Professional Documents
Culture Documents
Reinsurance Project PDF
Reinsurance Project PDF
INTRODUCTION TO REINSURANCE
Introduction
Reinsurance holds a greater role in the realm of insurance as primary insurers can
latch on to the business of insurance in an unshackled way as the risks they are
exposed to, constantly make them to look back with caution. Reinsurance provides
them cushion through risk transfer and a source to share their liability and increases
their ability to undertake huge risk exposures and undertake claims. Without
reinsurance cover, it is obvious that large claims might jeopardize the viability of
individual insurers or even the entire insurance system.
Reinsurance is an insurance of insured risk where the insurer retains a part and cedes
the balance of a risk to the reinsurer. This is done to facilitate a greater spread and
reduce liability on the part of the insurer. In other words, reinsurance is insurance of
insured risk taken by insurance companies to protect their liability commitments beyond
their net capacity. It is the foundation on which the whole edifice of insurance rests.
This is a widely used risk transfer mechanism and provides the backbone to
insurance industry. Reinsurance is one of the major risk and capital management
tools available to primary insurance companies.
The progress in science and technology brought in its wake many revolutions the way in
which the companies operate today, thus making insurers to face more complex risks, with
substantial values at single locations and demanding special types of cover. The
stakes involved are considerable and in money terms very huge. The changing legal
system and the increasing court awards, the increasing number of potential liabilities
and the depreciation of the money are affecting in a cumulative fashion the cost of
claims today. Reinsurers help the industry to provide protection for wide range of risks.
HISTORY OF REINSURANCE
In the early days of insurance, as there is no facility of reinsurance, an insurer accepted
only those risks that could be entirely handled by him. The origin of reinsurance dates
back to the fourteenth Century when the Lombardians began to develop the concept of
reinsurance. The need for reinsurance was first felt in marine business, where there
was a concentrated risk with a recognized catastrophe hazard. The oldest known
contract with the legal characteristics of a reinsurance contract occurred in Genoa in
1370. Soon marine insurance developed rapidly and became a common practice
throughout Europe. The earliest statutory reference to reinsurance was an Ordinance of
Louis XIV in 1681, when it was promulgated that ―it shall be lawful to the insurers to
make reassurance with other men of those effects which they had themselves
previously insured‖. Marine reinsurance was permitted by British legislation only when
the insurer died or became insolvent or went bankrupt. This prohibition continued until
1864. Fire reinsurance appears to have developed much later. The first fire reinsurance
was found in a royal concession granted to the Royal Chartered Fire Insurance
Company of Copenhagen in 1778. One of the earliest recorded fire reinsurance
transactions took place in 1813 when the Eagle Fire Insurance Company of New York
assumed all of the outstanding risks of the Union Insurance Company, but it was never
really executed, as the insurer did not avail this facility. However, in the year 1821 a fire
reinsurance treaty was executed between the National Assurance Company, Paris (the
reinsurer) and the United Proprietors of Belgium. It is the Supreme Court of New York,
in the year 1837 that provided real boost to reinsurance by upholding the contract of
reinsurance in the case of New York Browery Insurance Company, the cedent and the
New York Fire Insurance company, the reinsurer.
One of the earliest reinsurance companies are the Cologne Reinsurance Company
established in 1846 and started operations six years later. The Company is still in
existence and is thus the oldest professional reinsurance company. The Swiss
Reinsurance company which started its business in 1863 is the first reinsurance
company to be founded in Switzerland. The Munich Reinsurance company was
formed in 1880. The disruption of the two world wars resulted in London developing
into a substantial reinsurance market. The development was further aided by
Lloyds‘ increased involvement in reinsurance and the spread of excess of loss
covers which were predominantly written by Lloyds. Of the total business written at
Lloyds now, reinsurance constitutes a significant proportion.
Now reinsurance has spread all over the world especially for offshore risks, wide bodied
jets, satellite, and petrochemical risks. Development of reinsurance exchanges in the
139
Risk Management and Reinsurance
USA, and tax concessions in Bermuda, Panama, Honkong and Singapore have
also helped in the development of reinsurance.
In the beginning, reinsurance was done mostly in the area of facultative
transactions. With the progress of industry and commerce in 19th Century the
innovative forms of coverage came into operation, giving rise to automatic forms of
reinsurance known as treaties, which became an indispensable part of a company‘s
operations today. By the time of World War-I, proportional treaties became the main
vehicle replacing facultative reinsurance that proved costly to administer and slow
to operate besides being inflexible. The invention and technique of excess of loss
cover was the most significant development in reinsurance in the past 100 years.
This form of reinsurance filled a real gap for property policies which were extended
to cover catastrophe hazards.
By 1850 there were already 306 insurance companies in 14 countries. In 1900, this
number reached 1272 in 26 countries and in 1910, 2540 in 29 countries. Today
more than 10,000 insurance companies are working in over 100 countries in
addition to some 2600 agencies.
