Portfolio Management, Capacity and Reinsurance

Introduction

Insurance underwriting is not only the assessment of individual risks. An insurer must also manage the composition of its entire portfolio. A portfolio may contain thousands of individually acceptable policies and still be financially dangerous if exposures are concentrated in one location, peril, industry, class of business, or group of related policyholders. Portfolio management therefore connects underwriting decisions with capital, solvency, reinsurance, claims volatility, and long-term strategy.

The central strategic problem is to accept sufficient risk to earn an adequate return while preserving the capacity to pay claims under adverse circumstances. This requires decisions about risk appetite, diversification, aggregate limits, catastrophe exposure, underwriting cycles, and reinsurance. Reinsurance enables an insurer to transfer part of its assumed risk to another insurer or reinsurer, thereby increasing effective capacity and controlling volatility. It does not, however, eliminate risk: it introduces counterparty, basis, contractual, liquidity, and execution risks.

This chapter examines the main tools used to manage insurance portfolios and explains how facultative and treaty reinsurance, together with proportional and non-proportional structures, influence capacity and financial results.

Learning Objectives

By the end of this chapter, students should be able to:

1. Explain portfolio management, concentration, diversification, capacity, and risk appetite.
2. Distinguish accumulation risk from ordinary individual-risk exposure.
3. Explain catastrophe exposure, aggregate limits, and the management of correlated losses.
4. Describe underwriting cycles and their implications for portfolio strategy.
5. Distinguish facultative from treaty reinsurance.
6. Compare proportional and non-proportional reinsurance structures.
7. Calculate basic retention, ceded premium, loss recovery, and aggregate exposure measures.
8. Evaluate the strategic, financial, governance, and operational consequences of reinsurance decisions.

1. Portfolio Management in Insurance

1.1 Meaning and purpose

An insurance portfolio is the collection of policies, insured values, limits, deductibles, terms, locations, classes, and counterparties managed by an insurer. Portfolio management is the systematic process of selecting, pricing, monitoring, diversifying, limiting, and transferring these exposures.

Individual underwriting asks: “Is this risk acceptable, and at what price?” Portfolio management asks additional questions:

• How does this risk change the insurer’s total exposure?
• Is the risk correlated with existing policies?
• How much capital and reinsurance capacity does it consume?
• Does it fit the insurer’s strategy and risk appetite?
• What could happen under a severe but plausible event?

The objective is not necessarily to minimize risk. An insurer that avoids all risk cannot generate premium income. The objective is to create a portfolio whose expected return is appropriate for its risk, capital, liquidity, and regulatory constraints.

1.2 Portfolio dimensions

A portfolio should be analyzed across several dimensions:

A sound portfolio information system must identify these dimensions consistently. Poor data classification can make apparent diversification misleading. For example, ten subsidiaries may appear to be separate insureds even though they are controlled by one parent company.

2. Concentration, Diversification and Correlation

2.1 Concentration risk

Concentration risk arises when a relatively large proportion of an insurer’s potential loss is linked to a common factor. The common factor may be physical, economic, legal, operational, or contractual.

Concentration is not measured only by the number of policies. A portfolio of 10,000 policies may be highly concentrated if all properties are in one flood zone. Conversely, a smaller portfolio may be diversified if risks differ by geography, peril, industry, and loss drivers.

Useful concentration indicators include:

• largest exposure as a percentage of available capital;
• largest geographic zone as a percentage of total insured value;
• premium or expected loss by class of business;
• probable maximum loss by event zone;
• exposure to a single policyholder or corporate group;
• percentage of limits exposed to a single catastrophe peril.

A simple exposure concentration ratio is:

where CR_i is the concentration ratio for category i, E_i is exposure in that category, and E_T is total portfolio exposure. Exposure must be defined consistently—for example, total insured value, policy limit, expected loss, or capital requirement. The ratio is descriptive, not a complete risk measure, because it does not capture correlation or the severity distribution of losses.

2.2 Diversification

Diversification reduces dependence on any one risk source. It is most effective when exposures are not perfectly positively correlated. Diversification may occur across geography, product, customer type, peril, and claim timing.

