day 2: an introduction to reinsurance

DAY 2: AN INTRODUCTION TO REINSURANCETariq [email protected] – 00962 7 9767 7418

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INDEX

▪ Brief history of reinsurance

▪ The statistical basis of premiums

▪ About Tariq Al-Basha

BRIEF HISTORY OF REINSURANCE

▪ The first insurance companies

▪ Records show that the first insurer (as we understand the term today) known tohave been used printed insurance policies was based in Seville in 1552; the oldestprinted policy in Italian is dated 1583 and comes from Venice.

▪ Those early insurers needed to dilute the risks accepted and they managed to dothis by adopting a system of coinsurance: the largest risks were shared amongstthemselves according to different, previously agreed, percentages.

▪ The sums insured per policy grew rapidly, leading the number of coinsurers perrisk to grow too, as each one generally did not want to have significant shares.


▪ The consolidation of reinsurance

▪ This situation led these first insurers to cumbersome administrative situations andeven, in some cases, to a lack of capacity. In this way, pure reinsurance began todevelop and strengthen, becoming thoroughly accepted in the 17th century withthe almost simultaneous formation of joint-stock insurance companies.

▪ These grew stronger over time, and even more so with industrial developmentand the appearance of large accumulations of sums insured per risk.


▪ Some differences from modern-day reinsurance

▪ In the early period of reinsurance development, the term “reinsurance” was used torefer to different types of agreements which were very different from what we nowunderstand by the concept. It did not have a uniform meaning and was not clearlydefined. So, agreements similar to reinsurance, such as those will look at below - werealso referred to as “reinsurance”.

▪ An insurer look over the obligations accepted by another insurer who either wished towithdraw from the business or had died or gone bankrupt. This transaction, whichtook place in Amsterdam in 1595, differs from the current meaning of reinsurance,since it involves a 100% transfer of the obligations of the first insurer and there is alsoa direct relationship or an agreement between the second insurers (supposedreinsurer) and the insured.

▪ Another case, which existed in a Bilbao ordinance dated 1738, said that to avoid therisk of its insurer, the latter accepting the risk on a subsidiary basis. This agreement,which is described as reinsurance, is obviously not reinsurance as it was arrangeddirectly by the insured and at its own expenses.


▪ The England case

▪ Reinsurance expanded rapidly in Europe but, curiously, was interrupted in Englandby the intervention of Parliament. In order to avoid abuses which had occurred, aparagraph was added to the Act of 1746 declaring the practice of reinsuringBritish vessels and the merchandise carried on the to be illegal.

▪ This provision was withdrawn in 1864, though there are signs that reinsurancewas still practiced in some cases, despite the prohibition.

THE STATISTICAL BASIS OF PREMIUMS

▪ Insurers meet their indemnity commitments by setting up funds which, inturn, are made up from premiums received from their insureds. And how arethese premiums calculated? In principle, on a purely statistical basis.

▪ So what does the risk premium depend on?

▪ The answer is: on the number of insured risks that will be affected by a claimand the frequency with which claims occur. The calculation of the premium tobe applied may prove to be of greater or lesser accuracy.

▪ The accuracy of the calculation is thus directly related to the number ofsamples taken and the periods of time observed. Clearly, the more materialthat is analyzed (law of large numbers), the less deviation there will be in theinsurance premium calculations.

▪ Below we will look at various statistical sources that may be used in theinsurance sector, depending on what is trying to be achieved and the field inwhich the activities are to be carried out.


▪ Statistics from outside the insurance industry

▪ A typical example of these statistics are the mortality tables which are necessaryfro and which are usually official (published by Government bodies) and preparedby geographical area and by risk group. Insurers in turn make adjustmentsaccording to trends for periods of time subsequent to those considered in theoriginal statistics. They will also adjust for the different types of life insurances.

▪ Further examples of this type of statistics are those prepared by Spain’s DireccionGeneral de Trafico (Traffic Authority) relating to road accidents and used by motorinsurers. Another example is the statistics on total claims in maritime navigationpublished annually by Lloyd’s of London.


▪ Statistics prepared by insurer associations

▪ These are reliable enough to be used by insurers as they are compiled by all or arepresentative majority of insurers operating in a specific market. In Spain, thosepublished by

▪ UNESPA (Union Espanola de Entidades Aseguradoras y Reaseguradoras) [Spanish Unionof Insurance and Reinsurance Companies],

▪ the Directorate-General for Insurance and Pension Funds and ICEA (InvestigacionCooperativa Entidades Aseguradoras) [Cooperative Research by Insurance Companies]are worthy of mention


▪ Statistics prepared by insurance companies themselves

▪ How can the statistics prepared by reinsurers be used to calculate premiums? Toanswer this question, one should first into account the fact that the sphere ofactivity of companies dedicated to reinsurance is international.

▪ Because of their international nature, they are able to collate and compilestatistics from different countries to complement those obtained locally. Thisinformation is returned to different countries by the reinsurers, thus giving thedifferent insurers a further element which they are able to compare with the localinformation they already handle.


▪ Premiums for “large risks”

▪ We mentioned, previously, the difficulty of obtaining statistics on large risks andthis is where the information from reinsurers acquires greater importance.

▪ Certain types of insured companies only exist in very small numbers in eachcountry, which means that statistics based on just country’s data would not bevery reliable. This is the case of oil refineries, power stations, hydroelectric plants,nuclear plants, steel works, etc.

▪ Only international reinsurers has sufficient information as they operate in thevarious countries in which these large companies are situated.

ABOUT TARIQ AL-BASHA• Business & Financial Modelling

Consultant at several consulting firms inthe Middle East.

• Business management graduate from theUniversity of Greenwich, London – UK.

day 2: an introduction to reinsurance

Economy & Finance