2023 Edition

CONTENTS

SECTION 1. How Reinsurers Meet Insurers’ Needs

Topic 1: Reinsurance and Its Functions 12

1.a. Reinsurance Concepts 12

1.b. Structure: Reinsurance Functions 12

1.c. Increase large-line capacity 12

1.d. Stabilize loss experience 12

1.e. Provide surplus relief 13

1.f. Facilitate withdrawal from a market segment 13

1.g. Provide underwriting guidance 13

1.h. Key Terms 14

1.i. Treaty Reinsurance 14

1.j. Facultative Reinsurance 14

1.1. Reinsurance Concepts 15

1.2. Reinsurance Functions16

1.3. Treaty Reinsurance 17

1.4. Facultative Reinsurance 18

Topic 2: Alternatives to Traditional Reinsurance 19

2.a. Structure: Alternatives to Traditional Reinsurance 19

2.b. Finite Risk Reinsurance 19

2.c. Catastrophe bond 19

2.d. Catastrophe risk exchange 20

2.e. Contingent surplus note 20

2.f. Industry loss warranty (ILW) 20

2.g. Catastrophe option 20

2.h. Line of credit 20

2.i Sidecar 20

2.j. Key Terms 21

2.1. Alternatives to Traditional Reinsurance 22

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 Topic 3: Reinsurance Regulation 23
3.a. State Insurance Regulation to Reinsurers 23

3.b. Aspects of Insurance Regulation to Reinsurers 23

3.c. Licensing: Aspects of Insurance Regulation to Reinsurers 23

3.d. Rates and Forms: Aspects of Insurance Regulation to Reinsurers 24

3.e. Financial Examination and Market Analysis: Aspects of Insurance

Regulation to Reinsurers 24

3.f. Reinsurance Regulation Developments 25

3.g. Financial Solvency Oversight 26

3.h. Insurance Regulatory Information System (IRIS) 26

3.i. NAIC Risk-Based Capital (RBC) System 27

17.j. Structure: Regulatory Oversight of Reinsurance Transactions 27

3.k. NAIC Credit for Reinsurance Model Law and Regulation: Credit for a
Reinsurance Transaction 27

3.l. Accounting Requirements: Credit for a Reinsurance Transaction 28

3.m. Acceptable Letter of Credit: Creditworthiness of Reinsurers 28

3.n. Pritchard & Baird Case vs. New York Regulation 98: Creditworthiness of
Reinsurance Intermediaries 28

3.o. NAIC Reinsurance Intermediary Model Act: Creditworthiness of

Reinsurance Intermediaries 29

3.1. State Insurance Regulation 30

3.2. Financial Solvency Oversight 31

3.3. Regulatory Oversight of Reinsurance Transactions 32

SECTION 2. Types of Increasing Financial Strength with

Quota Share

Topic 4: Types of Reinsurance 34

4.a. Structure: Types of Reinsurance 34

4.b. Pro Rata Reinsurance 34

4.c. Quota share reinsurance 35

4.d. Surplus share reinsurance 35

4.e. Excess of Loss Reinsurance 36

4.f. Per Risk and Per Policy Excess of Loss 36

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 4.g. Per Occurrence and Catastrophe Excess of Loss 37

4.h. Aggregate Excess of Loss 37

4.i. Functions of Treaty Reinsurance 37

4.j. Key Terms 38

4.1. Reinsurance Calculation 39

4.2. Types of Reinsurance 40

4.3. Types of Reinsurance 41

4.4. Types of Reinsurance 42

4.5. Reinsurance Calculation 43

Topic 5: Quota Share Treaties 44

5.a. Operation of Quota Share Treaties 44

5.b. Functions of Quota Share Treaties 44

5.c. Quota Share Treaties as Part of a Reinsurance Program 45

5.d. Structure: Common Clauses Modi ed for Use in Quota Share Treaties
45

5.e. Reports and Remittances Clause 46

5.f. Clauses Designed or Adapted for Quota Share Treaties 46

5.g. Quota Share Treaty Pricing 47

5.h. Structure: Calculating a Quota Share Pro t-Sharing Ceding Commission

47

5.i. Example: Calculating a Quota Share Pro t-Sharing Ceding Commission

48

5.j. Structure: Evaluating a Quota Share Treaty 49

5.k. Example: Evaluating a Quota Share Treaty 49

5.1. Quota Share Treaties 50

5.2. Common Clauses Modi ed for Use in Quota Share Treaties 51

5.3. Clauses Designed or Adapted for Quota Share Treaties 52

5.4. Quota Share Treaty Pricing 53

5.5. Quota Share Treaty Pricing 54

5.6. Evaluating a Quota Share Treaty 55

SECTION 3. Financing Complex Exposures with Surplus

Share
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 Topic 6: Surplus Share Treaties 58
6.a. Operation of Surplus Share Treaties 58

6.b. Functions of Surplus Share Treaties 58

6.c. Surplus Share Treaties as Part of a Reinsurance Program 59

6.d. Common Clauses Modi ed for Use in Surplus Share Treaties 59

6.e. Clauses Designed or Adapted for Surplus Share Treaties 60

6.f. Disclosure of underlying reinsurance agreements: Surplus Liability Clause

60

6.g. Surplus Share Treaty Pricing 60

6.h. Limits Pro le 61

6.i. Line Guide 61

6.j. Example: Line Guide 62

6.1. Surplus Share Treaties 63

6.2. Common Clauses Modi ed for Use in Surplus Share Treaties 64

6.3. Clauses Designed or Adapted for Surplus Share Treaties 65

6.4. Surplus Share Treaty Pricing 66

SECTION 4. Managing Large Property Risk With Property

Per Risk

Topic 7: Property Per Risk Excess of Loss Treaties 68

7.a. Operation of Property Per Risk Excess of Loss Treaties 68

7.b. Functions of Property Per Risk Excess of Loss Treaties 68

7.c. Property Per Risk Excess of Loss Treaties as Part of a Reinsurance Program
68

7.d. Clauses Designed or Adapted for Property Per Risk Excess of Loss
Treaties 69

7.e. Reinsurance Premium Clause 69

7.f. Ultimate Net Loss Clause 70

7.g. Setting Retentions and Reinsurance Limit 70

7.h. Structure: Property Per Risk Excess of Loss Treaty Pricing 70

7.i. First loss scale: Exposure Rating 71

7.j. Price per million 71

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 7.k. Trend Losses: Experience Rating 71

7.l. Develop the Experience Rate: Experience Rating 71

7.m. Price the unused portion of the layer: Experience Rating 72

7.n. Example: Reinsurance Premium Calculation 72

7.o. Loss-Rated Covers 72

7.1. Property Per Risk Excess of Loss Treaties 73

7.2. Clauses Designed or Adapted for Property Per Risk Excess of Loss Treaties
74

7.3. Property Per Risk Excess of Loss Treaty Pricing 75

SECTION 5. Mitigating Liability With Casualty Excess

Topic 8: Casualty Excess of Loss Treaties78

8.a. Operation of Casualty Excess of Loss Treaties 78

8.b. Functions of Casualty Excess of Loss Treaties 78

8.c. Casualty Excess of Loss Treaties as Part of a Reinsurance Program 78

8.d. Reinsuring Clause in Casualty Excess of Loss Treaties 79

8.e. De nitions Clause in Casualty Excess of Loss Treaties 79

8.f. Structure: Clauses Designed or Adapted for Casualty Excess of Loss

Treaties 80

8.g. Reinstatement Clause 80

8.h. Declaratory Judgment Expense Clause 81

8.i. Structure: Casualty Excess of Loss Treaty Pricing 81

8.j. Exposure Rating 81

8.k. Reinsurance Rate Evaluation and Selection 83

8.l. Example: Calculation of Indicated Exposure Rate 83

8.1. Casualty Excess of Loss Treaties 84

8.2. Common Clauses Modi ed for Use in Casualty Excess of Loss Treaties
85

8.3. Clauses Designed or Adapted for Casualty Excess of Loss Treaties 86

8.4. Casualty Excess of Loss Treaty Pricing 87

SECTION 6. Covering Extreme Losses With Catastrophe

Excess

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 Topic 9: Catastrophe Reinsurance 90
9.a. Operation of Catastrophe Treaties 90

9.b. Functions of Catastrophe Treaties 90

9.c. Catastrophe Treaties as Part of a Reinsurance Program 90

9.d. Clauses Designed or Adapted for Catastrophe Treaties 91

9.e. Catastrophe Treaty Pricing 92

9.f. Reasons of Experience Rating for CAT Treaties 92

9.g. Underlying Insurance Analysis 93

9.h. Example: Payback Period and Rate On Line 93

9.j. Catastrophe Modeling 93

9.k. How Catastrophe Models Operate 93

9.l. How Catastrophe Models Are Used 94

9.m. Catastrophe Modeling Issues94

9.1. Catastrophe Treaties 95

9.2. Clauses Designed or Adapted for Catastrophe Treaties 96

9.3. Catastrophe Treaty Pricing 97

9.4. Catastrophe Modeling 98

SECTION 7. Stabilizing Loss Experience With Aggregate

Excess

Topic 10: Aggregate Excess of Loss Treaties 100

10.a. Operation of Aggregate Excess of Loss Treaties 100

10.b. Function of Aggregate Excess of Loss Treaties 100

10.c. Aggregate Excess of Loss Treaties as Part of a Reinsurance Program

100

10.d. Retention and Limits Clause Adapted for Aggregate Excess of Loss
Treaties 100

10.e. Example: Retention and Limits Clause of Aggregate XOL Treaties 101

10.f. Losses Occurring Basis: Retention and Limits Clause 101

10.g. Losses Incurred Basis: Retention and Limits Clause101

10.h. Aggregate Excess of Loss Treaty Pricing 101

10.1. Aggregate Excess of Loss Treaties 102

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 10.2. Retention and Limits Clause for Aggregate Excess of Loss Treaties 103

10.3. Aggregate Excess of Loss Treaty Pricing 104

SECTION 8. How Reinsurers and Insurers Collaborate

Topic 11: Reinsurance Program Design 106

11.a. Structure: Reinsurance Program Design 106

11.b. Growth Plans 106

11.c. Types of Insurance Sold 107

11.d. Insurer Size 107

11.e. Insurer Financial Strength 107

11.f. Factors Affecting Retention Selection107

11.g. Extra-contractual obligations107

11.h. Clash Cover 108

11.1. Factors Affecting Reinsurance Needs 109

11.2. Reinsurance Program Design 110

11.3. Reinsurance Program Design 111

Topic 12: Reinsurance Audits 112

12.a. Overview of Reinsurance Audits 112

12.b. The Reinsurance Audit Process 112

12.c. Structure: Types of Reinsurance Audits 113

12.d. Types of Reinsurance Audits113

12.e. Managing General Agent Reinsurance Audits 114

12.1. Reinsurance Audits 115

12.2. The Reinsurance Audit Process 116

12.3. Types of Reinsurance Audits 117

12.4. Managing General Agent Reinsurance Audits 118

Topic 13: Loss Reserving Methods119

13.a. Loss and Loss Adjustment Expense Reserves 119

13.b. Relationship Between Loss Reserves and Surplus 119

13.c. Signi cance of Primary Insurer Reserves for the Reinsurer 119

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 13.d. Methods for Establishing Case Reserves 120

