9. Reinsurance, Capital, and Enterprise Risk Management

Introduction and Context

Insurance is founded on risk pooling, but no insurer can pool every risk without limit. A portfolio may contain unusually large individual exposures, geographically concentrated property, correlated mortality or morbidity risks, and events capable of producing losses far beyond normal annual expectations. Reinsurance enables insurers to transfer part of these risks to other risk-bearing institutions. It is therefore more than a mechanism for reducing claims volatility: it is an instrument of capital management, capacity creation, underwriting discipline, solvency protection, and strategic growth.

The importance of reinsurance becomes clearer when it is considered alongside enterprise risk management (ERM). An insurer must decide how much risk it wishes to retain, how much capital is required to support that risk, how assets should be invested against liabilities, and how management will respond to severe but plausible events. These decisions are interdependent. A reinsurance programme that lowers underwriting risk may create counterparty, basis, liquidity, or operational risk. Capital that appears adequate under expected conditions may prove insufficient under catastrophe, market, lapse, inflation, or pandemic stress. ERM provides the governance framework within which these trade-offs are identified and managed.

For a postgraduate insurance manager, the central question is not simply whether reinsurance is available. It is whether the proposed arrangement produces an acceptable relationship among risk reduction, cost, capital relief, liquidity, operational complexity, and strategic objectives.

Learning Objectives

After studying this chapter, the learner should be able to:

1. Distinguish facultative from treaty reinsurance and proportional from non-proportional arrangements.

2. Explain retention, capacity, limits, attachment points, reinstatements, and other programme features.

3. Design reinsurance protection for individual, accumulation, catastrophe, mortality, morbidity, and longevity risks.

4. Assess accumulation, concentration, basis, liquidity, and counterparty risks.

5. Relate reinsurance decisions to solvency capital, economic capital, capital allocation, and risk appetite.

6. Explain asset-liability management, stress testing, scenario analysis, and reverse stress testing.

7. Evaluate governance, regulatory, ethical, technological, and strategic issues in ERM.

Reinsurance as Risk Transfer and Capital Architecture

Reinsurance is an agreement under which a reinsurer accepts some insurance risk assumed by a primary insurer, known as the cedent. The cedent remains responsible to its policyholders even when the relevant risk has been reinsured. This principle is important: reinsurance normally does not transfer the primary insurer’s contractual obligation to the insured.

The cedent pays a premium, and the reinsurer provides indemnity according to the contract. The arrangement may cover a defined class of policies, a particular large risk, or a portfolio of losses arising from a specified event. Reinsurance can smooth results, protect surplus, support underwriting capacity, improve access to expertise, and reduce the capital needed for retained risks. However, the benefit is not free. Reinsurance premiums, brokerage, collateral requirements, reinstatement costs, information demands, and contract disputes all affect its value.

The economic value of reinsurance may be represented conceptually as:

Net value = reduction in expected financial distress and capital cost + strategic capacity benefits − reinsurance premium − transaction and collateral costs − residual risks.

This is not a mechanical accounting formula. It reminds management that the cheapest premium is not necessarily the most effective programme. A contract with a low price may have a high attachment point, narrow event definition, weak counterparty, unsuitable exclusions, or inadequate limits.

Facultative and Treaty Reinsurance

Facultative reinsurance is negotiated separately for an individual risk or a defined small group of risks. It is suitable when an exposure is unusually large, technically complex, hazardous, or outside the normal underwriting authority of the cedent. The reinsurer evaluates the risk before accepting it. Facultative cover gives precision, but it may be slow, administratively demanding, and uncertain at the point of placement.

Treaty reinsurance applies automatically to risks falling within agreed terms. The reinsurer usually accepts the defined portfolio without separately approving each policy. Treaty arrangements provide speed, continuity, and operational efficiency, but the cedent must manage the portfolio carefully because the reinsurer is exposed to the quality of the cedent’s underwriting and claims practices.

Treaties may be obligatory, facultative-obligatory, or subject to specified reporting and acceptance provisions. Contract wording should clarify covered business, exclusions, underwriting standards, claims cooperation, data requirements, commutation, termination, and dispute resolution.

Proportional Reinsurance

Under proportional reinsurance, premiums and losses are shared according to an agreed proportion or formula. The principal forms are quota share and surplus share.

