Understanding Reinsurance Basics and Functions

operations, and practices. In this video, you will understand the meaning of reinsurance, the difference between insurance and reinsurance contracts, reinsurance functions, standard terms of a reinsurance treaty, legal principles of reinsurance, methods of reinsurance, and types of reinsurance pools. Now, let us start. What is reinsurance? Reinsurance is a risk transfer contract between an insurance company, known as the reinsured, and a reinsurance company, known as the reinsurer, whereby the reinsurer undertakes the liability incurred by the reinsured under a primary insurance contract in exchange for payment of a premium to the reinsurer. Reinsurance is a form of insurance based on the principles and practices applicable to the insurance business. A reinsurance contract is also a risk transfer mechanism between a reinsured and a reinsurer. An insurance contract is a contract between two parties, known as the insured and the insurer, whereby the insurer promises to indemnify the insured in the event of a loss caused by the insured perils in exchange with the payment of a consideration known as the premium. Differences between insurance and reinsurance contracts. Reinsurance contract differs fundamentally from other classes of insurance contracts in three primary ways. 1. A reinsurance contract is between insurers and reinsurers. A reinsurer may also reinsure insurances accepted under its reinsurance contracts. Such a contract is known as retrocession. The seeding company is known as the retrocedent, and the reinsurer is known as the retrocessionaire. 2. The subject matter of insurance is some property, person or benefit exposed to loss or damage or some potential legal liability the insured may incur arising out of activities undertaken by himself, his servants, or agents. A reinsurer only becomes directly interested in such property or loss since he has compensated the reinsured for payment the latter has made. Hence, The subject matter insured under a reinsurance contract is all or part of the contractual liability which the reinsured has accepted under the insured policies he has underwritten. 3. Not all insurance contracts are subject to the principle of indemnity. It is a well accepted law that insurances covering human life, life, personal accident, and sickness policies, are excluded from the principle and sometimes referred to as benefit policies or contracts. All reinsurance contracts, including life reinsurance, are contracts of indemnity because reinsurance C claims are limited to payments of claims based on the proportion of risk accepted under the reinsurance contract. Functions of Reinsurance The most common reasons for purchasing reinsurance include 1. Capacity Relief This allows the reinsured to write larger amounts of insurance. 2. Catastrophe Protection Protects the reinsured against a large single, catastrophic loss or multiple significant losses. 3. Stabilization. Helps smooth the reinsured's overall operating results from year to year. 4. Surplus relief. Reinsurance eases the strain on the reinsured's surplus during rapid premium growth. 5. Market withdrawal. provides a means for the reinsured to withdraw from a line of business or geographic area or production source. 6. Market Entrance, helps the reinsured spread the risk on new lines of business until the premium volume reaches a certain point of maturity, can add confidence when in unfamiliar coverage areas. 7. Expertise and Experience, Provide the reinsured with a source of underwriting information when developing a new product and entering a new line of insurance or a new market. Legal Principles of Reinsurance Reinsurance contracts are subject to the general law of contracts and the rules applicable to insurance contracts. Consequently, provisions of contract law relating to such matters as an intention to create a legal relationship, offer and acceptance, consideration, Capacity to enter contracts, and legality apply to the formation, construction, performance, and validity of reinsurance contracts. Re-insurance contracts are also subject to the special rules governing insurance contracts, notably. 1. There must be an insurable interest. 2. The contract is one of utmost good faith. 3. The contract is one of indemnity. There is no general requirement in English law that re-insurance contracts take any unique form. A re-insurance contract should comply with the basic requirements of a simple contract. It follows that a purely oral contract of reinsurance is valid. In practice, it is preferable that all reinsurance contracts, like direct insurances, should be embodied in a documentary form signed by the reinsurer. If there is an obligation on both parties under reinsurance treaties, it is conventional for the reinsurance policy to be issued in duplicate and signed by both parties. Insurable Interest Insurable interest constitutes a legal right to insure. This means that anyone who insures must have a legal and financial interest in the subject matter of insurance, which is the item, event or risk being insured. In broad terms, an insured is deemed to have insurable interest if the insured is in a legal or equitable relationship with the subject matter of the insurance, whereby the happening of the insured event will prejudice the insured. The validity of a reinsurance contract likewise rests on the ceding company possessing an insurable interest in the subject matter of T.T. insurance. The insurable interest of the primary insurer, that is, the retrocedent, is limited to the extent of the loss incurred under the original insurance contract or policy caused by the insured peril, subject to the sum insured, the limit of indemnity and liabilities insured. Utmost good faith. Both parties that is, the reinsured and the reinsurer, to the reinsurance contract must disclose to each other facts that are material to the risk, even if specific questions are not asked. Facts that are material to risk is known as material facts. According to Section 18-2 of the Marine Insurance Act 1906, a material fact is every circumstance which would influence the judgment of a prudent and reasonable underwriter in fixing a premium or determining whether to accept the risk. Like insurance contracts, all reinsurance contracts are subject to the principle of utmost good faith. It is not sufficient that the parties merely refrain from making misrepresentations, they must disclose all material facts in the same way as the duty applies to contracts of direct insurance. It has been held that this duty lies on both parties. Suppose an insurer had been given false information by the insured without checking its accuracy before passing the information to the reinsurer. In that case, the reinsurer is entitled to avoid the reinsurance agreement. Despite a breach of duty, the reinsured pays a claim, and this is known as an ex gratia payment by the reinsurer because the reinsurer is not legally liable to settle the claim. Facts that should be disclosed by the seeding company, that is, the reinsured. includes details of the reinsured risk and the amount of risk retained by the reinsured. Indemnity. All reinsurance contracts are contracts of indemnity, the general principle being that the reinsurer's liability is limited to the actual loss, which the seeding company has suffered, subject to the limit of the contract reinsurance. The general rule is that a seeding company must prove that the loss for which it claims an indemnity from the reinsurers falls within the terms of the reinsurance contract and that the company was liable to pay the loss. Hence, if a seeding company pays an ex gratia payment for a loss suffered by its insured, it will have no right to an indemnity from its reinsurer. In view of a restriction of the reinsured's right of recovery from the reinsurer, It is a market practice to override the strict rules of common law by incorporating into reinsurance contracts conditions that give the primary insurer the right to settle its primary insurance claims at its discretion and to seek indemnity from the reinsurer appropriately. Life insurance and personal accidents policies are benefit or compensation contracts, but all reinsurance contracts, including life insurance and personal accident reinsurance, are contracts of indemnity. Terms of Reinsurance Contracts or Treaties. Standard terms of a reinsurance treaty include. 1. Parties to the agreement are the seeding company and the reinsurer. The policyholder is not involved. In most cases, the policyholder will not know the policy is reinsured. 2. Reinsurance is usually an indemnity arrangement. The reinsurer indemnifies the seeding company for what it pays in claims. 3. Both parties have the right to defend against a claim, and if one chooses not to, it will pay its share to the other company and leave the other to absorb all legal costs. If the defense is successful, the one that did not join the defense does not get a refund. 4. The reinsurer has the right to inspect the records of the seeding company at any time. 5. A choice of law will be stated. In case of a dispute between the parties, there will be no time wasted arguing which law applies. The clause will say that the law of a specified country applies. The choice may be the law of the jurisdiction of the defendant. 6. The Errors and Omissions Clause says that unintentional clerical errors will be set right in the following statement and are not caused to cancel the contract. And, 7. An Actuarial Equivalent Clause can save pages of the formula for what happens if the treaty is terminated at at different times. Methods of Reinsurance Treaty. The primary methods of reinsurance are proportional and non-proportional. Proportional and non-proportional reinsurance can be transacted on a facultative and a treaty basis. There are many subtypes of both proportional and non-proportional forms. Facultative Reinsurance. Facultative means optional, and the power to act according to a free choice. The primary feature of facultative reinsurance is that the reinsurance company is free to accept or decline each proposition. The insurer is not obliged to cede, as in the case of treaty reinsurance. The other important feature is that this type of reinsurance is affected to cover individual acceptances. For instance, where a ceding company wished to write a fire and perils policy on a large industrial complex. and its financial capacity was limited to a sum equal to 25% of the overall exposure, it might seek facultative reinsurance to be able to accept the whole risk for its marketing advantage. From the reinsurer's standpoint, facultative also means the power to accept or decline each risk according to its underwriting judgment and other necessary considerations. Facultative reinsurances can be on a proportional or non-proportional basis. By effecting proportional facultative reinsurance, a direct insurer can relieve himself of part of the liability he has accepted on a particular direct risk by ceding a share to one or more reinsurers. The result is that the insurer pays to the reinsurer a share of the premiums, less commission, and in the event of a loss, the reinsurer that same share of the original claims from the reinsurer. The ceding company would thus be limiting its exposure to its share, provided the Reinsurers involved complied with the reinsurance agreement. Advantages of facultative reinsurance. 