For a portfolio with loss random variables L₁, L₂, …, L_n, total loss is:

If risks are independent, the variance of total loss is:

If risks are correlated, covariance terms must be included:

The formula assumes that the loss variables are defined over the same period and measured in compatible monetary units. Positive covariance increases portfolio volatility; negative covariance can reduce it. Catastrophe risks often have high dependence because one event can generate many claims simultaneously. Consequently, policy count alone is an unreliable measure of diversification.

A related portfolio standard-deviation expression for two risks is:

where σ₁ and σ₂ are the standard deviations of the two losses and ρ₁₂ is their correlation coefficient, with -1 ≤ ρ₁₂ ≤ 1. This is a risk-measure illustration, not a complete pricing model. Real insurance losses may be skewed, heavy-tailed, and dependent in ways not captured by a single correlation coefficient.

2.3 Diversification limits

Diversification can fail during systemic events. Examples include a financial crisis affecting many directors’ and officers’ liability policies, a supply-chain disruption affecting business interruption policies, or a cyber event affecting multiple insureds using the same software provider. Therefore, portfolio managers must supplement statistical diversification with scenario analysis and expert judgment.

3. Capacity and Risk Appetite

3.1 Capacity

Insurance capacity is the amount of risk an insurer is willing and able to accept. It has several meanings:

• Per-risk capacity: the maximum amount accepted on one risk.
• Event capacity: the maximum tolerable loss from one event.
• Aggregate capacity: the maximum loss or exposure over a defined period.
• Capital capacity: the amount supportable by available capital and solvency resources.
• Market capacity: the amount the insurer and available reinsurers can collectively support.

Capacity is constrained by capital, liquidity, regulatory requirements, underwriting expertise, claims resources, reinsurance availability, and risk appetite. A policy limit is not automatically equal to the insurer’s net exposure because deductibles, coinsurance, sublimits, and reinsurance may reduce the amount ultimately retained.

3.2 Risk appetite and risk tolerance

Risk appetite is the level and type of risk an organization is willing to pursue in achieving its objectives. Risk tolerance sets more specific boundaries around variation from objectives. A board-approved risk appetite statement may establish limits for:

• maximum net retention per risk;
• maximum catastrophe loss at selected return periods;
• acceptable solvency or capital buffer;
• maximum concentration by territory or class;
• counterparty quality for reinsurers;
• liquidity requirements after a catastrophe;
• aggregate cyber, pandemic, or climate-related exposure.

Risk appetite should be translated into underwriting authorities. Underwriters need clear referral rules, delegated limits, prohibited risks, pricing floors, accumulation controls, and escalation procedures. A limit that exists only in a board document but is not embedded in underwriting systems is not an effective control.

3.3 Gross, ceded and net exposure

Gross exposure is the amount before reinsurance. Ceded exposure is transferred to reinsurers. Net exposure is the amount retained by the insurer after applicable risk transfer.

This simplified identity assumes that the exposures are measured on a comparable basis and that the reinsurance responds fully to the exposure being measured. Actual recoveries may be limited by attachment points, exhaustion, exclusions, reinstatement terms, aggregation clauses, or reinsurer default.

4. Catastrophe Exposure and Aggregate Limits

4.1 Catastrophe risk

A catastrophe is an event or series of events producing unusually large and often correlated losses. Natural catastrophes include earthquakes, floods, hurricanes, wildfires, and severe convective storms. Man-made catastrophes include industrial accidents, terrorism, major transport losses, and large cyber events.

Catastrophe management requires analysis of:

1. hazard—the possibility of an event;
2. exposure—the people, property, activity, or limits affected;
3. vulnerability—the proportion of value likely to be damaged;
4. financial terms—deductibles, sublimits, exclusions, and policy conditions;
5. accumulation—the number and size of claims arising from one event;
6. reinsurance response—the protection available after attachment and within limits.

A catastrophe model may estimate event frequency and severity using hazard, exposure, vulnerability, and financial modules. Such models support decision-making but do not provide certainty. Model error, incomplete exposure data, changing climate conditions, and unprecedented events must be considered.

4.2 Aggregate limits

An aggregate limit is the maximum amount payable for all covered losses during a specified period or for a specified group of claims. It may apply to one policy, a portfolio segment, an event class, or a reinsurance contract.

