Basics of Reinsurance, Types, Purposes, Advantages and Disadvantages

Basics of reinsurance

1. REINSURANCE PRESENTATION BY TRUST INSURANCE BROKERS PVT. LTD. KALIAKSTHAN, KATHMANDU

2. Definition of Reinsurance “Reinsurance is insurance for insurance companies” “Reinsurance is the transfer of part of the hazards or risks that a primary insurer assumes by way of insurance contracts or legal provision on behalf of an insured to a second insurance carrier, the reinsurer who has no direct contractual relationship with the insured.” (according to M. Grossmann, Reinsurance – An introduction.)

3. NEED FOR REINSURANCE A primary insurer needs To limit the impact of annual fluctuation in the losses he must bear on his own account; To be protected in case of catastrophe; and To have capacity to handle larger risks To maintain solvency margin

4. Reinsurance - Advantages to the Primary insurer Reduces the probability of ruin by assuming catastrophe risks. Stabilizes the balance sheet by taking/ceding part of risks of random fluctuation, risks of change and risks of error. Improves the balance of the portfolios by covering large and highly exposed risks. Enlarges the underwriting capacity by accepting proportional share of risks and providing part of the necessary reserves. Releases equity from tied up and make it effectively available for his regular activity.

5. Advantages to the Primary insurer….contd Enhances the effectiveness by providing add on services such as: Compiling and presenting underwriting data from sources around the world; Assessing and evaluating special risks; Offering consultation in loss prevention; Providing loss adjustment support; Performing actuarial work; Training members of the cedent’s staff; and Helping ceding companies to invest their capital, to recruit managerial staff, find cooperation partners, arrange mergers, etc.

6. Reinsurance - Advantages to the Reinsures Better spread across the world Long term client relationship Lowering the chances of ruin by retrocession encouraging more balanced portfolios Advantage of law of large numbers

7. Facultative Obligatory proportional Non proportional proportional Non proportional Methods of Reinsurance

8. Facultative Reinsurance Oldest form Either proportional or non proportional For individual risk Ceding by selection Detailed examination and Optional acceptance by the reinsurance Largely matching terms and condition in both the contracts Most suitable for very large and innovative risks

9. ADVANTAGES OF Facultative Reinsurance Risks are considered individually. Reinsurers can negotiate a suitable premium for the actual risk concerned rather than having to consider it as part of an overall portfolio of risks. Facultative reinsurance increases the insurer’s competitive edge within its chosen markets. There is a freedom to offer any risk(by the insurer) which may be accepted or declined (by the reinsurer). The individual examination of the risk with the option to accept or decline allows the reinsurer to select a portfolio of risks which corresponds to their underwriting policy. An insurer’s treaty reinsurance could be protected by facultative reinsurance of particular risks to ensure a better overall result and lower premiums in the long term.

10. DISADVANTAGES OF Facultative Reinsurance As risks are considered individually, the cedant cannot be certain of the placement of the facultative reinsurance and this could affect their ability to underwrite the underlying risk. The administration involved is labour intensive and expensive and any delay in issuing a policy can create problems with both agents and clients. The insurer has to disclose full information regarding its underwriitng of the risk. This could be a problem if the reinsurer is also seen as a competitor in that field.

11. DISADVANTAGES OF Facultative Reinsurance There is the possibility of the reinsurer exercising a certain amount of influence over the insurer’s underwriting by asking them to improve the risk offered or influencing unduly their assessment of the premium on the original risk. The insurer may lose control over the handling of the risk. E.g it may not be allowed to agree policy amendments without the prior agreement of the reinsurer. Reinsurers may control the handling of any claims by use of a claims co-operation or claims control clause.

12. Obligatory Reinsurance Automatic reinsurance by means of treaties The cedent binds obligatorily to cede and reinsurer binds obligatorily to accepts contractually agreed share of the risks defined in the treaty, either on proportional or on non-proportional basis No selection of cessions within the defined risks Mostly blind treaties Follow the fortune Continuity feature with provision for annual renewal and termination with prior notice

13. Obligatory Reinsurance… Contd Periodical Accounts statement Monthly/Quarterly/ Half yearly/yearly Treaty share of premium in respect of risk attached during the period Treaty share of claims paid during the period Reinsurance commission ( Fixed/ sliding) Cash loss Profit commission Clean cut Run off treaty

14. Basic forms of Reinsurance Proportional Non- Proportional Quota share treaty Surplus treaty Excess of Loss cover Stop Loss cover Top and Drop cover

15. Proportional Reinsurance The primary insurer and the reinsurer share the premium and losses at contractually defined ratio; The reinsurer’s Share of the premium is directly proportional to his obligation to pay any losses; The price for the proportional cover is the commission on the premium ceded to take care of cedent's procurement cost and management expenses The important types of proportional reinsurance are: 1) Quota Share treaty 2) Surplus Treaty

16. Quota share Treaty The reinsurer assumes risks at a predetermined percentage of (a fixed quota) all the insurance policies written by the direct insurer within the defined branch or branches of insurance. The premium and claims are shared at this percentage. It is simple and cost effectiveness.

17. Surplus Treaty The reinsurer does not participate in all risks; the primary insurer, for himself retains upto certain amount called his retention The retention may be defined differently for each class of risk according to his practice the surplus over his retention is ceded which the reinsurer is obliged to accept upto a defined limit This limit is usually defined in multiples of the cedent’s retention known as lines. The ratio that results between the risk retained and the risk ceded is the criteria for distribution of liability There can be more than one surplus treaty arranged with different reinsurers Aims at better balancing of portfolios.