1. It enables a small developing insurance company with limited expertise to compete for large risks beyond its usual capacity, using the expertise and capacity of the international reinsurance markets. 2. An insurance company might choose the method of reinsurance to maintain a balanced portfolio, that is, It would divest itself of those large or hazardous risks where a significant loss would result in an overall loss for that year in a particular branch of business. It often happens in developing countries that a significant project such as a dam or large industrial complex is built where the exposures are many times those of any other risk in that territory. 3. Reciprocity, there may also, for certain insurance companies, b. Minimal opportunities to exchange a share in a sizable local risk for a share in a large risk in another territory, and by use of the facultative method within a circle of friendly insurance companies, a spread of the business may be possible which also ensures maintenance of a reasonable retained premium income. 4. For commercial reasons, an insurance company might also be obliged to accept a risk that falls outside the parameters of its usual acceptances. Here again, The facultative method can be used to solve the problem. This problem is likely to be either that the capacity required is larger than that which is allowed by the treaty facilities or that the class or type of business is excluded from the treaties or is usually not underwritten by the company. Disadvantages of facultative reinsurance. 1. Facultative reinsurance may result in the release of helpful information to competitors, the need to disclose full details of the original risk meant. that, where this method was employed on several occasions, those reinsurers frequently approached would gain an insight into the underwriting policies and portfolio of the seeding company. 2. The act of acceptance had to be employed until sufficient reinsurers had been obtained to cover the risk in question. This could mean losing the business to competitors with larger capacities, accepting the risk without full cover, or simply losing some valuable goodwill through protracted delay. 3. It is expensive. The administration involved in negotiations, wordings, and accounts could be both heavy and expensive, reducing the amount of retained premium income available to pay losses and provide profits. It is cumbersome to administer because each facultative reinsurance contract requires new documentation. 5. Before each renewal, the negotiation process had to be repeated, usually before renewal discussions with the client, to ensure that the reinsurance cover would be available for another year. Cancellation or change would result in additional work. Treaty Reinsurance. Due to the above problems and the ever larger number O. F. Reinsured risks. The treaty method of reinsurance, proportional and non-proportional treaty, evolved to overcome these difficulties. There are two main types of proportional treaty reinsurance, quota share and surplus treaty. Quota share treaty. Quota share treaty reinsurance is a form of prorata reinsurance, proportional. It is a form of reinsurance in which the seeding insurer seeds an agreed-on percentage of every risk it insures that falls within a class or classes of business subject to a reinsurance treaty. The reinsurer assumes an agreed percentage of each insurance being reinsured and shares all premiums and losses accordingly with the reinsured. Quota share treaty results in a sharing of the gross retention of the seeding company between itself and its reinsurer in a predetermined proportion. Quota share reinsurance is usually arranged to apply to the insurer's net retained account, that is, after deducting all other reinsurance except perhaps excessive loss catastrophe reinsurance, but practice varies. A quota share reinsurer may be asked to assume the quota share of a gross account, paying its share of the premium for other reinsurance protecting that gross account. Advantages of quota share treaty. Advantages of quota share include. 1. Sharing the risk, identity of interest, which allows for trust, long-term commitment. 2. The premium volume ceded to the reinsurers is a temptation for them to offer an excellent price to the insurance company. And, 3. It entails a simple process with a reduced handling cost. Disadvantages of Quota Share Treaty. Disadvantages of Quota Share include. 1. Seeded premium amount can be huge if a high capacity is required. 2. Insurance companies may cede risks and the premium they could keep without financial problems. 3. An unbalanced book with small and high sums insured will remain with the same imbalance. And, 4. Quota shares treaties do not offer protection against big claims. The same loss ratio remains, claims to premium, gross, before reinsurance, or net. after reinsurance. Usage of quota share treaty. Quota shares can be used where, 1. A company is new in a particular market, and its underwriting experience is unknown yet requires substantial reinsurance protection. 2. A company surplus treaty claims experience has been lacking. And, 3. seen as a means of saving costs by earning higher commission rates than on surplus treaties and cutting the administrative process of retention decision making. Surplus Treaty This type of treaty enables the seeding company to accept larger sums insured than its gross retention, the surplus being seeding to reinsurers. Gross retention is the amount the seeding company retains and its quota shares reinsurers. The net retention is the amount retained by the seeding company alone subject only to catastrophe reinsurance. The capacity of a surplus treaty is always a multiple of the seeding company's gross net retention. This retention is often called a line. Further multiples of the retention or lines can be added beyond the first and second surplus treaties. Generally, however, a first and perhaps a second surplus treaty are deemed sufficient if the seeding company is not. to become merely an agency accepting risks but passing nearly all the liability on to others. However, despite a low insurance penetration, there are several risks in territories where third and fourth surplus treaties can be found. A combination of first, second and third surplus treaties can be used. The obligatory nature of the treaty arrangement obviates the necessity for the ceding company to refer each risk to reinsurers. provided the risk falls within the scope of its treaties. it can give immediate cover. These days it is unusual for the seeding company to use open treaty or blind treaty, that is, the situation where reinsurers are supplied with details of each risk seeded to the treaty in the form of lists of sessions called borderos. Hence, the heavy administration necessary for facultative placements is avoided. Even in those exceptional cases where the seeding company provides each of its reinsurers with borderos. this requirement is less cumbersome than providing the vast amount of underwriting information required under the facultative method. The premiums and losses will be credited and debited in proportion to the share cede to the treaty. Accounts are issued either quarterly, monthly, half-yearly or sometimes even annually, possibly with border rows, setting out the premiums, the reinsurance commission, the losses, and the reserves, if any. Disadvantages of Proportional Treaties Proportional treaties, like all reinsurance methods, have their disadvantages including 1. If a risk does not fall within the scope or capacity of a company's treaty arrangements, the company must still resort to the facultative method of reinsurance. 2. Where a risk falls within the treaty arrangement's scope or capacity, the company must cede accounting to the treaty's terms. Therefore, it cannot unilaterally begin a relationship with a newfound company or deal with risk in another fashion unless a specific provision is included in the existing treaty for reinsuring in front of the treaty. It cannot alter its retentions or underwriting practice where these details form an integral part of the treaty or prior negotiations. 