13.e. Methods for Establishing Bulk Reserves 121

13.f. Loss Development Method 121

13.g. Example: Loss Development Factors 122

13.h. Combined Methods of Loss Reserving 122

13.i. Effect of Salvage and Subrogation on Loss Reserves 123

13.j. Reserving Methods for Excess of Loss Reinsurers 123

13.1. Loss Reserves 124

13.2. Signi cance of Primary Insurer Reserves for the Reinsurer 125

13.3. Methods for Establishing Case Reserves 126

13.4. Methods for Establishing Bulk Reserves 127

13.5. Combined Methods of Loss Reserving 128

13.6. Dif culties When Applying Reserving Techniques 129

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SECTION 1. HOW REINSURERS MEET
INSURERS’ NEEDS

Topic 1: Reinsurance and Its Functions

Topic 2: Alternatives to Traditional Reinsurance
Topic 3: Reinsurance Regulation

본 디지털에디션은 매 페이지마다 핵심용어가 삭제되어 강의를 수강하고 필기하여야 합니다. 동영상

강의 수강회원 이외에는 활용이 불가하므로 무단 복제, 배포, 판매를 삼가하시기 바랍니다.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

Topic 1: Reinsurance and Its Functions

ARe 321 Online 1st Edition / Assignment 1

1.a. Reinsurance Concepts

Reinsurance is the transfer from one insurer (the primary insurer) to another
(the reinsurer) of some or all of the nancial consequences of certain loss
exposures insured by the primary insurer's policies.
The primary insurer pays a reinsurance premium for the protection provided
in the same way any insured pays a premium for insurance coverage, but, since
the primary insurer incurs the expenses of issuing the underlying policy, the
reinsurer might pay a ceding commission towards the primary insurer.
Using a retrocession, one reinsurer, the retrocedent, transfers all or portion of
the reinsurance risk that it has assumed or will assume to another reinsurer, the
retrocessionaire.

1.b. Structure: Reinsurance Functions

Reinsurance Functions
• Increase Large-Line Capacity
• Provide Catastrophe Protection
• Stabilize Loss Experience
• Provide Surplus Relief
• Facilitate Withdrawal From a Market Segment
• Provide Underwriting Guidance

1.c. Increase large-line capacity

Increasing large-line capacity allows a primary insurer to assume more
substantial risks than its nancial condition and regulations would otherwise
permit. The maximum amount of insurance or limit of liability allowed by
insurance regulations, which prohibit an insurer from retaining more than l0
percent of its policyholders' net worth on anyone loss exposure

1.d. Stabilize loss experience

Volatile loss experience can impact the stock value of a publicly traded insurer;
alter an insurer's nancial rating by independent rating agencies; cause abrupt
alterations in the approaches used in operating the underwriting, claim, and
marketing departments; or undermine the con dence of the sales force.
Reinsurance can be arranged to stabilize the loss experience of a line of
insurance, a class of business, or a primary insurer's entire book of business.

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 Topic 1: Reinsurance and Its Functions

1.e. Provide surplus relief

State insurance regulators monitor several nancial ratios as part of their
solvency surveillance efforts, however the relationship of written premiums to
policyholders' surplus is usually a key nancial ratio and one regarded as out of
bounds if it exceeds 3 to 1 or 300 percent.
Many insurers use reinsurance to supply surplus relief, which satis es
insurance regulatory constraints on excess growth. Because the ceding
commission replenishes the primary insurer's policyholders' surplus, the surplus
relief facilitates the primary insurer's premium growth and the increased
policyholders' surplus lowers its capacity ratio.

1.f. Facilitate withdrawal from a market segment

One approach to withdrawal is for the primary insurer to transfer the liability
for all outstanding policies to a reinsurer by acquiring portfolio reinsurance. The
reinsurer accepts all the liability for speci c loss exposures covered under the
primary insurer's policies, but the primary insurer must continue to ful ll its
obligations to its insureds.
A novation perfectly eliminates the liabilities a primary insurer has assumed. It
is not considered portfolio reinsurance for the reason that substitute insurer takes
on the direct obligations to insureds covered by the underlying insurance.

1.g. Provide underwriting guidance

Reinsurers work with a wide variety of insurers in the domestic and global
markets under many different circumstances and accumulate a great deal of
underwriting expertise.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

1.h. Key Terms

Retention: The amount retained by the primary insurer under the reinsurance
transaction.
Reinsurance premium: The consideration paid by the primary insurer to the
reinsurer for accepting some or all of the primary insurer's insurance risk.
Ceding commission: An amount paid by the reinsurer to the primary insurer to
pay for part or all of the primary insurer's policy acquisition expenses.
Retrocession: A reinsurance agreement whereby one reinsurer (the retrocedent)
transfers all or portion of the reinsurance risk it has assumed or will assume to
another reinsurer (the retrocessionaire).
Line: The maximum amount of insurance or limit of liability that an insurer
will take on a single loss exposure.
Surplus relief: A replenishment of policyholders' surplus supplied by the
ceding commission paid to the primary insurer by the reinsurer.
Portfolio reinsurance: Reinsurance that passes to the reinsurer liability for a
whole type of insurance, territory, or book of business after the primary insurer
has issued the policies.
Novation: An agreement under which one insurer or reinsurer is replaced for
another.

1.i. Treaty Reinsurance

Treaty reinsurance uses one agreement for a whole class or portfolio of loss
exposures, and is also called obligatory reinsurance. The reinsurance agreement
is usually called the treaty.
Although a few treaties allow the reinsurer limited discretion in reinsuring
individual loss exposures, most treaties require that all loss exposures within the
treaty's terms must be reinsured. Most, but not all, treaty reinsurance agreements
require the primary insurer to cede all eligible loss exposures to the reinsurer,
therefore the reinsurer is not exposed to adverse selection.

1.j. Facultative Reinsurance

Facultative reinsurance makes use of a separate reinsurance agreement for
each loss exposure it wants to reinsure, and is also called non-obligatory
reinsurance. The reinsurer issues a facultative certi cate of reinsurance that is
attached to the primary insurer's copy of the policy being reinsured.
Facultative reinsurance serves four functions: (1) Facultative reinsurance can
provide large line capacity for loss exposures that exceed the limits of treaty
reinsurance agreements. (2) Facultative reinsurance can reduce the primary
insurer's exposure in a given geographic area. (3) Facultative reinsurance can
insure a loss exposure with atypical hazard characteristics and thereby maintain
the favorable loss experience of the primary insurer's treaty reinsurance and any
associated pro t-sharing arrangements. (4) Facultative reinsurance can insure
particular classes of loss exposures that are excluded under treaty reinsurance.

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 Topic 1: Reinsurance and Its Functions

1.1. Reinsurance Concepts

Which of the following statements is true with regard to reinsurance concepts?
I. Reinsurance is best identi ed as an agreement by a reinsurer to indemnify a
primary insurer for losses.
II. From a regulator's perspective, if an insurer's ratio of written premium to
policyholders' surplus exceeds 3 to 1, the insurer is selling more insurance
than is prudent compared to the size of its net worth.
III. A primary insurer could obtain surplus relief through reinsurance by
minimizing uctuations in retained losses from year to year.
IV. The retention under a reinsurance agreement is always expressed in the form
of percentage of the original amount of insurance.
V. State insurance regulation mandates that, for accounting purposes,
premiums be recognized as reserve right at that moment a new policy is sold
and expenses be recognized as they are earned throughout the policy's life.
(A) I and II only

(B) I and III only

(C) II and IV only

(D) II and V only

Answer
III. A primary insurer could obtain surplus relief through reinsurance by
receiving ceding commissions to offset policy acquisition expenses.
IV. The retention under a surplus share or excess of loss reinsurance is
expressed in the form of stipulated dollar amount.
V. For accounting purposes, expenses are recognized as reserve at the time a
new policy is sold and premiums be recognized as they are earned throughout
the policy's life.
The correct answer is (A) I and II only.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

1.2. Reinsurance Functions

Which of the following statements is incorrect with regard to reinsurance
functions?
I. Increasing large-line capacity allows a primary insurer to reduce the nancial
consequences of a single catastrophic event which causes multiple losses
II. Increasing large-line capacity allows a primary insurer to take a loss
exposure with potential nancial consequences that are higher than its
nancial condition would otherwise permit
III. Reinsurance is usually arranged to stabilize the loss experience of a line of
insurance, a class of business, or a primary insurer's entire book of business.
IV. One method to withdrawal is for the primary insurer to transfer the liability
for all outstanding policies to a reinsurer by purchasing portfolio
reinsurance.
V. A novation completely eliminates the liabilities a primary insurer has
assumed. It is not considered portfolio reinsurance for the reason that
substitute insurer assumes the direct obligations to insureds covered by the
underlying insurance.
(A) I only

(B) II only

(C) III only

(D) IV and V only

Answer
I. Large-line capacity is an insurer's ability to reinsure a larger proportion of its
single risk, not multiple risks.
The correct answer is (A) I only.

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 Topic 1: Reinsurance and Its Functions

1.3. Treaty Reinsurance

Which of the following statements is not true with regard to treaty
reinsurance?
I. Treaty reinsurance is best identi ed as a reinsurance agreement that covers a
whole class or portfolio of loss exposures, and all loss exposures that fall
within the treaty are automatically reinsured.
II. If treaty reinsurance agreements permitted primary insurers to select which
loss exposures they ceded, the reinsurer would be exposed to adverse
selection.
III. The treaty reinsurer is generally willing to allow the primary insurer to
eliminate high-hazard loss exposures from the treaty by using facultative
reinsurance.
IV. Treaty reinsurance agreements are usually intended to allow underwriters to
exercise discretion in determining which loss exposures to cede to the treaty
reinsurers.
V. A primary insurer's underwriting policy and underwriting guidelines are
usually designed by its treaty reinsurer.
(A) I and II

(B) III and IV

(C) IV and V

(D) II and V

Answer
IV. Although some treaties allow the reinsurer limited discretion in reinsuring
individual loss exposures, most treaties require that all loss exposures within the
treaty's terms must be reinsured.
V. A primary insurer's underwriting policy and underwriting guidelines are
usually developed by its staff underwriters.
The correct answer is (C) IV and V.

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SECTION 1. How Reinsurers Meet Insurers’ Needs

1.4. Facultative Reinsurance

Which of the following statements is true with regard to facultative
reinsurance?
I. The administrative costs related to placing facultative reinsurance are
relatively low.
II. Facultative reinsurance is generally not an option for insuring classes of loss
exposures that are excluded under treaty reinsurance.
III. Primary insurers generally use facultative reinsurance as the basis of their
reinsurance program.
IV. A facultative reinsurance agreement is written for a speci ed time period and
should not be cancelled by either party unless contractual obligations, such
as payment of premiums, are not met.
V. Facultative reinsurance can supply large line capacity for loss exposures that
exceed the limits of treaty reinsurance agreements.
(A) I and II only

(B) III and IV only

(C) IV and V only

(D) II and V only

Answer
I. The administrative costs associated with placing facultative reinsurance are
relatively high.
II. Facultative reinsurance is generally an important option for insuring classes
of loss exposures that are excluded under treaty reinsurance.
III. Primary insurers generally use treaty reinsurance as the foundation of their
reinsurance program.
The correct answer is (C) IV and V only.

