The question provides that the rate on line is 5%, and they conclude that the probabilities of 2 loss is very low. Can anyone explain in more details for me about this?
Rate on line = premium for the layer / width of layer. We can consider the (initial) premium charged by the reinsurer to approximately be their estimate of the expected cost of claims to the layer (if we ignore loadings for expenses, etc). A 5% rate on line is low, which suggests a low expected claims cost, and hence it is highly unlikely that the layer will be exhausted. Hence, allowing a reinstatement is unlikely to affect the losses experienced by the reinsurer.
I don't quite understand. Why expected cost of claims to the layer is low means frequency of reinsurance claim in that layer is low? Is that your reasoning is the frequency is low therefore the expected cost of claims is low? And you ignore the severity of that layer? Example: The frequency of the claim to a layer is 0.01 (which is low), but the average severity is 100 million (which is high) lead to high cost to the layer (1 million expected loss cost)? And where does the information of 5% rate on line is low? What percentage would be high? One more questions, does the loss cost to the lower layers higher than loss cost to the higher layers (ie: loss cost to 100-200 will be higher than loss cost of 200-300)? Thanks,
Yes that’s the assumption the examiners are making. Perhaps it’s a little oversimplistic of them to say so, but we’re probably being overpedantic. There’s very little detail in the question and the examiners are just giving a ball-park explanation. The examiners have used a simple reasonableness check. Call it gut feel if you like. It’s hard to give a benchmark. A working layer would expect a fairly regular flow of claims so you would expect a higher rate on line as a result. For a high layer the opposite is true.