3. Particularly under the quota share arrangement, the seeding company must share all its relevant business with its reinsurers. The subsequent loss of premium income, particularly during highly profitable periods, can prevent the seeding company from building up its resources and its ability to develop its capacity. Facultative Obligatory Reinsurance. Facultative obligatory reinsurance arrangements are contracts that combine some of the principles of both the facultative and the treaty methods of proportional reinsurance. Under a facultative obligatory treaty, The seeding company is not obliged to see to its reinsurers'risks falling within the treaty's scope. However, where it chooses to do so, reinsurers are obliged to accept the session so that the facultative obligatory treaty operates as a surplus treaty. Such arrangements provide considerable flexibility to the seeding company. A high degree of trust must exist between the contracting parties to ensure that the reinsurers receive a reasonable spread of risks. This type of treaty is often arranged to provide additional capacity after shares have been allocated to the quota share and surplus treaties, without the expense and uncertainty of the facultative method. Such treaties may be arranged mainly for an existing account. They may also be required to maintain acceptance limits on large, so-called target risks or where accumulation problems arise. They may also be used to cover specific categories of risks where the degree of hazard requires that the company should limit its retention. Like the surplus treaty, the capacity is a multiple of the seeding company's gross retention. The main difference between the surplus and the facultative obligatory is that under the latter arrangement, there is no obligation on the part of the seeding company to seed risks falling within its scope. It should also be noted that risks ceded to such a treaty are likely to be both fewer and more substantial than those ceded to the surplus treaty, thus producing an even less balanced portfolio for reinsurers. The optional characteristic can also work to the advantage of reinsurers as a ceding company may not cede specific risks to protect reinsurers. The concept of facultative obligatory has been adapted in several ways to suit a particular situation. Facultative excess of loss cover can be purchased to protect the sedent's retention or the common account of the sedent and its reinsurers. The sedent must ensure that the method chosen is permitted under the terms of its pro rata treaties. In particular, the second method, the common account of the sedent and its reinsurers, is considered unacceptable by some reinsurers as it significantly affects the pro rata treaty loss experience. The growth of facultative obligatory can be attributed to the fact that the sedent and its reinsurers are not subject to the same kind of tax. to two primary factors, one, the underwriting of high hazard and high value business, and, two, the development of the captive insurance company business. One, the underwriting of high hazard and high value business. The underwriting of high-hazard and high-value business, for example, petrochemical risks, may unbalance pro-rata treaties by exposing them to an increased risk of a catastrophe loss. In certain territories with a limited or highly competitive local market, a company may feel compelled to accept a more significant share of such a risk than can be managed within its treaty limits. 2. The development of the captive insurance company business. The second factor in increasing facultative excess of loss reinsurance is the captive insurance company business development. A captive is a company operated primarily for underwriting in whole or in part, directly or indirectly, the insurances of its parent. The rise of influential multinational organizations that prefer their risks to be experience-rated rather than class-rated and have been unable to achieve their required terms through the conventional market, has led to an increased tendency for this type of organization to form its insurance subsidiary. Reinsurance is then purchased to limit the captive's exposure to a tolerable level. Given the nature of the captive's portfolio, this is usually best achieved by using an excessive loss reinsurance. Although the treaty th underwriting considerations are such that many companies handle this class of business in their facultative departments. As an example of facultative accessory insurance, let us consider a petrochemical plant of value $50 million. The maximum probable loss, MPL, is assessed as $10 million, ignoring an existing vapor cloud hazard, but $30 million if this factor is considered. The sedent writes 100% of this risk and seeks to limit its potential loss to $500,000 any one loss. Different underwriters have different preferences when accepting excessive loss business. Some prefer to generate high premium income by writing low-level covers within the MPL, and others prefer to write a large portfolio of high-level covers. It is essential that the underwriter accepting high-level covers, where a little premium is generated regarding liabilities assumed, writes enough of such business to achieve a reasonable balance in his account. This is achieved when no single loss can eliminate his underwriting profit for the year. Due to varying preferences, the sedent decides could obtain the best terms by purchasing cover in layers. First layer, $9,500,000 in excess of $500,000, to cover the maximum probable loss exposure. Second layer, $20,000,000 in excess of $10,000,000, to cover vapor cloud exposure. And, Third layer, $20 million in excess of $30 million, to cover the maximum probable loss error exposure. It is worthwhile to emphasize that the facultative-obligatory concept has been adapted in several ways to suit specific situations, including open covers, brokers'covers, lines slips, and reinsurance pools. Let us examine some of the arrangements adapted from the facultative-obligatory concept. Open Covers In general usage, an open cover may be synonymous with a facultative obligatory treaty. However, open cover strictly speaking refers to an unlined treaty under which the session is not linked to the insurer's retention. The word cover, imported from direct insurance, gives the impression more of a facility in a particular branch or subcategory than a treaty's more general and broader scope, given the more precise nature of such arrangements. the business is often dealt with in the facultative department instead of the treaty department. By their nature, open covers tend to produce selection against the reinsurer, particularly if there is limited spread in quantity and even more limited spread in the type of risk included in the open cover.Brokers'covers. It is often common for brokers to hold direct covers to enable them to place clients'business with certain companies and Lloyd's underwriters. It is also possible for certain reinsurance brokers to obtain reinsurance covers to enable them to place reinsurance on behalf of their clients. The concept in this instance is entirely different from all methods dealt with so far, as the broker will not be in a legal position to take any share in the reinsurance risks because seeding companies, that is, the primary insurers, has engaged the broker to place the reinsurance business. Frequently, The broking house will be split into an underwriting department or company and a broking department or company to enable both tasks to be carried on effectively. Many brokers have also developed the underwriting side into an underwriting agency. In its basic form, the broker's cover has often produced heavy losses, and in many areas of the reinsurance markets, those covers can be difficult to obtain. Effectively, this depends on the level of competition within a market and whether participants work harder to increase the profit. However, some brokers have been able to recruit or develop considerable underwriting expertise, and in those situations, the covers have been successful and profitable for all parties concerned. Wordings and accounts are very similar to treaty wordings and accounts. The significant differences are that generally, the broker holds no reserves, and all items are as original, the broker receiving a small overrider and a prompt commission. Line slips. The origin and basis of this arrangement are virtually the same as the broker's cover. The main difference is that the broker does not have the authority to accept risks on behalf of participating reinsurers. Instead, he must submit the risks to the leading reinsurers, who will decide whether the risk is acceptable. Subject to the agreement of the leading reinsurers, all other reinsurers are obliged to accept risks placed under the facility. Such arrangements are often very convenient to both parties. The broker can fully represent the client and place quite large amounts rapidly. The acceptance by one or more leading reinsurers binds all the following reinsurers. Also, the reinsurers who must follow have the assurance that the skilled leaders had seen all the risks before being placed under the facility. Reinsurance Pools A pool is an arrangement whereby a certain number of insurance companies form a collective capacity to accept specific classes of risk, and each company is liable for its share in the pool. There are several types of pools. The most common types of reinsurance pools are market reinsurance pools. Government Reinsurance Pools and Underwriting Pools Market Reinsurance Pool A market pool, where most insurance companies within a country usually participate, is a beneficial method to underwrite significant or hazardous risks. Such risks can range from catastrophic to pooling expertise to provide a new type of insurance. Thus, for example, nuclear risks are commonly covered by a market pool. As there are very few risks and immense liabilities, almost all companies take a share. This also obviates the need for government intervention in such areas. Another example has been the underwriting of products liability cover. One of the Scandinavian countries, Denmark, commenced this type of insurance by forming a pool. Generally, any member company can introduce business to the pool. A committee usually does the rating. and members of the pool share the risk. The pool may take out collective reinsurance. Individual companies are often obliged to retain their share absolute net, to ensure that the pool sessions or reinsurances are the only sources of possible accumulations. In some pools, the producing company may only cede business to the pool in excess of specific retention, in other cases, all business must be transferred to the pool 100%.. Government Reinsurance Pools To prevent the exportation of significant businesses to foreign reinsurers, the government can create a reinsurance company or pool into which all insurance companies must cede or reinsure part or all their reinsurance business subject to the terms of the reinsurance pool. This is known as a government reinsurance pool. The participating insurance companies may be shareholders in the reinsurance pool. thereby receiving a share in the pool in return. Similar in concept is the regional reassurance pools organized over the last 30 years by many developing countries. The object has been to increase the regional market's total underwriting capacity and retain as much premium income as possible within the region. In some cases, the pool has been managed by one of the members, for example, the Arab pools. In other cases, A separate reinsurance company has been formed to manage the business, for example, the African RE and the Asian RE. Some pools, for example, the Africa RE, receive a compulsory quota share session from all companies operating in the region. Underwriting pools. Smaller, developing companies who wish to enter a new market, class, and type of business may not have the expertise or necessary capacity to establish a sound foothold. They may. Therefore, form a pool represented