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 Topic 2: Alternatives to Traditional Reinsurance

Topic 2: Alternatives to Traditional Reinsurance

ARe 321 Online 1st Edition / Assignment 1

2.a. Structure: Alternatives to Traditional Reinsurance

Traditional Reinsurance
Alternatives Finite Risk Reinsurance
Capital Market • Catastrophe bond
Alternatives
• Catastrophe risk exchange
• Contingent surplus note
• Industry loss warranty (ILW)
• Catastrophe option
• Line of credit
• Sidecar

2.b. Finite Risk Reinsurance

Finite risk reinsurance is a nontraditional type of reinsurance in which the
reinsurer's liability has limitations (or " nite") and anticipated investment income
is expressly identi ed as an underwriting component. Because this type of
reinsurance transfers a limited amount of risk to the reinsurer with the purpose
of improving the primary insurer's nancial result, it is often called nancial
reinsurance.
A nite risk reinsurance agreement typically has a multi-year term, which
allows the risk and losses to be spread over several years, while being subject to
an aggregate limit for the agreement's entire term. Finite risk reinsurance is
created to cover high-severity losses. The reinsurer commonly shares pro ts with
the primary insurer when it has favorable loss experience or has earned income
by investing the prepaid premium.

2.c. Catastrophe bond

A bond is issued by using a condition that if the issuer suffers a catastrophe
loss greater than the speci ed amount, the duty to pay interest and/or repay
principle is deferred or forgiven. As long as catastrophe-related losses do not
exceed the speci ed amount, investors earn a fairly high interest rate and receive
a return of their principal.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

2.d. Catastrophe risk exchange

This is a means through which a primary insurer can exchange a part of its
insurance risk for another insurer's risk. A primary insurer with a geographic
concentration of loss exposures can use a catastrophe risk exchange to reduce its
losses from just one loss occurrence.

2.e. Contingent surplus note

A primary insurer designs this so that, at its option, it can immediately obtain
funds by issuing notes at a pre-agreed interest rate. Surplus note is a kind of
unsecured debt instrument, issued only by insurers, that has characteristics of
both conventional equity and debt securities and is considered as policyholders'
surplus rather than as a liability on the insurer's statutory balance sheet.

2.f. Industry loss warranty (ILW)

This is an insurance-linked security that covers the primary insurer when the
industry-wide loss from a particular catastrophic event exceeds a predetermined
threshold. Its coverage is triggered only by industry losses.

2.g. Catastrophe option

This agreement provides the primary insurer the right to a cash payment from
investors when a speci ed index of catastrophe losses reaches a speci ed level
(the strike price).

2.h. Line of credit

This is an arrangement in which a bank or another nancial institution agrees
to provide a loan to a primary insurer when the primary insurer suffers a loss.

2.i Sidecar
This is a limited-existence special purpose vehicle (SPY) that provides a
primary insurer additional capacity to write property catastrophe business or
other short-tail lines by using a quota share agreement with private investors.

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 Topic 2: Alternatives to Traditional Reinsurance

2.j. Key Terms

Securitization of risk: Using securities or nancial instruments (stocks, bonds,
commodities, nancial futures) to fund an insurer's exposure to catastrophic loss.
Special purpose vehicle (SPV): A facility established for the purpose of
purchasing income producing assets from an organization, holding title to them,
and then using those assets to collateralize securities that might be sold to
investors.
Insurance derivative: Financial contract whose value is based upon the level of
insurable losses that occur within a speci c time period.
Contingent capital arrangement: An agreement, placed before any losses
occur, that allows an organization to raise cash by selling stock or issuing debt at
prearranged terms after a loss occurs that exceeds a certain threshold.
Insurance-linked security: A nancial instrument whose value is primarily
driven by insurance and/or reinsurance loss events.
Strike price: The price at which the stock or commodity underlying a call
option (such as a warrant) or a put option can be purchased (called) or sold (put)
during a speci ed period.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

2.1. Alternatives to Traditional Reinsurance

Which of the following statements is not true with regard to alternatives to
traditional reinsurance?
I. An industry loss warranty is an insurance-linked security that covers the
primary insurer in case the industry-wide loss from a particular catastrophe
exceeds a predetermined threshold.
II. Under a catastrophe risk exchange, a bond is issued using the condition that
if the issuer suffers a catastrophe greater than a speci ed amount, the
obligation to pay interest and/or repay principle is deferred or forgiven.
III. A catastrophe risk exchange is an agreement which provides the primary
insurer the right to a cash payment from investors if a speci ed index of
catastrophe losses by geographic area reaches a speci ed level.
IV. Under sidecar arrangements, the primary insurer charges a ceding
commission and may obtain a pro t commission if the book of business is
pro table.
V. A crucial characteristic that distinguishes nite risk reinsurance from other
types of reinsurance is that nite risk reinsurance transfers a limited amount
of risk to the reinsurer.
(A) I only

(B) II and III only

(C) IV and V only

(D) V only

Answer
II. Under a cat bond, investors receive their return for the risk assumed
through periodic interest payments on the principal amount assumed.
III. A catastrophe risk exchange is a means through which a primary insurer
can exchange a portion of its insurance risk for another insurer's insurance risk.
Cat option has a strike price at which the primary insurer will be able to receive
cash from its investors to enable it to pay losses from a catastrophe.
The correct answer is (B) II and III only.

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 Topic 3: Reinsurance Regulation

Topic 3: Reinsurance Regulation

ARe 321 Online 1st Edition / Assignment 1

3.a. State Insurance Regulation to Reinsurers

In the U.S., primary insurers and reinsurers are primarily regulated at the state
level. State legislatures enact laws providing the regulatory framework for
primary insurers and reinsurers. State insurance departments implement state
insurance laws and create and enforce regulations. The primary purpose of
insurance regulation is to protect insurer solvency so that contractual
commitments to insureds and claimants can be met.

3.b. Aspects of Insurance Regulation to Reinsurers

Licensing The authorization status of a reinsurer is critical to the primary
insurer because it determines the conditions required for a
transaction to qualify for accounting treatment as a reinsurance
transaction in the primary insurer's nancial statements.

Rates and Forms Reinsurance rates are not subject to the ling and approval
regulations applicable to most primary insurance rates. Rate
regulation of primary insurers indirectly affects any subsequent
reinsurance transaction.

Financial (1) In a nancial examination, a team of state insurance

Examination department examiners con rms that nancial reporting
and Market procedures and requirements are being followed. (2) Market
Analysis conduct regulation deals with the behavior of insurers.

3.c. Licensing: Aspects of Insurance Regulation to Reinsurers

A reinsurer that is authorized to do business in the primary insurer's state of
domicile is called an authorized reinsurer. (1) Authorized reinsurers include
licensed reinsurers and reinsurers otherwise accredited to do business in the
state. (2) An accredited reinsurer is an insurer that is otherwise unauthorized to
do business in the same state as the primary insurer but is granted approval to
assume reinsurance by meeting the state insurance department's requirements.
(3) An unauthorized reinsurer is a reinsurer that is not licensed or otherwise
authorized to do business in the primary insurer's state of domicile.
Unauthorized reinsurers are usually alien reinsurers doing business in the United
States. (4) A certi ed reinsurer is a reinsurer that has been evaluated, rated, and
approved by the primary insurer's domestic state for the purpose of reinsurance
collateral reduction.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

A reinsurance agreement with an authorized reinsurer bene ts a primary

insurer's nancial results due to the fact it transfers nancial obligations
(liabilities for unearned premium reserves and loss reserves) from the primary
insurer to the reinsurer, thus increasing the primary insurer's policyholders'
surplus. In addition, the primary insurer can treat amounts owed by the
reinsurer, usually loss payments, as an asset.

3.d. Rates and Forms: Aspects of Insurance Regulation to Reinsurers

Regulators in uence the content of reinsurance agreements by requiring that
they contain speci c clauses. Most states require these clauses in reinsurance
agreements with primary insurers:
Insolvency It states that the reinsurer is not relieved of its responsibility under
clause the reinsurance agreement should the primary insurer become
insolvent

Service of suit It requires an alien reinsurer to have an agent within the United
clause States who can accept the formal delivery of writs, summonses, or
other legal notices on the reinsurer's behalf

Intermediary It requires the reinsurer to accept nancial responsibility for funds

clause transferred to it by a primary insurer through an intermediary

Unauthorized It speci es requirements that an unauthorized reinsurer must

reinsurance satisfy for the primary insurer to receive favorable accounting
clause treatment for the reinsurance transaction

Funding It requires the certi ed reinsurer to provide security in an amount

clause suf cient to avoid the imposition of a nancial statement penalty
on the primary insurer

3.e. Financial Examination and Market Analysis: Aspects of Insurance

Regulation to Reinsurers
During a nancial examination, state insurance regulators verify these items:
(1) Assets (2) Liabilities (3) Underwriting results (4) Investment income (5)
Premiums earned (6) Losses and reserves (7) Loss adjustment expenses and
reserves (8) Reinsurance in force.
The goals of market analysis are threefold: (1) To nd which of the thousands
of companies writing insurance in the marketplace warrant further scrutiny by
the insurance department (2) To identify which market conduct concerns are
causing consumer harm and should be addressed by the insurance department
(3) To predict noncompliant behavior before it happens.

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 Topic 3: Reinsurance Regulation

3.f. Reinsurance Regulation Developments

NAIC's Solvency Modernization Initiative (SMI) is targeted on ve key
solvency areas: capital requirements, international accounting, insurance
valuation, reinsurance, and group regulatory issues. It has resulted in a variety of
modi cations and enhancements to the state regulatory system.
A federal function for insurance was developed with the passage of the Dodd-
Frank Act, which established the Federal Insurance Of ce (FlO) and includes the
Non-Admitted and Reinsurance Reform Act (NRRA). U.S. reinsurers are also
potentially subject to several other domestic functional regulators.
U.S. insurers and reinsurers must be knowledgeable about international
regulatory developments, particularly those of the International Association of
Insurance Supervisors (IAIS). Another important international regulatory
initiative is the European Union's development of Solvency II, which aims to
establish a revised set of EU-wide capital requirements and risk management
standards that will replace the current solvency requirements.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

3.g. Financial Solvency Oversight

1. NAIC Annual The NAIC Annual Statement is prepared in accordance with
Statement statutory accounting principles (SAP). The focus of these rules
and procedures is to value assets and liabilities as though the
insurer were to be immediately liquidated. As a consequence of
this conservative approach, assets are understated and liabilities
are overstated.

2. NAIC Model Two NAIC model laws that are directly applicable to reinsurance
Laws and are the Credit for Reinsurance Model Act and the Reinsurance
Guidelines Intermediary Model Act.

3. NAIC The purpose of the NAIC Accreditation Program is to provide

Accreditation consistency of solvency regulation among the states and to
Program improve the standards of solvency regulation and nancial
examinations conducted in all states.

4. Off-Site Insurance regulators use off-site monitoring and analysis to

Monitoring and assess, on an ongoing basis, the nancial condition of an insurer
Analysis as of the valuation date and to identify and assess current and
prospective risks through risk, focused surveillance.

5. On-Site, An NAIC association examination is also called a zone or

Risk-Focused multistate examination. NAIC recommends an association
Examinations examination for insurers licensed in more than one zone or in
more than three jurisdictions in a single zone.