CONCEPT OF REINSURANCE
Reinsurance may be defined as a contractual arrangement under which one
insurer, known as the primary insurer, transfers to another insurer, known as the
reinsurer, some or all of the losses to be incurred by the primary insurer under
insurance contracts it has issued or will issue in the future. Reinsurance is a
contract of indemnity, even in life insurance and personal accident insurance.
The primary insurer is sometimes referred to as the ceding insurer, ceding
company, cedent, or reinsured.
Reinsurers also may reinsure some of the loss exposures they assume under
reinsurance contracts. Such a transaction is known as retrocession. The insurer or
reinsurer to which the exposure is transferred is known as a retrocessionaire and
the reinsurer transferring the exposure is called the retrocedent.
Retrocession agreements do not differ greatly in detail from reinsurance
agreements.
In almost all cases, the reinsurer does not assume all of the liability of the primary
insurer. The reinsurance agreement usually requires the primary insurer to keep or
retain a portion of the liability. This is known as the insurer‘s retention and may be
expressed as a percentage of the original sum insured or a specified quantum.
In other words, reinsurance is insurance of the insured risk taken by insurance
companies to protect their liability commitments beyond their limit.
Under ideal conditions, the contractual relationship between a reinsured and its reinsurer
140
Introduction to reinsurance
141
Risk Management and Reinsurance
The following table illustrates how reinsurance provides the primary insurer stability
in its underwriting results through reinsurance.
Table 8.1
Stabilization of Loss Experience of a Primary Insurer Loss
Experience of a Primary Insurer Loss Experience of a
Primary Insurer for a Line of Business
Years Actual Loss Amount reinsured Stabilized Loss level
(Rs. in thousands) (Rs. in thousands) (Rs. in thousands)
1 200 - 200
2 450 50 400
3 260 - 260
4 160 - 160
5 820 420 400
6 740 340 400
7 330 - 330
8 185 - 185
9 120 - 120
10 215 - 215
Average Annual Losses Rs. 3,48,000.
The aggregate loss over a ten-year period is Rs. 34,80,000 or an average of Rs.
3,48,000 each year. If a reinsurance agreement were in place to cap losses to Rs.
4,00,000, the primary insurer‘s loss experience would be limited to the amounts
shown in the ‗stabilized loss level‘ column.
2. Large-line Capacity
Large line capacity refers to an insurer‘s ability to provide a higher limit of insurance
on a single loss exposure. In the commercial and industrial world, there are many
items of property, which are of high value, say exceeding Rs. 100 cores. Instances
are: a high rise building, a ship, an aircraft and so on.
Individually, many primary insurers would be unable to retain such a large amount
of insurance on a single loss exposure without reinsurance. Besides, governments
regulate the capacity of insurance and put a cap on the amount of insurance an
individual insurer can write on a single loss exposure.
142
Introduction to reinsurance
In practice, the limit varies, but it may be stated that generally state regulators in the
US prohibit a primary insurer from writing an amount of insurance in excess of 10
percent of its policy holder‘s surplus on any one loss exposure.
However, when the primary insurer has the reinsurance facility, he can write a large
line, keeping his retention within his stipulated maximum in relation to its capital and
surplus and reinsuring the balance of the risk.
3. Financing Surplus Relief
In practice, as if by convention, most insurers limit the amount of premiums they
can write, making it a function of the policyholders‘ surplus. For example, if the net
written premiums, after deducting premiums on reinsurance ceded, exceed the
policyholders‘ surplus by a ratio of more than 3 to 1, it means the insurers have
exceeded their capacity. In other words, a ratio below 3 to 1 is favorable.
In the case of the insurer with growth targets, the premium to surplus ratio will tend
to go over 3 to 11. This is because there will be shrinkage of the surplus resulting
from the prepaid expense portion of the unearned premium as agent‘s commission
is charged against surplus.
According to insurance regulations in force, every insurer is required to establish an
initial unearned premium reserve equal to the total premium for the policy and then
recognize the income over the life of the policy. The insurer has to charge the expenses
immediately against income and does not amortize them throughout the policy period
since most of these expenses are incurred at the inception of the policy. Since the
insurer has not yet earned any income, initial expenses are paid out of surplus. This is
referred to as the surplus drain as a result of growth in written premium.
The financing function of insurance is called surplus relief because of the reduction
of the surplus drain, by using reinsurance.
4. Catastrophe Protection
Catastrophe is a large loss to the community, resulting from such natural disasters as
earthquakes, hurricanes, plane crashes, industrial explosions, terrorist attacks etc. This
is a fundamental risk spread over the community. The September 11 attack in New
York in USA is a case in point. Total industry losses usually reach several crores of
rupees for one such catastrophe and, without reinsurance support, the primary insurer
cannot write large amounts of catastrophe insurance. Since catastrophes are major
causes of the instability of losses, one may say that this purpose of reinsurance is
closely related to the purpose of stabilizing loss experience.
