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The mechanism of risk transfer through insurance, reinsurance and retrocession

The mechanism of risk transfer through insurance, reinsurance and retrocession

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The paper focuses on the traditional and alternative mechanisms for insurance risk transfer that are available to global as well as to domestic insurance companies. The findings suggest that traditional insurance risk transfer solutions available to insurance industry nowadays will be predominant in the foreseeable future but the increasing role of...

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... reinsurers found solution in additional risk spreading through the retrocession market. The mechanism of risk transfer through insurance, reinsurance and retrocession is shown by Figure 2. 3 The oldest known trace of reinsurance existence is found in marine policy issued in Genoa in 1370. ...
Context 2
... researches suggest the increased severity of catastrophes as possibility that future Hurricanes impacting the Northeast USA and Florida could create losses of $20b and $75b, respectively, a California earthquake or continental European windstorm could lead to losses of $50b to $100b, an 8.5 magnitude earthquake in the New Madrid Seismic Zone of the central USA could create $100b of losses, and a repeat of the devastating 1923 Tokyo Earthquake in today's market could lead to losses of $500b to $1t. ( Banks, 2005: 10). The mechanism of risk transfer through insurance, reinsurance and retrocession As is shown in Figure 2, the risk transfer can be accomplished through direct or indirect relationships between contracting parties. Its path starts with the insureds that transfer life or non-life insurance risks and accompanying premiums through insurance market to insurers. ...

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... According to Takeda (2002), risk swaps must be clearly defined and quantified to be on a parity condition, meaning both sides of the swap have the same expected loss. Although they do not necessarily have to be designed on a parity basis, it is advantageous as no exchange of money is required (Cummins 2008;Njegomir and Maksimović 2009). In the past, risk swaps were mainly associated with catastrophe exposures. ...
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Diversification plays a pivotal role under the risk-based capital regime of Solvency II. The new rules reward large and well-diversified insurance companies with relatively low capital requirements compared to those of small and specialised nature. To enhance diversification, insurance companies can adjust their strategy by engaging in mergers and acquisitions or new market entries. Alternatively, insurers can accept higher Solvency II capital requirements, displaying a competitive disadvantage and impeding future growth. This research proposes a Solvency II portfolio swap as a new diversification solution that allows small and specialised insurance companies to improve their diversification, and thus, mitigate their diversification disadvantage. The effect of such swaps is demonstrated through the use of two hypothetical insurance companies by swapping 20% of their portfolio over four different scenarios. The swap allowed for a 6% reduction in the Solvency Capital Requirement (SCR) and a maximum increase of the SCR coverage ratio of 17%. With Solvency II posited to stimulate further mergers and acquisitions within the European insurance market, this paper offers an alternative method for insurers to diversify their portfolio. Furthermore, it is suggested that the proposed alternative risk transfer method may improve insurance market competition within the EU by facilitating small and specialised insurers’ competitiveness.
... In the framework of non-life insurance, the largest premium was secured by the sale of insurance policies from the consequences of the accident, insurance of loan collection and travel assistance. Insurance claims by state agencies in the Republic of Serbia represent a form of direct state participation in the insurance sector (Njegomir & Maksimović, 2009). The argument in support of the thesis on the justification of the establishment of state agencies in the field of insurance claims is the assistance to exporters in conquering new markets, as they are specialized institutions that have more detailed information about foreign markets and potential partners. ...
... Apart from the increased probability of adverse events, the other determinant that influence risk, the intensity of the consequences of adverse events, also increases. Concentration of people, buildings, factories and infrastructure per unit of land nowadays means that loss events with the same intensity could threaten more people and cause more damage to property than before [11]. For example, according to OECD estimates [12], repeating earthquake in Tokyo from 1923 would cause damage equal to approximately 75% of Japan's gross domestic product. ...