by an experienced underwriter in the chosen field of development, with sufficient collective capacity to accept competitive shares. There are many such bulls in existence around the world to write international reinsurance business. Now, let us discuss the Non-Proportional Reinsurance Treaty. Features and Operations of Non-Proportional Reinsurance Treaties Non-Proportional Reinsurance is based on claims sharing. The original risk, premium, claims, and acquisition costs will be shared between the sedent, reinsured, and reinsurer for proportional reinsurance. This means that the reinsurer usually follows the fortune of the sedent or the reinsured. In contrast, non-proportional reinsurance allows for tailor-made flexible solutions fitted to the targeted risk profile of the sedent. The non-proportional reinsurer is only liable for claims above a certain level. In proportional reinsurance, risks are shared between direct insurer and reinsurer based on sums insured. In non-proportional reinsurance, Claims are shed on the loss paid. The liability of the direct insurer is capped at a certain amount. This is called the deductible. The reinsurance pays whatever exceeds this amount. Non-proportional reinsurance is usually referred to as excess loss because the loss must exceed specific retention or deductible before a claim can be made against the reinsurance. Deductible, also known as retention, the first loss and the excess. is the part of a claim borne by an insurer before the reinsurer pays a reinsurance claim. Limit is the amount payable by the reinsurer. An excess of loss treaty provides the insurer capacity to underwrite large risks. It primarily protects the reinsured against the severity of a loss. While casualty reinsurance is written on an excess of loss basis, increased application of this approach is increasingly used for a property per risk business. Functions of Excessive Loss Reinsurance Functions of Excessive Loss Reinsurance include 1. Provide the sedent with the ability to provide more significant coverage limits. 2. Reduce the fluctuation in loss experience by limiting the number of sustained losses. and 3. Lessen the impact of losses from a single large event with multiple losses or the accumulation of losses from frequent events. characteristics of excessive loss reinsurance. Here are the characteristics of excessive loss reinsurance. 1. Protects the reinsured's net retained account, that is, after proportional treaties and facultative reinsurance. 2. Reinsurers pay only when claims exceed the deductible, net retention, and then only for the excess amount, up to agreed limits. 3. Premiums are shared non-proportionally between seeding company and the reinsurer. Premiums are calculated as a percentage of the primary insurer's premium charge. 4. Reinsurers may pay a profit commission, contingent commission, for an insurer's favorable loss experience. 5. It generally involves much less seeded premium than a pro rata structure. It, therefore, does not provide the sedent with meaningful surplus relief as would be the case under a pro-rata arrangement. 6 Cover is not primarily intended for catastrophes, affecting many risks. and 7 Excessive loss reinsurance is known as a working excess of loss when the deductible is set at a level likely to produce a relative frequency of claims. What are the advantages and disadvantages of non-proportional treaties? Advantages of Non-Proportional Treaty. Advantages of the Non-Proportional Treaty include, 1. The reinsured can retain more income than if wholly dependent on prorata treaties. 2. Administratively simple to operate. And, 3. Reduction of the impact of large claims has a stabilizing effect on the protected account. Disadvantages of Non-Proportional Treaty. Disadvantages of the Non-Proportional Treaty include 1. Excessive loss rates is subject to rapid and wide fluctuations, depending on claims experience. 2. If free of claim, the cost may not be cheaper than pro-rata treaties, bearing in mind their factors of commission and pro-rata contribution on claims recoveries. 3. No cover for small and medium-sized claims. 4. No commission from reinsurers. 5. Cover may be limited vertically, that is, limited to less than 100% of the sum insured, and horizontally, that is, limited reinstatements because not every claim will be covered. Forms and types of non-proportional reinsurance The primary forms of non-proportional reinsurance are, 1. Excessive loss, and, 2. Stop loss. Let us discuss these two forms of non-proportional reinsurance. Working excessive loss. Working excessive loss is also known as per-risk excessive loss. With a working excessive loss reinsurance, the reinsurer indemnifies the primary company for any loss above the specified retention on each risk. In per-risk. The sedent's insurance policy limits are more significant than the reinsurance retention. For example, an insurance company might insure commercial property risks with policy limits up to £10 million and then buy per risk reinsurance of N5 million in excess of £5 million. In this case, a loss of £6 million on that policy will recover £1 million from the reinsurer. What are the advantages and disadvantages of working excessive loss? Advantages of working excessive loss reinsurance. Advantages of working excessive loss include, 1. Limitation of the maximal exposure, 2. Simple administration, and 3. Small premium. Disadvantages of working excessive loss reinsurance. Disadvantages of working excessive loss include, 1. Fixing the reinsurance premium. 2. Inadequate against the accumulation of small claims. And, 3. Conditions can change faster. Catastrophe Excessive Loss Catastrophe Excessive Loss Reinsurance is also known as Prevent and Occurrence Excessive Loss. The purpose of a catastrophe excess treaty is to protect a primary company against adverse loss experiences resulting from the accumulation of losses arising from a single, major natural disaster or event such as a hurricane, tornado, earthquake, flood, and windstorm. This excessive loss cover is designed to protect an insurance company's overall underwriting results after applying other types of reinsurance it may have. It provides reinsurance for losses incurred during the treaty term, usually one year, in excess of a specified loss ratio or a predetermined dollar or designated currency amount. For a given event, the treaty applies once the accumulation of losses paid by the primary company reaches predetermined retention. What are the advantages and disadvantages of catastrophe excessive loss? Advantages and disadvantages of catastrophe excessive loss Advantages of catastrophe excessive loss include 1. Limitation of the maximal exposure in case of an event 2. Simple and easy to administer and 3. Payment of small premium Disadvantages of catastrophe excessive loss Disadvantages of catastrophe excessive loss include 1. The reinsurance premium is fixed as agreed at the inception of each contract 2. Conditions of catastrophe excessive loss contracts can change faster. 3. Often difficult or challenging to buy. And 4. Catastrophe excessive loss are always in form of aggregate excessive losses or stop losses. Bases of excessive loss cover. The three bases of excessive loss reinsurance contracts are, 1. Risks attaching basis. 2. Losses occurring basis. And 3. Losses discovered or claims made. basis. Now, let us discuss these three bases of excess loss cover. 1. Risk-attaching basis, a basis under which reinsurance is provided for claims arising from policies commencing during the period to which the reinsurance relates. The insurer knows there is coverage for the whole policy period when written. All claims from seed and underlying policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. Any claims from seed and underlying policies incepting outside the period of the reinsurance contract are not covered even if they occur during the period of the reinsurance contract. Reinsurers usually limit claims up to a maximum of 12 months after the expiry of the contract. 2. Loss Occurring Basis is a reinsurance treaty under which all claims occurring during the contract period, irrespective of when the underlying policies are incepted, are covered. Any claims occurring after the contract expiration date are not covered as opposed to a claims made policy. Insurance coverage is provided for losses occurring in the defined period. This is the usual basis of cover for most policies. 3. Loss is discovered or claims made basis, a policy covering all claims reported to an insurer within the policy period irrespective of when they occurred. This solves the problem of long-tail business. Non-proportional reinsurance pricing. There are two basic methods of non-proportional reinsurance pricing. One, experience-based methods. And, two, exposure-based methods. The non-proportional reinsurance premium calculation depends on the type of excessive loss, the claims history and structure of the layer. 1. Burning cost calculation is based on claims experience. A more sophisticated way of using claims experience is an extrapolation based on risk theory and modeling the claims profile. 2. Exposure rating is based on the composition of the portfolio according to sums insured. 3. Payback. calculation depends on how many years it would take the maximum probable losses to be repaid by future annual premiums. Conclusion Reinsurance meaning, operations and practices have been discussed in this video. Reinsurance is a form of insurance based on the principles and practices applicable to the insurance business. Reinsurance is a re-sk transfer contract between an insurance company, known as the reinsured, and reinsurance company. known as the reinsurer, whereby the reinsurer undertakes the liability incurred by the reinsured under a primary insurance contract in exchange for payment of a premium to the reinsurer. A reinsurance contract is also a risk transfer mechanism between reinsured and reinsurers. I hope this video is educative and beneficial to you. Please post your response and questions below in the comment section. If this video has been educative and beneficial to you, Then, give it a thumbs up and share it with your friends. Thank you for seeing the Risk Management of Everything videos. We love to hear from you, please post your comments and questions in the comment section down below. If you are new here, make sure to subscribe to our channel, Risk Management of Everything channel, and press the notification button so you can be notified when we upload new videos. Thank you.