In quota-share reinsurance, the reinsurer accepts a fixed percentage of each covered policy and receives the same percentage of premium, subject to contract terms. If the reinsurer takes 40 per cent, it generally pays 40 per cent of covered claims and receives 40 per cent of premiums. Quota share is useful for new or rapidly growing lines, where the cedent seeks capacity, underwriting support, or balance-sheet relief. Its weakness is that it cedes part of profitable as well as unprofitable business.

In surplus-share reinsurance, the cedent retains a fixed amount, called a line, and cedes the amount above that retention up to the treaty capacity. It is more selective than quota share and is particularly useful when policy sizes vary significantly. A policy of modest size may be retained entirely, while a large policy is shared with the reinsurer.

Proportional arrangements may include commissions paid by the reinsurer to compensate the cedent for acquisition and administration costs. Sliding-scale commissions may vary with the loss ratio, aligning remuneration more closely with portfolio performance. The cedent must nevertheless guard against moral hazard, weak underwriting incentives, and dependence on commission income.

Non-Proportional Reinsurance

Non-proportional reinsurance responds when losses exceed a specified threshold. The cedent retains losses up to the attachment point, and the reinsurer pays losses above that point, subject to a limit. The conventional notation “10 million excess of 5 million” means that the reinsurer covers up to 10 million of loss above the cedent’s 5 million retention.

Per-risk excess-of-loss cover protects against a severe loss arising from one insured risk. It is appropriate for large property, engineering, marine, liability, or individual life exposures. Per-occurrence or catastrophe excess-of-loss cover responds to the aggregation of losses from one event, such as a cyclone, earthquake, flood, industrial accident, or pandemic-related event, depending on the wording.

Aggregate excess-of-loss cover responds when total losses during a defined period exceed an annual attachment point. It protects the income statement from frequency deterioration, whereas catastrophe excess-of-loss primarily protects against event severity. Stop-loss reinsurance is a form of aggregate protection based on the loss ratio or total loss amount and may be useful for volatile health, crop, or motor portfolios.

Non-proportional reinsurance requires careful definition of event, loss occurrence, claims series, hours clauses, franchise deductibles, exclusions, reinstatements, and claims aggregation. Ambiguous wording can undermine protection precisely when it is most needed.

Designing a Reinsurance Programme

Reinsurance design begins with the insurer’s risk profile rather than with a standard market product. Management should examine policy limits, sums insured, claims distributions, geographic location, construction characteristics, peril correlations, policy conditions, inflation sensitivity, and historical as well as modelled losses.

Retention and Capacity

Retention is the amount of risk the cedent deliberately keeps. It may be expressed per risk, per event, per policy, per person, or for an annual aggregate. A rational retention reflects surplus, earnings volatility, risk appetite, claims-paying resources, diversification, and the cost of transferring risk.

A retention that is too low can make reinsurance uneconomic and create dependence on external capacity. A retention that is too high can expose capital to unacceptable volatility. Retention should also be tested against net retained loss, not merely the gross policy limit. A life insurer, for example, may retain ordinary mortality risk but seek protection against a concentration of deaths from one event. A health insurer may retain ordinary claims frequency while purchasing protection for epidemic or high-cost claimant accumulation.

Capacity is the maximum amount available under a treaty or layer. Layering divides protection into bands, often placing different layers with different reinsurers. The arrangement may combine a working layer for frequent medium-sized losses, a catastrophe layer for extreme events, and an aggregate cover for annual volatility.

Catastrophe Protection and Accumulation

Catastrophe protection requires more than examining individual policy limits. The insurer must identify accumulations: multiple insured exposures that may be affected by the same peril, location, infrastructure, supplier, employer, hospital, or event. Examples include life policies held by employees of one company, health policies covering members of one institution, properties within one floodplain, or motor policies concentrated in one metropolitan area.

Accumulation analysis uses exposure databases, geocoding, hazard maps, catastrophe models, scenario analysis, and policy-linkage data. A sound programme considers both known accumulations and unknown correlations. Catastrophe limits should be compared with probable maximum loss, modelled tail events, stress scenarios, reinstatement needs, and available liquidity.

Catastrophe contracts may use indemnity triggers, industry-loss triggers, parametric triggers, or modelled-loss triggers. Indemnity cover responds to the cedent’s actual loss but requires claims adjustment. Parametric cover responds to a measurable event parameter, such as wind speed or earthquake intensity, and may pay quickly, but it introduces basis risk: the payment may not match the cedent’s actual loss.