18. Non-proportional Treaty Loss based; not on risk based No predetermined ratio for dividing premiums and losses; Share of loss that each one pays depends on the amount loss incurred; The treaty defines deductible upto which the primary insurer pays all losses; the reinsurer takes on liability beyond deductible upto certain limit The deductibles are also called “net retention”, “excess point” and “priority” The important types of non-proportional reinsurance are 1) excess of loss treaty 2) stop loss treaty

19. Non-proportional Treaty Non-proportional reinsurance is based on the size of the loss and not the reinsurer’s share in the risk. Non-proportional reinsurance is usually referred to as excess of loss as the loss has to exceed a certain retention or deductible(usually a monetary amount) before a claim can be made against the reinsurance. E.g , if the insurer’s motor account was protected by a reinsurance of NRs. 100,000 excess of NRs. 50,000, the reinsurer would indemnify the insurance company for a loss once a loss exceeded NRs. 50,000 but only upto the maximum indemnity of NRs. 100,000 available under the contract for that loss. Any loss in excess of NRs. 150,000 would be the original insurer’s responsibility.

20. What to Reinsure One risk Group of similar risk Individual loss Accumulated loss Annual loss.

21. Operative Clause of a treaty “The company binds itself obligatorily to cede and the reinsurer binds obligatorily to accept by way of reinsurance a percentage stated in the schedule of the first surplus over and above the amount retained by the company for its own account on all insurances and/or facultative reinsurances written in the Fire dept of the company and emanating from all parts of the world except the USA & Canada. within the scope of this agreement, the company may cede hereunder on any risk up to --------times of net retention and not exceeding an amount equivalent to --------”.

22. Other contents of the treaty in-respect of proportional treaties Attachment of cessions Follow the fortunes Exclusions Accounting clause Commissions and profit commission Loss advices and accounting of losses Premium and loss portfolios Cessions running to expiry Valuation of portfolios Commencement and terminations Notice of cancellation (anniversary date) Termination

23. Contents of non proportional treaty Terms of agreement Insuring clause Definition of loss occurrence Ultimate net loss Net retention Premium clause Reinstatement arbitration Errors and omissions Alterations Set-off clauses Underwriting policy Intermediaries

24. ADVANTAGES OF TREATY The reinsured has automatic reinsurance cover. The reinsured receives a contribution towards costs (ceding commission) for proportional treaties. The reinsured can receive an additional contribution if the business is profitable(profit commission) for proportional treaties. Administration is quicker and easier than facultative reinsurance, particularly for proportional treaties. Accounting procedures can be simplified by use of quarterly accounting. As treaties generally deal with large numbers of homogeneous risks, computer technology can be used for data storage and analytical techniques.

25. DISADVANTAGES OF TREATY There is no freedom since both parties are tied into the contract. Therefore faith has to be placed in the underwriting ability of the original insurer as the treaty cannot be cancelled prior to the end of the period. Too much premium can be ‘lost’ to reinsurers on small good risks which an insurer would otherwise retain net for their own account.

26. Other Methods Facultative obligatory / Open cover Pool Inter Group Transfer Captive companies Alternate Risk Transfer Mechanism

27. REINSURANCE PREMIUMS The reinsurance premium is the price of cover charged by the reinsurer in consideration for offering to underwrite the risk. In all contracts of reinsurance, the premium is a reflection of the original insurer’s risk, and the basis for calculation of reinsurance premium varies according to the type of reinsurance contract. There are a number of different definitions of the reinsurer’s premium income on which the reinsurance premium is based. Gross premium – gross written premiums equal the premiums received for one year. Written premium – premium income in respect of proportional reinsurance written (new or renewed) during an annual period regardless of the proportions earned. Gross written premium (GWP) – the gross written premium describes the total premium on insurance underwritten by an insurer during a period before deduction of any outwards reinsurance premium deductions for retrocession cover.

28. REINSURANCE PREMIUMS Net written premium – written premiums net of outwards reinsurance premium deductions for retrocession/reinsurance cover. Gross net written premium (GNWP) – gross written premium net of policy cancellations and outwards reinsurance premiums but gross of commissions and expense. Gross net written premium income (GNWPI) – gross written premium less only returned premiums and less premiums paid for reinsurance that inure to the benefit of the cover in question. Its purpose is to create a base to which the reinsurance rate is applied. It is the same as GNEPI except premiums are written instead of earned.

29. REINSURANCE PREMIUMS Earned premium – written premium is premium registered on books of an insurer or reinsurer at the time a policy is issued and paid for. Premium for a future exposure period is said to be unearned premium. Gross earned premium – gross premium less any part of the premium being paid in advance for later insurance years Gross net earned premium (GNEP) – gross earned premium less any policy cancellations and outwards reinsurance premiums but inclusive of commissions and expenses. Gross net earned premium income (GNEPI) – This represents the earned premiums of the original, reinsuring company for the lines of business covered net, meaning after cancellations, refunds and premiums paid for any reinsurance protecting the cover being rated, but gross, meaning before deducting the premium for the cover being rated.

30. Regulatory Requirements Minimum Paid up Capital Rs. 1000/-crores Obligatory cession to National Reinsurers 16% as Direct Cession – 15% as Mandatory to each local reinsurer Maximum retention within the country Preferential Cession to National Reinsurers. Minimum Credit Rating for lead market to be “A” by AM Best or equivalent international Rating Agency and follow market “B” by AM Best or by equivalent international Rating Agency for the past five years Filing of concluded Treaties: within 30 days of commencements of the financial year RI Brokers – minimum capital Rs. 5 Crores

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