Reinsurance is a risk transfer contract between an insurance company, known as the reinsured, and a reinsurance company, known as the reinsurer, whereby the reinsurer undertakes the liability incurred by the reinsured under a primary insurance contract in exchange for payment of a premium to the reinsurer. Reinsurance is a form of insurance based on the principles and practices applicable to the insurance business. A reinsurance contract is also a risk transfer mechanism between a reinsured and a reinsurer.

An insurance contract is a contract between two parties, known as the insured and the insurer, whereby the insurer promises to indemnify the insured in the event of a loss caused by the insured perils in exchange with the payment of a consideration known as the premium. Differences between insurance and reinsurance contracts. Reinsurance contract differs fundamentally from other classes of insurance contracts in three primary ways.

1. A reinsurance contract is between insurers and reinsurers. A reinsurer may also reinsure insurances accepted under its reinsurance contracts. Such a contract is known as retrocession. The seeding company is known as the retrocedent, and the reinsurer is known as the retrocessionaire.

2. The subject matter of insurance is some property, person or benefit exposed to loss or damage or some potential legal liability the insured may incur arising out of activities undertaken by himself, his servants, or agents. A reinsurer only becomes directly interested in such property or loss since he has compensated the reinsured for payment the latter has made. Hence, The subject matter insured under a reinsurance contract is all or part of the contractual liability which the reinsured has accepted under the insured policies he has underwritten.

3. Not all insurance contracts are subject to the principle of indemnity. It is a well accepted law that insurances covering human life, life, personal accident, and sickness policies, are excluded from the principle and sometimes referred to as benefit policies or contracts. All reinsurance contracts, including life reinsurance, are contracts of indemnity because reinsurance C claims are limited to payments of claims based on the proportion of risk accepted under the reinsurance contract. Functions of Reinsurance The most common reasons for purchasing reinsurance include 1. Capacity Relief This allows the reinsured to write larger amounts of insurance.

2. Catastrophe Protection Protects the reinsured against a large single, catastrophic loss or multiple significant losses. 3. Stabilization. Helps smooth the reinsured's overall operating results from year to year. 4. Surplus relief. Reinsurance eases the strain on the reinsured's surplus during rapid premium growth.

5. Market withdrawal. provides a means for the reinsured to withdraw from a line of business or geographic area or production source. 6. Market Entrance, helps the reinsured spread the risk on new lines of business until the premium volume reaches a certain point of maturity, can add confidence when in unfamiliar coverage areas.

7. Expertise and Experience, Provide the reinsured with a source of underwriting information when developing a new product and entering a new line of insurance or a new market. Legal Principles of Reinsurance Reinsurance contracts are subject to the general law of contracts and the rules applicable to insurance contracts. Consequently, provisions of contract law relating to such matters as an intention to create a legal relationship, offer and acceptance, consideration, Capacity to enter contracts, and legality apply to the formation, construction, performance, and validity of reinsurance contracts.

Re-insurance contracts are also subject to the special rules governing insurance contracts, notably. 1. There must be an insurable interest. 2. The contract is one of utmost good faith. 3. The contract is one of indemnity.

There is no general requirement in English law that re-insurance contracts take any unique form. A re-insurance contract should comply with the basic requirements of a simple contract. It follows that a purely oral contract of reinsurance is valid.

In practice, it is preferable that all reinsurance contracts, like direct insurances, should be embodied in a documentary form signed by the reinsurer. If there is an obligation on both parties under reinsurance treaties, it is conventional for the reinsurance policy to be issued in duplicate and signed by both parties. Insurable Interest Insurable interest constitutes a legal right to insure. This means that anyone who insures must have a legal and financial interest in the subject matter of insurance, which is the item, event or risk being insured.

In broad terms, an insured is deemed to have insurable interest if the insured is in a legal or equitable relationship with the subject matter of the insurance, whereby the happening of the insured event will prejudice the insured. The validity of a reinsurance contract likewise rests on the ceding company possessing an insurable interest in the subject matter of T.T. insurance.

The insurable interest of the primary insurer, that is, the retrocedent, is limited to the extent of the loss incurred under the original insurance contract or policy caused by the insured peril, subject to the sum insured, the limit of indemnity and liabilities insured. Utmost good faith. Both parties that is, the reinsured and the reinsurer, to the reinsurance contract must disclose to each other facts that are material to the risk, even if specific questions are not asked.

Facts that are material to risk is known as material facts. According to Section 18-2 of the Marine Insurance Act 1906, a material fact is every circumstance which would influence the judgment of a prudent and reasonable underwriter in fixing a premium or determining whether to accept the risk. Like insurance contracts, all reinsurance contracts are subject to the principle of utmost good faith.

It is not sufficient that the parties merely refrain from making misrepresentations, they must disclose all material facts in the same way as the duty applies to contracts of direct insurance. It has been held that this duty lies on both parties. Suppose an insurer had been given false information by the insured without checking its accuracy before passing the information to the reinsurer. In that case, the reinsurer is entitled to avoid the reinsurance agreement. Despite a breach of duty, the reinsured pays a claim, and this is known as an ex gratia payment by the reinsurer because the reinsurer is not legally liable to settle the claim.

Facts that should be disclosed by the seeding company, that is, the reinsured. includes details of the reinsured risk and the amount of risk retained by the reinsured. Indemnity.

All reinsurance contracts are contracts of indemnity, the general principle being that the reinsurer's liability is limited to the actual loss, which the seeding company has suffered, subject to the limit of the contract reinsurance. The general rule is that a seeding company must prove that the loss for which it claims an indemnity from the reinsurers falls within the terms of the reinsurance contract and that the company was liable to pay the loss. Hence, if a seeding company pays an ex gratia payment for a loss suffered by its insured, it will have no right to an indemnity from its reinsurer. In view of a restriction of the reinsured's right of recovery from the reinsurer, It is a market practice to override the strict rules of common law by incorporating into reinsurance contracts conditions that give the primary insurer the right to settle its primary insurance claims at its discretion and to seek indemnity from the reinsurer appropriately.

Life insurance and personal accidents policies are benefit or compensation contracts, but all reinsurance contracts, including life insurance and personal accident reinsurance, are contracts of indemnity. Terms of Reinsurance Contracts or Treaties. Standard terms of a reinsurance treaty include. 1. Parties to the agreement are the seeding company and the reinsurer.

The policyholder is not involved. In most cases, the policyholder will not know the policy is reinsured. 2. Reinsurance is usually an indemnity arrangement.

The reinsurer indemnifies the seeding company for what it pays in claims. 3. Both parties have the right to defend against a claim, and if one chooses not to, it will pay its share to the other company and leave the other to absorb all legal costs. If the defense is successful, the one that did not join the defense does not get a refund.

4. The reinsurer has the right to inspect the records of the seeding company at any time. 5. A choice of law will be stated. In case of a dispute between the parties, there will be no time wasted arguing which law applies.

The clause will say that the law of a specified country applies. The choice may be the law of the jurisdiction of the defendant. 6. The Errors and Omissions Clause says that unintentional clerical errors will be set right in the following statement and are not caused to cancel the contract. And, 7. An Actuarial Equivalent Clause can save pages of the formula for what happens if the treaty is terminated at at different times. Methods of Reinsurance Treaty.

The primary methods of reinsurance are proportional and non-proportional. Proportional and non-proportional reinsurance can be transacted on a facultative and a treaty basis. There are many subtypes of both proportional and non-proportional forms.

Facultative Reinsurance. Facultative means optional, and the power to act according to a free choice. The primary feature of facultative reinsurance is that the reinsurance company is free to accept or decline each proposition. The insurer is not obliged to cede, as in the case of treaty reinsurance.

The other important feature is that this type of reinsurance is affected to cover individual acceptances. For instance, where a ceding company wished to write a fire and perils policy on a large industrial complex. and its financial capacity was limited to a sum equal to 25% of the overall exposure, it might seek facultative reinsurance to be able to accept the whole risk for its marketing advantage.