Common forms include:

• annual aggregate limits;
• per-occurrence limits;
• occurrence caps within an aggregate;
• aggregate deductibles;
• event limits for catastrophe treaties;
• limits by territory, peril, or insured group.

An aggregate limit controls cumulative exposure but may create coverage gaps if losses develop slowly or if multiple events occur. Managers must distinguish an annual aggregate from an event limit: an annual aggregate applies across the policy period, while an event limit generally applies to one occurrence as defined by the contract.

4.3 Probable maximum loss and stress testing

Probable maximum loss (PML) is an estimate of loss from a defined severe event or return-period scenario, subject to stated assumptions. It is not a universal or legally fixed quantity. Different models may produce different PMLs because they use different event definitions, confidence levels, damage assumptions, and financial terms.

Scenario analysis should include deterministic stresses such as:

• a major earthquake affecting a concentrated city portfolio;
• a flood following a period of heavy rainfall;
• a hurricane making landfall in a high-value coastal zone;
• a cloud-service outage affecting cyber and business interruption policies;
• simultaneous claims inflation and reinsurer delays.

The analysis should report gross loss, recoveries, net loss, liquidity needs, capital impact, and operational consequences.

5. Underwriting Cycles

Insurance markets commonly experience cycles of hard and soft conditions. In a hard market, capacity is scarce, prices and deductibles tend to rise, terms become stricter, and insurers may reduce limits or withdraw from classes. In a soft market, capacity is abundant, competition increases, prices and deductibles may fall, and terms may broaden.

The cycle is influenced by catastrophe losses, investment returns, capital availability, new market entrants, inflation, regulation, reserve development, and reinsurance pricing. Underwriting cycles can cause insurers to expand aggressively during profitable soft conditions and then suffer when claims emerge or capacity contracts.

Strategic portfolio management should be cycle-aware. During soft markets, an insurer should resist inadequate pricing and uncontrolled growth, preserve underwriting discipline, and monitor deteriorating terms. During hard markets, it should distinguish sustainable opportunities from temporary price spikes and maintain service quality and claims capability.

One useful performance measure is the combined ratio:

The first fraction is commonly called the loss ratio and the second the expense ratio. Both fractions are dimensionless percentages. A combined ratio below 100% indicates an underwriting profit before investment income and other items; a ratio above 100% indicates an underwriting loss on the stated basis. Accounting definitions and treatment of expenses can vary, so comparisons require consistent reporting bases.

6. Reinsurance: Purpose and Functions

Reinsurance is an agreement under which a reinsurer assumes specified insurance risks from a ceding insurer. The insurer purchasing reinsurance is the cedent or ceding company. Reinsurance may serve several functions:

• increase underwriting capacity;
• protect capital from large individual losses;
• reduce catastrophe volatility;
• stabilize results over time;
• support entry into new lines or territories;
• facilitate portfolio restructuring;
• provide technical expertise and claims support.

Reinsurance is not simply a method of improving reported results. The cedent remains responsible to the original policyholder even if the reinsurer fails to pay. This principle is often described as the separation between the primary insurance contract and the reinsurance contract.

7. Facultative and Treaty Reinsurance

7.1 Facultative reinsurance

Facultative reinsurance is negotiated separately for an individual risk or a defined exposure. The cedent presents the risk, and the reinsurer decides whether to accept it, usually after reviewing detailed underwriting information.

Facultative reinsurance is useful for:

• unusually large or complex risks;
• risks outside the cedent’s treaty terms;
• hazardous or unusual occupancies;
• high-value property or infrastructure;
• temporary capacity needs;
• risks requiring specialist underwriting.

Its disadvantages include negotiation time, administrative cost, possible uncertainty at quotation, and the risk that capacity will not be available when required.

7.2 Treaty reinsurance

Treaty reinsurance covers a portfolio or defined class of business under pre-agreed terms. The reinsurer generally agrees to accept risks that fall within the treaty scope, and the cedent has an obligation to cede according to the contract.

Treaties provide efficiency, predictable capacity, and portfolio-level protection. They require accurate underwriting controls because an incorrectly classified or ineligible risk may create disputes. Treaty provisions commonly address covered business, territories, exclusions, limits, retention, ceding commissions, claims cooperation, reporting, premium adjustment, and commutation.

