Running Head: INSURANCE AND RISK SECURITIZATION 1

Insurance and Risk Securitization

Student Name

Student Number

Course Name

Course Name
INSURANCE AND RISK SECURITIZATION 2

Part One
Reinsurance refers to an act of ratifying an agreement with the third parties through

shifting a proportion of risk investments to them. If an insurance claim is lodged as a result of an

occurrence, the company is shielded from having to pay hefty compensation. The main goal of

reinsurance for an insuring firm is to lessen the risks related to the underwritten policies. This

aids in risk spreading across different companies (Kielholz & Durrer, 1997).

The risks are apportioned to different companies through reinsurance because they share the

risks with several insurance companies. These companies buy policies from other insurance

companies, and therefore in the event of a disaster, the losses are limited for the primary insurer.

The clients are covered more effectively when the individual insurance company spread the risks

as the liability is shared among all the insurance firms when an event occurs (Cummins &

Trainar, 2009). All the insurance companies that are involved share the premium payments in the

case of reinsurance.

Risk sharing is one of the key principles of insurance. A group of likeminded individuals

who are subjected to the same kinds of risks is creating through people buying insurance

policies. All the participants in the pool share the same risks. This same principle is the same in

which reinsurance works. One of the critical merits of risk-sharing is that the compensation

liability does not fall on a single insurance firm.

Securitization refers to a financial transaction in which the securities that represent a

mutual interest is issued, and the assets are pooled together (Cummins & Trainar, 2009).

Liquidity is generated in the best way through securitization. For example, a financing institution

that deals with issuing a large amount of automobile credit lending requires additional funding

for business expansion. However, there are no buyers in the market for the existing loan in the

secondary market for automobile credit. Therefore, the company pools a massive amount of its
INSURANCE AND RISK SECURITIZATION 3

loans credits and sell its interests in the group to the stakeholders. In addition to helping the

company to get the loan, the company gets the financing required to raise the required capital.

The company can now issue new automobile loans. Furthermore, an opportunity is offered to the

investors to participate in different types of automobile loans with an attractive rate of returns,

which may serve as an alternative fixed return on investment. Eventually, the debtors such as car

owners should not be aware of the transaction. The payments should be continuously be made as

per the original agreement, with the difference being that amounts to be channeled to the new

investors (Cummins & Trainar, 2009).

Securitization refers to a process through which a company issuing makes a monetary

instrument by merging with other monetary assets, which are then advertised to investors

(Doherty & Schlesinger, 2002). This process can include any financial asset. It aids in liquidity

in the financial market. A case of securitization is in securities backed by a mortgage. The larger

pool containing the mortgages is subdivided into minor pools based on the risks that are inherent

to particular individuals that are marketed to the investors. The liquidity is created when small

investors purchase them. The large pool of mortgages may not be afforded by the small retailers

without securitization of mortgages. Examples of assets that are securitized include; automobile

loans, mortgages, student financial credit, credit card debt, account receivables, lease payments,

and sovereign debt.

Part Two

Rebating

The fair-trade practice violated is referred to as rebating. This practice is unfair and

illegal. This term refers to giving a discount or taking advantage or amount of consideration that

is not stated in the insurance policy. Rebating is an unlawful practice for the insurance agents to
INSURANCE AND RISK SECURITIZATION 4

be engaged in (Doherty & Schlesinger, 2002). This act implies giving or offering something of

value other than what is specified in the insurance policy as an incentive to purchase insurance.

There are different forms of rebating, such as splitting the agent’s commission, return of the

premium, accepting or giving cash, or anything valuable gift. A purchaser of insurance policy

receiving the rebate is also illegal (Cummins & Trainar, 2009).

Illegitimate policy replacement

Substituting one insurance policy with another can, in some instances, benefit the policy

owner. However, through replacement, a policy owner, in several cases, stands to lose a great

deal. Illegal policy replacement comes about when an agent persuades a client not buy one policy

to purchase another without offering him a precise clarification of any merits or by giving

distorted facts at the expense of the policy owner. The case where policy replacement is

considered involves an agent using trickery to gain from the sales without feeling the owner of

the policy (Kielholz & Durrer, 1997). The significant amount of values of cash is lost, regarded

as one of the negative impacts of policy replacement on life insurance policy owners.

On the other hand, the agents gain from the administration fees and sales commission.

The owners of the insurance policy may not benefit from the same amount of premium rate.

Furthermore, the policy owner would also lose out on contestable and suicide omission periods

(Doherty & Schlesinger, 2002). The appropriate analysis of policy should be done by the agents

being due diligent before buying a new insurance policy. The policy should be beneficial, and its

replacement is not unlawful. There are some instances where it is essential to make contrasts of

the plans, that is signed by the client to show acknowledgment of having comprehended its

effects (Kielholz & Durrer, 1997).

INSURANCE AND RISK SECURITIZATION 5

Part Three

Damage of $100,000 will be sustained by Julia. Therefore, the claim made should not

exceed the scope of the damage suffered. According to the insurance agreement, the claimant is

assured of the indemnity to the extent of the losses incurred during the event. The individual

insured cannot utilize insurance policy to obtain yield.

The insured amount is supposed to be paid by each company obligated. However, the

same amount cannot be claimed by Julia from all the firms. Moreover, if Julia claims $100,000

from Firm C, then she is not supposed to claim the similar sum of compensation from Firm A or

Firm B.

Suitable term to be used in this state is the contribution whereby the insurers which have

the same liability to the indemnified and paid the insurance indemnification fee based on the

specified formula. The principle of contribution in insurance studies specifies what will happen if

a client purchases the same policy to cover for the same peril from multiple insurance firms

(Doherty & Schlesinger, 2002).

To put the insured in his or her original state, an insurance cover is offered to cushion in

the event of the loss. The objective is to prevent the claimant from gaining from the insurance

coverage. Indemnification is the term that is used in this scenario. The term denotes to make a

complete again or to be restored to the original state in which one was in before happening of a

specific peril or event (Doherty & Schlesinger, 2002).

INSURANCE AND RISK SECURITIZATION 6

References
Cummins, J., & Trainer, P. (2009). Securitization, Insurance, and Reinsurance. Journal of Risk

and Insurance, 76(3), 463-492. doi: 10.1111/j.1539-6975.2009.01319.x

Doherty, N., & Schlesinger, H. (2002). Insurance Contracts and Securitization. Journal of Risk

&Amp; Insurance, 69(1), 45-62. doi: 10.1111/1539-6975.00004

Kienholz, W., & Durrer, A. (1997). Insurance Derivatives and Securitization: New Hedging

Perspectives for the US Cat Insurance Market. The Geneva Papers on Risk and Insurance -

Issues and Practice, 22(1), 3-16. doi: 10.1057/gpp.1997.1