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Tutorial 9.4 question on reinsurance

0 votes
asked Nov 7, 2017 in BUS 1003H - Introduction to Financial Risk by Ireneus (410 points)

For the following scenario, what type of reinsurance would you recommend and why? Scenario: An insurer is concerned that it has a concentration of household insurance policies in an area that is prone to frequent flooding.

I would like to know if it is it aggregation by event or cause. There seems to be a contradiction between the answer given (Tutorial 9, 9.4) and examples given in course reader. Any clarity on this will be greatly appreciated.

1 Answer

+1 vote
answered Nov 9, 2017 by Landi (300 points)
selected Nov 12, 2017 by Richard van Gysen
Best answer

Thanks for your question :) 

Let's start with the answer given in the Tut as I dont think it is contradicting but perhaps could be exlpained clearer:

Catastrophe XL reinsurance; Aggregate XL aggregated by cause, where the cause is flooding. This would protect the insurer from a large volume of claims arising due to flooding."

ioWhat the solution says is that both CatXL and Aggregate XL by cause could be considered, here is why:

Our main risk is an aggregation of claims from floding, this could happen as a result of a single event (Flood) causing a lot of damage and claims, to protect against this risk, Cat XL would be best.

Another risk faced is that a single flood event might not cause a lot of damage, however that a lot of small claims, due to regular flooding in the area causes the total claims in a period (say a year) that were as a result of flooding, to be high, in this case Aggregate XL cover by cause ( flooding) will be the right option.

Hope this makes it clearer, please shout if not yet!!