Reinsurance Lecture Notes

Introduction

• Reinsurance: A risk transfer contract between an insurance company (the reinsured) and a reinsurance company (the reinsurer).
• Purpose: Reinsurer undertakes liability from the primary insurance contract in exchange for a premium.
• Similar to insurance but involves insurers and not individual policyholders.

Differences Between Insurance and Reinsurance

1. Parties Involved:
   • Insurance: Insured and insurer.
   • Reinsurance: Reinsurer and reinsured, with possible retrocession (retrocedent and retrocessionaire).
2. Subject Matter:
   • Insurance: Property, person or benefits exposed to loss.
   • Reinsurance: Contractual liability accepted by reinsured.
3. Indemnity:
   • All reinsurance contracts are contracts of indemnity.

Functions of Reinsurance

• Capacity Relief: Enables writing of larger insurance.
• Catastrophe Protection: Shields against large losses.
• Stabilization: Smoothens operating results.
• Surplus Relief: Eases strain during premium growth.
• Market Withdrawal/Entrance: Facilitates withdrawal or entry into markets.
• Expertise and Experience: Provides underwriting support.

Legal Principles of Reinsurance

• Governed by general contract law and insurance-specific rules:
  1. Insurable interest.
  2. Utmost good faith.
  3. Indemnity.

Methods and Types of Reinsurance

• Proportional and Non-Proportional:
  • Facultative (optional) and Treaty (obligatory).
• Types:
  • Facultative Reinsurance: Optional, per-risk basis.
  • Treaty Reinsurance: Includes quota share and surplus treaties.

Types of Reinsurance Pools

• Market Pools: Companies collectively cover risks.
• Government Pools: Government mandates participation.
• Underwriting Pools: Used by companies entering new markets.

Non-Proportional Reinsurance

• Excessive Loss: Covers claims beyond a set deductible.
• Stop Loss: Protects against total loss exceeding a limit.

Pricing and Bases of Excess Loss

• Pricing Methods:
  1. Experience-based.
  2. Exposure-based.
• Excess Loss Bases:
  1. Risk-attaching.
  2. Losses occurring.
  3. Losses discovered/claims made.

Conclusion

• Reinsurance is a crucial risk management tool for insurers.
• Offers various forms and functions to manage and distribute risk effectively.
• Important for stabilizing insurance companies' operational and financial performance.