guide:Bd67fa8d90

Reinsurance is insurance that is purchased by an insurance company, in which some part of its own insurance liabilities is passed on ("ceded") to another insurance company. The company that purchases the reinsurance policy is called a "ceding company" or "cedent" or "cedant" under most arrangements. The company issuing the reinsurance policy is referred simply as the "reinsurer". In the classic case, reinsurance allows insurance companies to remain solvent after major claims events, such as major disasters like hurricanes and wildfires. In addition to its basic role in risk management, reinsurance is sometimes used to reduce the ceding company's capital requirements, or for tax mitigation or other purposes.

A company that purchases reinsurance pays a premium to the reinsurance company, who in exchange would pay a share of the claims incurred by the purchasing company. The reinsurer may be either a specialist reinsurance company, which only undertakes reinsurance business, or another insurance company. Insurance companies that accept reinsurance refer to the business as 'assumed reinsurance'.

Methods of Reinsurance

There are two basic methods of reinsurance: facultative reinsurance and treaty insurance.

Method	Description
Facultative reinsurance	Facultative reinsurance is normally purchased by ceding companies for individual risks not covered, or insufficiently covered, by their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurance treaties and for unusual risks. Underwriting expenses, and in particular personnel costs, are higher for such business because each risk is individually underwritten and administered. However, as they can separately evaluate each risk reinsured, the reinsurer's underwriter can price the contract more accurately to reflect the risks involved. Ultimately, a facultative certificate is issued by the reinsurance company to the ceding company reinsuring that one policy.
Treaty insurance	The ceding company and the reinsurer negotiate and execute a reinsurance contract under which the reinsurer covers the specified share of all the insurance policies issued by the ceding company which come within the scope of that contract. The reinsurance contract may obligate the reinsurer to accept reinsurance of all contracts within the scope (known as "obligatory" reinsurance), or it may allow the insurer to choose which risks it wants to cede, with the reinsurer obligated to accept such risks (known as "facultative-obligatory" or "fac oblig" reinsurance).

This page focuses on treaty reinsurance.

Types of Reinsurance

There are two main types of treaty reinsurance: proportional and non-proportional. Under proportional reinsurance, the reinsurer's share of the risk is defined for each separate policy, while under non-proportional reinsurance the reinsurer's liability is based on the aggregate claims incurred by the ceding office. In the past 30 years there has been a major shift from proportional to non-proportional reinsurance in the property and casualty fields.

Proportional

Under proportional reinsurance, one or more reinsurers take a stated percentage share of each policy that an insurer issues ("writes"). The reinsurer will then receive that stated percentage of the premiums and will pay the stated percentage of claims. In addition, the reinsurer will allow a "ceding commission" to the insurer to cover the costs incurred by the ceding insurer (mainly acquisition and administration, as well as the expected profit that the cedant is giving up).

The arrangement may be "quota share" or "surplus reinsurance" (also known as surplus of line or variable quota share treaty) or a combination of the two. Under a quota share arrangement, a fixed percentage (say 75%) of each insurance policy is reinsured. Under a surplus share arrangement, the ceding company decides on a "retention limit": say $100,000. The ceding company retains the full amount of each risk, up to a maximum of $100,000 per policy or per risk, and the excess over this retention limit is reinsured.

The ceding company may seek a quota share arrangement for several reasons. First, it may not have sufficient capital to prudently retain all of the business that it can sell. For example, it may only be able to offer a total of $100 million in coverage, but by reinsuring 75% of it, it can sell four times as much, and retain some of the profits on the additional business via the ceding commission.

The ceding company may seek surplus reinsurance to limit the losses it might incur from a small number of large claims as a result of random fluctuations in experience. In a 9 line surplus treaty the reinsurer would then accept up to $900,000 (9 lines). So if the insurance company issues a policy for $100,000, they would keep all of the premiums and losses from that policy. If they issue a $200,000 policy, they would give (cede) half of the premiums and losses to the reinsurer (1 line each). The maximum automatic underwriting capacity of the cedant would be $1,000,000 in this example. Any policy larger than this would require facultative reinsurance.

Non-proportional

Under non-proportional reinsurance the reinsurer only pays out if the total claims suffered by the insurer in a given period exceed a stated amount, which is called the "retention" or "priority". For instance the insurer may be prepared to accept a total loss up to $1 million, and purchases a layer of reinsurance of $4 million in excess of this $1 million. If a loss of $3 million were then to occur, the insurer would bear $1 million of the loss and would recover $2 million from its reinsurer. In this example, the insurer also retains any excess of loss over $5 million unless it has purchased a further excess layer of reinsurance.

The main forms of non-proportional reinsurance are excess of loss and stop loss.

Excess of loss (XL) reinsurance can have three forms: per risk, catastrophe, and aggregate.

XL Form	Description
Per risk	The cedant's insurance policy limits are greater 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 $5 million in excess of $5 million. In this case a loss of $6 million on that policy will result in the recovery of $1 million from the reinsurer. These contracts usually contain event limits to prevent their misuse as a substitute for Catastrophe XLs.
Catastrophe	The cedant's retention is usually a multiple of the underlying policy limits, and the reinsurance contract usually contains a two risk warranty (i.e. they are designed to protect the cedant against catastrophic events that involve more than one policy, usually very many policies). For example, an insurance company issues homeowners' policies with limits of up to $500,000 and then buys catastrophe reinsurance of $22,000,000 in excess of $3,000,000. In that case, the insurance company would only recover from reinsurers in the event of multiple policy losses in one event (e.g., hurricane, earthquake, flood).
Aggregate	Affords a frequency protection to the reinsured. For instance if the company retains $1 million net any one vessel, $5 million annual aggregate limit in excess of $5m annual aggregate deductible, the cover would equate to 5 total losses (or more partial losses) in excess of 5 total losses (or more partial losses). Aggregate covers can also be linked to the cedant's gross premium income during a 12-month period, with limit and deductible expressed as percentages and amounts. Such covers are then known as "stop loss" contracts.

Risks 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 during the whole policy period even if claims are only discovered or made later on.

All claims from cedant 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 cedant underlying policies incepting outside the period of the reinsurance contract are not covered even if they occur during the period of the reinsurance contract.

Losses occurring basis

A Reinsurance treaty under which all claims occurring during the period of the contract, irrespective of when the underlying policies incepted, are covered. Any losses occurring after the contract expiration date are not covered.

As opposed to claims-made or risks attaching contracts. Insurance coverage is provided for losses occurring in the defined period. This is the usual basis of cover for short tail business.

Claims-made basis

A policy which covers all claims reported to an insurer within the policy period irrespective of when they occurred.

References

• Wikipedia contributors. "Reinsurance". Wikipedia. Wikipedia. Retrieved 23 October 2020.