6. Insurance The primary purpose of the Insurance Regulatory Information

Regulatory System (IRIS) is to identify insurers that are in the early stages of
Information nancial dif culty.
System (IRIS)

7. NAIC Risk- This system determines the minimum amount of capital an

Based Capital insurer needs to support its operations, given its risk
(RBC) System characteristics.

3.h. Insurance Regulatory Information System (IRIS)

The Insurance Regulatory Information System (IRIS) is a set of nancial ratios
developed by NAIC to assist regulators in evaluating an insurer's nancial
strength: (1) Capacity ratio = Net written premiums ÷ Policyholders' surplus. A
capacity ratio that is greater than 3 to 1 is typically considered to be outside
acceptable limits. (2) Surplus aid to surplus ratio = Ceding commissions ÷
Policyholders' surplus. If the ceding commission on unearned ceded premiums
exceeds 25 percent of the insurer's policyholders' surplus, the ratio is considered
unsatisfactory.

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 Topic 3: Reinsurance Regulation

3.i. NAIC Risk-Based Capital (RBC) System

In the context of the NAIC RBC system, risk characteristics are categorized into
multiple risks: (1) Asset risk: the risk that an asset's value will be lower than
expected (2) Underwriting risk: the loss volatility of the types of insurance sold
(3) Credit risk: the risk that the insurer will be unable to collect monies owed to
it.

17.j. Structure: Regulatory Oversight of Reinsurance Transactions

Credit for a 1. NAIC Credit for Reinsurance Model Law and

Reinsurance Regulation
Transaction 2. Primary Insurer's Balance Sheet
3. Accounting Requirements
Creditworthiness of United States ceding insurers are not allowed credit for
Reinsurers reinsurance with respect to agreements with unauthorized
or certi ed reinsurers unless the reinsurer provides the
appropriate amount of collateral in the form of letters of
credit, trust agreements, or funds deposited by and
withheld from reinsurers.

Creditworthiness of 1. Pritchard & Baird Case

Reinsurance 2. New York Regulation 98
Intermediaries 3. NAIC Reinsurance Intermediary Model Act
Contract Certainty Contract certainty generally requires the complete and
nal agreement of all terms between the insured and
insurer by the time the contract is entered into, with
contract documentation provided promptly thereafter.

3.k. NAIC Credit for Reinsurance Model Law and Regulation: Credit for a
Reinsurance Transaction
In November 2011, NAIC adopted modi cations to the Credit for Reinsurance
Model Law and Credit for Reinsurance Model Regulation. These modi cations
serve to reduce reinsurance collateral requirements for unauthorized reinsurers
that are licensed and domiciled in quali ed jurisdictions. They establish a
certi cation process in which each state that adopts them gains the authority to
approve reinsurers for collateral reduction based on certain factors. A certi ed
reinsurer will be required to post collateral in an amount that corresponds with
its assigned rating in order for a primary insurer to be permitted credit for the
reinsurance ceded.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

3.l. Accounting Requirements: Credit for a Reinsurance Transaction

In the past, some reinsurance transactions were structured so that poorly
capitalized primary insurers received surplus relief without any transfer of
insurance risk, typically through one of two methods. The 1st method was to
have a reinsurance transaction in which all of the primary insurer's losses were
reimbursed by the reinsurer and eventually paid back by the primary insurer.
The 2nd method was to have a reinsurance transaction that commenced on the
last day of the calendar year and terminated on the rst day of the following year
to improve the balance sheet for National Association of Insurance
Commissioners (NAIC) Annual Statement purposes only.
According to FAS 113, a short-duration transaction quali es as a reinsurance
transaction if these two requirements are met: (1) The reinsurer assumes
signi cant insurance risk under the reinsured portions of the underlying
insurance contracts. (2) It is reasonably possible that the reinsurer may realize a
signi cant loss from the transaction.

3.m. Acceptable Letter of Credit: Creditworthiness of Reinsurers

An acceptable letter of credit must satisfy these criteria: (1) The letter of credit
must be clean; that is, it must not be conditioned on the delivery of any other
documents or materials that would inhibit obtaining the funds. (2) The letter of
credit must be irrevocable; that is, it cannot be modi ed or revoked without the
bene ciary's consent, once the bene ciary is established. (3) The letter of credit
must contain an evergreen clause, which automatically renews the letter of credit
for a speci c time unless the issuer of the letter of credit signi es its intent not to
renew the letter at expiration. (4) The letter of credit must be issued by an
approved bank, which is a United States nancial institution that is organized or
licensed under state or federal laws; regulated, supervised, and examined by U.S.
federal or state bank regulatory authorities; and determined by the NAIC
Securities Valuation Of ce to have adequate nancial condition and standing.

3.n. Pritchard & Baird Case vs. New York Regulation 98: Creditworthiness of
Reinsurance Intermediaries
In the Pritchard & Baird case, the court determined that the insurance
intermediaries were agents of the primary insurers because the primary insurers
had exercised primary supervision of Pritchard & Baird's activities.
As a result of the Pritchard & Baird case, the New York legislature took these
actions: (1) Required the licensing of reinsurance intermediaries and authorized
the New York Insurance Department to examine and regulate reinsurance
intermediaries (2) Adopted Regulation Number 98, which includes an
intermediary clause in the reinsurance agreement when a reinsurance
intermediary is involved in the reinsurance transaction.

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 Topic 3: Reinsurance Regulation

3.o. NAIC Reinsurance Intermediary Model Act: Creditworthiness of

Reinsurance Intermediaries
This is what the provisions of the NAIC Reinsurance Intermediary Model Act
specify: (1) The reinsurance intermediary must have written authority from the
primary insurer before it negotiates or accepts any reinsurance agreement for the
primary insurer. (2) When the reinsurance intermediary negotiates a reinsurance
agreement, it must give prompt written notice to the primary insurer. (3) If the
reinsurance intermediary places reinsurance with a reinsurer that is not licensed
in, or accredited by, the state of New York, the reinsurance intermediary must
make a reasonable inquiry about the nancial strength of such reinsurer. (4) The
reinsurance intermediary must notify the primary insurer of any con icts of
interest that the intermediary has at the beginning of the relationship or that may
arise in the future. (5) The reinsurance intermediary must maintain records
adequate to permit an audit of its activities to ensure that it has complied with all
statutes and regulations. (6) The reinsurance intermediary must deposit funds
received from primary insurers and reinsurers in at least one bank account
separate from the accounts in which the reinsurance intermediary's funds are
deposited.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

3.1. State Insurance Regulation

Which of the following statements is not true regarding the State Insurance
Regulation?
(A) A fundamental purpose of regulating reinsurers is to protect insurer
solvency.
(B) A reinsurer that is authorized to do business in the primary insurer's state
of domicile is called an authorized reinsurer.
(C) An insurer that a state insurance department has granted a license to sell
insurance to is best referred to as an admitted insurer.
(D) An accredited reinsurer is a reinsurer that has been evaluated, rated, and
approved by the primary insurer's domestic state for the purpose of
reinsurance collateral reduction.

Answer
(D) An accredited reinsurer is an insurer that is otherwise unauthorized to do
business in the same state as the primary insurer but is granted approval to
assume reinsurance by meeting the state insurance department's requirements. A
certi ed reinsurer is a reinsurer that has been evaluated, rated, and approved by
the primary insurer's domestic state for the purpose of reinsurance collateral
reduction.
The correct answer is (D).

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 Topic 3: Reinsurance Regulation

3.2. Financial Solvency Oversight

Which of the following statements is not true regarding Financial Solvency
Oversight?
I. An NAIC association examination is sometimes also called zone
examination.
II. When the NAIC develops a model law it provides a common basis for
drafting state laws.
III. ILLI Reinsurance Company (ILLI) wishes to do business in a number of
states. Each of the states requires that ILLI have an insolvency clause in its
reinsurance agreement. This clause would require that ILLI respond even if
the primary insurer becomes insolvent.
IV. To monitor insurer solvency, state insurance regulators employ a variety of
nancial regulatory tools that the National Association of Insurance
Commissioners (NAIC) has developed. Off-site monitoring and analysis was
established to develop and maintain standards to promote sound insurance
company nancial solvency regulation.
V. The Insurance Regulatory Information System (IRIS) is a set of nancial
ratios developed by the NAIC. The primary purpose of using the IRIS ratios
is to identify insurers in early stages of nancial dif culty.
(A) I and II only

(B) III only

(C) IV only

(D) V only

Answer
IV. The NAIC Accreditation program was established to develop and maintain
standards to promote sound insurance company nancial solvency regulation.
The correct answer is (C) IV only.

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 SECTION 1. How Reinsurers Meet Insurers’ Needs

3.3. Regulatory Oversight of Reinsurance Transactions

Which of the following statements is not true regarding Regulatory Oversight
of Reinsurance Transactions?
I. The mismatch between income and expenses under statutory accounting
principles (SAP) is that full policy-related expenses are charged against the
earned portion of premiums.
II. A key regulatory concern that regulators have regarding the use of
reinsurance is the standards by which an insurer can take credit for
reinsurance.
III. A primary insurance company, Sharing Insurance, has obtained reinsurance
with unauthorized reinsurer, ILLI Re. For Sharing to have this reinsurance
qualify for reinsurance accounting, ILLI must provide some form of collateral
to Sharing.
IV. State insurance regulators have adopted requirements that must be met for a
reinsurance agreement to be treated as a reinsurance transaction on an
insurer's nancial statements. Finite risk is the type of reinsurance agreement
that these requirements were designed to address.
V. In 2011, the National Association of Insurance Commissioners (NAIC)
revised the Credit for Reinsurance Model Law. They allow a reduction in
collateral requirements for certi ed reinsurers.
(A) I only

(B) II and III only

(C) IV and V only

(D) None of the above

Answer
The correct answer is (D) none of the above.

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SECTION 2. TYPES OF INCREASING FINANCIAL
STRENGTH WITH QUOTA SHARE

Topic 4: Types of Reinsurance

Topic 5: Quota Share Treaties

본 디지털에디션은 매 페이지마다 핵심용어가 삭제되어 강의를 수강하고 필기하여야 합니다. 동영상

강의 수강회원 이외에는 활용이 불가하므로 무단 복제, 배포, 판매를 삼가하시기 바랍니다.

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SECTION 2. Types of Increasing Financial Strength with Quota Share

Topic 4: Types of Reinsurance

ARe 321 Online 1st Edition / Assignment 2.

4.a. Structure: Types of Reinsurance

Pro Rata • Quota Share

• Surplus Share
Excess of Loss • Per Risk XOL
• Catastrophe XOL
• Per Policy XOL
• Per Occurrence XOL
• Aggregate XOL

4.b. Pro Rata Reinsurance

Under pro rata reinsurance, or proportional reinsurance, the primary insurer
cedes a percentage of the original insurance premiums to the reinsurer as a
reinsurance premium. Pro rata reinsurance can be labeled as either quota share or
surplus share.
The reinsurer usually pays the primary insurer a ceding commission for that
loss exposures ceded. The ceding commission reimburses the primary insurer for
policy acquisition expenses incurred when the underlying policies were sold.
Types of commission are: (1) Flat commission (2) Pro t-sharing commission (3)
Sliding scale commission (see key terms).

