Chapter 27 Self-Check Quiz

Twenty questions. Answer before opening the key at the bottom. The multiple-choice questions test recall and recognition; the short-answer questions test whether you can use the reinsurance ideas at the desk. All figures are illustrative.

Multiple choice

  1. Reinsurance is best described as: a. A second policy sold to the same insured b. Insurance purchased by an insurer to transfer part of its own risk to a reinsurer c. A government guarantee of insurer solvency d. The same thing as a large deductible

  2. The three jobs reinsurance does for a primary insurer are: a. Marketing, claims handling, and investment b. Capacity, catastrophe protection, and earnings/volatility smoothing c. Pricing, reserving, and distribution d. Compliance, audit, and reinsurance accounting

  3. The ceding company (cedent): a. Is released from liability to its policyholder once it reinsures b. Remains fully liable to its policyholder even after ceding the risk c. Is the same party as the reinsurer d. Is the original insured

  4. Treaty reinsurance differs from facultative reinsurance mainly in that treaty is: a. Negotiated one risk at a time, optionally b. Automatic and obligatory across a defined class or book c. Only used for catastrophe d. Never used for property

  5. A cedent reaches for facultative reinsurance primarily when: a. Every ordinary risk is bound b. A risk is larger than the treaty will hold, is excluded from the treaty, or is unusually exposed c. It wants to avoid paying any reinsurance cost d. The reinsurance market is soft

  6. Under a quota share, the reinsurer: a. Pays only losses above an attachment point b. Takes a fixed percentage of every risk — premium and loss — from the first dollar c. Takes only the part of each risk above the cedent's retention d. Responds only to catastrophe events

  7. A surplus-share treaty is most useful because it: a. Cedes the same percentage of every risk regardless of size b. Lets the cedent keep its full retention on each risk and cede only the part that is too large c. Pays nothing until a catastrophe occurs d. Eliminates the need for any retention

  8. "\$4M xs \$1M" in an excess-of-loss layer means the reinsurer pays: a. The first \$1M of every loss b. Losses above \$1M, up to \$4M more (covering the band \$1M–\$5M) c. \$4M of every loss regardless of size d. 4% of every loss above \$1M

  9. Catastrophe XOL is distinctive because it responds to: a. The loss on a single large risk b. The aggregate loss to the whole book from one catastrophe event, above an event retention c. Only fire losses d. The cedent's expense ratio

  10. Ceding commission exists: a. In all reinsurance, proportional and non-proportional b. Only in proportional reinsurance, where the reinsurer shares the original premium c. Only in catastrophe XOL d. Only when the reinsurer is unrated

  11. Which reinsurance form best relieves a fast-growing young insurer's surplus strain? a. Catastrophe XOL b. Per-risk excess of loss c. Quota share d. Facultative

  12. The phrase that best captures the lesson of §27.5 for the primary underwriter is: a. "Always measure yourself on gross premium" b. "Your capacity and your price are governed by your net retention, not your gross limit" c. "Reinsurance makes catastrophe risk disappear" d. "Ceding commission is irrelevant to the combined ratio"

  13. A coastal account that is "profitable gross but ruinous net" is dangerous because: a. Gross premium is always understated b. Its price, though adequate against gross expected loss, fails to cover the cost of the cat reinsurance it forces the company to buy c. Reinsurers never pay catastrophe claims d. Net premium is always higher than gross

  14. The most important credit/regulatory fact about reinsurance — the reason a reinsurer's financial strength is your risk — is: a. Reinsurers are unregulated b. Collectability: the cedent still owes its policyholder even if the reinsurer cannot pay, so an insolvent reinsurer leaves the cedent exposed c. Reinsurance is always collateralized d. The policyholder can sue the reinsurer directly

  15. The LMX spiral is the canonical example of: a. A well-functioning retrocession market b. Risk passed through opaque, interconnected retrocession returning amplified to participants who thought they had passed it on c. A quota-share treaty d. A successful catastrophe bond

Short answer

  1. Reinsurance's catastrophe cover exists to address the failure of a specific assumption that makes the law of large numbers work (Chapter 1). Name the assumption and explain in two sentences why a hurricane violates it. (§27.1)

  2. A cedent's per-risk tower is: retention \$1M; layer 1 = \$4M xs \$1M; layer 2 = \$5M xs \$5M. A single \$6,500,000 loss occurs. State exactly who pays what. (§27.4)

  3. In two or three sentences, distinguish quota share from surplus share, and name the one problem each is best at solving. (§27.3)

  4. Explain why an underwriter should price a catastrophe-exposed account against its net risk rather than its gross risk, and name one cost that the net price must carry. (§27.5)

  5. Harbor Steel's \$20M property line sits against a surplus-share treaty over a \$5M net retention, and the plant is in a named-windstorm zone. Explain (a) how the \$20M per-risk exposure is handled and whether facultative might be needed, and (b) how the catastrophe exposure is ceded. (§27.4, §27.5, The Underwriting File)

Answer key (try all twenty first) **Multiple choice:** 1. **b** · 2. **b** · 3. **b** · 4. **b** · 5. **b** · 6. **b** · 7. **b** · 8. **b** · 9. **b** · 10. **b** · 11. **c** · 12. **b** · 13. **b** · 14. **b** · 15. **b** **Short answer:** 16. The assumption is **independence** — that one insured's loss does not make another's more likely. A hurricane violates it because a single event strikes many policies in the same zone *at once*, so losses are highly *correlated* rather than independent; no amount of writing "more, similar" coastal business diversifies away a peril that hits the whole pool simultaneously, which is exactly why catastrophe needs its own cover (cat XOL). 17. The cedent pays the first **\$1M** (its retention). Layer 1 (\$4M xs \$1M) pays the band \$1M–\$5M, i.e. **\$4M**, and is fully exhausted. Layer 2 (\$5M xs \$5M) pays the band \$5M–\$6.5M, i.e. **\$1.5M**. Total: \$1M + \$4M + \$1.5M = **\$6.5M**, with layer 2 only partly used and layer 1 exhausted. 18. **Quota share** cedes a *fixed percentage of every risk* (premium and loss) from the first dollar — best at relieving *surplus strain* and funding growth. **Surplus share** cedes only the part of each risk *above the cedent's retention*, in multiples called lines — best at solving the *large-line* problem and *homogenizing the net book* so the cedent keeps a similar-sized net line on every risk. 19. Because the company's economics live in what it *keeps*: gross premium minus the cost of the reinsurance the risk forces it to buy, against the *net* losses it retains. An account adequate against *gross* expected loss can be a money-loser *net* once charged for the reinsurance it consumes. One cost the net price must carry: the account's allocated share of the **catastrophe-treaty cost** (or the facultative premium / surplus-share cession net of ceding commission). 20. (a) The **\$20M per-risk** line is shared: the company keeps its **\$5M net retention** and cedes the \$15M above it to the **surplus-share treaty**, so its net line on a total fire loss is \$5M, not \$20M. *Facultative* is needed only if the treaty's per-risk capacity tops out below \$20M — then the over-treaty slice is placed facultatively (as a subjectivity, confirmed before binding the full limit). (b) The **catastrophe** (named-windstorm) exposure is not ceded risk-by-risk but through the **cat XOL** treaty, which responds to the aggregate event loss above the company's event retention; Harbor Steel consumes capacity in that cat tower, a cost the net price must reflect.