Reinsurance: Proportional vs Nonproportional

Proportional Reinsurance

• Definition: Insurer and reinsurer share both premiums and losses in a pre-agreed ratio.
• Examples:
  • Quota Share Agreement
    • Reinsurer covers a fixed percentage of risk.
    • Example: 50/50 agreement means the reinsurer covers 50% of the risk, receives 50% of the premiums, and pays 50% of claims.
  • Surplus Share Reinsurance
    • Insurer retains risk up to a certain limit, with the excess passed to the reinsurer.
    • Example: If insurer retains $1 million and a policy is for $3 million, the remaining $2 million is handled by the reinsurer.

Nonproportional Reinsurance

• Definition: Reinsurer covers losses that exceed a certain amount (retention limit).
• Common Type: Excess of Loss Reinsurance.
• Example:
  • Insurer has a $5 million retention limit.
  • If a claim is $7 million, the insurer pays the first $5 million, and the reinsurer covers the remaining $2 million.

Differences Between Proportional and Nonproportional Reinsurance

• Proportional Reinsurance
  • Shares both premiums and claims from the start.
  • Suitable for managing regular, predictable risks.
• Nonproportional Reinsurance
  • Reinsurer covers losses only after they exceed a set threshold.
  • Ideal for rare, large-scale, or catastrophic events.

Benefits of Both Types

• Proportional Reinsurance: Consistent risk management and premium sharing.
• Nonproportional Reinsurance: Protects against significant, unexpected losses.

Usage in Insurance

• Insurers often use a combination of both types to balance their risk portfolio.
• Proportional reinsurance for predictable, regular risks.
• Nonproportional reinsurance for protection against large-scale events.

Strategic Importance

• Understanding both types is crucial for broader risk management strategies.
• They help insurers manage risks at all levels, enhancing financial stability.