Reinsurance and Loss Ratio

Professional Actuarial Topics Property/Casualty
1

May I know if anyone can point me to papers/ articles explaining how reinsurance can cause distortion to loss ratio/ combined ratio?

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  1. what do you mean by “distortion”?
  2. from whose perspective is this ‘distortion’ happening?

if you want general reinsurance knowledge, read the Friedland paper on the Exam 7 syllabus, or the Clark paper on Exam 8.

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3

Not an article, but maybe what you are thinking about is a situation like this:

An insurer prices and sells a product with an expected loss ratio is 70%. This product has a small potential for a very large loss, so they also purchase excess of loss reinsurance.

Their net premium is now lower than if they hadn’t bought reinsurance. If the product performs as expected, they will experience a direct loss ratio of 70%, but their net loss ratio will be 75% because they spent money on reinsurance (smaller denominator) and didn’t get any reduction to losses.

Theoretically, someone who doesn’t understand could look at that and say 75%>70%, this product is underperforming! Which would be a dumb comment because it ignores the potential year where the reinsurance kicks in, bringing a 200% loss ratio down to 90%.

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4

I think these days reinsurance is mostly evaluated from an ERM perspective. You can basically simulate underwriting results under difference reinsurance structures and evaluate what the loss outcomes look like under each. The brehm paper from exam 7 covers this in detail

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5

Loss outcomes and capital utilization.

Remember that the amount of capital a P&C insurer seeks to hold will be significantly influenced by the need to handle extreme results. You can run simulations to see how different potential reinsurance portfolios will impact loss results, surplus needs, and the implications of such if a particular ROE is being targeted.

6

Thanks for this. I get this part of the effects of how the cedent’s gross ratios is sort of the weighted average of the cedent’s net ratio and the reinsurer’s gross ratio. What I am looking for is something less straight forward because I recall seeing a paper that there are scenarios where net earned premium can become negative, or very low loss ratio not related to reserve release, in some reinsurance structure. I cannot remember if the design of reinsurance commission was the cause. It is something along the lines of “if the insurer’s direct ratio is 90% and deemed too high, it can use some reinsurance structure to bring the net ratio lower”. Basically trying to make the reported results look better.

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Thanks. I am looking for something slightly less straightforward. Somethings that sometimes cedents may use to make their reported results look better. Please see my reply to CuriousGeorge.

8

It sounds like you’re looking for information on finite reinsurance and definitions of risk transfer. There are papers on exam 6 that cover the definitions and rules, but it may be difficult to find anything official on “how to” distort balance sheets using reinsurance. Suffice it to say, there have been actuaries in the past who have gotten in trouble for doing so, which is why the rules were created.