Reinsurance in Life and Health Insurance

In life insurance, common arrangements include yearly renewable term reinsurance, coinsurance, risk premium reinsurance, financial reinsurance, mortality catastrophe cover, and longevity reinsurance. Mortality catastrophe cover may protect against an unusual concentration of deaths, while longevity reinsurance transfers some risk that annuitants live longer than expected. Health reinsurance may address individual high-cost claims, aggregate medical inflation, epidemic events, provider concentration, and portfolio loss ratios.

The insurer should distinguish biometric risk from financial or behavioural risks. Reinsurance may cover mortality but not necessarily lapse, expense, interest-rate, inflation, or policyholder-option risk. Contract terms must address underwriting evidence, claim definitions, exclusions, pre-existing conditions, recoveries, data quality, and changes in medical practice.

Capital, Solvency, and Risk Appetite

Solvency means the insurer has sufficient financial resources to meet obligations as they fall due, including under adverse conditions. Regulatory capital is determined under the applicable supervisory framework and may include prescribed factors, standard formulae, approved internal models, or combinations of these. Economic capital estimates the capital required for the insurer’s own risk profile at a selected confidence level and time horizon.

The solvency position is commonly expressed conceptually as:

Solvency ratio = eligible own funds / required capital.

A high ratio does not automatically indicate superior management. Excess capital may imply inefficient deployment, while a low ratio may indicate unacceptable vulnerability. The quality, permanence, and loss-absorbing capacity of capital are as important as its quantity.

Risk appetite describes the aggregate amount and type of risk an organization is willing to accept in pursuit of its objectives. Risk tolerances translate appetite into measurable boundaries, such as maximum catastrophe loss, minimum solvency ratio, counterparty exposure limits, liquidity coverage, lapse sensitivity, or concentration thresholds. Reinsurance purchasing should be consistent with these boundaries. It should not be used to conceal an underwriting strategy that is fundamentally outside the organization’s appetite.

Capital allocation assigns capital to products, lines, business units, or distribution channels. Allocated capital supports pricing, performance measurement, growth decisions, and risk-adjusted remuneration. Allocation is difficult because risks are correlated and diversification benefits are not additive. A business unit may appear unattractive on a standalone basis but contribute valuable diversification to the group.

Risk-adjusted measures such as return on risk-adjusted capital compare economic profit with the capital consumed. They should be interpreted cautiously because results depend on model assumptions, allocation methods, reinsurance costs, and treatment of diversification.

Enterprise Risk Management Framework

ERM integrates strategic, insurance, market, credit, liquidity, operational, legal, conduct, cyber, and emerging risks. Its purpose is not to eliminate uncertainty but to ensure that risks are understood, owned, measured, monitored, and managed in relation to objectives.

A practical ERM cycle contains the following connected activities:

• establish governance, strategy, and risk appetite;
• identify and classify material risks;
• assess likelihood, severity, correlation, and velocity;
• select controls, mitigations, and risk transfer;
• monitor indicators, limits, capital, and emerging conditions;
• report to management and the board;
• review outcomes and improve the framework.

The board sets tone and approves strategy and appetite. Senior management implements the framework. The risk function provides challenge and aggregation, while underwriting, actuarial, investment, claims, finance, compliance, and technology functions own risks within their areas. Internal audit independently evaluates governance and control effectiveness.

The three-lines model is useful but should not become a substitute for accountability. The first line owns and manages risk; the second line establishes frameworks and challenges decisions; the third line provides independent assurance.

Asset-Liability Management and Stress Testing

Asset-liability management (ALM) coordinates investment decisions with the timing, currency, duration, liquidity, guarantees, and optionality of insurance liabilities. Life insurers with long-term guarantees may be highly sensitive to interest rates, reinvestment conditions, inflation, mortality improvement, and policyholder behaviour. General insurers must consider claims development, catastrophe liquidity, inflation, and the shorter but uncertain duration of claims liabilities.

ALM involves cash-flow projection, duration and convexity analysis, duration matching, liquidity planning, currency matching, scenario analysis, and governance of investment limits. A liability-driven investment strategy does not mean that every asset must exactly match every liability; it means that asset risk is evaluated against the liability profile and capital resources.

Stress testing examines the effect of adverse but plausible changes. Scenarios may include a severe storm, pandemic mortality, medical inflation, rapid interest-rate movement, equity decline, mass lapse, reinsurer default, operational outage, cyberattack, or simultaneous events. Reverse stress testing begins with an undesirable outcome—such as breach of the minimum solvency threshold—and asks what combination of events could produce it.

Scenario analysis is especially valuable where historical data are inadequate. Models should not create false precision. Management judgment, qualitative narratives, expert review, and model validation remain essential.