... Reinsurance companies perform reinsurance that insurance companies traditionally use in order to diversify risk, or off-balance sheet exchange for capital "bound" in the balance sheet. Reinsurance represents a transfer of parts or whole risks that are accepted by insurance companies from the insured to reinsurance companies, thereby reinsurance is an extension of the insurance concept and basically represents insurance for insurance companies (Njegomir, 2006;Njegomir & Maksimović 2009). Reinsurance is particularly used for the higher levels of risk whose potential negative impact can overcome available funds of insurer's retention. ...
... Reinsurance companies perform reinsurance that insurance companies traditionally use in order to diversify risk, or off-balance sheet exchange for capital "bound" in the balance sheet. Reinsurance represents a transfer of parts or whole risks that are accepted by insurance companies from the insured to reinsurance companies, thereby reinsurance is an extension of the insurance concept and basically represents insurance for insurance companies (Njegomir, 2006;Njegomir & Maksimović 2009). ...
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Climate changes are now visible, tangible, and quantifiable and are one of the most significant risks facing the entire world. Floods in 2016 and 2014 and the drought in 2012 are striking examples of the manifestation of climate changes in Serbia as well. The aim of the research is to analyze the pattern of climate changes in the world and in Serbia, pointing out the necessity to safeguard agriculture. We present the trends of climate changes in general and their implications for agriculture. After pointing to the effects of climate change, we analyze the importance of agriculture insurance.
... For the development of alternative risk transfer solutions that provide insurance risk transfer to capital market in addition to insurance and reinsurance companies' demand the interest from institutional capital market investors, above all insurance and reinsurance companies and investment funds, especially hedge funds, was critical. The interest from investment management community for investments in insurance risk stemmed from the fact that these investments are uncorrelated with other risks in investor's portfolio, relatively high returns offered and an absence of exposure to other risks of insurance companies (Njegomir & Maksimović, 2009). Although alternative risk transfer solutions emerged under conditions of the hard reinsurance/retrocession market, the continuation of (re)insurers interest for their application during the soft reinsurance/retrocession market and investors interest despite the financial crisis lead us to the conclusion that they are a sustainable solution for managing exposures to catastrophes. ...
Article
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The aim of this paper is to review the recent progress in innovation activities of investment funds and insurance companies. The paper reviews the main innovation trends globally, their causes and consequences. The research has identified that innovations of insurance companies and invesmtnet funds are predominantly incremental and focused on products although they usually refer also to processes, marketing and overall organisation. In investment fund industry, the main innovations recently have been credit swap defaults (CDS), Exchange Traded Funds (ETF), hedge funds, social impact bonds and other innovative products. In insurance industry, in addition to incremental innovations such as amendments to contracts terms and conditions, recent innovations encompass microinsurance, enterprise risk management, e-businss applications, bancassurance, index insurance and alternative risk transfer. By summarizing the current state of knowledge of innovation activities among insurance companies and investment funds, the paper can be useful for domestic investment funds and insurance companies to identify possible areas for innovation as well as for government bodies to understand why fostering creation of innovation-friendly environment will bring benefits not only to financial services industry but to the society as a whole. Finally, the results presented in the paper are a good starting point for future research.
... The concept of risk transfer or risk spreading entails that the individual (the insured) risks are reduced by spreading or transferring the risks from the insured to the insurance provider (the insurer) since the insurer is in a stronger financial position than the insured (Njegomir & Maksimovic, 2009). The insurance provider is able to insure the risks of the insured to a great extent due to the fact that the insurer obtains premiums from a large number of insured who are at different levels of risks and by making sure that the total amount of premiums collected exceeds the underwriting of risks (termed as the law of large numbers). ...
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Climate change has brought an additional dimension to disaster risks in the Asia-Pacific Region as it is projected to exacerbate the intensity and magnitude of various natural hazards such as storms, high-intensity rainfall events, heat waves, floods and droughts. Risk transfer has been widely advocated as one of the best means of risk mitigation across the world. In order to address additional risks brought by the impact of climate change, there is a need to reassess and re-frame the current risk reduction strategies especially in terms of development and utilization of risk-spreading instruments within the Asia-Pacific Region. Keeping this in mind, this chapter reviews the current status of risk insurance and identifies emerging issues and experiences.