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 Topic 4: Types of Reinsurance

4.c. Quota share reinsurance

A type of pro rata reinsurance in which the primary insurer and the reinsurer
share the sums of insurance, policy premiums, and losses (including loss
adjustment expenses) by using a xed percentage. Quota share reinsurance can
be used with both property insurance and liability insurance but is more
frequently used in property insurance.
Because the primary insurer cedes a xed percentage under a quota share
treaty, even policies with low amounts of insurance that the primary insurer
could safely retain are reinsured. Because the primary insurer and the reinsurer
share liability for every loss exposure depending upon the quota share treaty, the
reinsurer is usually not susceptible to adverse selection.
A variable quota share treaty has the advantage of enabling a primary insurer
to retain a larger proportion of the small loss exposures that are within its
nancial capability to absorb, while maintaining a safer and smaller retention on
larger loss exposures.

4.d. Surplus share reinsurance

A type of pro rata reinsurance in which the policies covered are those whose
amount of insurance exceeds a stipulated dollar amount, or line.
The surplus share treaty does not cover policies with amounts of insurance
that are lower than the primary insurer's line. Many primary insurers use surplus
share reinsurance as an alternative to quota share reinsurance therefore they do
not have to cede any part of the liability for loss exposures that can be safely
retained.
Because the percentage of policy premiums and losses varies for each loss
exposure ceded, surplus share treaties cost more to administer than quota share
treaties. Primary insurers must keep records and, in many cases, periodically
provide the reinsurer with a report termed as a bordereau.
Many surplus share treaties allow the primary insurer to increase its line from
a minimum amount to a maximum amount. The exibility provided by the
reinsurer in the surplus share treaty is usually communicated to the primary
insurer's underwriters through a line guide, or line authorization guide.

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

4.e. Excess of Loss Reinsurance

The reinsurer responds to a loss only if the loss exceeds the primary insurer's
retention, known as the attachment point. The primary insurer fully retains losses
that are lower than the attachment point, and will sometimes, with co-
participation provision, be required by the reinsurer to also retain responsibility
for a proportion of the losses that exceed the attachment point.
Excess of loss reinsurance premiums are negotiated based on the likelihood
that losses will exceed the attachment point. The reinsurance premium for excess
of loss reinsurance is generally stated as a percentage (often called a rate) of the
policy premium charged by the primary insurer (often called the subject
premium or underlying premium).
Generally, reinsurers never pay ceding commissions, but the reinsurer may
reward the primary insurer for favorable loss experience by paying a pro t
commission or reducing the rate applied in calculating the reinsurance premium.
A working cover enables the primary insurer to spread its losses over several
years. Reinsurers typically require a working cover to contain an occurrence
limitation of two or three times the reinsurance limit.
The purpose of a co-participation provision is to provide the primary insurer
with a nancial incentive to ef ciently manage losses that exceed the attachment
point.
In addition to indemnifying losses in a layer of coverage, the reinsurer's
obligation may also extend to payment of loss adjustment expenses. These are
the two most common approaches to handling loss adjustment expenses: (1) Pro
rata in addition: Prorate the loss adjustment expenses between the primary
insurer and the reinsurer based on the same percentage share that each is
responsible for the loss. (2) Loss adjustment expense included in the limit: Add
the loss adjustment expenses to the amount of the loss when applying the
attachment point of the excess of loss reinsurance agreement.

4.f. Per Risk and Per Policy Excess of Loss

Per risk excess of loss is often called property per risk excess of loss and is
generally used with property insurance. It applies separately to each loss
occurring to each risk, with the primary insurer usually determining what
constitutes one risk (loss exposure).
Per policy excess of loss is used predominantly with liability insurance and
applies the attachment point and the reinsurance limit separately to each
insurance policy issued by the primary insurer, despite the number of losses
occurring under each policy.

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 Topic 4: Types of Reinsurance

4.g. Per Occurrence and Catastrophe Excess of Loss

Per occurrence excess of loss is generally used in liability insurance. It applies
the attachment point and the reinsurance limit to the total losses as a result of a
single event affecting one or more of the primary insurer's policies.
Catastrophe excess of loss protects the primary insurer from an accumulation
of retained losses that arise from just one catastrophic event. Because the
attachment point and reinsurance limit apply separately to each catastrophe
occurring during a policy period, the catastrophe excess of loss reinsurance
agreement de nes the scope of a catastrophic occurrence by using a loss
occurrence clause.

4.h. Aggregate Excess of Loss

Aggregate excess of loss reinsurance can be used in property or liability
insurance and covers aggregated losses that exceed the attachment point and
occur during a stated period, usually one year. The attachment point in an
aggregate excess of loss treaty can be stated as a dollar amount of loss or as a loss
ratio. When the attachment point is stated as a loss ratio, the treaty is called "stop
loss reinsurance."

4.i. Functions of Treaty Reinsurance

Stabilizing Improving Providing

Protecting
Type of Reinsurance Loss Large-Line Catastrophe Surplus Main Purpose
Experience Capacity Relief

To provide
Quota share No Yes No Yes
surplus relief
To provide
Pro Rata large-line
capacity while
Surplus share No Yes No Yes providing
some surplus
relief
To provide
large-line
Yes, to
Per risk capacity while
Yes Yes some No
(Per policy) stabilizing
extent loss
experience
Excess To protect
of Loss against
Per occurrence Yes, to No Yes No catastrophic
(Catastrophe) some extent losses from
one event
Yes, to To stabilize
Aggregate Yes some Yes No loss
extent experience

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

4.j. Key Terms

Flat commission: A ceding commission which is a xed percentage of the
ceded premiums.
Pro t-sharing commission: A ceding commission that is contingent on the
reinsurer realizing a predetermined proportion of excess pro t on ceded loss
exposures.
Sliding scale commission: A ceding commission based on a formula that
adjusts the commission based on the pro tability of the reinsurance agreement.
Bordereau: A report the primary insurer provides periodically to the reinsurer
which includes a history of all loss exposures reinsured under the treaty.
Line guide: A document that provides the minimum and maximum line a
primary insurer can retain on one loss exposure.
Attachment point: The dollar amount above which the reinsurer responds to
losses.
Subject premium: The premium the primary insurer charges on its underlying
policies and to which a rate is used to determine the reinsurance premium.
Working cover: An excess of loss reinsurance agreement having a low
attachment point.
Co-participation provision: A provision in a reinsurance agreement that
requires the primary insurer to retain a particular portion of the losses that
exceed its attachment point.

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 Topic 4: Types of Reinsurance

4.1. Reinsurance Calculation

Which of the following statements is true with regard to reinsurance
calculations?
I. Mountain Insurance Company has entered into a 80 percent quota share
treaty with Swift Reinsurance Company. An $80,000 loss occurs that is subject
to the reinsurance treaty. Under the terms of the treaty, Swift would
indemnify Mountain for the loss of $64,000.
II. A primary insurer has a ve-line surplus share treaty with a $50 million limit.
For a speci c loss exposure with coverage limit needs of $30 million, the
primary insurer's line guide permits a $5 million line. The percentage used to
cede premiums and losses to the reinsurer would be 80%.
III. The losses listed below arose from three policies and one occurrence: Policy
A, loss amount $300,000; Policy B, loss amount $400,000; Policy C, loss
amount $900,000. Given these losses, the difference between the amount of
loss a primary insurer would recover under a $750,000 xs $250,000 per policy
excess of loss reinsurance treaty versus a $800,000 xs $800,000 per occurrence
excess of loss reinsurance treaty would be $250,000.
(A) I only

(B) II only

(C) III only

(D) All of the above

Answer
I. Reinsurance cession is 80%, 0.8 x $80,000. = $64,000.
II. A speci c loss exposure is $30mil., primary insurer’s retention is $5mil., and
reinsurance cession amount is $25mil., so the percentage of reinsurance cession is
83.33%.
III. The difference between (A) and (B) is $50,000.
Reinsurance recovery
Loss
Policy $750,000 xs $250,000 per $800,000 xs $800,000 per
Amount
policy XOL (A) occurrence XOL (B)
1 $300,000 $50,000 -
2 $400,000 $150,000 -
3 $900,000 $650,000 -
Total $1,600,000 $850,000 $800,000

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SECTION 2. Types of Increasing Financial Strength with Quota Share

4.2. Types of Reinsurance

Which of the following statements is not true with regard to types of
reinsurance?
I. Many primary insurers use excess of loss reinsurance as an alternative to
quota share reinsurance so that they do not have to cede any part of the
liability for loss exposures that can be safely retained.
II. Per occurrence excess of loss may provide surplus relief to the primary
insurer mainly because the reinsurer usually pays a ceding commission for
those policies ceded.
III. In an excess of loss reinsurance, reinsurers do not pay ceding commissions,
however the reinsurer may reward the primary insurer for favorable loss
experience by paying a pro t commission or lowering the rate used in
calculating the reinsurance premium.
IV. Per policy excess of loss applies primarily to liability insurance, and per risk
excess of loss applies primarily to property insurance.
V. The attachment point in an aggregate excess of loss treaty can be stated in the
form of dollar amount of loss or in the form of loss ratio.
(A) I and II only

(B) III only

(C) IV and V only

(D) II and IV only

Answer
I. The surplus share treaty does not cover policies with amounts of insurance
that are less than the primary insurer's line. So, many primary insurers use
surplus share reinsurance instead of quota share reinsurance so that they do not
have to cede any part of the liability for loss exposures that can be safely
retained.
II. Quota share and surplus share reinsurance provide surplus relief to the
primary insurer.
The correct answer is (A) I and II only.

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 Topic 4: Types of Reinsurance

4.3. Types of Reinsurance

Which of the following statements is not true with regard to types of
reinsurance?
I. Facultative reinsurance is the term used for reinsurance of individual loss
exposures where the primary insurer chooses which loss exposures to send
to the reinsurer, and the reinsurer can accept or reject any loss exposures
submitted.
II. Facultative reinsurance is usually chosen by newly incorporated insurers or
insurers with limited capital mainly because it is effective in providing
surplus relief.
III. Under pro rata reinsurance, the reinsurer generally pays a ceding
commission to reimburse the primary insurer for acquisition costs associated
with the underlying policies.
IV. Surplus share reinsurance is bene cial when the primary insurer needs to
increase its large-line capacity.
V. Pro rata reinsurance treaties has the bene t of enabling a primary insurer to
retain a larger proportion of the small loss exposures that are within its
nancial capability to absorb, while maintaining a safer and smaller retention
on larger loss exposures.
(A) I and II only

(B) II and IV only

(C) III and V only

(D) II and V only

Answer
II. Pro rate reinsurance is generally chosen by newly incorporated insurers or
insurers with limited capital because it is effective in providing surplus relief.
V. Variable quota share treaties has the advantage of enabling a primary
insurer to retain a larger proportion of the small loss exposures that are within its
nancial capability to absorb, while maintaining a safer and smaller retention on
larger loss exposures.
The correct answer is (D) II and V only.

