form of reinsurance commission. This source of financing of insurance business can be attractive compared to other sources such as bank loans or equity. Reinsurers, knowing the business, will have lower risk

charges than non insurance financing sources. Also, in most reinsurance agreements the pay back is contingent on the performance of the reinsured business. i.e. the advancement of future profits are only recovered by the reinsurer if the business actually generates those expected profits. If the payback of the reinsurance financing is totally contingent on the performance of the reinsured business, in most

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REINSURANCE jurisdictions no liability needs to appear in the balance sheet of the cedant. Other reinsurance needs and a word of warning Insurance companies enter reinsurance agreements for one or more of the above mentioned reasons. There might be other special situations where reinsurance is used as a valid financial and operational tool, however if none of the above mentioned needs is present, special scrutiny of the transaction is required. The great flexibility of reinsurance treaties that allows effective tailor-made solutions to meet individual insurance companys needs has been abused in the past to design tax avoidance, money laundry and other illegal activities. A reinsurance agreement that does not transfer any type of risk is always questionable.

THE FORMS OF RE-INSURANCE


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Facultative Certificates
A facultative certificate reinsures just one primary policy. Its main function is to provide additional capacity. It is used to cover part of specified large, especially hazardous or unusual exposures to limit their potential impact upon the cedants net results or to protect the cedants ongoing ceded treaty results in order to keep treaty costs down. The reinsurer underwrites and accepts each certificate individually; the situation is very similar to primary insurance individual risk underwriting. Because facultative reinsurance usually covers the more hazardous or unusual exposures, the reinsurer must be aware of the potential for antiselection within and among classes of insureds. Property certificate coverage is sometimes written on a proportional basis; the reinsurer reimburses a fixed percentage of each claim on the subject policy. Most casualty certificate coverage is written on an excess basis; the reinsurer reimburses a share (up to some specified dollar limit) of the part of each claim on the subject policy that lies above some fixed dollar attachment point (net retention).

Facultative Automatic Agreements or Programs


A facultative automatic agreement reinsures many primary policies of a specified type. These policies are usually very similar, so the exposure is very homogeneous. Its main
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REINSURANCE function is to provide additional capacity, but since it covers many policies, it also provides some degree of stabilization. It may be thought of as a collection of facultative certificates underwritten simultaneously. It may cover on either a proportional or excess basis. It is usually written to cover new or special programs marketed by the cedant, and the reinsurer may work closely with the cedant to design the primary underwriting and pricing guidelines. For example, a facultative automatic agreement may cover a 90% share of the cedants personal umbrella business, in which case the reinsurer will almost certainly provide expert advice and will monitor the cedants underwriting and pricing very closely. Facultative automatic agreements are usually written on a fixed cost basis, without the retrospective premium adjustments or variable ceding commissions sometimes used for treaties (as we shall see below). There are also nonobligatory agreements where either the cedant may not be required to cede or the reinsurer may not be required to assume every single policy of the specified type.

Treaties
A reinsurance treaty represents the terms of agreement between an insurer and a reinsurer. Reinsurance treaties can either be written on a continuous basis or on a term basis. A
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REINSURANCE continuous contract continues indefinitely, but generally has a defined noticing period whereby either party can give its intent to cancel or amend the treaty within a period of about 60 to 90 days. On the contrary, a term agreement has an explicitly built-in expiration date. It is typical for insurers and reinsurers to have long term relationships that span many years. Reinsurance can also be purchased on a per policy basis in which case it is known as facultative reinsurance, which is commonly used for large or unusual risks that do not fit within standard reinsurance treaties due to their exclusions. The term of a facultative agreement coincides with the term of the specific policy in concern. Almost all insurers do not place reinsurance agreements with one single reinsurer but with treaties shared among a number of reinsurers. The reinsurer who sets the terms and contract conditions for the reinsurance contract is the lead reinsurer, whereas the other companies subscribing to the contract are the following reinsurers.

