GIC Re

Reinsurance Basics,

Methods & Types

Ramaswamy N.,

AGM , GIC Re

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Risk Management

• Avoidance

• Prevention

• Control

• Acceptance

• Transfer

• Spread

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Coinsurance Relationship

Risk

Insurer1 Insurer2 Insurer3

• Relationships are between insured and each insurer

• If one insurer is unable to honor his share of claim, other

insurers are not liable for making good his share

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Reinsurance Relationship

Insured

Insurer

Reinsurer1 Reinsurer2 Reinsurer3

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Reinsurance Relationship

• Insured has relationship only with insurer

• Insured is not party to the reinsurance

contract

• If any of the reinsurers do not pay their

share of the claim, insurer must still

indemnify the insured

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Reinsurance - Definition

Mr. Robert Kiln

– insuring insurers

Dr. F. L. Tuma

– Mechanism used by an insurance company to

reduce possible losses from risks accepted

– Reinsurance does not reduce losses, but

gives insurance companies the strength to

withstand losses

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What is Reinsurance

• Insurance of Insurance

• Risk transfer from Insurance Company to

Reinsurance Company

• Spreading of risk

• Smoothening Peaks & Troughs

• Acts like a shock absorber in cars

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Effect of claims

• Large individual claims

• Frequent sizable claims

• Unexpected accumulation of claims /

Aggregations over a period

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Reinsurance - Functions

• Protection

• Increase in capacity

• Financial stability

• Stabilizing claims ratio

• Spread of risks

• Protection of solvency margins

• Improve profitability

• Expertise

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Reinsurance - Advantages

• Increased capacity

• Ability to accept larger shares

• Spread of risk to other markets

• Stabilizing operating results

• Improves the insurance market

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Historical Developments

• Originally associated with ships & cargoes

• 300 BC – loans on maritime venture

• 916 BC – law passed in Rhodes, defining

general average

• 1347 – earliest marine policy

• 1370 – Earliest record of marine

reinsurance

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Historical Developments

• 1666 – Great Fire of London led to the

emergence of many insurance companies

• 1601 – Act concerning matters of

assurance passed in England

• 1650 – initial formation of Lloyds

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Reinsurance Market

Buyers of Reinsurance

• Direct Insurance Companies

• State Insurance Corporations

• Lloyd’s Syndicates

• Reinsurance Companies

• Insurance Pools

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Reinsurance Market

Sellers of Reinsurance

• Professional Reinsurance Companies

• Lloyd’s Syndicates

• Direct Insurance Companies

• National Reinsurance Companies

• Regional Reinsurance Corporation

• Reinsurance Pools

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World Markets

Top 15 Global Reinsurance Groups (NWP)

Rank Company Country

1. Munich Re Germany

2. Swiss Re Switzerland

3. Hannover Re Germany

4. Berkshire Hathaway Re USA

5. Lloyds UK

6. SCOR France

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World Markets

Top 15 Global Reinsurance Groups (contd.)

Rank Company Country

7. Reinsurance Group of America USA

8. China Re China

9. Partner Re Bermuda

10. Korean Re Korea

11. Everest Re Bermuda

12. Transatlantic Holdings Inc. USA

12. Tokio Marine Japan

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Retention

• Risk Retention : Amount a company is

willing to put at stake for its own account

when underwriting risks

• Loss Retention : Maximum amount a

company is prepared to pay on any loss

affecting a policy, risk or group of risks.

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Types & Methods

Reinsurance

Treaty

Proportional

Facultative

Non-

Proportional Proportional

Non-

Proportional

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Treaty

• Automatic – no choice for either party

• Multiple Risks – Portfolio protection

• Blind acceptance – risk details not given

• Convenient and efficient

• Placed for each class separately

• Terminable on annual basis

• Accounts rendering by way of periodic documents called bordereaux

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Facultative

• Simplest and oldest method

• Single risk method

• Full disclosure of facts

• Better exposure control

• Option to accept or reject

• Element of uncertainty

• Cumbersome & expensive administration

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Fac – when used

• Hazardous, unusual & large risks

• Expertise of reinsurer is required

• When capacity required is larger than

automatic capacity

• For businesses excluded under treaty

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Facultative Slip

• Name of Cedant

• Name of Assured

• Risk Details – location, occupancy, age

• Period of cover

• Perils covered

• Basis of Underwriting–PML/TSI/Loss Limit

• Sum Insured with break up

• Rate charged for all sections

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Facultative Slip

• Deductibles

• Total Premium

• Total Deductions – commission, brokerage & taxes

• Past experience

• Cedant’s retention

• FAC order available

• Survey report

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Proportional Treaties

• Automatic – no choice for either party

• Equal sharing of premium & claims

• Risks shared on pro-rata basis

• Reinsured is compensated acquisition

costs by way of commission

• Two main types

– Quota Share & Surplus

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Quota Share Treaty

• Operates on Fixed Percentage basis

• Every risk has to be compulsorily ceded

• Full spread of business for reinsurers

• Inflexible method for reinsured

• Retention & Quota Share percentage to

be optimal & meaningful

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Quota Share

• 50% QS with a gross limit of Rs. 100 crore

– Net retention will be Rs. 50 crores

– QS treaty will be Rs. 50 crores

If QS percentage is 80%, then ?

