Hi all, I've been puzzled by a couple of flashcards for a while now, and wondered if anyone could expand/explain in another way what the following two actually mean - ie WHY the following methods would work/be done in practice: 1. Allowing for the cost of reinsurance in pricing Either use - gross risk premium plus net reinsurance cost ( where small proportion of gross premium passed to reinsurer), or net risk premium plus gross reinsurance cost (where there is high level XL/cat reinsurance). 2. Allowing for investment income i) Long-tail classes - discount projected claims and expense cashflows to the date of premium payment, usually assuming a conservative rate of return ii) Short-tailed/volatile long-tailed classes - adjust the profit loading to allow roughly for premium investment income Many thanks! Thistle
Allowing for the cost of reinsurance in pricing: a) gross risk premium means that you are accounting for all claims gross of reinsurance, ie the whole (uncapped) claim amount. But you still need to allow for the extra cost that's there as a result of paying profit etc to the reinsurer, so you add on the net cost of reinsurance so that you don't double-count the claims. b) net risk premium means that you just account for the claims up to the reinsurance attachment point - therefore the claims are net of the RI. But then you still need to allow for the claims in excess of the RI as well as the reinsurer's profits - so use the gross cost of reinsurance. The choice between which to go for depends on the materiality of the reinsurance layer/contract. Allowing for investment income: Again, boils down to materiality I think. So if it's long-tail and investment income is important then do it in a more accurate way. If not, or if there's lots of uncertainty then use a more approximate approach.
Regarding the cost of reinsurance in pricing, the important thing to appreciate here is that you get the same answer both ways and therefore the choice is actually arbitrary. The gross risk premium is the expected claim cost gross of reinsurance. The net cost of reinsurance is the premium you pay to the reinsurer minus the recoveries you make. So: Gross Risk Premium + Net Reinsurance Cost = Expected Gross Claims Cost + (Expected RI Premiums - Expected RI Recoveries) The net risk premium is the expected claim cost net of reinsurance. The gross reinsurance cost simply means the expected reinsurance premium. So: Net Risk Premium + Gross Reinsurance Cost = Expected Net Claims Costs + Expected RI Premiums = (Expected Gross Claims Cost - Expected RI Recoveries) + Expected RI Premiums