Treaty Proportional Covers


A quota-share treaty reinsures a fixed percentage of each subject policy. Its main function is financial results management, although it also provides some capacity. The reinsurer usually receives the same share of premium as claims, and pays the cedant a ceding commission

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REINSURANCE commensurate with the primary production and handling costs (underwriting, claims, etc.). Quotashare treaties usually assume in-force exposure at inception. The cedants financial results are managed because the ceding commission on the ceded unearned premium reserve transfers statutory surplus from the reinsurer to the cedant. The cession of premium also reduces the cedants netpremium- to-surplus ratio. The ceding commission on quota-share treaties is often defined to vary within some range inversely to the loss ratio. This allows the cedant to retain better-than-expected profits, but protects the reinsurer somewhat from adverse claims experience. The term quotashare is sometimes (mis-)used when the coverage is a percentage share of an excess layer; we will more properly treat this kind of coverage as being excess. A surplus-share treaty also reinsures a fixed percentage of each subject policy, but the percentage varies by policy according to the relationship between the policy limit and the treatys specified net line retention. Its main function is capacity, but it also provides some stabilization. A surplus-share treaty may also assume in-force exposure at inception, which together with a ceding commission provides some management of financial results. This is typically a property cover; it is rarely used for casualty business.

Treaty Excess Covers

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REINSURANCE An excess treaty reinsures, up to a limit, a share of the part of each claim that is in excess of some specified attachment point (cedants retention). Its main functions are capacity and stabilization. An excess treaty typically covers exposure earned during its term on either a losses-occurring or claimsmade basis, but run-off exposure may be added in. The definition of subject loss is important. For a per-risk excess treaty, a subject loss is defined to be the sum of all claims arising from one covered loss event or occurrence for a single subject policy. Per-risk excess is mainly used for property exposures. It often provides protection net of facultative coverage, and sometimes also net of proportional treaties. It is used for casualty less often than per-occurrence coverage. For a per-occurrence excess treaty, a subject loss is defined to be the sum of all claims arising from one covered loss event or occurrence for all subject policies. Per-occurrence excess is used for casualty exposures to provide protection all the way up from working cover layers through clash layers. A working cover excess treaty reinsures an excess layer for which claims activity is expected each year. The significant expected claims frequency creates some stability of the aggregate reinsured loss. So working covers are often retrospectively rated, with the final reinsurance premium partially determined by the treatys loss experience. A higher exposed layer excess treaty attaches above the working cover(s), but within policy limits. Thus there is direct single policy exposure to the treaty. A

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REINSURANCE clash treaty is a casualty treaty that attaches above all policy limits. Thus it may be only exposed by: 1. extra-contractual-obligations (i.e., bad faith claims) 2. excess-of-policy-limit damages (an obligation on the part of the insurer to cover losses above an insurance contracts stated policy limit) 3. catastrophic workers compensation accidents 4. the clash of claims arising from one or more loss events involving multiple coverages or policies. Both higher exposed layers and clash are almost always priced on a fixed cost basis, with no variable commission or additional premium provision.

Catastrophe Covers
A catastrophe cover is a per-occurrence treaty used for property exposure. It is used to protect the net position of the cedant against the accumulation of claims arising from one or more large events. It is usually stipulated that two or more insureds must be involved before coverage attaches. The coverage is typically of the form of a 90% or 95% share of one or more layers (separate treaties) in excess of the maximum retention within which the cedant can comfortably absorb a loss, or for which the cedant can afford the reinsurance prices.

Aggregate Excess, or Stop Loss Covers

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REINSURANCE For an aggregate excess treaty, also sometimes called a stop loss cover, a loss is the accumulation of all subject losses during a specified time period, usually one year. It usually covers all or part of the net retention of the cedant and protects net results, providing very strong stabilization. Claims arising from natural catastrophes are often excluded, or there may be a per-occurrence maximum limit.

TYPES OF RE-INSURANCE Quota share


Quota share, or proportional reinsurance, involves one or more reinsurers taking on a specified percentage share of each policy from an insurance company. The reinsurance agreement is typically administered on a periodic basis such as quarterly. At the end of each quarter, the reinsurer(s) will receive that specified percentage of each dollar of premiums from the insurer and will in turn pay that percentage of each dollar of losses as claims recoverable to the insurer. In addition, the reinsurer will normally make an upfront ceding commission payment to the insurer to compensate it for the costs of writing and administering the business. This type of reinsurance allows insurers to write business which they may not have sufficient capital to retain fully. While premiums and claims are all shared on a pro rata basis, ceding commission
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REINSURANCE from the reinsurer(s) helps the relief of new business strains. Another, though less common, form of proportional reinsurance is surplus share. An insurance company defines a policy limit amount X and each additional amount of X is considered as a layer. In the simplest form of arrangement, if the insurance company issues a policy with X = US$100,000 coverage, all of the premiums and claims generated from the policy will be retained by the insurer. If a

US$200,000 policy is issued then half of the premiums and claims will be ceded to the reinsurer (1 additional layer); whereas for a US$800,000 policy the additional 7 layers of coverage will be ceded to reinsurer(s) implying a quota share percentage of 87.5%. There is usually a maximum number of layers defined in the terms of agreement between the insurer and reinsurer, and this in turn determines the maximum policy limit that can be offered by the insurance company to policyholders.

