Hi, In the notes, chapter 26 (Reinsurance 2), it states that to reduce new business strain, a company should use original terms quota share or financial reinsurance. I do not understand this since surely all types of reinsurance should reduce new business strain. Reinsurance can reduce new business strain by reducing capital requirements. All reinsurance reduces a company's expected liabilities, which will in turn reduce capital requirements, which should reduce new business strain. Why is it only original terms quota share or financial reinsurance that can reduce new business strain? Thanks for any replies, Andrew
Andrew New business strain is caused by a combination of setting up large reserves on day 1, and incurring high up-front initial expenses and commission. Risk premium methods are generally focused on reducing the death strain (the difference between the sum assured and the policy reserve). As such they replace (part of) the actual death strain (which depends on how many people actually die) with a known cost (the risk premium paid to the reinsurer). Other than reducing risk - ie reducing the margin the insurer may need in its reserving mortality basis - it does not reduce the policy reserves, and hence the new business strain is hardly reduced by the reinsurance. Original terms reinsurance shares all aspects of the policy with the reinsurer, in proportion to the amount reinsured. In effect, the reinsurer takes on a proportion of the reserve, and the insurer can reduce its reserve in the same proportion (regulation permitting), subject to allowing for the risk of the reinsurer defaulting. So it will reduce the strain. Additionally, with OT reinsurance, the reinsurer pays a substantial reinsurance commission back to the insurer on day 1. This returns much of the large expense loadings that the reinsurer is receiving in the reinsurance premium. This also helps reduce the new business strain. You would use quota share not surplus as it allows you to control more accurately the proportion of your total business that you will reinsure. (With surplus the % reinsured would vary with the mix of business (small or large policies), which is not relevant to the total strain incurred.) Financial reinsurance povides alternative ways of providing the insurer with additional free assets (= working capital), so allowing the insurer to incur more new business strain without going insolvent. But it does not reduce new business strain as such. You CAN reduce NBS using risk premium if you make some adjustments. The main thing you can do is to negotiate an up-front initial reinsurance commission (like original terms). The risk premium rates would then have to be increased in order to pay for this. Hope this helps. Best of luck.
I see what you mean by the gearing effect and, provided the initial reserve is less that the first premium, then you are quite right that (ignoring commission) the reinsurance would increase the strain! On the other hand, should the reserve be bigger than the first premium (which might be a monthly premium) then the gearing effect would work in the insurer's favour and reduce NBS (even without the commission). So there certainly can be benefits of having all aspects of the contract reinsured (as in OT). Incidentally, I think it is quite possible for the reinsurance commission to be higher than the proportion reinsured, if the reinsurer has lower overhead costs etc than the insurer, so a further reduction in strain (and increased value from the arrangement) can be obtained.