From the reinsurer's standpoint, facultative also means the power to accept or decline each risk according to its underwriting judgment and other necessary considerations. Facultative reinsurances can be on a proportional or non-proportional basis. By effecting proportional facultative reinsurance, a direct insurer can relieve himself of part of the liability he has accepted on a particular direct risk by ceding a share to one or more reinsurers.

The result is that the insurer pays to the reinsurer a share of the premiums, less commission, and in the event of a loss, the reinsurer that same share of the original claims from the reinsurer. The ceding company would thus be limiting its exposure to its share, provided the Reinsurers involved complied with the reinsurance agreement. Advantages of facultative reinsurance. 1. It enables a small developing insurance company with limited expertise to compete for large risks beyond its usual capacity, using the expertise and capacity of the international reinsurance markets.

2. An insurance company might choose the method of reinsurance to maintain a balanced portfolio, that is, It would divest itself of those large or hazardous risks where a significant loss would result in an overall loss for that year in a particular branch of business. It often happens in developing countries that a significant project such as a dam or large industrial complex is built where the exposures are many times those of any other risk in that territory. 3. Reciprocity, there may also, for certain insurance companies, b.

Minimal opportunities to exchange a share in a sizable local risk for a share in a large risk in another territory, and by use of the facultative method within a circle of friendly insurance companies, a spread of the business may be possible which also ensures maintenance of a reasonable retained premium income. 4. For commercial reasons, an insurance company might also be obliged to accept a risk that falls outside the parameters of its usual acceptances. Here again, The facultative method can be used to solve the problem. This problem is likely to be either that the capacity required is larger than that which is allowed by the treaty facilities or that the class or type of business is excluded from the treaties or is usually not underwritten by the company. Disadvantages of facultative reinsurance.

1. Facultative reinsurance may result in the release of helpful information to competitors, the need to disclose full details of the original risk meant. that, where this method was employed on several occasions, those reinsurers frequently approached would gain an insight into the underwriting policies and portfolio of the seeding company. 2. The act of acceptance had to be employed until sufficient reinsurers had been obtained to cover the risk in question.

This could mean losing the business to competitors with larger capacities, accepting the risk without full cover, or simply losing some valuable goodwill through protracted delay. 3. It is expensive. The administration involved in negotiations, wordings, and accounts could be both heavy and expensive, reducing the amount of retained premium income available to pay losses and provide profits.

It is cumbersome to administer because each facultative reinsurance contract requires new documentation. 5. Before each renewal, the negotiation process had to be repeated, usually before renewal discussions with the client, to ensure that the reinsurance cover would be available for another year. Cancellation or change would result in additional work.

Treaty Reinsurance. Due to the above problems and the ever larger number O. F. Reinsured risks.

The treaty method of reinsurance, proportional and non-proportional treaty, evolved to overcome these difficulties. There are two main types of proportional treaty reinsurance, quota share and surplus treaty. Quota share treaty.

Quota share treaty reinsurance is a form of prorata reinsurance, proportional. It is a form of reinsurance in which the seeding insurer seeds an agreed-on percentage of every risk it insures that falls within a class or classes of business subject to a reinsurance treaty. The reinsurer assumes an agreed percentage of each insurance being reinsured and shares all premiums and losses accordingly with the reinsured. Quota share treaty results in a sharing of the gross retention of the seeding company between itself and its reinsurer in a predetermined proportion. Quota share reinsurance is usually arranged to apply to the insurer's net retained account, that is, after deducting all other reinsurance except perhaps excessive loss catastrophe reinsurance, but practice varies.

A quota share reinsurer may be asked to assume the quota share of a gross account, paying its share of the premium for other reinsurance protecting that gross account. Advantages of quota share treaty. Advantages of quota share include. 1. Sharing the risk, identity of interest, which allows for trust, long-term commitment. 2. The premium volume ceded to the reinsurers is a temptation for them to offer an excellent price to the insurance company.

And, 3. It entails a simple process with a reduced handling cost. Disadvantages of Quota Share Treaty. Disadvantages of Quota Share include. 1. Seeded premium amount can be huge if a high capacity is required. 2. Insurance companies may cede risks and the premium they could keep without financial problems.

3. An unbalanced book with small and high sums insured will remain with the same imbalance. And, 4. Quota shares treaties do not offer protection against big claims. The same loss ratio remains, claims to premium, gross, before reinsurance, or net. after reinsurance.

Usage of quota share treaty. Quota shares can be used where, 1. A company is new in a particular market, and its underwriting experience is unknown yet requires substantial reinsurance protection. 2. A company surplus treaty claims experience has been lacking.

And, 3. seen as a means of saving costs by earning higher commission rates than on surplus treaties and cutting the administrative process of retention decision making. Surplus Treaty This type of treaty enables the seeding company to accept larger sums insured than its gross retention, the surplus being seeding to reinsurers. Gross retention is the amount the seeding company retains and its quota shares reinsurers.

The net retention is the amount retained by the seeding company alone subject only to catastrophe reinsurance. The capacity of a surplus treaty is always a multiple of the seeding company's gross net retention. This retention is often called a line. Further multiples of the retention or lines can be added beyond the first and second surplus treaties.

Generally, however, a first and perhaps a second surplus treaty are deemed sufficient if the seeding company is not. to become merely an agency accepting risks but passing nearly all the liability on to others. However, despite a low insurance penetration, there are several risks in territories where third and fourth surplus treaties can be found.

A combination of first, second and third surplus treaties can be used. The obligatory nature of the treaty arrangement obviates the necessity for the ceding company to refer each risk to reinsurers. provided the risk falls within the scope of its treaties. it can give immediate cover. These days it is unusual for the seeding company to use open treaty or blind treaty, that is, the situation where reinsurers are supplied with details of each risk seeded to the treaty in the form of lists of sessions called borderos.

Hence, the heavy administration necessary for facultative placements is avoided. Even in those exceptional cases where the seeding company provides each of its reinsurers with borderos. this requirement is less cumbersome than providing the vast amount of underwriting information required under the facultative method. The premiums and losses will be credited and debited in proportion to the share cede to the treaty. Accounts are issued either quarterly, monthly, half-yearly or sometimes even annually, possibly with border rows, setting out the premiums, the reinsurance commission, the losses, and the reserves, if any.

Disadvantages of Proportional Treaties Proportional treaties, like all reinsurance methods, have their disadvantages including 1. If a risk does not fall within the scope or capacity of a company's treaty arrangements, the company must still resort to the facultative method of reinsurance. 2. Where a risk falls within the treaty arrangement's scope or capacity, the company must cede accounting to the treaty's terms. Therefore, it cannot unilaterally begin a relationship with a newfound company or deal with risk in another fashion unless a specific provision is included in the existing treaty for reinsuring in front of the treaty.

It cannot alter its retentions or underwriting practice where these details form an integral part of the treaty or prior negotiations. 3. Particularly under the quota share arrangement, the seeding company must share all its relevant business with its reinsurers. The subsequent loss of premium income, particularly during highly profitable periods, can prevent the seeding company from building up its resources and its ability to develop its capacity.

Facultative Obligatory Reinsurance. Facultative obligatory reinsurance arrangements are contracts that combine some of the principles of both the facultative and the treaty methods of proportional reinsurance. Under a facultative obligatory treaty, The seeding company is not obliged to see to its reinsurers'risks falling within the treaty's scope. However, where it chooses to do so, reinsurers are obliged to accept the session so that the facultative obligatory treaty operates as a surplus treaty.

Such arrangements provide considerable flexibility to the seeding company. A high degree of trust must exist between the contracting parties to ensure that the reinsurers receive a reasonable spread of risks. This type of treaty is often arranged to provide additional capacity after shares have been allocated to the quota share and surplus treaties, without the expense and uncertainty of the facultative method. Such treaties may be arranged mainly for an existing account.