Excess of loss
Excess of loss reinsurance is in essence non-proportional reinsurance, under which an insurer sets a retention limit of policy coverage, and the reinsurer will take on any losses in excess of that specified retention amount. An example of this form of reinsurance is where the insurer is prepared to accept a loss of HK$1 million for any loss which may occur and purchases reinsurance of HK$4 million in excess of the retention limit. If a HK$2.5 million claim occurs the insurer is able to recover the extra HK1.5 million from the reinsurer. In this case, for any claims exceeding HK$5 million, the insurer will not be able to fully recover the
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REINSURANCE claims payable from the reinsurer, hence insurance companies often purchase a few excess layers of reinsurance. This type of excess of loss reinsurance is typically known as per risk reinsurance.

Excess of loss reinsurance can also be on a per occurrence, or catastrophe, level. In catastrophe excess of loss, the insurance policy limits must be less than the reinsurance retention amount. An example of this form of reinsurance involves an insurance company writing a homeowner's contract with policy limit up to HK$1,000,000 and then purchase catastrophe reinsurance of HK$60,000,000 in excess of HK$1,000,000. In such circumstances, the insurance company would recover from reinsurers in the event of multiple losses in one event such as earthquake, flood or typhoon. This is more commonly seen in the general insurance domain.

Retrocession
Sometimes, reinsurance companies themselves also resort to purchasing reinsurance and this is known as a retrocession. The type of reinsurance is normally offered by some other reinsurance companies. The reinsurance company who sells the reinsurance in this case is known as retrocessionaires whereas the ceding reinsurance company is known as the retrocedent. Demand for retrocession arises when a reinsurer providing quota share reinsurance capacity to direct insurers may want to protect its own exposure to catastrophes by purchasing excess of loss protection. Alternatively, a reinsurer offering excess of loss reinsurance protection may

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REINSURANCE look to protect itself against an accumulation of losses in different branches of business which may all become affected by the same catastrophe.

Financial reinsurance
Financial Reinsurance, also known as Finite Reinsurance or Fin Re, is an innovative alternative to traditional forms of reinsurance as described above, and its recent popularity has led to a significant rise in premiums devoted to this category. Financial reinsurance is a practical risk management tool, especially useful when the motivations of the ceding insurance company are focussed not only on managing underwriting risk but also on explicitly recognising and addressing other financially oriented risks.The use of financial reinsurance, which represents a combination of risk transfer and risk financing, could add value to an insurer's risk management by providing flexibility and liquidity. A major function of financial reinsurance is to distribute an extraordinary negative or positive expected underwriting result by the ceding company in a certain year over a longer time period. In this way, financial reinsurance stabilises the business result of the year involved. The opposite approach is to create a highly positive underwriting result for a particular year by bringing forward future earnings. For instance, the reinsurer pays a ceding commission equal to the embedded value of a portfolio which is amortised during the run-off of the business, this is effectively a loan taken and such embedded value financing is not uncommon in case of life insurance company acquisitions. Depending on the domestic regulations governing the respective jurisdiction, insurance companies may be required to obtain approval from the relevant authority on a case-by-case basis for every financial
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REINSURANCE reinsurance transaction they are looking to enter into. If there has been a material change in contract terms during the period of the contract then the insurer must reapply for approval. A typical application process involves the direct insurer describing to the authority the reasons for purchasing financial reinsurance, an analysis of projected cash flows reflecting the possibleoutcomes of the treaty, and descriptions of the expected impact of the proposed arrangement on actuarial statutory reserves and surplus. In particular, underwriting risk and timing risk are important criteria for supervisory and tax authorities when deciding whether a financial reinsurance contract is reinsurance, pure loan or investment. Most of the insurance authorities require there to be a significant underwriting risk and the possibility of a loss to the reinsurer in order to acknowledge a financial reinsurance contract as reinsurance. Underwriting risk Underwriting risk is defined as the risk that actual claims within a period of insurance will deviate from expected claims, which equals the pure risk premium. Deviations may occur in the number and size of claims as well as in the timing of the claims events within the period of insurance. Timing risk Timing risk results from uncertainty about the time when claims must be paid out. This is the risk that claims will have to be paid out earlier than expected.

