UNIVERSITI UTARA MALAYSIASCHOOL OF ECONOMICS, FINANCE AND BANKING

A172 / BWRR3153 RISK FINANCING

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PRACTICAL APPLICATION CASES

“USING SPREADSHEETS IN RISK MANAGEMENT SOLUTIONS”

SUBMITTED TO :

(LECTURER’S NAME)

SUBMITTED BY;

NAMES MATRIC. No.

200xxx

201xxx

202xxx

203xxx

204xxx

24th MAY 2018

BWRR3153 RISK FINANCING

CASES ; CALCULATIONS

Case 1

CDE Insurance is looking for an alternative risk financing tool to manage their risk. The company is deliberating the option to develop their own pure captive. The following are costs entailed in the formation. As the risk consultant for the company, your job is to evaluate the feasibility of this option and advice the company if they should adopt the option.

In order to form a pure captive as their licensed reinsurer, CDE needs to invest an initial fee of $550,000 and annual captive administration fee of $125,000. Since the captive will be formed as a reinsurer, the formation requires mediation from a fronting company. Thus, CDE will be required to use a fronting insurer, and this involves the cost of $84,000 in fronting fees. The fronting fee will be paid upfront and at the end of every year in which the captive remains active. At the end of the project period, CDE will enjoy a 3% discount on the captive administration fee and the fronting fee.

Without the captive, CDE will have to resort to the traditional insurance plan, which required them to pay an annual premium of $1.05 million per year. Their estimation shows that by using their own captive, they will enjoy an insurance premium savings of $300,000 per annum. Insurance premiums are paid at the beginning of each year. The initial process will involve a five-year trial period and the contract has the following additional information: The pure captive does not obtains premium tax deductibility, its cost of capital is 6.4% and its corporate tax rate is 33%.

Show the cash flows that would occur over the 5 years (round off all amounts to the nearest dollar).

Calculate the Net Present Value (NPV) of this project? Based on the NPV calculation, should CDE Inc. forms their own pure captive? Justify your answer.

CDE Insurance is totally committed to develop their own captive reinsurer even if the project is not profitable. As the risk consultant, you need to make changes in the captive formation plan so that the development of a captive will be beneficial and profitable to CDE. Suggest ONE strategy that should be implemented so that the project becomes profitable and provide evidence (calculations) to support your answer.

You have to use MS Excel to answer ALL questions.

Case 2

JKL Insurance is looking for an alternative risk financing tool to manage their risk. The company is deliberating the option to enter into a finite risk reinsurance (FRR) contract. As the risk consultant for the company, your job is to evaluate the feasibility of this option and advice the company if they should adopt the option. JKL Insurance then signed a FRR contract with PQR Re. The terms and conditions of this contract have been discussed and agreed as follow:

The contract period is 5 years and the contract has an aggregate limit of $10m over the 5-year period. Premium will be paid at the beginning of each year and the amount of premium to be paid by JKL is $1.75m. As the reinsurer, PQR Re. will receive an annual underwriting fee on the basis of 19% out of each premium payment. An interest of 6.7% will be credited to the beginning balance in the account for each year.

In case of deficit in the policyholder’s account, the policyholder will be required to pay 95% of any deficit in equal instalments over the subsequent 5 years.

During the contract period, losses incurred and reported are $1.35m, $2.29m, $0.998m, $1.56m and $1.22m respectively at the end of each years.

Tasks:

Compute the cash flows that would occur over the five years (round off all amounts to the nearest dollar)

Does the total claim amount exceed the policy limit? Explain your answer.

How much is the equal, annual installments that JKL Insurance. have to pay to PQR Re.?

To what extent will PQR Re. covers the excessive amount? How do Good Inc. deals with the excessive amount which is not covered by the FRR contract? Explain your answer.

You have to use MS Excel to answer ALL questions.

Case 3

FGH Insurance Company has a 40:60 QST contract with LMN Re. According to the contract, all premiums and losses will be apportioned between FGH and LMN Re. subject to the pro-rata clauses as follow:

Number of policyholders in the portfolio 1,000

Amount of coverage per policyholder $1,000

Premium rate 6.5‰

Commission paid to the ceding company 45%

Loss 60% of S.I

Based on the information, compute the followings:

Amount of sum insured

Amount of retention

Amount of cession

Amount of premium paid to the reinsurer

Amount of commission paid to the cedant

The apportionment (division) of losses between cedant and reinsurer

Case 4

UVW Insurer has a 10-line SST contract with BDE Re. and a net line of $100,000. Based on the following information about policies and losses, work out the F.O.S, division of loss between insurer and reinsurer and determine the primary insurer’s total obligation. (You need to construct a table using MS Excel, similar to those used and discussed in class to help you answer this question).

Policy A: S.I $80,000 — loss is $55,000.

Policy B: S.I $1,250,000 — loss is $750,000.

Policy C: S.I is $1,000,000 — loss is $50,000.

Case 5

RST Insurance Company has the following reinsurance agreement with IJK Re.

Policy Original S.I Loss

Policy X $1,500,000 20%

Policy Y $2,000,000 25%

Policy Z $1,000,000 50%

Under a $900,000 xs $100,000 per risk XS treaty, will RST be indemnified by IJK Re.? Why?

Work out the division of payment between RST’s retention and IJK’s compensation.

How would your answer in (b) differ under a $900,000 xs $100,000 per occurrence XS treaty. Assume that all losses are caused by a severe hurricane. Show your calculations and explain the difference(s) in your answer.

Case 6

Your company is involved in providing an insurance cover for the construction of the East-Coast Railway project with a sum insured of $250 million. Since this is a risky project, you decided to take a reinsurance protection to cover your risk. Road (highway) construction is a one-off project, thus in your opinion, it is best to opt for a facultative arrangement. At the end of the project, claims arising out of accumulated losses totaled up to $70 million. There are two options, as the following:

Plan 1:

Reinsured proportionally with a 60% cession

Reinsurer pays =

Cedent pays =

Plan 2:

Reinsured non-proportionally with an excess limit of $30 million

Reinsurer pays =

Cedent pays =

Based on these estimations, which one is the best option? Justify your answer.

Requirements:

All questions must be answered in MS Excel. Attempt each case on separate sheets. Label your sheets accordingly – Case1, Case2 etc.

All students must use the cover format as shown above. Fill in your names and matric numbers in correct order. The cover format is only applicable for hardcopy submission.

The Excel file must be named by the “first person in your group” name.

Make sure all the mathematical/formula functions in your spreadsheet are working correctly.

The softcopy file must be submitted via and uploaded onto Online Learning Portal by 24th May 2018, before 12 noon. Only one submission from each group – the first person in your group is accountable to complete the online submission.

The hardcopy file must be printed and submitted to me (my mailbox #125) by 24th May 2018, before 12 noon.