Reinsurance, risk transfer and capital management
Reinsurance questions test whether you can structure cover, cost it, and explain its capital effect net of credit risk.
Structures
- Proportional: quota share (fixed percentage of premium and claims) and surplus (retains a line as a multiple of the retention). Both attract ceding commission.
- Non-proportional: per-risk excess of loss, per-occurrence or catastrophe XL, aggregate XL and stop loss. Catastrophe covers need an event definition and hours clause.
- Facultative for individual risks, treaty for portfolios. Reinstatements may be free or paid, pro rata as to amount and/or time.
Costing and capital
- Price XL by burning cost (historic recoveries trended for exposure and inflation), exposure rating against an exposure curve, or a blend where data is thin.
- Reinsurance cuts net volatility; the capital benefit depends on the SCR credit allowed, collateral and counterparty rating.
- Reinsurance never removes the insurer's obligation to the policyholder.
Worked example
A layer of 10m xs 5m, annual premium 3m, one free reinstatement then one at 100% pro rata as to amount and time. A single event costs 18m; the ceded claim is the full 10m limit, so the layer is exhausted and the free reinstatement is used up. A second event would need a paid reinstatement: if two-thirds of the period remained and the limit were eroded in full, the reinstatement premium would be 3m x (10/10) x (2/3) = 2m. Link the exhaustion to both the recovery and the reinstatement mechanics, then to net capital.
Traps
Applying the retention after the layer; ignoring reinstatement cost in net premium; treating cat and risk XL as interchangeable; assuming recoveries are quick and undisputed.