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Risk Chapter 7

Reinsurance is a transaction where one insurance company transfers part or all of the risk it insures to another insurance company. There are two main types of reinsurance treaties: facultative and treaty. Facultative reinsurance is negotiated on a case-by-case basis, while treaty reinsurance involves a general agreement to automatically accept certain types of risks. Common treaty types include quota-share, surplus-share, and excess-of-loss treaties. Reinsurance provides benefits like stabilizing profits, increasing underwriting capacity, protecting against catastrophic losses, and obtaining underwriting advice.

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57 views18 pages

Risk Chapter 7

Reinsurance is a transaction where one insurance company transfers part or all of the risk it insures to another insurance company. There are two main types of reinsurance treaties: facultative and treaty. Facultative reinsurance is negotiated on a case-by-case basis, while treaty reinsurance involves a general agreement to automatically accept certain types of risks. Common treaty types include quota-share, surplus-share, and excess-of-loss treaties. Reinsurance provides benefits like stabilizing profits, increasing underwriting capacity, protecting against catastrophic losses, and obtaining underwriting advice.

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CHAPTER 7

RE-INSURANCE

1
Defining Re-insurance

• It is a financial transaction by which risk is


transferred (ceded) from an insurance company
(cedant) to a reinsurance company (reinsurer)
in exchange of a payment (reinsurance premium).

• Providers of reinsurance are highly professional


reinsurers which are entities exclusively
dedicated to the activity of reinsurance.
2
Meaning of Reinsurance and related terms
Reinsurance
– It is an arrangement by which the primary
insurer that initially writes the insurance
transfers to another insurer (called the
reinsurer) part or all of the potential losses
associated with such insurance.
Direct (primary) insurers
– These are ordinary insurance companies who
transact insurance with the general public.
Ceding company
– The party transferring all or part of its business
to a reinsure. 3
Reinsurers
– The insurer that accepts part or all of the insurance from the
ceding company.
– large companies which specialized in reinsurance and do not
write any direct insurance.
– They are usually international organizations.
Cessions:
– It is the amount of insurance ceded to the reinsurer.
Line or retention
– The amount of insurance (portion of risk) retained by
the ceding company for its account.
Retrocession
– the process by which a reinsurer passes on risks to
another reinsurer. 4
Loss Adjustment expenses (LAE)
– The expenses of settling claims including legal
and other fees and the portion of general
expenses allocated to claim settlement costs.
Advantage of Reinsurance
1. Security and stability of profits
2. Increasing underwriting capacity
3. Providing protection against catastrophic losses
4. Retiring from underwriting
5. To obtain underwriting advice
6. Macro benefits 5
1. Security and stability of profits
– Reinsurance is used to stabilize profits.
– An insurer may wish to avoid large
fluctuations in annual financial results.
– Loss experience can fluctuate widely because of
social and economic conditions, natural
disasters, and chance.
– Reinsurance can be used to stabilize the effects
of poor loss experience.
2. Increasing underwriting capacity
– Reinsurance can be used to increase the
insurance company’s underwriting capacity
to write new business. 6
3. Providing protection against catastrophic losses
- The reinsurer pays part or all of the losses that
exceed the ceding company’s retention up to
some specified maximum limit.
4. Retiring from underwriting
- Reinsurance permits the insurer’s liabilities
for existing insurance to be transferred to
another carrier; thus, policyholders’ coverage
remains undisturbed.
5. To obtain underwriting advice from reinsurer
6. Macro benefits
7
Types of Reinsurance
• There are two types of reinsurance arrangements:
Facultative and Treaty reinsurance

1. Facultative reinsurance
– Is a specific reinsurance arrangement on optional
basis (the ceding company and the reinsurer may
or may not agree on the arrangement).
– It is case-by-case method used when the ceding
company receives an application for insurance that
exceeds the retention limit. 8
Facultative cont’d …..
• Under this agreement, both the primary insurer and
the reinsurer retain full decision-making powers
with respect to each insurance contract.