8. Proportional Reinsurance

In proportional reinsurance, the reinsurer receives an agreed share of premium and pays the same share of covered losses, subject to contract terms. The principal forms are quota share and surplus share.

8.1 Quota share

Under quota-share reinsurance, the cedent transfers a fixed percentage of each covered policy’s premium and losses.

If the quota-share percentage is q, gross premium is P, and gross loss is L, then, ignoring commissions and other adjustments:

Here 0 ≤ q ≤ 1. Quota share provides broad risk transfer and can support rapid growth, but it also cedes premium from profitable risks. It may be attractive for a new insurer that needs capital support and underwriting capacity.

8.2 Surplus share

Under surplus-share reinsurance, the cedent retains a fixed net line and cedes amounts above that retention, usually in a specified number of lines. The percentage ceded varies by policy size. It is therefore more selective than quota share and is useful where policy limits vary substantially.

Proportional treaties commonly include a ceding commission paid by the reinsurer to compensate the cedent for acquisition and administration expenses. Commission structures affect reported results and may include profit commissions, sliding scales, or loss-ratio adjustments. They should not be interpreted as risk-free income because future adjustments may depend on experience and contract terms.

9. Non-Proportional Reinsurance

Non-proportional reinsurance responds when losses exceed a specified attachment point. The reinsurer pays the amount above the attachment, up to the limit of the layer.

9.1 Per-risk excess of loss

Per-risk excess-of-loss protection covers losses from an individual risk. If the loss is L, retention is R, and treaty limit is U, the recovery, before exclusions and contractual adjustments, is:

The insurer retains the first R of loss; the reinsurer pays above R up to U. The formula assumes that the loss is measured on the treaty’s covered basis and that one risk is not improperly aggregated with another.

9.2 Catastrophe excess of loss

Catastrophe excess of loss responds to the aggregate losses from one event or occurrence. It protects against accumulation of many claims caused by the same event. A structure may be described as “amount in excess of attachment, with a stated limit.” For example, a layer of 40 million excess of 10 million covers losses above 10 million up to a further 40 million, subject to the event definition and contract wording.

9.3 Aggregate excess of loss and stop loss

Aggregate excess-of-loss protection responds when cumulative losses during a period exceed an attachment point. Stop-loss reinsurance may attach when an aggregate loss ratio exceeds a specified percentage, subject to a monetary limit.

These protections can stabilize annual results, but they may be expensive and may include exclusions, corridors, event definitions, hours clauses, and annual limits. The cedent must examine whether the protection responds to the volatility it actually faces.

9.4 Proportional and non-proportional comparison

10. Worked Applications

Example 1: Quota-share arrangement

An insurer writes a portfolio with gross earned premium of 12 million and incurs covered losses of 7.2 million. It cedes 30% under a quota-share treaty. Ignore commission and expenses.

Ceded premium:

Retained premium:

Ceded losses:

Retained losses:

The loss ratio remains unchanged because both premium and losses are transferred in the same proportion:

This does not mean the economic result is unchanged. Commission, capital relief, administrative costs, and the reinsurer’s credit quality affect the overall value of the arrangement.

Example 2: Per-risk excess of loss

A policy produces a covered loss of 18 million. The insurer retains 5 million per risk, and its per-risk excess-of-loss treaty provides 10 million of cover.

The cedent retains 8 million: the original 5 million retention plus the 3 million loss exceeding the treaty limit. If the loss were 9 million, the recovery would be 4 million and the cedent would retain 5 million. If the loss were 4 million, recovery would be zero.

Example 3: Concentration measure

An insurer has total property exposure of 500 million, of which 140 million is located in one coastal zone. The zone concentration ratio is:

The ratio signals concentration, but it does not by itself show whether the exposure is unacceptable. Management must compare it with risk appetite, hazard quality, deductibles, catastrophe-model results, reinsurance protection, and available capital.

11. Applied Case: Coastal Property Portfolio

This is an illustrative case.

Background

HarborShield Insurance writes commercial property in a rapidly growing coastal region. Over three years, gross written premium increased from 80 million to 150 million. Management attributes the growth to strong broker relationships and attractive market pricing. However, 62% of insured values are within one coastal catastrophe zone, and several industrial parks contain multiple policies insured by related companies.

