All doubts from chapter 24

[Kamal Sardana]

Hi Tutor, here are some of my queries: italics is core reading lines
1.
Financial reinsurance is a contingent loan from reinsurer to insurer where repayments are contingent on say, insurer making profit on that block of business. Now Core reading says ," FinRE is not effective under supervisory regime where credit can already be taken for future profits and/or where a realistic liability must be held in loan repayments"
(a) What is the meaning of credit for future profits is already taken and how does it leads to inefficiency of my FinRe deal?
(b) What do we mean by realistic liability for loan repayments and again.. how does it leads to inefficiency of my FinRe?

2.
Risk premium reinsurance: Core reading says, "Reinsurer provides loan in the form of commission and repayments are spread over number of years as addition to premiums.
(a) What is meaning of this line --> reinsurer takes into account the expected lapse experience of the portfolio in determining the loan repayments?
(b) Why liability would not increase in this. If reinsurer premium is increased, it is my liability--> Assets will be increased by reinsurance commission but liabilities may not need to increase the cover the additional reinsurance premium

3.
How does reinsurance commission works ? -> Let's say i am an insurer and i write term assurance and then i have original terms quota share reinsurance. Then reinsurer will pay me reinsurer commission quite heavy at time 0 ? or on a recurring basis ?

4. What exactly is net level risk premium arrangement ? Can you explain with the help of an example

 

[Mark Willder]

Hi Tutor, here are some of my queries: italics is core reading lines
1.
Financial reinsurance is a contingent loan from reinsurer to insurer where repayments are contingent on say, insurer making profit on that block of business. Now Core reading says ," FinRE is not effective under supervisory regime where credit can already be taken for future profits and/or where a realistic liability must be held in loan repayments"
(a) What is the meaning of credit for future profits is already taken and how does it leads to inefficiency of my FinRe deal?
(b) What do we mean by realistic liability for loan repayments and again.. how does it leads to inefficiency of my FinRe?

2.
Risk premium reinsurance: Core reading says, "Reinsurer provides loan in the form of commission and repayments are spread over number of years as addition to premiums.
(a) What is meaning of this line --> reinsurer takes into account the expected lapse experience of the portfolio in determining the loan repayments?
(b) Why liability would not increase in this. If reinsurer premium is increased, it is my liability--> Assets will be increased by reinsurance commission but liabilities may not need to increase the cover the additional reinsurance premium

3.
How does reinsurance commission works ? -> Let's say i am an insurer and i write term assurance and then i have original terms quota share reinsurance. Then reinsurer will pay me reinsurer commission quite heavy at time 0 ? or on a recurring basis ?

4. What exactly is net level risk premium arrangement ? Can you explain with the help of an example

Hi Kamal

1. This type of financial reinsurance works by increasing the assets without increasing the liabilities. The idea is that if the regulatory reserves are overly prudent, then they understate the true position of the company. For that reason the reinsurer is happy to lend money to the insurer knowing that profits will emerge later once the prudent reserves are released. So the assets go up due to the loan from the reinsurer, but the liabilities don't go up, because the insurer pays the loan back from future profits (this doesn't worry the regulator as the loan is not repaid if the insurer needs the money to pay the claims, ie if there are no profits).

(a) The above approach doesn't work if the reserves are best estimate as there is no prudence to generate the future profits to repay the loan.

(b) The above approach also doesn't work if the insurer had to increase the liabilities to cover the future loan repayments.

I'll return to your other questions later.

Best wishes

Mark

 

[Kamal Sardana]

Hi Kamal

1. This type of financial reinsurance works by increasing the assets without increasing the liabilities. The idea is that if the regulatory reserves are overly prudent, then they understate the true position of the company. For that reason the reinsurer is happy to lend money to the insurer knowing that profits will emerge later once the prudent reserves are released. So the assets go up due to the loan from the reinsurer, but the liabilities don't go up, because the insurer pays the loan back from future profits (this doesn't worry the regulator as the loan is not repaid if the insurer needs the money to pay the claims, ie if there are no profits).

(a) The above approach doesn't work if the reserves are best estimate as there is no prudence to generate the future profits to repay the loan.