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FUNCTIONS OF RE-INSURANCE
Almost all insurance companies have a reinsurance program. The ultimate goal of that program is to reduce their exposure to loss by passing the exposure to loss to a reinsurer or a group of reinsurers. Therefore, they are 'transferring some of the risk to the reinsurer or a group of reinsurers Risk transfer
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REINSURANCE With reinsurance, the insurer can issue policies with higher limits than it would otherwise be allowed, therefore being permitted to take on more risk because some of that risk is now transferred to the reinsurer. Reinsurance has gone from a relatively unsophisticated business to a highly sophisticated endeavor. The reason for this is the number of reinsurers that have suffered significant losses and become financially impaired. From 2000 onward, reinsurers have become much more reliant on actuarial models and tight review of the companies they are willing to reinsure. They review their financials closely, examine the experience of the proposed business to be reinsured, review the underwriters that will write that business, review their rates, and much more. Almost all reinsurers now visit the insurance company and review underwriting and claim files and more. Arbitrage The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than they charge the insured for the underlying risk, which can be in the area of risk associated with any form of the asset that is being issued or loaned against. It can be a car, a mortgage, an

insurance (personal, fire, business, etc.) and the like. In general, the reinsurer may be able to cover the risk at a lower premium than the insurer because:

The reinsurer may have some intrinsic cost advantage due to economies of scale or some other efficiency

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Reinsurers may operate under weaker regulation than their clients. This enables them to use less capital to cover any risk, and to make less prudent assumptions when valuing the risk. Even if the regulatory standards are the same, the reinsurer may be able to hold smaller actuarial reserves than the cedant if it thinks the premiums charged by the cedant are excessively prudent. The reinsurer may have a more diverse portfolio of assets and especially liabilities than the cedant. This may create opportunities for hedging that the cedant could not exploit alone. Depending on the regulations imposed on the reinsurer, this may mean they can hold fewer assets to cover the risk. The reinsurer may have a greater risk appetite than the insurer.

Creating a manageable and profitable portfolio of insured risks By choosing a particular type of reinsurance method, the insurance company may be able to create a more balanced and homogenous portfolio of insured risks. This would lend greater predictability to the portfolio results on net basis (after reinsurance) and would be reflected in income smoothing. While income smoothing is one of the objectives of reinsurance arrangements, the mechanism is by way of balancing the portfolio.

Managing cost of capital for an insurance company

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REINSURANCE By getting a suitable reinsurance, the insurance company may be able to substitute "capital needed" as per the requirements of the regulator for premium written. It could happen that the writing of insurance business requires x amount of capital with y% of cost of capital and reinsurance cost is less than x*y%. Thus more unpredictable or less frequent the likelihood of an insured loss, the more profitable it can be for an insurance company to seek reinsurance. Stabilization Reinsurance can help stabilize the cedants underwriting and financial results over time and help protect the cedants surplus against shocks from large, unpredictable losses. Reinsurance is usually written so that the cedant retains the smaller, predictable claims, but shares the larger, infrequent claims. It can also be written to provide protection against a larger than predicted accumulation of claims, either from one catastrophic event or from many. Thus the underwriting and financial effects of large claims or large accumulations of claims can be spread out over many years. This decreases the cedants probability of financial ruin. Management Advice Many professional reinsurers have the knowledge and ability to provide an informal consulting service for their cedants. This service can include advice and assistance on underwriting, marketing, pricing, loss prevention, claims
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REINSURANCE handling, reserving, actuarial, investment, and personnel issues. Enlightened self-interest induces the reinsurer to critically review the cedants operation, and thus be in a position to offer advice. The reinsurer typically has more experience in the pricing of high limits policies and in the handling of large and rare claims. Also, through contact with many similar cedant companies, the reinsurer may be able to provide an overview of general issues and trends. Reinsurance intermediaries may also provide some of these same services for their clients.