Counterparty, Basis, Liquidity, and Operational Risk

Reinsurance replaces some underwriting risk with counterparty risk. A reinsurer may delay payment, dispute coverage, become insolvent, or be affected by the same catastrophe as the cedent. Counterparty assessment should consider financial strength, jurisdiction, collateral, diversification, claims-paying record, concentration, contract enforceability, and recoverables ageing.

Collateral may include funds withheld, trust arrangements, letters of credit, or other security. Collateral reduces credit exposure but can introduce legal, valuation, liquidity, and operational risks. The cedent should not rely solely on external ratings; ratings are useful inputs but do not replace internal due diligence.

Basis risk arises when the protection trigger does not closely track the cedent’s actual loss. It is central to parametric and industry-loss covers, but it can also arise from differences in definitions, geographical scope, exclusions, attachment calculations, or claims development.

Liquidity risk occurs when the insurer cannot meet payments when due, even though it may be solvent on a balance-sheet basis. Catastrophe claims, collateral calls, premium payments, and delayed recoveries can create acute liquidity pressure. Reinsurance recoverables should not automatically be treated as immediately available cash.

Operational risk includes errors in bordereaux, inadequate data, missed reporting deadlines, contract misinterpretation, weak claims documentation, system failures, and poor segregation of duties. Contract certainty before coverage begins is a basic but important control.

Governance, Ethics, and Regulation

Reinsurance governance requires clear authority for programme design, documented placement decisions, independent review, and board visibility over material exposures. The insurer should document why a layer exists, how limits were selected, what assumptions were used, and how the programme performs under stress.

Ethical concerns arise where reinsurance is used to obscure financial weakness, manipulate reported earnings, transfer risk without genuine substance, or create misleading impressions of solvency. Financial reinsurance and complex structured transactions require especially careful analysis of risk transfer, accounting treatment, disclosure, and regulatory expectations.

The insurer owes duties to policyholders, shareholders, regulators, employees, and wider society. Excessive reliance on opaque models or low-quality counterparties may appear efficient in the short term but can undermine claims-paying capacity. Fair treatment also requires that exclusions, limits, and trigger conditions be understood and applied consistently.

Regulatory regimes commonly require capital adequacy, governance, risk management, reporting, reinsurance documentation, and controls over related-party or concentrated exposures. Exact requirements vary by jurisdiction; managers must therefore interpret this chapter alongside applicable law and supervisory guidance.

Technology, Analytics, and Emerging Developments

Modern reinsurance management depends on integrated exposure, policy, claims, finance, and investment data. Catastrophe models estimate loss distributions by combining hazard, exposure, vulnerability, and financial terms. Actuarial models support pricing, reserving, capital estimation, mortality and lapse analysis, and scenario testing.

Artificial intelligence and machine learning can assist in claims triage, anomaly detection, exposure classification, treaty wordings, and early-warning indicators. Their use requires controls for data quality, explainability, bias, privacy, cybersecurity, and human oversight. A model that predicts claims accurately may still be unsuitable for capital decisions if its behaviour under extreme conditions is unknown.

Emerging developments include insurance-linked securities, catastrophe bonds, collateralized reinsurance, parametric covers, climate-risk analytics, cyber reinsurance, and more frequent use of real-time exposure data. Alternative capital can broaden capacity and reduce dependence on traditional reinsurers, but it introduces basis, model, collateral, investor, and market-structure risks.

Illustrative Case Study: Designing Protection for a Growing Insurer

Background

HarborShield is a fictional regional insurer operating in property, motor, group life, and medical insurance. It has grown rapidly through digital distribution. Its gross written premium has increased, but its portfolio is concentrated in two coastal cities and several large employer groups.

Situation and Problem

The board observes that the insurer’s solvency ratio remains above its internal minimum, yet stress testing shows that a severe cyclone could produce property and motor losses, business interruption claims, and concentrated group-life deaths. A major employer also accounts for a substantial share of medical premium. Recoveries from one reinsurer are already significant. Management must design a programme without purchasing excessive protection.

Analysis

The risk team maps exposures by location, peril, employer, hospital network, and policyholder group. It estimates ordinary annual losses, severe event losses, aggregate medical deterioration, and mortality concentration. The analysis identifies four distinct risks: individual large property losses, catastrophe accumulation, medical portfolio volatility, and counterparty concentration.