If 40% QS with limit of 200 crores, then ?

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Quota Share - Advantages

• Easy to operate and administer

• Works like a partnership

• No anti-selection against reinsurer

• Normally well-balanced treaties

• Gives wide spread to reinsurers

• Provides capacity to new companies or

new class where results are unpredictable

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Quota Share - Disadvantages

• Inflexible method of reinsurance

• Huge premium outflow

• Insurer cannot vary his retention based on

risk perception or soft market conditions

• Sometimes capacity is not available,

especially when results are unpredictable

• Prevents ability to develop own capacity

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Surplus Treaty

• Amount surplus after gross retention (net +

quota share) is ceded

• Placed in terms of lines

• Reinsured decides table of retentions

• Maximum gross limit need not always be

taken for each risk

• Used to add automatic capacity

– Normally one, but sometimes two or three

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Surplus Treaty

• Gross Retention is Rs. 10 crores

• Surplus Treaty with 15 lines

• Surplus Treaty limit = ?

• Net retention – 15 crores, QS is 40%

• Cedant wants automatic capacity to cover

risks upto 150 crores, so how many lines?

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Auto FAC / FAC Obligatory

• Combination of Facultative & Treaty

Methods of Reinsurance

• Cedant has option to cede

• Reinsurer has no option to refuse

• Operates like a surplus treaty

• Normally used in Marine or Engineering

where abnormally large policies are issued

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Prop Treaties (Accounting)

• Run-off basis / Underwriting Year basis

– Treaty continues till everything is settled

– premium / claims are accounted back to the

respective treaty year

• Clean-cut / Accounting Year basis

– Treaty terminated at the end of the year

– losses and premium outstanding at the end

of the period, is transferred to the new treaty

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Proportional Treaty Slip

• Ceding Co.

• Treaty Type

• Period

• Scope of Business

• Territorial Scope

• Retention

• No. of Lines

• Treaty Limit

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Proportional Treaty slip

• Commission

• Profit Commission

• Accounts Settlement

• Premium Reserves

• Loss Reserves

• Premium Portfolio Transfer

• Loss Portfolio Transfer

• Exclusions

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Proportional Treaty slip

• Cash Loss Limit

• EPI

• Brokerage

• Statistics

• Table of Retention

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Example

• 500 crores risk

• Insurer has a 10 crore net retention

• 50% QS Treaty

• 20 line surplus treaty

• Balance to be ceded to FAC

• Rate charged is 1.20%o

• Risk suffers a loss of 120 crores

• Work out the premium & loss cession

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Example solved

Underwriting (Total premium 60,00,000)

Arrangement Amount share premium

Net retention 10 crores 2% 1,20,000

QS Treaty 10 crores 2% 1,20,000

Surplus Treaty 400 crores 80% 48,00,000

FAC 80 crores 16% 9,60,000

Total 500 crores 100% 60,00,000

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Example solved

Loss (120 crores)

Arrangement share Loss

Net retention 2% 2.4 crores

QS Treaty 2% 2.4 crores

Surplus Treaty 80% 96 crores

FAC 16% 19.2 crores

Total 100% 120 crores

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Non-Proportional Treaty

• Distribution of Loss Liability

• Cedant agrees to retain a loss upto a

certain amount – called as deductible,

underlying or priority

• Reinsurer agrees to pay the excess loss,

upto a specified amount

• Normally split into various layers

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XL Treaties

• The Excess of Loss contract provides a cap or ceiling to the loss ratio, provided that adequate levels of cover have been bought.

• Naturally, there is always a risk from the reinsured’s perspective that the deductible may be set too high, or that the cover proves to be inadequate in the event of a worse than expected catastrophic year.

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Setting the Deductible

• The setting of the deductible is a key issue and

needs to be done rationally

• Too high a deductible may threaten its solvency,

too low a deductible might result in it giving away

unnecessary levels of premium (that might

eventually have become profit).

• The key is to find a comfortable balance

between the reinsured’s capital base and the

underlying risk of the portfolio.

