PHASE 2 IP

Part 1

What is the meaning of the term reinsurance?

Explain the reasons for reinsurance.

Explain the term securitization of risk.

Reinsurance is the practice of transferring a portion of risk portfolios to other parties by way of
signing an agreement with them. This is done to reduce the chances of having to pay a large
obligation in case of occurrence of an event, when an insurance claim is lodged. The primary
objective of reinsurance for an insurance company is to reduce the risks associated with polices
underwritten by them. This helps in spreading the risks across alternate entities.

With reinsurance, multiple insurance companies share the risk by buying insurance policies
from other insurers. This helps in limiting the losses to the original insurer in case of a disaster.
When risks are spread, an individual insurance company can cover clients more effectively as
the burden of meeting the obligation would be shared amongst all the insurance companies. In
case of reinsurance, the premium paid by the insured is shared by all of the insurance
companies involved.

The primary principle of insurance is sharing of risks. When a person buys an insurance policy,
the insurance company forms a pool of likeminded people, who are exposed to similar types of
risk. These risks are shared by all the participants. Reinsurance works on the same principle. Its
biggest advantage is sharing of risk so that burden of meeting the obligation does not fall on an
individual insurance company.

Securitization is termed as a financial transaction in which assets are pooled together and
securities representing the common interests in the pool are issued. This is an ideal way of
generating liquidity. For instance, a financing company, involved in the business of issuing large
number of auto loans is in need of cash to expand its business. It can sell off its existing loans,
but there are no buyers for the same in the secondary market for individual auto loans. So, the
company pools a large number of its loans and sells interests in the pool to investors. This helps
financing company in raising the required capital and also gets the loan off from its balance
sheet. It can now issue new auto loans. Investors, on the other hand, get an opportunity to
participate in a diversified pool of auto loans which they might attractive alternative to
corporate bond or any other fixed income investment. The ultimate debtors, i.e. the car owners
need not be aware of this transaction. They continue making payments on their loans as per
their original agreement. The only difference is that now these payments are channeled to new
investors.
 Securitization is the process through which an issuing company creates a financial instrument by
combining other financial assets, which are then marketed by repackaging them to investors.
This process can involve any type of financial asset. It helps in promoting liquidity in the market
place. The best example of securitization is mortgage-backed securities. Mortgages are
combined into large pool, and then divide the same into smaller pool on the basis of inherent
risks of default of individuals. These are then marketed to investors. Smaller investors can
purchase them and thus help in creating liquidity. Without securitization of mortgages, retail
investors may not be able to afford to buy into large pool of mortgages.

Some other assets that can be securitized are, auto loans, student loans, mortgages ,credit card
receivables ,lease payments ,accounts receivable ,corporate or sovereign debt, etc.

Part 2

What unfair trade practices is each of the following insurance agents violating? Explain the
terms that you use.

Agent Jones offers a client to pay a portion of the premium if the client purchases a
policy.

Rebating

This is a clear case of rebating, which is an unfair trade practice. Rebating is offering a discount
of premium, advantage, or valuable consideration that is not specified in policy

It is illegal for insurance agents to be involved in the practice of rebating. It implies offering or
giving something of value, other than the insurance policy itself, to an individual as an
inducement to buy insurance. A rebate could take many different forms, such a return of the
premium, splitting the agents commission, giving or receiving cash or a valuable gift. Accepting
rebate is also illegal for the buyer of insurance policy.

Agent Peterson convinces a client to replace a life insurance policy with a new policy
that adds little value.

Illegal policy replacement

In certain cases, a policy owner can benefit from replacing one insurance policy with another.
However, in several cases the policy owner stands to lose a great deal by replacement. An agent,
who convinces a customer to drop one policy in order to buy another, without providing him a
clear explanation of any disadvantages and / or by misrepresenting facts to the policy owners
determinant, is guilty of illegal policy replacement.

Policy replacement is considered as illegal when an agent uses deception in order to gain the
sale for his benefit without regard for the policy owner. The negative consequences of this are
 that life insurance policy owners lose out a significant amount of cash values. Agent would gain
new sales commission and administrative fees. The policy holder may not get the same amount
of type of coverage for the same premium rate. Moreover, the policy holder would also lost out
on contestable and suicide exclusion periods.

It is important for an agent to be diligent in making appropriate policy comparisons in order to

make sure that the purchasing of a new policy is beneficial to the insured and replacement is
not illegal in nature. In some cases, it is obligatory to make written comparisons of polices, that
is to be signed by the applicant as an acknowledgement of having understood the implication.
Agents are supposed to provide them a copy of the signed document for their reference. Agents
are also required to notify both the new insurer and the insurer of the old policy that
replacement is being considered.

Part 3

Julia owns a building worth $800,000. She insures the building for $300,000 with Company A,
$400,000 with Company B, and $100,000 with Company C. There is a fire, and the building
sustains $100,000 in damage.

How much will Julia collect in insurance?

Julia sustains a damage of $100,000. So she cannot make a claim exceeding the extent of
damage sustained. This is because, the insurance contract promises to indemnify the claimant
to the extent of losses incurred. The insured cannot use the insurance policy to gain profit.

How much will each company pay?

Each company is obliged to pay the insured amount. However, Julia cannot claim the same
amount from all the companies. Furthermore, if she claims $100,000 from Company C, then she
cannot claim the same amount for Company B or Company A.

What insurance term describes this situation?

The terms used for this situation is called contribution. Under this, insurers which have similar
obligations to the insured, contribute in the indemnification according to some method.

What is its purpose

insurance cover is provided to put the insured in the same condition as he was before the loss
occurred. Its purpose is to restrain the claimant in making a profit out of the coverage.

The word used here is indemnification. To "indemnify" means to make whole again, or to be
reinstated to the position that one was in, to the extent possible, prior to the happening of a
specified event or peril.