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REINSURANCE

PARTICIPANTS OF THE REINSURANCE INDUSTRY


As discussed above the main participants in the reinsurance industry are the professional reinsurers, the retrocessionaires and the insurance companies. Reinsurance brokers also play a fundamental role in the placement of reinsurance programs, in particularly when dealing with special programs. Captives, Pools and Offshore Reinsurers complete the reinsurance industry. Reinsurance brokers For complex reinsurance programs or when the reinsurance capacity is scarce, insurance companies utilize the services of reinsurance brokers. Reinsurance brokers are companies or professional individuals that are licensed and supervised dedicated to provide brokers professional are paid also advice through offer to insurance reinsurance administrative companies on the placement of their reinsurance programs. Reinsurance premium. commissions that are proportional to the placed reinsurance Reinsurance brokers services and product development. In most jurisdictions

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REINSURANCE reinsurance brokers are required to hold an error and omissions liability policy for the protection of the insurance companies. In recent years the press has reported on major financial scandals related to the non transparency of the reinsurance commissions. Professional reinsurance brokers have reacted offering detailed disclosure of their commissions. As an example we have attached in Annex 3 a disclosure commitment issued by Guy Carpenter. Captives Large industrial conglomerates that are interested in keeping their risks within the group usually operate with a captive. A captive is a legal entity, usually a

stock insurance company owned by the group that accepts and retains risks emanating only from the same industrial group. Pools Insurance companies may want to insure an unusual or new type of risk but fear they will not have enough business of that type to benefit from the law of large numbers. In an insurance pool, several companies agree to share all their risks of this type. This will provide a large enough sample to give more predictable and consistent results from year to year. The pool could be reinsured or the sharing of each policy in the pool may be according to how much business each company puts
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REINSURANCE into the pool or it could be a formula relating to how much risk each company would accept on any one case. Pooling was in fact the way insurance of modern passenger airplanes began. The World Bank has been promoting pools to cover catastrophic risks like the Turkish Catastrophic Insurance Pool (TCIP) and the Caribbean Catastrophic Risk Insurance Facility (CCRIF). Offshore reinsurance Offshore reinsurance companies are reinsurers which operate in special geographic zones, often with less demanding regulatory and favorable tax environments. A great deal of reinsurance is conducted through these centers although much of the actual management of these companies is done in the parents home offices in Europe, London and New York. The purpose of offshore reinsurance has been to optimize the use of capital and thus create competitive advantage. However, special scrutiny is required when offshore reinsurance is involved. The lack of a strict regulation or the low capital requirements in some offshore centers can lead to failing reinsurers in case of

mayor claims. Also money laundering activity has used this type of reinsurance in the past.

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REINSURANCE

REINSURANCE IN INDIA

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REINSURANCE Until GIC was notified as a National Reinsurer, it was operating as a holding / parent company of the 4 public sector companies, controlling their reinsurance programmes. GIC would receive 20% obligatory cession of each policy written in India. Since deregulation, GIC has assumed the role of the markets only professional re-insurer. In order to focus on reinsurance, both in India and through its overseas offices and trading partners, GIC has divested itself of any direct business that it wrote prior to November 2000, with the temporary exception of crop insurance. It currently manages Hull Pool on behalf of the market, which receives a cession from writing companies and after a pool protection the business is retro-ceded back to the member companies. GIC also manages the Terrorism Pool. REINSURANCE REGULATION The placement of reinsurance business from be Indian market is now governed by Reinsurance Regulations formed by the IRDA. The objective of the regulation is to maximize the retention of premiums within the country and to ensure that IRDA has issued the following instructions: Placement of 20% of each policy with National Re subject to a monetary limit for each risk for some classes Inter-company cession between four public sector companies. Indian Pool for Hull managed by GIC. The treaty and balance risk after automatic capacity are to be first offered to other insurance companies in the market before offering it to international re-insurers. Each company is free to arrange its own reinsurance program, which has to be submitted to the IRDA 45 days before commencement.

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REINSURANCE Not more than 10% of reinsurance premium to be placed with one reinsurer. No re-insurer will have a rating of less than BBB from Standard and Poors or an equivalent rating from AM Best.