• As each insurance contract is issued, the primary


insurer decides whether or not to seek reinsurance,
and the reinsurer retains the flexibility to accept or
reject each application for reinsurance on a case-
by-case basis. 9
Advantage of facultative reinsurance
– Flexibility (it can fit any kind of case)
Disadvantage of facultative reinsurance
– It involves substantial administrative cost in
the process of finding a willing reinsurer
– There is delay, since the policy will not be
issued until reinsurance is obtained
– It is uncertain
– Unreliable: In times of bad lose experience the
reinsurance market tends to dry up (it will be
difficult to find a willing reinsurer)
10
2. Treaty reinsurance
• Under this form, an agreement is made between
the primary insurer and the reinsurer to the
effect that all risks within certain parameter will
be offered to the reinsurer and the insurer cannot
decline the risk.
• It is automatic or obligatory throughout the term
of the agreement.
• The treaty is signed in advance and the primary
insurer writes any insurance without consulting the
reinsurer as far as it is within the agreement.

11
Advantage of treaty reinsurance
• It is automatic and no uncertainty involved
• No delay in writing insurance
• It is economical because it is not necessary to search
for reinsures before the policy is written
Disadvantage of treaty reinsurance
• Could be unprofitable to the reinsurer
• If the primary insurers consistently cede unprofitable
business to its reinsurers, the ceding insurers will find
it difficult operate since reinsurers will not want to do
business with them.

12
Types of reinsurance treaties
1. Quota-Share Treaty Under this method, the
ceding company and reinsurer agree to share
premiums and losses based on pre-agreed
percentage (proportion).
2. Surplus-Share Treaty Under this method the
reinsurer agrees to accept insurance in excess of
the ceding insurer’s retention limit, up to some
maximum amount.
– The retention limit is referred to as a line and is
stated as a dollar amount.

13
Example
Assume that Apex Fire Insurance has a retention limit of Br
200,000 (called a line) for a single policy, and that four
lines, or Br 800,000, are ceded to General Reinsurer. Apex
Fire now has a total underwriting capacity of Br 1 million
on any single exposure.
Assume that a Br 500,000 property insurance policy is
issued. Apex Fire takes the first Br 200,000 of insurance, or
two-fifths, and General Reinsurer takes the remaining Br
300,000, or three-fifths.
These fractions then determine the amount of loss paid by
each party. If a Br 5000 loss occurs, Apex Fire pays Br
2000 (two-fifths), and General Reinsurer pays the
remaining Br 3000 (three-fifths). 14
This arrangement can be summarized as follows:
Apex Fire Br 200,000 (one line)
General Reinsurance 800,000(four lines)
Total underwriting capacity Br 1,000,000
Birr 500,000 policy
Apex Fire Br 200,000 (2/5)
General Reinsurance 300,000 (3/5)
These fractions then used to determine the amount of
loss paid by each party.
If there is Birr 5,000 loss
Apex Fire Br 2,000 (2/5)
General Reinsurance 3,000 (3/5)
15
 Under a surplus-share treaty, premiums are
also shared based on the fraction of total
insurance retained by each party.
 However, the reinsurer pays a ceding
commission to the primary insurer to help
compensate for the acquisition expenses.

16
3. Excess-of-Loss Reinsurance
– This method is designed largely for protection
against a catastrophic loss.
– The reinsurer pays part or all of the loss that
exceeds the ceding company’s retention limit up
to some maximum level.

17
Example:
Assume that the reinsurer agrees to pay for all losses in
excess of birr 50,000 up to further birr 200,000: the way
in which various losses are divided is shown below:
Loss Direct Insurer Excess Treaty
Br 10,000 Br 10,000 Nil
50,000 50,000 Nil
70,000 50,000 Br 20,000
100,000 50,000 50,000
250,000 50,000 200,000
300,000 100,000 200,000
18

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