Problem

The portfolio appears profitable under ordinary claims experience, but catastrophe analysis indicates that a severe windstorm could generate gross losses of 220 million. The insurer’s board-approved risk appetite permits a net catastrophe loss of no more than 75 million at the selected stress level. Existing reinsurance consists mainly of a quota-share treaty that cedes 25% of premium and losses. It provides capacity but does not adequately control the remaining event accumulation.

Analysis

The quota-share recovery on the stressed loss would be:

The estimated net loss before additional protection would therefore be:

This exceeds the 75 million appetite by 90 million. Moreover, the analysis may be optimistic if related insureds are aggregated incorrectly or if business interruption claims develop beyond initial estimates.

Approach and solution

Management adopts a combined strategy:

1. improve location and corporate-group data;
2. impose sublimits and deductibles in the highest-risk zones;
3. stop accepting new exposure in the most concentrated coastal segment until capacity is reviewed;
4. purchase catastrophe excess-of-loss protection designed to respond to event accumulation;
5. retain a facultative option for exceptionally large industrial risks;
6. test reinsurer security, collateral, claims-payment ability, and contract wording;
7. revise pricing to reflect updated hazard and reinsurance costs;
8. report gross, ceded, and net PML to the board quarterly.

Suppose the new catastrophe layer produces a recovery of 95 million on the modeled event, after the quota-share recovery. The net loss becomes:

The result falls within the 75 million stated appetite, subject to the assumptions and terms of the contracts. The insurer also reduces new coastal accumulation, so the protection is not used as a substitute for underwriting discipline.

Outcome

The revised program lowers net catastrophe exposure and improves capacity for diversified inland business. However, premium growth slows, reinsurance expense increases, and underwriting staff must monitor accumulation more frequently. The board accepts the trade-off because the revised portfolio is more resilient and aligned with capital objectives.

Learning points

• Capacity should be evaluated on a net and gross basis.
• Quota share alone may not protect against severe accumulation.
• Data quality is a prerequisite for effective catastrophe management.
• Reinsurance must be matched to the loss mechanism: per-risk protection is not a substitute for event protection.
• Portfolio controls, pricing, and reinsurance should operate together.

12. Governance, Regulation and Ethics

Portfolio and reinsurance decisions are subject to governance obligations. Senior management and boards should approve risk appetite, delegated authority, reinsurance strategy, counterparty standards, and stress scenarios. Internal audit and risk functions should test compliance rather than merely review written policies.

Regulatory concerns commonly include solvency capital, concentration limits, asset and liability matching, reinsurance recoverables, contract certainty, claims-paying ability, and reporting accuracy. Reinsurance recoverables may be subject to capital charges or admissibility rules. A nominal transfer of risk may provide limited capital benefit if the contract contains restrictive terms or if the reinsurer is weak.

Ethical underwriting requires fair treatment of policyholders, transparent communication of exclusions and limits, responsible use of data, and avoidance of discriminatory practices. Portfolio withdrawal decisions can affect vulnerable communities. Climate-related risk may justify revised pricing or limits, but insurers should consider transition strategies, resilience incentives, and clear explanations rather than opaque exclusion.

Reinsurance placement also presents conflicts of interest. Brokers and intermediaries should disclose remuneration and material relationships. Employees should not select reinsurers solely on commission or short-term accounting effects. Contract certainty is an ethical and operational requirement: ambiguous wording can create disputes precisely when policyholders need protection.

13. Technology, Data and Artificial Intelligence

Modern portfolio management uses geospatial data, exposure databases, catastrophe models, dashboards, predictive analytics, and automated referral rules. Artificial intelligence can assist with data classification, anomaly detection, accumulation mapping, document review, and claims forecasting. It should support—not replace—professional judgment and governance.

Important controls include:

• documented data definitions and lineage;
• validation of geocodes, limits, occupancy, and corporate relationships;
• monitoring for model drift;
• explainability for material underwriting decisions;
• human review of unusual or high-impact risks;
• cybersecurity and access controls;
• testing for unfair or unstable outcomes;
• independent validation of catastrophe and pricing models.

Technology can create false confidence. A sophisticated model using incomplete exposure data may be less reliable than a simpler model with disciplined data governance. Managers should communicate uncertainty and use multiple scenarios where model risk is material.