A quota-share treaty would provide capacity and reduce net growth pressure, but it would cede profitable business. A per-risk excess-of-loss layer would protect large property claims. A catastrophe excess-of-loss programme would respond to the cyclone scenario. An aggregate medical cover would address frequency and medical inflation, while a mortality catastrophe layer would protect the group-life book. However, all covers must be tested for exclusions, event definitions, reinstatement, basis risk, and liquidity timing.

Strategy and Solution

HarborShield retains ordinary losses within a board-approved percentage of surplus. It purchases per-risk protection for large property exposures and layered catastrophe cover based on modelled and reverse-stress losses. It adds an aggregate medical layer with a clearly defined loss-ratio trigger and reviews the employer concentration limit. The placement is diversified among financially strong reinsurers, with collateral or other security where appropriate.

The investment committee also holds a liquidity buffer for claims before recoveries arrive. A quarterly exposure-data reconciliation is introduced, and the risk committee receives reports on net catastrophe exposure, recoverables ageing, counterparty concentration, and solvency under stress.

Outcome

The final programme costs more than the cheapest quotation but materially reduces tail loss and concentration risk. The board accepts a somewhat higher retention for ordinary claims because the insurer has reliable liquidity and a diversified core portfolio. The arrangement is reviewed annually and after material changes in geography, policy limits, or distribution strategy.

Learning Points

The case demonstrates that reinsurance design is a portfolio decision, not a purchasing exercise. Protection must correspond to the risk’s cause, frequency, severity, timing, and correlation. Capital, liquidity, counterparty quality, data governance, and strategic growth must be evaluated together.

Challenges and Common Mistakes

Common weaknesses include purchasing limits from historical loss experience alone, ignoring accumulation, treating model output as fact, failing to examine exclusions, relying on one reinsurer, confusing accounting relief with genuine risk transfer, and overlooking delayed recoveries. Other errors include setting retention without reference to liquidity, failing to update exposure data, using inconsistent catastrophe definitions, and not testing a programme after mergers or rapid growth.

A further challenge is model risk. Catastrophe and capital models may understate losses because of incomplete data, unstable relationships, unknown correlations, or changing climate and social conditions. Sound practice combines models with expert judgment, sensitivity analysis, scenario narratives, and transparent governance.

Best-Practice Framework

An effective reinsurance and ERM programme should:

1. begin with documented risk appetite and strategic objectives;

2. measure gross, ceded, and net exposures consistently;

3. distinguish frequency, severity, accumulation, and liquidity risks;

4. use layered protection appropriate to the loss distribution;

5. diversify and monitor counterparties;

6. test wording, triggers, exclusions, basis risk, and recoverability;

7. integrate underwriting, actuarial, investment, finance, claims, and technology data;

8. perform stress, scenario, and reverse-stress testing;

9. maintain contract certainty and reliable reporting;

10. review the programme after material changes and learn from actual events.

Chapter Summary

Reinsurance is a central component of insurance risk and capital strategy. Facultative reinsurance addresses selected individual risks, whereas treaty reinsurance covers portfolios under agreed terms. Proportional arrangements share premiums and losses, while non-proportional arrangements respond above defined thresholds. Retention, capacity, attachment points, limits, reinstatements, and triggers determine how protection operates.

Effective programme design considers individual exposure, catastrophe accumulation, mortality and morbidity concentration, basis risk, counterparty quality, liquidity, and operational execution. Reinsurance must be integrated with solvency management, economic capital, capital allocation, risk appetite, ALM, stress testing, and ERM governance. Technology and models improve analysis but do not remove uncertainty or managerial responsibility. The strongest programmes are transparent, diversified, contractually certain, stress-tested, and aligned with the insurer’s strategic capacity and obligations to policyholders.

Key Terms

Reinsurance: Transfer of part of an insurer’s assumed risk to a reinsurer.

Cedent: The primary insurer transferring risk to a reinsurer.

Facultative reinsurance: Individually negotiated reinsurance for a specific risk.

Treaty reinsurance: Automatic reinsurance applying to a defined portfolio.

Quota share: Proportional treaty sharing a fixed percentage of premiums and losses.

Surplus share: Proportional arrangement under which amounts above the cedent’s line are ceded.

Excess of loss: Cover responding to losses above a specified attachment point.

Retention: Amount or layer of risk retained by the cedent.

Attachment point: Loss level above which non-proportional reinsurance responds.

Capacity: Maximum amount of protection available under a contract or layer.

Reinstatement: Restoration of reinsurance limit after it has been exhausted by a loss.

Accumulation: Concentration of exposures vulnerable to the same event or cause.