... For the development of alternative risk transfer solutions that provide insurance risk transfer to capital market in addition to insurance and reinsurance companies' demand the interest from institutional capital market investors, above all insurance and reinsurance companies and investment funds, especially hedge funds, was critical. The interest from investment management community for investments in insurance risk stemmed from the fact that these investments are uncorrelated with other risks in investor's portfolio, offered relatively high returns and absence of exposure to other risks of insurance companies (Njegomir & Maksimović, 2009). Although alternative risk transfer solutions emerged under conditions of the hard reinsurance/retrocession market the continuation of (re)insurers interest for their application during the soft reinsurance/retrocession market and investors interest despite the financial crisis lead us to the conclusion that they are sustainable solution for managing exposures to catastrophes. ...
Conference Paper
Full-text available
The aim of this paper is to review recent progress in innovation activities of investment funds and insurance companies. The paper reviews main innovation trends globally, their causes and consequences. The research has identified that innovations of insurance companies and invesmtnet funds are predominantly incremental and focused on products although they usually refer to processes, marketing and overall organisation as well. In investment fund industry main innovations recently have included credit swap defaults (CDS), Exchange Traded Funds (ETF), hedge funds, social impact bonds and other innovative products. In insurance industry, in addition to incremental innovations such as amendments to contracts' terms and conditions, recent innovations encompass microinsurance, enterprise risk management, e-business applications, bancassurance, index insurance and alternative risk transfer. By summarizing the current state of knowledge of innovation activities among insurance companies and investment funds, the paper could be useful for domestic investment funds and insurance companies in their efforts to identify possible areas for innovation, as well as for the government bodies to understand why fostering the creation of an innovation-friendly environment will bring benefits not only to financial services industry but to society as a whole. Finally, the results presented in the paper are a good starting point for future research.
... The number of catastrophe events caused by nature and man (Enz et al., 2008) and their financial impact (Geo Risks Research, Munich Re, 2007) is rising globally. This increase is caused by climate change and the concentration of population and material goods (Njegomir, Maksimović, 2009). Given that (re)insurers traditionally have financial potential to compensate the insured (Rejda, 2005), they are exposed to the influence of catastrophe events more than others. ...
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Optimization of a diversified portfolio has been realized through the changes in the allocation of existing and new types of financial assets or changing the investment manager, which affects exposure to the systematic and non-systematic risk, well known as beta and alpha coefficients, with the ultimate goal of achieving a better relationship between portfolio risk and return. In the recent years one of the most significant developments in the field of risk management and insurance is risk securitization which means the transfer of insurance risk by creating financial instruments such as catastrophe bonds. Portfolio diversification can be achieved by investing in catastrophe bonds, because investors have the possibility of gaining higher return in comparison to investing in corporate bonds of the same credit rating. The risk and return of catastrophe bonds depend only on insurance market fluctuations and by investing in these bonds additional effects of risk diversification can be realized accompanied with avoidance of negative risks interdependence effects of securities related to their issuers’ business performances and financial markets trends.
Chapter
Durch eine sich immer schneller verändernde Risikolandschaft, technologischen Fortschritt und die Globalisierung zeigen sich auch die Grenzen der Kapazität des Versicherungsmarktes. Um diese Kapazitäten zu erhöhen, wurden Methoden entwickelt, die eine Einbeziehung des Finanzmarktes ermöglichen. Diese Methoden werden aufgrund ihrer unterschiedlichen Charakteristika als alternativer Risikotransfer bezeichnet. Alternativer Risikotransfer gewinnt immer mehr an Bedeutung. Durch die erhöhte Frequenz von Naturkatastrophen, das Niedrigzinsniveau sowie durch Ineffizienzen des Versicherungsmarktes sind die Rahmenbedingungen für eine weitere positive Entwicklung alternativen Risikotransfers günstig. In diesem Kapitel werden eine Eingliederung der verschiedenen Instrumente des Alternativen Risikotransfers vorgenommen, die verschiedenen Instrumente vorgestellt und abschließend ein Fazit und ein Ausblick für die weitere Entwicklung gegeben.