14. Best-Practice Framework

A practical portfolio and reinsurance framework should include the following sequence:

1. Define objectives: connect growth, profitability, solvency, liquidity, and service goals.
2. Classify exposures: use consistent geographic, peril, industry, group, and policy-limit data.
3. Measure accumulation: examine gross limits, expected losses, PML, aggregates, and correlations.
4. Set controls: establish underwriting authorities, referral rules, deductibles, sublimits, and aggregate caps.
5. Assess capital: compare net stress losses with available capital and risk appetite.
6. Select reinsurance: match facultative or treaty protection and proportional or non-proportional structure to the risk.
7. Evaluate counterparties: consider financial strength, diversification, collateral, jurisdiction, and claims reputation.
8. Test wording: confirm event definitions, hours clauses, exclusions, reinstatements, aggregation, and claims provisions.
9. Monitor performance: review loss ratios, combined ratios, concentration, recoverables, and actual versus modeled losses.
10. Review continuously: update assumptions for inflation, climate, emerging risks, legal change, and underwriting-cycle conditions.

Challenges and Limitations

Portfolio management faces several limitations. Exposure data may be incomplete, inconsistent, or outdated. Correlations can change during crises. Catastrophe models contain parameter and structural uncertainty. Reinsurance contracts may respond differently from simplified financial illustrations. Capacity can disappear during a hard market, while cheap capacity can encourage excessive growth during a soft market. Finally, risk appetite may be weakened by sales incentives or pressure to meet short-term targets.

These limitations make judgment, scenario testing, documentation, and governance essential. No single metric—policy count, premium volume, concentration ratio, PML, or combined ratio—adequately represents portfolio quality.

Chapter Summary

Portfolio management extends underwriting analysis from individual policies to the insurer’s total exposure. Concentration may arise through geography, peril, industry, corporate ownership, distribution channels, or correlated claims. Diversification can reduce volatility, but correlation and systemic events can undermine its benefits.

Capacity is constrained by capital, liquidity, expertise, regulation, reinsurance, and risk appetite. Gross, ceded, and net exposures must be distinguished. Catastrophe management requires accumulation analysis, aggregate limits, scenario testing, and careful interpretation of PML estimates.

Underwriting cycles influence pricing, terms, capacity, and strategic behavior. Reinsurance increases capacity and can stabilize results, but it introduces counterparty and contractual risks. Facultative reinsurance is individually negotiated and flexible; treaty reinsurance covers a defined portfolio. Proportional reinsurance transfers premium and losses by an agreed share, while non-proportional reinsurance responds above an attachment point or aggregate threshold.

Effective practice combines disciplined underwriting, accurate data, appropriate limits, capital analysis, well-designed reinsurance, counterparty assessment, contract certainty, and continuing governance. Reinsurance should complement—not replace—portfolio diversification and sound risk selection.

Key Terms

Portfolio management: The process of selecting, monitoring, diversifying, limiting, and transferring an insurer’s total exposures.

Concentration risk: The risk of excessive exposure to a common factor or source of loss.

Diversification: The reduction of portfolio dependence achieved by combining less-than-perfectly correlated risks.

Correlation: The statistical association between two risk variables.

Capacity: The amount of risk an insurer is willing and able to accept.

Risk appetite: The level and type of risk an organization is prepared to pursue.

Risk tolerance: Specific boundaries for acceptable variation around objectives.

Accumulation: The aggregation of exposures that may be affected by one event or common cause.

Catastrophe risk: The possibility of an unusually severe, correlated loss event.

Aggregate limit: The maximum payable amount over a specified period or group of claims.

PML: An estimate of loss from a defined severe event under stated assumptions.

Reinsurance: Risk transfer from a cedent to a reinsurer.

Cedent: The insurer transferring risk to a reinsurer.

Facultative reinsurance: Individually negotiated reinsurance for a particular risk.

Treaty reinsurance: Reinsurance covering a defined portfolio under pre-agreed terms.

Quota share: Proportional reinsurance transferring a fixed percentage of premium and losses.

Excess of loss: Non-proportional reinsurance responding above a specified retention.

Attachment point: The loss level above which non-proportional reinsurance begins to respond.

Retention: The portion of risk or loss kept by the cedent.