General Insurance Corporation of India


GIC as a national re-insurer is providing useful capacity to all insurance companies. BREAK-UP OF NET PREMIUM INCOME & CLAIMS

Division Claims Indian Reinsurance 19,898,2 Foreign Inward 1498.9 Aviation 186.1 Crop 1367.6 Total 2,950.8

Premium 21,996.3 1591.4 244.1 2,880.6 26,712.3

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REINSURANCE In November 2000, GIC was renotified as India's Reinsurer, but its supervisory role over its subsidiaries was ended. This was followed by the General Insurance Business (Nationalisation) Amendment Act of 2002. Coming into effect from 21 March 2003, this amendment ended GIC's role as a holding company of its subsidiaries. The ownership of the subsidiaries was transferred to the Government of India, which in turn divested its stake in the companies through listings on Indian stock exchanges. As a result of these reforms, GIC became the sole Re-Insurer in India, and is now called GIC Re. Indian insurance companies are required by law to cede 10% of every policy value to GIC Re, subject to some limitations and exceptions. GIC Re has diversified its operations and is now emerging as an important Re-Insurer in SAARC countries, Southeast Asia, Middle East and Africa. GIC Re has also expanded its international operations through branches in London and Moscow.

GIC as International Re-insurer


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REINSURANCE

Backed by experience of more than three decades in handling the reinsurance requirement of the Indian market, GIC has now placed itself as an effective Reinsurance Partner. To Afro-Asian countries and also other markets. If offers a capacity of US$ 50 million on facultative risks and US$ 10 million for treaty business. GIC reinsurance as part its strategy to expand its operation and to make its present felt globally has recently upgraded its representative offices in London and Dubai. Incidentally, the sole national reinsurer of india also has another representative office in Moscow. GIC has developed necessary skills and has qualified manpower to take care of growing needs of the expanding Indian industry. 3rd Asian Reinsurers Summit was organised by GIC of India, in February 2003at Mumbai. Eleven reinsurers from Japan, China, Hong Kong, Singapore, Taiwan, Korea, Indonesia, Malaysia, Singapore, Philippines and India participated in the summit with the aim of reinforcing of strengths for mutual development, undertaking joint research, data sharing & information management and furthering business co-operation.

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REINSURANCE

TOP 10 GLOBAL REINSURANCE COMPANIES

Rank

Company

Net

Premiums ($ billions) 1 Munich Re 24,218 2 Swiss Re 23,202 3 Berkshire Hathaway Re 4 Hannover Re 8,907 5 Lloyd's of London 7,950 6 SCOR 6,948 7 Everest Re Group 3,875 8 PartnerRe 3,689 9 Transatlantic Holdings 3,633 10 ACE Tempest Reinsurance 3,405 11,577

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REINSURANCE

The goal of the reinsurance policy is to transfer the risk of the insurer to the reinsurer. Reinsurance companies basically insure consumer insurance companies who supply coverage for various types of contracts. Most insurance companies have a reinsurance program in place in order to make them more financially secure. Under a reinsurance contract, the reinsurer agrees to pay a portion of the insurers losses in return for the premium paid to them by the insurer. Insurers with a reinsurance program in effect are capable of issuing policies with higher limits meaning they can shoulder more risk since a

portion of that risk is shifted to the reinsurer. Due to record losses suffered during recent financial crisis, the top reinsurers fluctuate in their ranks, among them are Swiss Re, Munich Re, and Hannover Re. While reinsurance aids in
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REINSURANCE making an insurance companys bottom line more foreseeable by lowering the amount of capital required to supply compensation to policyholders, natural catastrophes are unpredictable and are something that reinsurers have to be prepared for, particularly events like earthquakes that can occur any time of the year. Reinsurance policies fall under the proportional and the non-proportional type. Further proportional reinsurance can be divided in to quota share and surplus reinsurance. Under proportional reinsurance, one or more reinsurers take a percentage share of every policy written by an insurer. What it means is that the reinsurer will receive a percentage on the dollar for premiums paid to the insurer, however they are required to pay that same percentage to compensate losses. Premiums and losses are shared on a pro rata basis under a quota share treaty. A surplus share treaty is also seen as a variable quota share contract, in this type of policy a retention limit is set for each policy as a specific dollar amount, the reinsurer pays anything above that amount up to a maximum limit. In the event of a loss, the insurer and the reinsurer would compensate based on the same proportion as that policys provided coverage. Only if the losses suffered by an insurer exceed a particular amount, then will the non-proportional reinsurance respond. Among the types of nonproportional insurance coverage are excess of loss and stop loss. Excess of loss reinsurance covers the insurer against all or a part of the loss that exceeds the specified loss retention. Stop loss covers the insurer for the amount the losses they sustain surpass an agreed amount.