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

4.4. Types of Reinsurance

Which of the following statements is not true with regard to types of
reinsurance?
I. Per policy excess of loss reinsurance is used mainly with liability insurance;
applies the attachment point and the reinsurance limit separately to the
losses occurring on each insurance policy; and is activated when a loss on a
policy exceeds the attachment point.
II. One typical feature of quota share reinsurance agreements is that the
agreement states a maximum dollar limit above which responsibility for
additional coverage limits or losses reverts to the primary insurer.
III. Under a per policy excess of loss treaty, the attachment point and the
reinsurance limit apply separately to each loss under each policy up to an
aggregate limit speci ed in the treaty.
IV. Under a per occurrence excess of loss treaty, the attachment point and the
reinsurance limit apply to all losses from a single event affecting liability and
property insurance within the same policy.
V. A reinsurance arrangement that is stated as "95 percent of $10 million xs $5
million" is an excess of loss reinsurance agreement with an attachment point
of $5 million, and a 5 percent co-participation provision of the $10 million
layer.
(A) I and III only

(B) II and IV only

(C) III and IV only

(D) IV and V only

Answer
III. Under a per policy excess of loss treaty, the attachment point and the
reinsurance limit apply separately to each insurance policy regardless of the
number of losses occurring under each policy.
IV. Under a per occurrence excess of loss treaty, the attachment point and the
reinsurance limit apply to the total losses arising from a single event affecting one
or more policies.
The correct answer is (C) III and IV only.

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 Topic 4: Types of Reinsurance

4.5. Reinsurance Calculation

Which of the following statements is not true with regard to reinsurance
calculations?
Heungkuk Insurance has a 5-line surplus share treaty with Cedars
Reinsurance. The line is $100,000. Heungkuk Insurance has the following
policies:

Limit Premium Loss

Policy A $50,000 $1,000 $1,000
Policy B $400,000 $4,000 $50,000
Policy C $800,000 $16,000 $100,000

(A) The limit for Policy A will Heungkuk Insurance cede to Cedars Reinsurance
is $0.
(B) The premium for Policy B will Heungkuk Insurance cede to Cedars
Reinsurance is $3,000.
(C) The limit for Policy C will Heungkuk Insurance cede to Cedars
Reinsurance is $500,000.
(D) The loss for Policy C will Cedars Reinsurance pay is $87,500.

Answer
(D) The reinsurance percent would be 62.5% (= $500,000/$800,000), so the loss
paid by reinsurer will be $62,500.
The correct answer is (D).

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

Topic 5: Quota Share Treaties

ARe 321 Online 1st Edition / Assignment 2

5.a. Operation of Quota Share Treaties

A quota share treaty's operation is straightforward. During the reinsurance
negotiation process, the primary insurer and the reinsurer determine the
following: (1) Types of insurance or other speci ed categories of loss exposures to
which the quota share treaty will apply (2) Quota share percentage (3) Treaty
limit (4) Ceding commission.
In a standard quota share treaty, premiums and losses are shared according to
a xed percentage. Under a variable quota share treaty, the applicable percentage
of premium and loss sharing varies by features of the loss exposure, such as the
loss exposure's size. Together with both the standard quota share and the
variable quota share, the percentage employed to share premiums and losses is
determined at the onset of the treaty. A variable quota share treaty typically
involves more administrative expenses than a standard quota share treaty since
the primary insurer must evaluate the applicable features of each loss exposure
in order to cede the appropriate amount of each premium and seek
reimbursement for the appropriate percentage of each loss.

5.b. Functions of Quota Share Treaties

• Increase Large Line Capacity
• Provide Catastrophe Protection
• Provide Surplus Relief
• Facilitate Withdrawal From a Market Segment
• Provide Underwriting Guidance

Quota share treaties are less effective than other types of reinsurance in
providing large line capacity for the reason that primary insurer's liability
increases as the amounts of insurance increase.
A quota share treaty provides some catastrophe protection, however the
primary insurer must still pay its share of each loss incurred under the treaty,
which may result in a signi cant accumulation of losses. Due to this possible
accumulation of losses, primary insurers usually purchase catastrophe
reinsurance in addition to the quota share treaty.
Quota share reinsurance is regarded as the effective type of reinsurance a
primary insurer can use to obtain surplus relief. Under a quota share treaty, a
primary insurer usually cedes a substantial amount of premium and receives a
ceding commission that increases its policyholders' surplus.

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 Topic 5: Quota Share Treaties

5.c. Quota Share Treaties as Part of a Reinsurance Program

Primary insurers usually employ quota share treaties when they begin selling a
new insurance product, enter a new territory, or need surplus relief. In
developing a reinsurance program, a primary insurer and its reinsurer must
determine how the quota share treaty ts into the entire program.
These categories describe the order of treaty application: (1) Gross account
basis: A quota share treaty that applies on a gross account basis reimburses the
primary insurer for covered losses before other pro rata reinsurance treaties
apply. (2) Net of pro rata basis: A quota share treaty on a net of pro rata basis
applies after other applicable pro rata reinsurance recoveries apply. (3) Net of all
reinsurance basis: A quota share treaty on a net of all reinsurance basis applies
after all other applicable reinsurance recoveries apply, whether that reinsurance
is pro rata or excess of loss.
Quota share treaties may also be used by a captive insurer. A captive insurer
could provide insurance directly to its owner, but to do this it must satisfy state
insurance licensing requirements. Instead, many captive insurers use the
solutions of a fronting company.

5.d. Structure: Common Clauses Modi ed for Use in Quota Share Treaties
1. Reinsuring Clause This clause speci es the QS percentage assumed by the
reinsurer, states whether the QS cession is obligatory,
describes the business covered, and states the basis of
attachment.

2. De nitions Clause The terms de ned in the de nitions clause vary by QS

treaty depending on the needs and concerns of the parties.

3. Commencement Most QS treaties provide coverage for losses from policies

and Termination that were subject to the treaty after the termination date
Clause (run-off basis). Most property QS treaties take effect at 12:01
a.m. standard time at the location of the loss exposure.

4. Reports and This clause requires the primary insurer to submit

Remittances Clause information to the reinsurer so that net balances owed to
each party can be calculated and remitted and so that
nancial statements can be completed.

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

5.e. Reports and Remittances Clause

A reports and remittances clause may include these requirements: (1) The
primary insurer must maintain adequate records regarding the liabilities ceded
and report cessions periodically in a designated format. (2) The primary insurer
and reinsurer must pay balances within a speci ed period. (3) The primary
insurer must report large individual losses. (4) The primary insurer must provide
information regarding catastrophe losses.
A primary insurer might use the cash call provision when an unusually large
loss occurs that may cause a cash ow problem in case the primary insurer has to
wait until the next reporting period to be reimbursed by the reinsurer.
Cash call: A reinsurance treaty provision that allows the primary insurer to
obtain payment from the reinsurer for certain losses without having to wait until
the next payment period.

5.f. Clauses Designed or Adapted for Quota Share Treaties

1. Retention and This clause in a QS treaty speci es the primary insurer's
Limits Clause minimum net retention and the maximum amount of
insurance that the primary insurer can cede to the
reinsurer.

2. Reinsurance This clause in a quota share treaty speci es how the subject
Premium Clause premium is determined and when the primary insurer
must pay the reinsurer its share of the unearned premium.
It also determines the basis for calculating ceding
commissions.

3. Sliding Scale This clause speci es how pro ts from the ceded business
Commission Clause are to be shared by the reinsurer with the primary insurer.
4. Portfolio Transfer This clause speci es how the unearned premium reserve is
Clause transferred, the payment terms, and the reinsurer's
obligation for losses.

5. Losses, Loss This clause states that the primary insurer has full
Adjustment Expenses, authority to settle claims for the loss exposures ceded
and Salvages Clause under the treaty.

6. Outside This clause allows the primary insurer to not cede certain
Reinsurance Clause types of loss exposures that normally would be subject to
the reinsurance treaty.

7. Warranties Clause Warranted conditions are those for which the primary
insurer's lack of compliance voids reinsurance coverage for
losses, and they are used when the reinsurer wants to
ensure absolute compliance.

8. Original This clause states that the coverage provided by the

Conditions Clause reinsurer will be on the same basis as that provided by the
primary insurer.

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 Topic 5: Quota Share Treaties

5.g. Quota Share Treaty Pricing

Because premium, limits, and losses are shared proportionately as agreed in
the reinsurance contract, the ceding commission is the key pricing variable under
quota share treaties. These are the ve factors a reinsurer takes into consideration
when negotiating the ceding commission of a quota share treaty: (1) The primary
insurer's retention (2) The reinsurance treaty limit (3) The primary insurer's
policy acquisition expenses (4) The primary insurer's expected loss ratio, as well
as underwriting ability and rate adequacy (5) The competition in the
marketplace.
These are the factors affecting a primary insurer's geographic retention: (1)
Concentration of loss exposures in a geographic area (2) Susceptibility of the
geographic area to catastrophes (3) Cost of catastrophe protection.

5.h. Structure: Calculating a Quota Share Pro t-Sharing Ceding Commission

Step 1: Estimate the Quota Share Reinsurance Premium

Step 2: Subtract Reinsurer 1. Costs and Desired Pro t

and Primary Insurer Costs 2. Flat Ceding Commission
3. Estimated Average Losses and Loss Adjustment
Expenses

Step 3: Determine a Percentage for the Pro t-Sharing Commission

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

5.i. Example: Calculating a Quota Share Pro t-Sharing Ceding Commission

• Friday insurer purchases a 30 percent quota share treaty from Raymond Reinsurer.
• The estimated subject premium is $8 million.
• Raymond Re's costs for Friday's treaty: Overhead 3.0%; Brokerage 1.5%;
Investment income offset (3.5%); Minimum pro t 5.0%
• Friday requires a at ceding commission of 10 percent of the quota share
reinsurance premium.
• The historical loss ratios show no upward or downward trends. Raymond Re
determines a 0.50 projected loss ratio for Friday.
• Raymond Re quotes Friday a 20 percent pro t-sharing commission.