They may also be required to maintain acceptance limits on large, so-called target risks or where accumulation problems arise. They may also be used to cover specific categories of risks where the degree of hazard requires that the company should limit its retention. Like the surplus treaty, the capacity is a multiple of the seeding company's gross retention. The main difference between the surplus and the facultative obligatory is that under the latter arrangement, there is no obligation on the part of the seeding company to seed risks falling within its scope.

It should also be noted that risks ceded to such a treaty are likely to be both fewer and more substantial than those ceded to the surplus treaty, thus producing an even less balanced portfolio for reinsurers. The optional characteristic can also work to the advantage of reinsurers as a ceding company may not cede specific risks to protect reinsurers. The concept of facultative obligatory has been adapted in several ways to suit a particular situation. Facultative excess of loss cover can be purchased to protect the sedent's retention or the common account of the sedent and its reinsurers.

The sedent must ensure that the method chosen is permitted under the terms of its pro rata treaties. In particular, the second method, the common account of the sedent and its reinsurers, is considered unacceptable by some reinsurers as it significantly affects the pro rata treaty loss experience. The growth of facultative obligatory can be attributed to the fact that the sedent and its reinsurers are not subject to the same kind of tax.

to two primary factors, one, the underwriting of high hazard and high value business, and, two, the development of the captive insurance company business. One, the underwriting of high hazard and high value business. The underwriting of high-hazard and high-value business, for example, petrochemical risks, may unbalance pro-rata treaties by exposing them to an increased risk of a catastrophe loss. In certain territories with a limited or highly competitive local market, a company may feel compelled to accept a more significant share of such a risk than can be managed within its treaty limits.

2. The development of the captive insurance company business. The second factor in increasing facultative excess of loss reinsurance is the captive insurance company business development. A captive is a company operated primarily for underwriting in whole or in part, directly or indirectly, the insurances of its parent.

The rise of influential multinational organizations that prefer their risks to be experience-rated rather than class-rated and have been unable to achieve their required terms through the conventional market, has led to an increased tendency for this type of organization to form its insurance subsidiary. Reinsurance is then purchased to limit the captive's exposure to a tolerable level. Given the nature of the captive's portfolio, this is usually best achieved by using an excessive loss reinsurance. Although the treaty th underwriting considerations are such that many companies handle this class of business in their facultative departments. As an example of facultative accessory insurance, let us consider a petrochemical plant of value $50 million.

The maximum probable loss, MPL, is assessed as $10 million, ignoring an existing vapor cloud hazard, but $30 million if this factor is considered. The sedent writes 100% of this risk and seeks to limit its potential loss to $500,000 any one loss. Different underwriters have different preferences when accepting excessive loss business. Some prefer to generate high premium income by writing low-level covers within the MPL, and others prefer to write a large portfolio of high-level covers. It is essential that the underwriter accepting high-level covers, where a little premium is generated regarding liabilities assumed, writes enough of such business to achieve a reasonable balance in his account.

This is achieved when no single loss can eliminate his underwriting profit for the year. Due to varying preferences, the sedent decides could obtain the best terms by purchasing cover in layers. First layer, $9,500,000 in excess of $500,000, to cover the maximum probable loss exposure. Second layer, $20,000,000 in excess of $10,000,000, to cover vapor cloud exposure. And, Third layer, $20 million in excess of $30 million, to cover the maximum probable loss error exposure.

It is worthwhile to emphasize that the facultative-obligatory concept has been adapted in several ways to suit specific situations, including open covers, brokers'covers, lines slips, and reinsurance pools. Let us examine some of the arrangements adapted from the facultative-obligatory concept. Open Covers In general usage, an open cover may be synonymous with a facultative obligatory treaty.

However, open cover strictly speaking refers to an unlined treaty under which the session is not linked to the insurer's retention. The word cover, imported from direct insurance, gives the impression more of a facility in a particular branch or subcategory than a treaty's more general and broader scope, given the more precise nature of such arrangements. the business is often dealt with in the facultative department instead of the treaty department. By their nature, open covers tend to produce selection against the reinsurer, particularly if there is limited spread in quantity and even more limited spread in the type of risk included in the open cover.Brokers'covers.

It is often common for brokers to hold direct covers to enable them to place clients'business with certain companies and Lloyd's underwriters. It is also possible for certain reinsurance brokers to obtain reinsurance covers to enable them to place reinsurance on behalf of their clients. The concept in this instance is entirely different from all methods dealt with so far, as the broker will not be in a legal position to take any share in the reinsurance risks because seeding companies, that is, the primary insurers, has engaged the broker to place the reinsurance business. Frequently, The broking house will be split into an underwriting department or company and a broking department or company to enable both tasks to be carried on effectively. Many brokers have also developed the underwriting side into an underwriting agency.

In its basic form, the broker's cover has often produced heavy losses, and in many areas of the reinsurance markets, those covers can be difficult to obtain. Effectively, this depends on the level of competition within a market and whether participants work harder to increase the profit. However, some brokers have been able to recruit or develop considerable underwriting expertise, and in those situations, the covers have been successful and profitable for all parties concerned. Wordings and accounts are very similar to treaty wordings and accounts.

The significant differences are that generally, the broker holds no reserves, and all items are as original, the broker receiving a small overrider and a prompt commission. Line slips. The origin and basis of this arrangement are virtually the same as the broker's cover. The main difference is that the broker does not have the authority to accept risks on behalf of participating reinsurers. Instead, he must submit the risks to the leading reinsurers, who will decide whether the risk is acceptable.

Subject to the agreement of the leading reinsurers, all other reinsurers are obliged to accept risks placed under the facility. Such arrangements are often very convenient to both parties. The broker can fully represent the client and place quite large amounts rapidly.

The acceptance by one or more leading reinsurers binds all the following reinsurers. Also, the reinsurers who must follow have the assurance that the skilled leaders had seen all the risks before being placed under the facility. Reinsurance Pools A pool is an arrangement whereby a certain number of insurance companies form a collective capacity to accept specific classes of risk, and each company is liable for its share in the pool.

There are several types of pools. The most common types of reinsurance pools are market reinsurance pools. Government Reinsurance Pools and Underwriting Pools Market Reinsurance Pool A market pool, where most insurance companies within a country usually participate, is a beneficial method to underwrite significant or hazardous risks.

Such risks can range from catastrophic to pooling expertise to provide a new type of insurance. Thus, for example, nuclear risks are commonly covered by a market pool. As there are very few risks and immense liabilities, almost all companies take a share. This also obviates the need for government intervention in such areas.

Another example has been the underwriting of products liability cover. One of the Scandinavian countries, Denmark, commenced this type of insurance by forming a pool. Generally, any member company can introduce business to the pool.

A committee usually does the rating. and members of the pool share the risk. The pool may take out collective reinsurance.

Individual companies are often obliged to retain their share absolute net, to ensure that the pool sessions or reinsurances are the only sources of possible accumulations. In some pools, the producing company may only cede business to the pool in excess of specific retention, in other cases, all business must be transferred to the pool 100%.. Government Reinsurance Pools To prevent the exportation of significant businesses to foreign reinsurers, the government can create a reinsurance company or pool into which all insurance companies must cede or reinsure part or all their reinsurance business subject to the terms of the reinsurance pool. This is known as a government reinsurance pool.

The participating insurance companies may be shareholders in the reinsurance pool. thereby receiving a share in the pool in return. Similar in concept is the regional reassurance pools organized over the last 30 years by many developing countries.

The object has been to increase the regional market's total underwriting capacity and retain as much premium income as possible within the region. In some cases, the pool has been managed by one of the members, for example, the Arab pools. In other cases, A separate reinsurance company has been formed to manage the business, for example, the African RE and the Asian RE.

Some pools, for example, the Africa RE, receive a compulsory quota share session from all companies operating in the region. Underwriting pools. Smaller, developing companies who wish to enter a new market, class, and type of business may not have the expertise or necessary capacity to establish a sound foothold.

They may. Therefore, form a pool represented by an experienced underwriter in the chosen field of development, with sufficient collective capacity to accept competitive shares. There are many such bulls in existence around the world to write international reinsurance business. Now, let us discuss the Non-Proportional Reinsurance Treaty.

