BU353 Lecture Notes - Lecture 8: Reinsurance Treaty, Enterprise Risk Management, Reinsurance
Chapter 8: Insurance Companies: Financial Structure and Legal Environment
Insurance companies are institutions that economize on the contracting costs associated with pooling
arrangements, including distribution, underwriting, and loss adjustment expenses.
Economic Capital – the difference between the market value of assets and the market value of liabilities
The most common form of policyholder-owned insurer is called a mutual insurer. They are
incorporated insurance companies that usually charge fixed, advance premiums to policyholders.
Another type of insurer with policy ownership is called a reciprocal; these are not incorporated, but
instead managed by an attorney in fact (a management company).
Limited Liability – maximum loss limited to amount of money invested
Lloyd’s of London is not an insurance company but instead an organization that provides a set of rules
and procedures under which insurance business is transacted.
Specific Assets – when assets have greater value to one firm than to other firms
Franchise Value – alue of a fir’s speifi assets
Agency Cost – the redutio i fir alue due to aagers ot atig i the stokholders’ iterest
Underwriting Risk – the risk that average claim costs will differ from the amount expected when policies
are sold; can be reduced by selling large numbers of policies across different types of insurance
coverage in different areas
Reinsurance – the purchase of insurance by an insurer
- insurers can transfer underwriting risk by purchasing reinsurance
- the reinsurance contract specifies the conditions under which the reinsurer will pay some of the
uyer’s lai osts ad the aout that the reisurer ill pay; the uyer pays the reisurer a preiu
Reinsurance arrangements can be categorized as either proportional reinsurance (pro-rata insurance)
or excess-of-loss contracts (non-proportional reinsurance). A reinsurance treaty covers multiple policies
written by the ceding insurer. In contrast, with facultative reinsurance, the reinsurer evaluates each
risk (policy) that the primary insurer would like to cede and decides whether to accept it on a case-by-
case basis. Both treaty reinsurance and facultative reinsurance can use either proportional or
excess-of-loss contracts.
Enterprise Risk Management (ERM) – the process of coordinated risk management that manages the
orgaizatio’s full rage of risks as a hole; this allows for a continuous recognition of the array of risks
facing an organization which leads to well-defined strategic action
Additional capital reduces the probability of insolvency, but also is costly. Investors require
compensation for (1) any additional risk arising from the negative correlation between insurer liabilities
ad iestors’ other assets, 2 agey osts, ad (3) issuance and underpriced costs.
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Document Summary
Chapter 8: insurance companies: financial structure and legal environment. Insurance companies are institutions that economize on the contracting costs associated with pooling arrangements, including distribution, underwriting, and loss adjustment expenses. Economic capital the difference between the market value of assets and the market value of liabilities. The most common form of policyholder-owned insurer is called a mutual insurer. They are incorporated insurance companies that usually charge fixed, advance premiums to policyholders. Another type of insurer with policy ownership is called a reciprocal; these are not incorporated, but instead managed by an attorney in fact (a management company). Limited liability maximum loss limited to amount of money invested. Lloyd"s of london is not an insurance company but instead an organization that provides a set of rules and procedures under which insurance business is transacted. Specific assets when assets have greater value to one firm than to other firms. Franchise value (cid:448)alue of a fir(cid:373)"s spe(cid:272)ifi(cid:272) assets.