Step 1: Estimate the Quota Share Reinsurance Premium

Estimated quota share reinsurance premium = Estimated subject premium x
QS percentage = $8,000,000 x 0.3 = $2,400,000

Step 2: Subtract Reinsurer and Primary Insurer Costs

1. Costs and Desired Pro t
Raymond Re's costs and minimum pro t percentage is 3.0% + 1.5% -3.5% +
5.0% = 6.0%.
Raymond Re's costs and minimum pro t = Costs and minimum pro t
percentage x Estimated quota share reinsurance premium = 0.06 X $2,400,000 =
$144,000
2. Flat Ceding Commission
Flat ceding commission = Flat ceding commission percentage x Estimated
quota share reinsurance premium = 0.1 x $2,400,000 = $240,000
3. Estimated Average Losses and Loss Adjustment Expenses
Estimated average loss and loss adjustment expense = Projected loss ratio x
Estimated subject premium = 0.5 x $2,400,000 = $1,200,000

Step 3: Determine a Percentage for the Pro t-Sharing Commission

1. This is the estimated amount of premium available for pro t sharing:
$816,000
• Estimated quota share premium: $2,400,000
• Reinsurer's costs and minimum pro t: ($144,000)
• Flat ceding commission: ($240,000)
• Estimated loss and LAE: ($1,200,000)
$2,400,000 - $144,000 - $240,000 + $1,200,000 = $816,000
2. This is the estimated pro t-sharing commission: $163,200
Estimated pro t sharing commission = Pro t sharing commission percentage x
Estimated premium available for pro t sharing = 0.2 x $816,000 = $163,200

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 Topic 5: Quota Share Treaties

5.j. Structure: Evaluating a Quota Share Treaty

Current Evaluation • The subject loss ratio
• The ceding commission
• Ceded written premiums
• Ceded earned premiums
• The ceded incurred loss
Historical Evaluation • Surplus Relief Effect
• Underwriting Pro t Margin
• Investment Income

5.k. Example: Evaluating a Quota Share Treaty

Using the information in this table, evaluate an existing quota share treaty:
! Quota Share Structure: 20% Quota share net of all other reinsurance
! Sliding Scale Commission: (1) 30% Provisional ceding commission; (2) 25%
Minimum ceding commission; (3) 50% Speci ed loss ratio; (4) Commission
slides 0.5% inversely for each 1% that the loss ratio differs from 50%.
! Historical Experience: (1) Subject written premiums $50,000,000 (2) Subject
earned premiums $40,000,000 (3) Subject incurred losses including a suf cient
provision for incurred but not reported (IBNR) losses $30,000,000

1. Subject loss ratio = subject incurred losses ÷ subject earned premiums =

$30,000,000 ÷ $40,000,000 = 0.75 = 75%
2. Ceding commission = provisional commission + 0.5 x (speci ed loss ratio -
subject loss ratio) = 0.3 + 0.5 x (0.5 - 0. 75) = 0.175 = 17.5%, but min. 25%.
3. Ceded written premiums = quota share percentage x subject written
premiums = 0.2 x $50,000,000
= $10,000,000
4. Ceded earned premiums = quota share percentage x subject earned
premiums = 0.20 x $40,000,000 = $8,000,000
5. Ceded incurred loss = subject loss ratio x ceded earned premiums = 0.75 x
$8,000,000 = $6,000,000
6. Ceded unearned premiums = ceded written premiums - ceded earned
premiums = $10,000,000 - $8,000,000 = $2,000,000
7. Surplus relief effect = provisional commission x ceded unearned premiums =
0.30 x $2,000,000 = $600,000
8. Reinsurer's underwriting pro t margin = {ceded earned premiums – (ceded
commission + general expense loading) x ceded earned premiums – ceded
incurred losses} ÷ ceded earned premiums
= {$8,000,000 - (0.25 + 0.05) x $8,000,000 - $6,000,000} ÷ $8,000,000
= [$8,000,000 - $2,400,000 - $6,000,000] ÷ $8,000,000
= - $400,000 ÷ $8,000,000 = -0.05 = -5%

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SECTION 2. Types of Increasing Financial Strength with Quota Share

5.1. Quota Share Treaties

Which of the following statements is not true regarding Quota Share Treaties?
(A) A quota share treaty is most effective in providing surplus relief.

(B) Quota share reinsurance may be less effective in increasing large line
capacity than other types of reinsurance because the primary insurer's
liability increases as the amounts of insurance provided increase.
(C) When the quota share treaty enables a small insurer to compete for
business with amounts of insurance that are greater than its policyholders'
surplus could otherwise support, the function that it is providing is large
line capacity.
(D) Primary Insurer has a 75 percent quota share treaty with one reinsurer and
a $3,000,000 xs $2,000,000 excess of loss treaty with another. If the quota
share treaty is provided on a gross account basis, Primary Insurer recovers
$2,250,000 from the quota share reinsurer on a $6,000,000 loss.

Answer
(D) If the quota share treaty is provided on a gross account basis, Primary
Insurer recovers $4,500,000 from the quota share reinsurer on a $6,000,000 loss.
The correct answer is (D).

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 Topic 5: Quota Share Treaties

5.2. Common Clauses Modi ed for Use in Quota Share Treaties

Which of the following statements is not true regarding Common Clauses
Modi ed for Use in Quota Share Treaties?
I. Reinsuring clauses in a quota share reinsurance treaty describes the policies
covered and identi es the basis of attachment.
II. Language obligating a quota share reinsurer to pay losses until the rst
anniversary or cancellation of each policy, up to a maximum of twelve
months after the treaty's termination, would be found in reinsuring clauses.
III. A primary insurer may not want to delay recovery of the reinsurer's share of
a loss until the next payment period, particularly when that share of the loss
is large. Therefore, the reports and remittances clause may have a provision
allowing the primary insurer to expedite the payment. This provision is
known as a cash call.
IV. Quota share reinsurance treaties are sometimes written with provisions that
allow immediate termination due to poor loss experience. If this provision is
put into effect, the reinsurer returns the unearned premium reserve to the
insurer.
(A) I only

(B) II only

(C) III and IV only

(D) None of the above

Answer
II. Language obligating a quota share reinsurer to pay losses until the rst
anniversary or cancellation of each policy, up to a maximum of twelve months
after the treaty's termination, would be found in commencement and termination
The correct answer is (B) II only.

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

5.3. Clauses Designed or Adapted for Quota Share Treaties

Which of the following statements is not true regarding Clauses Designed or
Adapted for Quota Share Treaties?
I. The purpose of the outside reinsurance clause added to a quota share treaty
is to allow the primary insurer to secure other reinsurance under certain
circumstances.
II. A reinsurer requires that the primary insurer add a pollution endorsement to
every policy covered by a quota share treaty. This requirement is usually
contained in a warranties clause.
III. The original conditions clause speci es that additional reinsurance,
facultative or treaty, applies before the application of this reinsurance
agreement.
IV. A primary insurer moves its quota share reinsurance treaty from one
reinsurer to another. The incoming reinsurer demands that the primary
insurer pay it the unearned premium reserve within 60 days of treaty
inception, whereas the terminated reinsurer refuses to return the unearned
premium to the primary insurer within the 60-day period. Portfolio transfer
clause requires the primary insurer to pay the incoming reinsurer the
unearned premium within the 60 days even though it has not received
payment from the outgoing reinsurer.
(A) I and II only

(B) III only

(C) IV only

(D) None of the above

Answer
III. The original conditions clause establishes that the liability assumed by the
reinsurer under the reinsurance treaty is on the same basis as the underlying
coverage provided by the primary insurer. The original conditions clause states
the reinsurer's share of the underlying premium, net of ceding commission, will
not be reduced by dividends (if any) paid by the primary insurer to the
underlying insured. The original conditions clause addresses dividends
speci cally because many primary insurers have dividend plans that enable the
policyholder to share in pro ts which potentially diminish the amount of subject
premium.
The correct answer is (B) III only.

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 Topic 5: Quota Share Treaties

5.4. Quota Share Treaty Pricing

Which of the following statements is not true regarding Quota Share Treaty
Pricing?
I. An insurer and reinsurer enter into a 75 percent quota share treaty. The treaty
provides for ceding and pro t-sharing commissions. The insurer estimates
$16,000,000 in premium subject to the treaty. The ceding commission is 20
percent and the pro t-sharing commission is 50 percent. The reinsurer
projects 10 percent for costs and minimum pro t and 60 percent for loss and
loss adjustment expenses. Based on the information given, the estimated
amount of the insurer's pro t-sharing commission would be $600,000.
II. Reinsurer and Primary Insurer agree to share the pro t-sharing commission
equally under a quota share treaty because the underlying insurance is found
to be pro table with little catastrophe exposure. (1) Estimated quota share
premium: $2,000,000 (2) Reinsurer's costs and desired pro t: 7% (3) Flat
ceding commission to Primary: 20% (4) Estimated average losses and loss
adjustment expenses: 63%. Using the information, the amount of the
estimated pro t-sharing commission would be $100,000.
(A) I only

(B) II only

(C) None of the above

(D) All of the above

Answer
Calculations refer to 10.i. Example: Calculating a Quota Share Pro t-Sharing
Ceding Commission.
The correct answer is (C) none of the above.

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 SECTION 2. Types of Increasing Financial Strength with Quota Share

5.5. Quota Share Treaty Pricing

Which of the following statements is not true regarding Quota Share Treaty
Pricing?
I. A reinsurer has provided a primary insurer with a 70 percent quota share
treaty containing a pro t-sharing provision. The reinsurer determines items
as a percentage of the quota share treaty as: (1) Overhead 4.0% (2) Brokerage
paid to intermediary 1.5% (3) Investment income offset (4.5%) (4) Minimum
pro t 5.0%. Assuming a subject premium of $10 million, the estimated
reinsurer costs and minimum pro t would be $420,000.
II. Reinsurer must determine its costs and minimum pro t as part of the process
to arrive at a pro t-sharing ceding commission. Reinsurer's overhead and
brokerage total 5.5%, which is offset with its investment income percentage
of 3.5%. Reinsurer also desires a minimum pro t of 5%. The estimated quota
share premium for this transaction is $2 million. The dollar amount of
Reinsurer's costs and minimum pro t totals $140,000.
III. The estimated quota share reinsurance premium for a treaty that includes a
pro t-sharing component is $2 million. The expected loss and loss
adjustment expense ratio is 65%. The at ceding commission to the primary
insurer is 20%, and the reinsurer's expected costs and minimum pro t is 5%.
Using this information, the estimated average loss and loss adjustment
expense would be $1,300,000.
(A) I only

(B) II only

(C) III only

(D) None of the above

Answer
Calculations refer to 10.i. Example: Calculating a Quota Share Pro t-Sharing
Ceding Commission.
The correct answer is (D) none of the above.

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 Topic 5: Quota Share Treaties

5.6. Evaluating a Quota Share Treaty

Which of the following statements is not true regarding Evaluating a Quota
Share Treaty?
I. CDE Insurance purchases a 60 percent quota share treaty for which subject
written premiums are $25,000,000 and subject earned premiums are
$20,000,000. The provisional ceding commission is 30 percent. The surplus
relief effect of the quota share treaty would be $900,000.
II. ILLI Re wrote a reinsurance treaty that has $30 million in earned premium
ceded to the treaty. The treaty has $18 million in incurred losses. When
calculating the premium, ILLI Re added a 10 percent expense loading. The
ceding commission is 20 percent. ILLI Re's historical underwriting pro t
margin would be 10%.
III. Based on the data: (1) Ceded earned premiums: $ 10.0 million (2) Ceded
incurred losses: $5.0 million (3) Ceded commission: 25% (4) General expense
loading: 5%. the reinsurer's pro t margin is 0.2.
(A) I only

(B) II only

(C) III only

(D) None of the above

Answer
Calculations refer to 10.k. Example: Evaluating a Quota Share Treaty
The correct answer is (D) none of the above.

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SECTION 2. Types of Increasing Financial Strength with Quota Share

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SECTION 3. FINANCING COMPLEX EXPOSURES
WITH SURPLUS SHARE

Topic 6: Surplus Share Treaties

본 디지털에디션은 매 페이지마다 핵심용어가 삭제되어 강의를 수강하고 필기하여야 합니다. 동영상

강의 수강회원 이외에는 활용이 불가하므로 무단 복제, 배포, 판매를 삼가하시기 바랍니다.

