June 21st, 2012

Alternative Risk Transfer

Posted at 1:00 AM ET

Here we review GC Capital Ideas’ recent series on alternative risk transfer.

Alternative Risk Transfer: Part I, Adverse Development Cover, Aggregate Stop Loss:  Alternative risk solutions are used to address the following client motivations: rating agency issues, adverse development, earnings stability, reserve and premium leverage issues, reinsurance recoverables, terrorism risk, capital optimization constraints, mergers and acquisitions, discontinued lines of business, provide coverage for gaps in traditional placements and optimizing costs. The structured risk team designs customized solutions to achieve a particular client’s goals. An optimal reinsurance structure is determined by capacity needs, risk tolerances, capital management, cost of risk and degree of confidence in results. A cedent will need to balance the cost of transferring sources of risk with not only its own capital management strategies but also capital requirements imposed by rating agencies.

Alternative Risk Transfer: Part II, BCAR Impact, Quota Share and Working Layer Excess of Loss Covers: Purchasing an aggregate stop loss provides a positive impact to the BCAR score by decreasing the capital charge. In year one, the benefit of the purchase is applied to the premium risk charge for the current accident year with benefit to the reserve risk charge in future years. In the first year, the accident year stop loss may reduce the premium risk charge significantly. The biggest reduction in the premium risk charge will occur when the stop loss provides protection between A.M. Best’s estimate of the expected loss ratio and 35 percent to 45 percent above that estimate. The decrease in the capital factor is equal to the limit purchased net of the AP that must be paid in the event of a loss. Surplus is reduced by the after-tax margin paid. For the second year, the reduction in capital charge is applied against the loss reserves. This reduces the benefit in the second year from that achieved in the first year, as the reserves are net of loss payments made in year one.

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