Basis risk: Difference between the protection payment and the cedent’s actual loss.

Counterparty risk: Risk that a reinsurer fails to perform its contractual obligation.

Economic capital: Capital estimated for the insurer’s own risk profile and confidence standard.

Risk appetite: Aggregate level and types of risk an organization is willing to accept.

Asset-liability management: Coordinated management of assets against liability characteristics.

Stress testing: Assessment of financial effects under adverse specified conditions.

Reverse stress testing: Analysis of events that could produce a specified adverse outcome.

Enterprise risk management: Integrated governance and management of the organization’s material risks.

Review Questions

Short Answer Questions

1. What is the principal distinction between facultative and treaty reinsurance?

2. How does quota-share reinsurance differ from surplus-share reinsurance?

3. Define retention and attachment point.

4. Why is accumulation analysis important in catastrophe protection?

5. What is basis risk in a parametric reinsurance arrangement?

Long Answer Questions

1. Explain the major forms of proportional and non-proportional reinsurance and discuss their suitability for different insurance portfolios.

2. Describe the process an insurer should follow when designing a catastrophe reinsurance programme.

3. Discuss the relationship among reinsurance, solvency capital, economic capital, and risk appetite.

4. Explain how ALM and stress testing support enterprise risk management in life and general insurance.

5. Analyse the governance, counterparty, liquidity, and ethical risks associated with reinsurance.

Analytical / Application Questions

1. An insurer has moderate ordinary claims but severe geographic concentration in a cyclone-prone region. Recommend a retention and reinsurance structure, explaining the trade-offs.

2. A health insurer’s largest reinsurer is financially strong but represents 55 per cent of its total recoverables. Assess the risks and propose management actions.

3. A parametric earthquake cover pays only when an event exceeds a specified intensity at selected locations. Evaluate the cover’s usefulness and identify the basis-risk controls required.

22. Multiple Choice Questions with Answers

Question 1

Which arrangement normally requires the reinsurer to evaluate and accept an individual risk before coverage is provided?

A. Facultative reinsurance

B. Obligatory treaty reinsurance

C. Quota-share treaty

D. Aggregate stop-loss cover

Correct Answer: A. Facultative reinsurance

Question 2

Under a quota-share treaty, premiums and covered losses are generally shared according to:

A. The attachment point

B. A fixed agreed percentage

C. The annual loss ratio only

D. The geographical distance from the insured risk

Correct Answer: B. A fixed agreed percentage

Question 3

A catastrophe excess-of-loss contract primarily protects an insurer against:

A. Every small claim in the portfolio

B. An accumulation of losses from one event

C. All investment losses

D. Only losses that fall below the retention

Correct Answer: B. An accumulation of losses from one event

Question 4

The amount of loss retained by the cedent before an excess-of-loss reinsurer responds is called the:

A. Capacity

B. Reinstatement

C. Attachment point or retention

D. Commission

Correct Answer: C. Attachment point or retention

Question 5

Which situation best illustrates accumulation risk?

A. One policy has a high deductible

B. Many insured employees work in the same vulnerable building

C. A reinsurer pays claims promptly

D. An insurer invests in short-term securities

Correct Answer: B. Many insured employees work in the same vulnerable building

Question 6

Why may a parametric catastrophe cover fail to indemnify an insurer fully after a severe event?

A. Because it creates basis risk

B. Because it always excludes catastrophe losses

C. Because it is proportional by definition

D. Because it eliminates the insurer’s retention

Correct Answer: A. Because it creates basis risk

Question 7

Which measure most directly compares eligible own funds with required capital?

A. Combined ratio

B. Solvency ratio

C. Loss frequency

D. Claims settlement ratio

Correct Answer: B. Solvency ratio

Question 8

Reverse stress testing begins by identifying:

A. The cheapest available reinsurance quotation

B. A desired investment return

C. An adverse outcome such as a solvency breach

D. The reinsurer’s commission scale

Correct Answer: C. An adverse outcome such as a solvency breach

Question 9

A reinsurer’s inability to pay an otherwise valid recovery represents:

A. Counterparty risk

B. Moral hazard only

C. Duration risk

D. Underwriting capacity

Correct Answer: A. Counterparty risk

Question 10

The main purpose of asset-liability management is to:

A. Maximize gross premium regardless of risk

B. Coordinate investments with liability cash flows and characteristics

C. Replace all reinsurance arrangements

D. Remove the need for stress testing

Correct Answer: B. Coordinate investments with liability cash flows and characteristics