CHALLENGES FOR REINSURANCE MARKET


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REINSURANCE Prior to nationalization in 1973, the reinsurance market in India had a much diluted presence in the industry. The foreign companies operating in India were managing their risk portfolio with their parent companies overseas. To safeguard the identified and limited risk of insurance companies, local companies created India Insurance Pool. The developments after nationalizations insurance industry created a new body with the merger of India Reinsurance and Indian Guarantee for its reinsurance business to support the technology and engineering mega projects. Some of the major issues in accounting have been undertaken considering there cent developments in the business. The return from foreign companies are to be incorporated when received up to 31stmarch and returns from Indian companies and state insurance funds received as of different dates are accepted up to the date of finalization of accounts. Arising out of the occurrence of disastrous like terrorist attack on world trade center etc. which brought about unprecedented loss of life and property and thereby unbearable liability and operational crisis onto the reinsurance industry world over. There is a wide difference between the rates required by the international reinsurers and those charged by the domestic insurers leading to the price affordability as an issue. Where there are tarrifs, like a case of India, the customers cushioned from the rate of increase in the international market. Such impositions are required to be self absorbed. The Indian market is in absence of the competitive environment of the international reinsurers at the local level, and has depended mainly on the domestic market understanding and basing probability of business ceded rather than on underwriting and risk information criteria. A regular interaction for regional co-operation has to be developed to set up a framework of the

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REINSURANCE areas of co-operation and the mechanism, with this India has to compete with the global reinsurance giants. However, the tightening of reinsurance premium in India has been attributed to the low volumes. As market become global, country regulators face challenges in policy formulation for creating a market that develops and keeps confidence of the industry and for keeping international trade regulation intact.

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REINSURANCE

RESEARCH/PUBLICATIONS
Key players in the reinsurance field produce and release periodic research reports, many of which are available on subscription basis, on specialised reinsurance related topics including: Dread disease survey Group life market survey Long term and managed care Medical advancement and health insurance Casualty reports Underwriting system Workers compensation Occupational disease Enterprise risk and captial management Genetics engineering Terrorism Climate change and natural disasters and many others.

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REINSURANCE

REINSURANCE SUPERVISIONS
The International Association of Insurance Supervisors (IAIS), established in 1994, provides the highest level of supervisory guideline on insurance issues including the practice of reinsurance. IAIS represents insurance regulators and supervisors of some 180 jurisdictions. Its members in Asia include the following key insurance authorities in the respective region: China Insurance Regulatory Commission (CIRC), China Office of the Commissioner of Insurance (OCI), Hong Kong Monetary Authority of Macao (AMCM), Macau Insurance Bureau of Financial Supervisory Commission (IB), Taiwan Monetary Authority of Singapore (MAS), Singapore Bank Negara Malaysia (BNM), Malaysia Financial Services Agency (FSA), Japan Financial Supervisory Service (FSS), Korea Insurance Regulatory and Development Authority (IRDA), India Insurance Board of Sri Lanka (IBSL), Sri Lanka

IAIS has issued a number of principle, standards and guidelines for its insurance supervisory members to use as best practices to work towards. In particular, the Reinsurance and other forms of Risk Transfer Subcommittee has developed reinsurance guidelines both from the perspective of evaluating the reinsurance cover of primary insurers and of supervising reinsurers.
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REINSURANCE

CONCLUSION
Reinsurance means insuring again. It is transfer of insurance risk from one insurer to another. Under reinsurance the original insurer who has insured a risk, insures a part of that risk with another insurer. Reinsurance premium is an income to there insurer and an expense to the insurer. Reinsurance is a good method to diversify and distribute risks of an insurer. Reinsurance even provide technical assistance and rating assistance to the original insurers. Reinsurance is also a contract of indemnity. The object of underwriting is to make a reasonable profit, it is equally essential that the business ceded to reinsurers should also give them a margin. For profit, therefore, the overall quality of business accepted by direct insurers should be good. The complexity of the reinsurance business has been treated in numerous publications. Basically every professional reinsurer offers excellent learning material that go from basics into complex topics. Here we have aimed to pass enough information to the reader to make her/him familiar with the basic concepts of reinsurance in a compressed manner. At the same time we hope that the course will allow and encourage
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REINSURANCE the reader to reach out for further literature to satisfy the individual needs of knowledge in the matter.

WEBILIOGRAPHY
www.actuaries.org.hk www.casact.org

www.wikipedia.org

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