Features and Operations of Non-Proportional Reinsurance Treaties Non-Proportional Reinsurance is based on claims sharing. The original risk, premium, claims, and acquisition costs will be shared between the sedent, reinsured, and reinsurer for proportional reinsurance. This means that the reinsurer usually follows the fortune of the sedent or the reinsured. In contrast, non-proportional reinsurance allows for tailor-made flexible solutions fitted to the targeted risk profile of the sedent.

The non-proportional reinsurer is only liable for claims above a certain level. In proportional reinsurance, risks are shared between direct insurer and reinsurer based on sums insured. In non-proportional reinsurance, Claims are shed on the loss paid.

The liability of the direct insurer is capped at a certain amount. This is called the deductible. The reinsurance pays whatever exceeds this amount. Non-proportional reinsurance is usually referred to as excess loss because the loss must exceed specific retention or deductible before a claim can be made against the reinsurance. Deductible, also known as retention, the first loss and the excess.

is the part of a claim borne by an insurer before the reinsurer pays a reinsurance claim. Limit is the amount payable by the reinsurer. An excess of loss treaty provides the insurer capacity to underwrite large risks. It primarily protects the reinsured against the severity of a loss. While casualty reinsurance is written on an excess of loss basis, increased application of this approach is increasingly used for a property per risk business.

Functions of Excessive Loss Reinsurance Functions of Excessive Loss Reinsurance include 1. Provide the sedent with the ability to provide more significant coverage limits. 2. Reduce the fluctuation in loss experience by limiting the number of sustained losses. and 3. Lessen the impact of losses from a single large event with multiple losses or the accumulation of losses from frequent events.

characteristics of excessive loss reinsurance. Here are the characteristics of excessive loss reinsurance. 1. Protects the reinsured's net retained account, that is, after proportional treaties and facultative reinsurance. 2. Reinsurers pay only when claims exceed the deductible, net retention, and then only for the excess amount, up to agreed limits. 3. Premiums are shared non-proportionally between seeding company and the reinsurer.

Premiums are calculated as a percentage of the primary insurer's premium charge. 4. Reinsurers may pay a profit commission, contingent commission, for an insurer's favorable loss experience. 5. It generally involves much less seeded premium than a pro rata structure.

It, therefore, does not provide the sedent with meaningful surplus relief as would be the case under a pro-rata arrangement. 6 Cover is not primarily intended for catastrophes, affecting many risks. and 7 Excessive loss reinsurance is known as a working excess of loss when the deductible is set at a level likely to produce a relative frequency of claims.

What are the advantages and disadvantages of non-proportional treaties? Advantages of Non-Proportional Treaty. Advantages of the Non-Proportional Treaty include, 1. The reinsured can retain more income than if wholly dependent on prorata treaties. 2. Administratively simple to operate.

And, 3. Reduction of the impact of large claims has a stabilizing effect on the protected account. Disadvantages of Non-Proportional Treaty. Disadvantages of the Non-Proportional Treaty include 1. Excessive loss rates is subject to rapid and wide fluctuations, depending on claims experience.

2. If free of claim, the cost may not be cheaper than pro-rata treaties, bearing in mind their factors of commission and pro-rata contribution on claims recoveries. 3. No cover for small and medium-sized claims. 4. No commission from reinsurers. 5. Cover may be limited vertically, that is, limited to less than 100% of the sum insured, and horizontally, that is, limited reinstatements because not every claim will be covered. Forms and types of non-proportional reinsurance The primary forms of non-proportional reinsurance are, 1. Excessive loss, and, 2. Stop loss.

Let us discuss these two forms of non-proportional reinsurance. Working excessive loss. Working excessive loss is also known as per-risk excessive loss.

With a working excessive loss reinsurance, the reinsurer indemnifies the primary company for any loss above the specified retention on each risk. In per-risk. The sedent's insurance policy limits are more significant than the reinsurance retention. For example, an insurance company might insure commercial property risks with policy limits up to £10 million and then buy per risk reinsurance of N5 million in excess of £5 million. In this case, a loss of £6 million on that policy will recover £1 million from the reinsurer.

What are the advantages and disadvantages of working excessive loss? Advantages of working excessive loss reinsurance. Advantages of working excessive loss include, 1. Limitation of the maximal exposure, 2. Simple administration, and 3. Small premium.

Disadvantages of working excessive loss reinsurance. Disadvantages of working excessive loss include, 1. Fixing the reinsurance premium. 2. Inadequate against the accumulation of small claims.

And, 3. Conditions can change faster. Catastrophe Excessive Loss Catastrophe Excessive Loss Reinsurance is also known as Prevent and Occurrence Excessive Loss. The purpose of a catastrophe excess treaty is to protect a primary company against adverse loss experiences resulting from the accumulation of losses arising from a single, major natural disaster or event such as a hurricane, tornado, earthquake, flood, and windstorm.

This excessive loss cover is designed to protect an insurance company's overall underwriting results after applying other types of reinsurance it may have. It provides reinsurance for losses incurred during the treaty term, usually one year, in excess of a specified loss ratio or a predetermined dollar or designated currency amount. For a given event, the treaty applies once the accumulation of losses paid by the primary company reaches predetermined retention. What are the advantages and disadvantages of catastrophe excessive loss? Advantages and disadvantages of catastrophe excessive loss Advantages of catastrophe excessive loss include 1. Limitation of the maximal exposure in case of an event 2. Simple and easy to administer and 3. Payment of small premium Disadvantages of catastrophe excessive loss Disadvantages of catastrophe excessive loss include 1. The reinsurance premium is fixed as agreed at the inception of each contract 2. Conditions of catastrophe excessive loss contracts can change faster.

3. Often difficult or challenging to buy. And 4. Catastrophe excessive loss are always in form of aggregate excessive losses or stop losses. Bases of excessive loss cover.

The three bases of excessive loss reinsurance contracts are, 1. Risks attaching basis. 2. Losses occurring basis. And 3. Losses discovered or claims made. basis. Now, let us discuss these three bases of excess loss cover.

1. Risk-attaching basis, a basis under which reinsurance is provided for claims arising from policies commencing during the period to which the reinsurance relates. The insurer knows there is coverage for the whole policy period when written. All claims from seed and underlying policies incepting during the period of the reinsurance contract are covered even if they occur after the expiration date of the reinsurance contract. Any claims from seed and underlying policies incepting outside the period of the reinsurance contract are not covered even if they occur during the period of the reinsurance contract. Reinsurers usually limit claims up to a maximum of 12 months after the expiry of the contract.

2. Loss Occurring Basis is a reinsurance treaty under which all claims occurring during the contract period, irrespective of when the underlying policies are incepted, are covered. Any claims occurring after the contract expiration date are not covered as opposed to a claims made policy. Insurance coverage is provided for losses occurring in the defined period.

This is the usual basis of cover for most policies. 3. Loss is discovered or claims made basis, a policy covering all claims reported to an insurer within the policy period irrespective of when they occurred. This solves the problem of long-tail business. Non-proportional reinsurance pricing. There are two basic methods of non-proportional reinsurance pricing.

One, experience-based methods. And, two, exposure-based methods. The non-proportional reinsurance premium calculation depends on the type of excessive loss, the claims history and structure of the layer.

1. Burning cost calculation is based on claims experience. A more sophisticated way of using claims experience is an extrapolation based on risk theory and modeling the claims profile. 2. Exposure rating is based on the composition of the portfolio according to sums insured.

3. Payback. calculation depends on how many years it would take the maximum probable losses to be repaid by future annual premiums. Conclusion Reinsurance meaning, operations and practices have been discussed in this video.

Reinsurance is a form of insurance based on the principles and practices applicable to the insurance business. Reinsurance is a re-sk transfer contract between an insurance company, known as the reinsured, and reinsurance company. known as the reinsurer, whereby the reinsurer undertakes the liability incurred by the reinsured under a primary insurance contract in exchange for payment of a premium to the reinsurer. A reinsurance contract is also a risk transfer mechanism between reinsured and reinsurers.

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Transcript for:Understanding Reinsurance Basics and Functions

Transcript for:
Understanding Reinsurance Basics and Functions