Introduction to Reinsurance

NLC-RISC Trustee Conference

May 2011

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Presentation Agenda

Types of reinsurance and cost-sharing options

The key doctrines of reinsurance Why to buy reinsurance How to evaluate reinsurers Reinsurance market overview How reinsurance is purchased

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Reinsurance

Contractual agreement Reinsurer agrees to indemnify the pool

Some or all of certain losses covered by the pool

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Types of Reinsurance Facultative Reinsurance

Coverage for a specific exposure or risk Attaches to a specific risk

Treaty Reinsurance Cover for entire class or portfolio Sharing of losses

Excess Insurance Transfer of risk

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Key Doctrines - Reinsurance Utmost Good Faith

Pool has obligation to reinsurer to act in good faith for underwriting, pricing and claims handling

Pool keeps reinsurer informed of developments that would materially impact the reinsurer

Follow the Fortunes Reinsurer agrees to follow the fortunes of the pool

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Basis of Paying Losses

Most arrangements are hybrid Quota share

Fixed proportionate share Variable quota share

Excess of Loss Above a stipulated dollar amount

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Excess Insurance orExcess of Loss?

The pool pays the first $250,000

The pool pays 50 percent of the next

$250,000 ($125,000) RE pays the other 50 percent

RE pays all loss amounts over $500,000

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Other things out there… Aggregate policies Catastrophe policies Clash treaties …and more

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Why Buy Reinsurance?

Catastrophic relief Stabilize loss experience & reduce

uncertainty Capacity to write larger (or more) risks Ability to better meet member needs Premium capacity & regulatory

compliance

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Choosing to Reinsure

Risk factors should impact the decision process Size of potential loss Unpredictable frequencies Length of time for claim payments Volatility of loss outcomes

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Evaluation of Reinsurers

CostFinancialSecurity

CoverageRelationship

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Evaluation of Reinsurers Financial standing and capabilities

Commercial ratings & performance tests Size, leverage, liquidity of balance sheets

Commitment to line of business Degree of input (interference)

Underwriting and claims Claim payment reputation Organizational structure and management

philosophy

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Financial Rating Systems for Insurance CompaniesWhy are they important?

Reinsurance financials are complex Independent evaluations subject all

insurers to the same criteria and provide benchmark Quantitative and qualitative review Balance sheet, operating performance Business profile

Benchmarks even more important in an international market

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Financial Rating Systems for Insurance CompaniesWhy are they important?

Perceived ability of a company to pay its claims

Not a warranty of financial strength or ability to meet obligations 10 of 20 largest commercial insurance

companies failed or were merged in the last 20 years

All were rated A or better at the beginning of the period

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Rating Agencies A.M. Best

Primarily focused on insurance Standard & Poor’s

An investor rating service Moody’s

An investor rating service Fitch

An investor rating service

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Ratings Considerations

Claims payment rating A company’s ability to pay its claims

Investor ratings Risk-to-return ratio for investors Creates profit incentive that could lead to

riskier behavior• AIG• Mortgage insurers

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Underneath it all…

Reinsurers and excess insurers exist to make money for capital investors

Expected to pay claims & expenses

Must produce profit over time

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Excess Risk Pool Pool of similar insurers who in part self-

insure for risks typically reinsured Requires capital commitment Long-term financial focus Participatory governance and direction Regulatory credit for reinsurance

recoverable Generally no rating agency help to evaluate

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Key Factors for Evaluating an Excess Risk Pool

Capital adequacy Competency of management Risk-taking philosophy Commitment level of other participants Pricing philosophy Coverage philosophy Willingness to pay claims Long-term viability By-Laws

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Reinsurance Market

ART - Alternative Risk Transfer

Public Entity Risk

Commercial Insurance Companies Specialty Insurance Companies

Reinsurance Companies

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Reinsurance Market

Public Entity Liability Small number of reinsurers Losses had been declining relative to

expenditures Trends in public officials, land use, law

enforcement Reinsurers looking to expand market share Flat or decreasing rates

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Reinsurance Market

Public Entity Property Small number of reinsurers May be hard for smaller pools to meet

minimum premium requirements Coastal exposures difficult to place Large losses - global and U.S. Pricing generally flat, perhaps will begin to

harden

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Reinsurance Market

Public Entity Work Comp Almost entirely made up of excess insurers Very few, at that Heavily competitive for good risks Soft pricing to increase market share Some market unknowns

Impact of the recession Medicare as a Secondary Payer Presumption legislation

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Reinsurance Market

Reinsurance Association of America

1982 - 68 reinsurance companies (84 total members)

2011 - 26 reinsurance companies (40 total members)

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Buying Reinsurance

Apply Provide data Define terms and conditions Receive quote Agree Contract

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Buying Reinsurance

Direct Market Pool purchases direct from reinsurer

Broker Market Pool must access reinsurer through a

broker or intermediary

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Buying Reinsurance

Outside Advisors (?)

Domestic

Munich ReGeneral ReSwiss Re

Direct Purchase

Domestic

Bermuda Reinsurers

Bermuda Broker

Correspondent Broker

Bermuda

LloydsForeign Reinsurers

Correspondent Broker

Offshore

Broker Purchase

Insurance Pool

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Buying Reinsurance

Direct Market Might have more

capacity for individual risks

Traditional risk focus Direct relationship &

communications

Broker Market Increased pricing

competition Specialty risk options Broker involved in

communications & relationship management

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Direct Market Reinsurers

General Re Munich Re Swiss Re Excess Risk Pools

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Broker Market Reinsurers ACE Arch Re Argo Re Aspen Re AXIS Employers Re Endurance Everest Re Hannover Re

Harbor Point Hiscox Lloyds & Syndicates Partner Re Safety National Scor Re Transatlantic Re XL Re

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Sample Reinsurance Structure

D (ex) $200,000,000

C (ex) 40%

A (ex) 30%

B (ex) 30%

$125,000,000

A (ex) $25,000,000

B (ex)

$5,000,000

A (re) 20%

Pool 80%

B (ex) $2,000,000

Pool 50%

B (re) 50%

$1,000,000

Pool

Pool

$500,000

LIABILITY PROPERTY