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Setting the Upper Limit

• Assessing how much cover to buy is just as important as establishing the level of the deductible.

• Any loss exceeding the limits of the XL treaty cover will fall back to the net retained account of the cedant and will have to be borne by him.

• Historical losses are a major influence

• Some models are available to to determine probable loss scenarios on current exposures in case of catastrophic events

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Layering

• In XL treaties, it is desirable to arrange the programme in two or more layers; the first or lower ones being the ‘working layers’, with the subsequent ones regarded as ‘catastrophe layers / upper layers’.

• This will ensure better pricing from the reinsurers, especially for the higher layers and also ensure better participation from reinsurers, depending on risk appetite

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Non-Proportional Treaty

• Two main types

– Risk Excess of Loss

– Event Excess of Loss

• Other types

– stop loss

– umbrella xl

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Types of Non-prop treaties

• Risk XL – protects individual risk

• CAT XL – protects multiple risks against a catastrophic event

• Stop Loss – Aims to prevent wide fluctuations of net claims ratio

• Umbrella XL – protects aggregations between different classes

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Risk / CAT XL

• The XL treaty limits and deductible will be expressed in amount as under :

• 10 crores each and every risk / event

In excess of

• 5 crores each and every risk / event

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Stop Loss

• E.g. “20% loss ratio in excess of 110% loss ratio”

or, ‘20% GNPI xs 110% GNPI’

• This is usually in conjunction with actual monetary limits, to ensure that exposures do not go up unchecked

• Alternatively, the same limits could be given as:

‘ To pay all losses in excess of a loss ratio of 110% up to a further 20% loss ratio’

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Non-Prop Treaties

Risk Attaching basis –

Reinsurers assume liability in respect of original policies issued or renewed during the period of treaty

Loss Occurring during –

Reinsurer assumes liability for claims arising where date of loss falls within the treaty period, irrespective of the date of the underlying policies

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Previous example solved

Loss (120 crores)

• Net retention – 2% - 2.4 crores

• 50% QS Treaty – 2% - 2.4 crores

• Surplus Treaty – 80% - 96 crores

• FAC – 16% - 19.2 crores

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Example solved

Underwriting (Total premium 60,00,000)

Arrangement Amount share premium

Net retention 10 crores 2% 1,20,000

QS Treaty 10 crores 2% 1,20,000

Surplus Treaty 400 crores 80% 48,00,000

FAC 80 crores 16% 9,60,000

Total 500 crores 100% 60,00,000

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Example solved

Risk XL (to protect net retention) • 9 crores XS 1 crore

Loss (120 crores)

Arrangement share Loss

Net retention 2% 2.4 crores

QS Treaty 2% 2.4 crores

Surplus Treaty 80% 96 crores

FAC 16% 19.2 crores

Total 100% 120 crores

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Event XL layers

• Net retention – 10 crores

• Protected as under :

• 5 crores XS 5 crores

• 10 crores XS 10 crores

• 30 crores XS 20 crores

• Each layer can have a different set of

reinsurers

Hard and soft Market

• Availability of the R/I capacity is a function of the profitability, this is eminently cyclical in nature

• SOFT MARKET: In absence of big losses, if reinsurers make profits, then more reinsurers enter the market with capacity or existing reinsurers increase their capacity. This leads to a situation of more capacity less business and leads to fall in the rates and reinsurance becomes cheaper

• HARD MARKET: Losses suffered could affect reinsurers adversely and lead to exit of some of the reinsurers and capacity. This will harden the market and leads to increase in rates.

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Non-Proportional Slip

• Ceding Company

• Period

• Type of Contract

• Class of Business

• Territorial Scope

• Cover Limit

• Deductible

• Reinstatements

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Non-Proportional Slip

• Rate of Adjustment

• Minimum & Deposit Premium

• General Conditions

• Exclusions

• GNPI

• Brokerage

• Other Information

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Non-Prop Treaty terms

• Minimum & Deposit Premium (MDP)

– Normally at 85-90% of XL premium. If GNPI

achieved is less than the MDP percentage,

the MDP premium is taken as the 100%

premium. If it exceeds, then the premium is

calculated by multiplying the GNPI by the

premium rate.

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MDP working

• GNPI is 1 crore; MDP 85%

Layer Ded Rate Premium MDP

3 crore 2 crore 10% 10,00,000 8,50,000

5 crore 5 crore 5% 5,00,000 4,25,000

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Non-Prop Treaty terms

• Two-Risk Warranty

– Cat Reinsurers will pay claims only if two or

more risks are affected in the same event

• Reinstatement

– Pro-rata as to amount reinstated

– Pro-rata as to time

The number of reinstatements and the amount

at which it is to be reinstated is also

mentioned in the slips