Combined ratio: Loss ratio plus expense ratio, used to assess underwriting performance.

Review Questions

Short Answer Questions

1. Why can a portfolio with many policies still be highly concentrated?
2. Distinguish gross exposure, ceded exposure, and net exposure.
3. What is the difference between facultative and treaty reinsurance?
4. What is an aggregate limit, and how does it differ from a per-occurrence limit?
5. Why might quota-share reinsurance be attractive to a growing insurer?

Long Answer Questions

1. Explain how correlation affects diversification and catastrophe exposure. Include the limitations of relying only on policy counts.
2. Compare proportional and non-proportional reinsurance in terms of pricing, loss response, capacity, and risk transfer.
3. Discuss how risk appetite should be translated into underwriting authorities and portfolio controls.
4. Explain underwriting cycles and recommend strategies for managing a portfolio during soft and hard markets.
5. Evaluate the governance, ethical, and regulatory issues involved in selecting and managing reinsurance.

Analytical / Application Questions

1. An insurer has gross catastrophe exposure of 300 million and a 25% quota-share treaty. It also purchases event excess-of-loss protection that recovers 100 million on the modeled event. Calculate the net modeled loss and explain the assumptions required.
2. A portfolio has 45% of its insured value in one earthquake zone, but the policies are spread among 2,000 insureds. Analyze whether the portfolio is diversified and identify additional information required for a decision.
3. A per-risk excess-of-loss treaty has a retention of 8 million and a limit of 15 million. Determine the recovery and cedent retention for a covered loss of 30 million, then explain how the result would change if the loss were caused by a catastrophe affecting multiple risks.

Multiple Choice Questions with Answers

Question 1

Which situation best illustrates concentration risk?

A. Policies are distributed across unrelated territories and perils

B. Many properties are insured in the same flood zone

C. Premium is collected through several brokers

D. Claims are settled at different times

Correct Answer: B. Many properties are insured in the same flood zone

Question 2

If two loss variables have positive covariance, what is its usual effect on total portfolio variance?

A. It increases total variance

B. It always reduces total variance

C. It has no effect on total variance

D. It makes total losses zero

Correct Answer: A. It increases total variance

Question 3

Which reinsurance arrangement is negotiated separately for an individual large industrial risk?

A. Quota share treaty

B. Aggregate stop loss

C. Facultative reinsurance

D. Catastrophe treaty

Correct Answer: C. Facultative reinsurance

Question 4

Under a 30% quota-share arrangement, what percentage of covered premium is retained by the cedent, ignoring adjustments?

A. 30%

B. 50%

C. 70%

D. 130%

Correct Answer: C. 70%

Question 5

A loss is 18 million, retention is 5 million, and excess-of-loss limit is 10 million. What is the recovery?

A. 5 million

B. 8 million

C. 10 million

D. 13 million

Correct Answer: C. 10 million

Question 6

What is the principal purpose of catastrophe excess-of-loss reinsurance?

A. To transfer a fixed share of every policy’s premium

B. To protect against accumulated losses from one event

C. To eliminate all underwriting expenses

D. To guarantee investment income

Correct Answer: B. To protect against accumulated losses from one event

Question 7

What generally characterizes a hard insurance market?

A. Abundant capacity and falling deductibles

B. Scarce capacity and firmer pricing

C. No reinsurance availability

D. Automatic reduction in catastrophe exposure

Correct Answer: B. Scarce capacity and firmer pricing

Question 8

Which statement about an aggregate limit is correct?

A. It applies only to the first claim

B. It sets a maximum payable amount over a defined period or claim group

C. It always equals the policy premium

D. It eliminates the need for deductibles

Correct Answer: B. It sets a maximum payable amount over a defined period or claim group

Question 9

A quota-share treaty transfers 25% of a 200 million covered loss. What is the ceded loss?

A. 25 million

B. 40 million

C. 50 million

D. 175 million

Correct Answer: C. 50 million

Question 10

Why must a cedent assess reinsurer credit quality?

A. The reinsurer becomes the original policyholder

B. The cedent remains responsible to the policyholder if the reinsurer fails

C. Credit quality determines the policy deductible

D. It guarantees that no catastrophe will occur

Correct Answer: B. The cedent remains responsible to the policyholder if the reinsurer fails