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 SECTION 3. Financing Complex Exposures with Surplus Share

Topic 6: Surplus Share Treaties

ARe 321 Online 1st Edition / Assignment 3

6.a. Operation of Surplus Share Treaties

The primary insurer and reinsurer under a surplus share treaty share the
underlying policy premiums and losses for each loss exposure on a percentage
basis. The percentage employed to share policy premiums and losses varies for
each loss exposure subject to a surplus share treaty.
These are two disadvantages of quota share reinsurance that are addressed by
surplus share reinsurance: (1) Every loss exposure, regardless of its size, is ceded.
(2) The xed percentage retention of a quota share treaty results in larger dollar
amount retentions as the size of the loss exposure increases.
The line employed in a surplus share treaty is used to determine whether the
treaty applies to an individual loss exposure, as opposed to the attachment point
in excess of loss reinsurance establishes the dollar amount above which the
reinsurer responds to losses. The primary insurer can change the line for a
speci c loss exposure by using a line guide.
A primary insurer may possibly need more capacity than is available in its rst
surplus layer. Additional surplus layers handle loss exposures with higher
coverage limit needs and provide additional large line capacity.

6.b. Functions of Surplus Share Treaties

• Increased Large Line Capacity
• Stabilized Loss Experience
• Surplus Relief

Surplus share reinsurance was created to provide primary insurers with

exibility in insuring large loss exposures, provided the characteristics of those
loss exposures meet predetermined parameters. A primary insurer's capacity has
limitations to a multiple of the line it is willing to accept on a loss exposure.
Surplus share reinsurance can provide loss stabilization on an individual loss
exposure basis by limiting the primary insurer's participants on each loss to its
line. But, surplus share reinsurance is not effective in stabilizing an accumulation
of losses that may be sustained from a catastrophic event.
Surplus share reinsurance can provide surplus relief, for the reason that
primary insurer receives a ceding commission for loss exposures ceded.
However, compared to quota share reinsurance, surplus share reinsurance is less
effective in providing surplus relief because less premium is ceded.

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 Topic 6: Surplus Share Treaties

6.c. Surplus Share Treaties as Part of a Reinsurance Program

A surplus share treaty can be used as the only reinsurance treaty that applies to
the primary insurer's insurance policies, or it may be used in conjunction with a
quota share treaty or excess of loss treaty.
A primary insurer will in some cases use per risk excess of loss reinsurance to
increase its line and a surplus share treaty to obtain greater large line capacity.
When excess of loss reinsurance is used like this, it is called underlying excess.

6.d. Common Clauses Modi ed for Use in Surplus Share Treaties

Reinsuring Clause 1. Nature of Cession: surplus share treaties are usually
obligatory for both the primary insurer and the reinsurer.
2. Statement of Attachment: a risks attaching basis is easier
for the primary insurer to administer from an underwriting
perspective than a losses occurring basis.
3. Description of Policies Covered: identify insurance policies
to which the surplus share treaty applies.

Liability of the This clause establishes when the reinsurer assumes liability
Reinsurer Clause and on what basis. The primary insurer's underwriter usually
consults the line guide, sets the line, and cedes the surplus
liability when the insurance application is accepted.

De nitions Clause Three key de nitions for a surplus share treaty are those for
surplus liability, risk, and net retention.

Exclusions Clause No standard list of exclusions exists for surplus share treaties,
and the variety of possible exclusions is extensive.

Reports and The primary insurer is required to record the net retention
Remittances Clause and cession amount for each loss exposure subject to the
treaty and to supply the information to reinsurer via a
bordereau.

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 SECTION 3. Financing Complex Exposures with Surplus Share

6.e. Clauses Designed or Adapted for Surplus Share Treaties

Surplus Liability The purpose of this clause is to de ne the threshold at which
Clause the primary insurer will cede to the reinsurer. The clause
establishes a cession priority when several layers of surplus
share treaties are used. It can also establish a minimum net
retention and identify underlying reinsurance agreements.

Net Retention This clause usually states whether or not the primary insurer is
Clause permitted to use underlying reinsurance to reinsure its net
retention.
Retention and This clause in a surplus share treaty limits (sometimes PML
Limits Clause basis) the amount of liability that the primary insurer can
transfer to the reinsurer and establishes the primary insurer's
minimum net retention.

Method of The purpose of this clause is to address the methods of ceding

Cession Clause policies covering multiple locations, multiple coverage parts,
causes of loss insured within sub limits, and loss exposures
insured on a blanket basis and to reduce adverse selection by
specifying how loss exposures are ceded to the treaty.

6.f. Disclosure of underlying reinsurance agreements: Surplus Liability Clause

A primary insurer may reinsure its surplus share treaty's net retention via
other reinsurance agreements, such as a quota share treaty, another surplus share
treaty, an excess of loss treaty, or a combination of treaties. Primary insurers
reinsure their net retentions for these main reasons: (1) To increase net retention
to a level greater than their own nancial resources may be able to support (2) To
increase large line capacity available in the surplus share treaty.

6.g. Surplus Share Treaty Pricing

As with quota share treaty pricing, surplus share treaty pricing depends on the
amount of ceding commission the reinsurer is willing to pay to the primary
insurer. This amount depends on several factors: (1) The treaty's perceived
pro tability (2) The treaty's limits (3) The primary insurer's line (4) Competition
in the reinsurance marketplace.

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 Topic 6: Surplus Share Treaties

6.h. Limits Pro le

A limits pro le is a table in which the policies subject to the treaty have been
categorized by coverage limit. A limits pro le helps the primary insurer
determine the nancial effect of a surplus share treaty with a retention set at
various levels.
Homeowners limits Pro le for ILLI Primary Insurance Company

Dwelling Coverage Policies Premium

Limits
Count Percent Amount Percent

$100,000-$150,000 5 25% $ 4,000 16%

$150,000-$200,000 8 40% $ 7,000 28%

$200,000-$250,000 4 20% $ 6,000 24%

$250,000-$300,000 3 15% $ 8,000 32%

Total 20 100% $25,000 100%

6.i. Line Guide

The primary insurer's line guide functions as an underwriting tool by
specifying the maximum amounts of insurance that the primary insurer is
prepared to provide for various categories of policies.
Line guides tend to be more frequently used in property insurance than in
liability insurance because property loss exposures are easier to quantify than
liability loss exposures. Risk-speci c features that are often considered in a line
guide include construction type, occupancy, and public protection classi cation.

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SECTION 3. Financing Complex Exposures with Surplus Share

6.j. Example: Line Guide

Insurer A insures a home in protection class 5. The homeowners policy
provides limits of (1) $200,000 for the dwelling, (2) $20,000 for other structures,
(3) $100,000 for personal property, and (4) $40,000 for loss of use. Using the
homeowners line guide below, calculate how much limit is ceded to a ve-line
surplus share treaty.
Homeowners Line Guide
Public Protection Class (PPC) Maximum Line

1 to 4 $70,000

5 and 6 $60,000

7 and 8 $50,000

9 and 10 $40,000

In the case of Insurer A, the amount ceded to a ve-line surplus share treaty is
calculated as shown:
Dwelling limit $200,000
Other structures limit 20,000
Personal property limit 100,000
Loss of use limit 40,000

Total limit $360,000

Retention per line guide (class 5) (60,000)

Amount ceded to surplus share treaty $300,000

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 Topic 6: Surplus Share Treaties

6.1. Surplus Share Treaties

Which of the following statements is not true regarding Surplus Share Treaties?
(A) A surplus share treaty is often used for large, complex property loss
exposures.
(B) A surplus share treaty could apply over a quota share treaty.

(C) The primary reason for using a surplus share treaty rather than a quota
share treaty is that the cession percentage is variable for each risk under the
treaty allowing automatic insurance capacity on large risks.
(D) The reason surplus share reinsurance is said to provide the primary insurer
with automatic capacity is that it increases surplus so that capacity is
increased as necessary.

Answer
(D) The reason surplus share reinsurance is said to provide the primary insurer
with automatic capacity is that it adjusts underwriting capacity based on the
relevant attributes of the exposure.
The correct answer is (D).

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 SECTION 3. Financing Complex Exposures with Surplus Share

6.2. Common Clauses Modi ed for Use in Surplus Share Treaties

Which of the following statements is not true regarding Common Clauses
Modi ed for Use in Surplus Share Treaties?
I. The nature of cession in the reinsuring clause in a surplus share treaty states
that indemni cation is subject to the limits set forth in the retention and
limits clause.
II. The liability amount ceded to a reinsurer under a surplus share treaty is
known as surplus cession
III. Three de nitions are key to a surplus share treaty. They are the de nitions of
surplus liability, risk, and limits.
IV. Reinsurance treaties contain a reports and remittances clause. The main
difference in this clause between the surplus share treaty and the quota share
treaty is that for the surplus share treaty, the clause speci es that the primary
insurer must record the net retention and cession amount for each exposure
on the bordereau.
(A) I only

(B) II and III only

(C) IV only

(D) I and IV only

Answer
II. The liability amount ceded to a reinsurer under a surplus share treaty is
known as surplus liability
III. Three de nitions are key to a surplus share treaty. They are the de nitions
of surplus liability, risk, and net retention.
The correct answer is (B) II and III only.

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 Topic 6: Surplus Share Treaties

6.3. Clauses Designed or Adapted for Surplus Share Treaties

Which of the following statements is not true regarding Clauses Designed or
Adapted for Surplus Share Treaties?
I. The net retention clause is designed for surplus share treaties and usually
states whether or not the primary insurer is permitted to use underlying
reinsurance to further reinsure its net retention.
II. One purpose of the method of cession clause in a surplus share treaty is to
allow the primary insurer to adjust the percentage ceded for coverage
sublimits to the reinsurer's detriment.
III. Primary insurers entering into surplus share treaties are sometimes not
permitted to use underlying reinsurance. When this restrictive wording is
included as a separate clause, it is referred to as the net retention clause.
IV. Retention and limits clause limits the amount of the liability that the primary
insurer can transfer to the reinsurer and establishes the primary insurer's
minimum net retention.
V. Primary Insurer's underwriter is writing a $1 million commercial property
policy with a $100,000 earthquake coverage sublimit. Primary's retention
under the line guide is 20 percent for this policy, but the underwriter wants
to cede more than 20% of the earthquake exposure to the reinsurer. Method
of cession clauses in the surplus share treaty should the underwriter review
to determine whether or not she is permitted to do so.
(A) I only

(B) II only

(C) III and IV only

(D) V only

Answer
II. One purpose of the method of cession clause is to reduce adverse selection
by specifying how loss exposures are ceded to the treaty. The method of cession
clause states that the primary insurer can adjust the percentage ceded for
coverage sublimits, but not to the reinsurer's detriment.
The correct answer is (B) II only.

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 SECTION 3. Financing Complex Exposures with Surplus Share

6.4. Surplus Share Treaty Pricing

Which of the following statements is not true regarding Surplus Share Treaty
Pricing?
(A) The amount of ceding commission that a reinsurer is willing to pay is based
on the treaty's limits
(B) A limits pro le is a table in which policies subject to a treaty have been
categorized by coverage limits.
(C) A limits pro le is used to aid primary insurers and reinsurers in
determining the nancial effects of a surplus share treaty with the retention
set at various levels.
(D) The primary insurer's property reinsurance program typically is based on
line guide information. Property line guides re ect the building
construction, occupancy, and public protection classi cations of buildings.
With regard to building construction classi cations, there are three essential
classi cations. They are load-bearing exterior wall material, material in the
roof and oors, and the type of occupancy of the building.

Answer
(D) They are load-bearing exterior wall material, material in the roof and
oors, and re-resistive rating of the building materials used.
The correct answer is (D).

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