Running Head: WEEK 7 CASE STUDIES 1

Chapter 6

Reinsurance can be used by an insurer to solve several problems. Assume you are an

insurance consultant who is asked to give recommendations concerning the type of

reinsurance plan or arrangement to use. For each of the following situations, indicate the

type of reinsurance plan or arrangement that the ceding insurer should use, and explain

the reasons for your answer.

a. Company A is an established insurer and is primarily interested in having protection

against a catastrophic loss arising out of a single occurrence.

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I would suggest for company A to go with excess-of-loss reinsurance which is designed to

protect against catastrophic loss. This includes different coverage such as single exposure, single

occurrence, and excess loss. This policy has a limit in loses that the reinsurer is responsible for

during specific time period. Therefore, the excess-of-loss reinsurance is the best option for

company A to protect against catastrophic loss from single occurrence (Rejda & McNamara,

2014, p. 114).

b. Company B is a rapidly growing new company and desires a plan of reinsurance

that will reduce the drain on its surplus because of the expense of writing a large

volume of new business.

Quota Share Treaty will help company B to reduce the drain on its surplus. In this situation the

insurer and reinsurer share premiums and losses based on the fixed percentage. Also, all of the

unearned premiums are reduced for the primary insurer which makes it effective for new

businesses to reduce the drain on surplus (Rejda & McNamara, 2014, p. 113-114).

c. Company C has received an application to write a $ 50 million life insurance policy

on the life of the chief executive officer of a major corporation. Before the policy is

issued, the underwriter wants to make certain that adequate reinsurance is

available.

Facultative coverage is a type of reinsurance that allows company to review the risk and

determine whether to accept or reject potential risk. It is often used when primary insurer

receives a large amount of applications that exceeds its retention limits. This type of coverage

has several advantages that include flexibility which can fit many cases, it has increased amount

of primary insurer to write large amounts of insurances, and can help to stabilize financial

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operations during large losses (Rejda & McNamara, 2014, p. 113). This type of insurance can be

a little more expensive but it can help Company C to cede the risk and protect from large losses

and stabilize financial situation.

d. Company D would like to increase its underwriting capacity to underwrite new

business.
I would suggest for company D to consider the Surplus Share Treaty. Under this coverage

the reinsurer does not participate in all risks and agrees to accept insurance in excess of

the ceding insurer’s retention up to specific amount. The retention limit is called a line

and stated in dollar amount. The main advantage of this coverage is that the primary

insurer’s underwriting capacity on any single exposure is increased (Rejda & McNamara,

2014, p. 114). Therefore, the Company D would be able to increase its underwriting

capacity to underwrite new business under Surplus Share Treaty policy.

Chapter 7
Carolyn is senior vice president of finance and chief actuary for Rock Solid

Insurance Company (RSIC). Lonnie is double-majoring in finance and mathematics

at State University. Lonnie applied for an internship with Rock Solid, and he is

working for the company during the summer before the start of his senior year of

college. Curious to learn what Lonnie knew about insurance company financial

statements and ratemaking, Carolyn prepared a quiz for Lonnie to take on his first

day on the job. See if you can help Lonnie answer these questions.
1. At year-end last year, Rock Solid had total liabilities of $640 million and total

assets of $900 million. What was the company's policyholders' surplus?

In order to calculate company’s policy holders’ surplus we will use the following

formula:

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Company’s policyholders’ surplus= company’s’ assets ($900 million)- company’s

liabilities ($640 million)= $260 million.

2. Explain how it is possible for Rock Solid to have $500 million in written

premiums last year and $505 million in earned premiums last year.
Written premiums are the total premiums on policies distributed during accounting

period by an insurance company. These premiums are earned by the insurer and

therefore, it is possible for Rock Solid to have $500 million in written premium last

year and $505 million in earned premiums last year. According to Rejda and

McNamara (2014), ‘’ earned premiums represent the portion of the premiums for

which insurance protection has been provided’’(p.127).

3. Rock Solid's net underwriting result last year was a $540,000 loss. Explain how it

is possible that Rock Solid was required to pay income taxes.

The income tax is not calculated based on underwriting profit but rather on operating

income. The Rock Solid Company can lose money on underwriting operations but

still gain profit if the investment income offsets the underwriting loss. Therefore, it is

possible for the company to pay the income taxes regardless the net underwriting loss.
4. Rock Solid provides collision coverage for one year on 50,000 autos located in a

specific territory within the state. During the one-year period, the company

expects to pay $10 million in incurred losses and loss-adjustment expenses for

these 50,000 autos. Based on this information, what is the pure premium?
According to Rejda and McNamara (2014), ‘’ the pure premium refers to that portion

of the rate needed to pay losses and loss –adjustment expenses’’ (p. 132). In order to

calculate the pure premium I will use the following formula:

Pure premium= incurred losses and loss adjustment expenses / number of exposure

units= $10 million/50,000 autos=$200

5. The pure premium per unit of personal liability insurance for one group of

prospective purchasers is $300. If Rock Solid wants to allow for a 40 percent

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expense ratio for this line of coverage, what gross rate per unit of coverage

should be charged?
In order to calculate the gross rate I will use the following formula:
Gross rate= pure premium / 1- expense ratio= $300/ (1-0.40) =$500

References

Rejfa, E., McNamara, J. (2014). Principles of Risk Management and Insurance (12th edition).

Pearson Education, NJ: Upper Saddle River.

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