(b) The above approach also doesn't work if the insurer had to increase the liabilities to cover the future loan repayments.

I'll return to your other questions later.

Best wishes

Mark

Thanks Mark. Waiting for solutions to other queries

 

[Kamal Sardana]

Just adding one more question
5. Under the risk premium - sum at risk approach: Core reading says, " Under sum-at-risk reinsurance the insurer retains the full reserves under its contracts. The reserve does not constitute any risk to the insurer from mortality, as the reserve needs to be available whether a policyholder dies or survives during the year. So, reinsurance that covers any part of the insurer’s reserves is a waste of money, at least from the view of covering mortality risk. Also, such reinsurance would allow the reinsurer to set up its own reserves for its share of the risk, and so would allow the reinsurer to earn investment profits at the expense of the insurer. Hence, it is (usually) in the insurer’s best interests to retain 100% of the reserve if it can do so. (The exception to this would be if the insurer wishes to share the investment risk as well as the mortality risk with the reinsurer.)

Can you please explain the bold part?

 

[Mark Willder]

Hi Tutor, here are some of my queries: italics is core reading lines

2.
Risk premium reinsurance: Core reading says, "Reinsurer provides loan in the form of commission and repayments are spread over number of years as addition to premiums.
(a) What is meaning of this line --> reinsurer takes into account the expected lapse experience of the portfolio in determining the loan repayments?
(b) Why liability would not increase in this. If reinsurer premium is increased, it is my liability--> Assets will be increased by reinsurance commission but liabilities may not need to increase the cover the additional reinsurance premium

3.
How does reinsurance commission works ? -> Let's say i am an insurer and i write term assurance and then i have original terms quota share reinsurance. Then reinsurer will pay me reinsurer commission quite heavy at time 0 ? or on a recurring basis ?

4. What exactly is net level risk premium arrangement ? Can you explain with the help of an example

2. (a) So the reinsurer has increased the reinsurance premium by 2 per policy for each future year to recover the loan of 200. If too many policies lapse then it won't get the loan amount back. For example if there are 20 policies and they all lapse after 3 years (instead of the full term of 5 years) the reinsurer only gets 2 x 20 x 3 = 120 back.

(b) Regulation sometimes doesn't require that future premiums are reserved for, which is what was covered in your first question. If regulation does allow for future reinsurance premiums then we have the same problem as with 1. that the financial reinsurance won't work.

3. It will be most helpful to the insurer if it is initial commission.

4. Let's say the sum assured is 200 under a term assurance and 50% is reinsured. The reinsurer could charge 200 x 50% x q_x each year - the reinsurance premium would then increase each year as the policyholder gets older. For example q_x = 0.11, q_(x+1) = 0.12, q_(x+2) = 0.13. Instead a net level risk premium would charge the same each year, so on average q = 0.12.

Best wishes

Mark

 

[Mark Willder]

Just adding one more question
5. Under the risk premium - sum at risk approach: Core reading says, " Under sum-at-risk reinsurance the insurer retains the full reserves under its contracts. The reserve does not constitute any risk to the insurer from mortality, as the reserve needs to be available whether a policyholder dies or survives during the year. So, reinsurance that covers any part of the insurer’s reserves is a waste of money, at least from the view of covering mortality risk. Also, such reinsurance would allow the reinsurer to set up its own reserves for its share of the risk, and so would allow the reinsurer to earn investment profits at the expense of the insurer. Hence, it is (usually) in the insurer’s best interests to retain 100% of the reserve if it can do so. (The exception to this would be if the insurer wishes to share the investment risk as well as the mortality risk with the reinsurer.)

Can you please explain the bold part?

Let's say the sum assured is 100 and the reserve is 40 for an endowment assurance. The insurer wants to reinsure 50%. Normally the insurer only wants to reinsure the mortality risk, so buys 50% of the sum at risk, ie 30 - this way the insurer keeps the reserve of 40 and so keeps the investment profit (or loss). The bold text says that instead the insurer could reinsure 50% of the whole sum assured so that the reinsurer takes half the reserve of 20 and so the insurer and reinsurer share whatever profits or losses there are on this amount.

Best wishes

Mark