5. Underwriting Assistance
In general, reinsurers have good expertise in underwriting different classes of insurance all
over the world. This expert knowledge available with the reinsurer can be beneficially
shared with many small and medium sized primary insurers. This service of reinsurers is
143
Risk Management and Reinsurance
144
Introduction to reinsurance
? Questions
1. ―Reinsurance holds a greater role in the realm of insurance‖-
Discuss.
2. Briefly trace the history of reinsurance.
3. Explain the concept of reinsurance and outline the roles of
primary insurer and reinsurer.
4. Discuss the main functions of reinsurance.
5. What are the requirements of a valid reinsurance contract?
Explain.
145
CHAPTER – 2
REINSURANCE THEORY
LEARNING OBJECTIVES
Understanding the operations of reinsurance
Distinguishing between various types of Reinsurance
- Proportional and Non-Proportional
- Facultative or Treaty
To get to know the Magnitude of coverage and period of coverage
To understand Premium sharing and claim liability under different varieties
To know the meanings of Common terms in reinsurance
Introduction
―Although the primary purpose of reinsurance is to avoid too large a risk concentration within
one company, it may be used to take advantage of the underwriting judgment of the
reinsurer, to transfer all or certain classes of substandard business to reduce the strain on
surplus caused by writing new business, to stabilize the overall mortality or morbidity
experience of the ceding company or in the case of newly organized small companies, to
obtain advice and counsel on underwriting procedures, rates and forms.‖…Dr. Skipper. Jr.
Reinsurance business operations require considerable skill and expertise. With
competition among reinsurers growing, it is all the more challenging. From the
cedent company point of view certain aspects need consideration.
a) Historic relationships: Cedent companies often prefer a reinsurance company
which is reputed and financially sound with a large customer base spread
over a wide geographical area. It is assumed that such companies can serve
customers well. However, there are cases wherein the small companies also
carried on the business successfully with exponential growth in their business.
146
reinsurance Theory
147
Risk Management and Reinsurance
TYPES OF REINSURANCE
There is no single kind of reinsurance that effectively serves all purposes. Several
kinds of reinsurance have developed to serve the various functions listed in the
preceding chapter.
While reinsurance contracts can be categorized in several ways, one basic
categorization is between facultative reinsurance and treaty reinsurance. In
facultative reinsurance, the primary insurer and reinsurer negotiate reinsurance
contract for each risk separately. There is no compulsion for the primary insurer that
it should purchase reinsurance on a policy that it does not wish to insure. Likewise,
there is no obligation on the part of the reinsurer to reinsure proposals submitted to
it. The reinsurer has the option of either accepting or declining a proposal.
Facultative reinsurance may be either proportional or non-proportional.
Facultative reinsurance is now widely used for reinsuring hazardous risks not
covered by treaty arrangements, for the purpose of reducing the insurance in
certain area, for reducing the treaty reinsurers‘ liability, to augment risk capacity and
to get advice of the reinsurer on risks that are considered new and complicated.
In the treaty reinsurance there is a prior agreement between the primary insurer and
reinsurer whereby the former reinsures certain lines of business in accordance with the
terms and conditions of the treaty and the latter agrees to accept the business that falls
within the scope of the agreement. An obligation is imposed that all policies that come
within the terms of the treaty are required to be placed with the reinsurer. Similarly, the
reinsurer can not decline risks that come within the terms of the treaty.
Given that the treaty reinsurance guarantees a definite amount of reinsurance
protection on every risk which the primary insurer accepts, treaty reinsurance works
out to the cheaper than the facultative reinsurance.
Though there seems to be a clear distinction between facultative and treaty reinsurance,
there are some insurance contracts, called facultative treaties, which are hybrid in nature.
The Reinsurance Association of America defines a facultative treaty as ―a reinsurance
contract under which the ceding company has the option to cede and the reinsurer has the
option to accept or decline classified risks of a specific business line. The contract merely
reflects how individual facultative reinsurance shall be handled‖.
Sometimes a facultative treaty is referred to as facultative obligatory treaty or
automatic facultative treaty. Under this, the primary insurer may submit risks within
a specified class which the reinsurer is obligated to accept, if ceded. As this type of
reinsurance provides plenty of opportunities for adverse selection, reinsurers
exercise abundant caution in selecting primary insurers.
The Facultative Obligatory Treaty which is not very common is a combination of
facultative and treaty forms of reinsurance.
148
reinsurance Theory
CATEGORIES OF REINSURANCE
Excess of loss reinsurance written on a facultative basis is always per risk or per policy
excess basis. Per occurrence and aggregate excess of loss reinsurance relate to a
Reinsurance
149
Risk Management and Reinsurance
class of business, a territory, or the primary insurer‘s entire book of business rather
than a specific policy or a specific loss exposure. A financial reinsurance agreement
can be written for any of the above types of reinsurance.
Adopted from Micheal W. Elliott, Bernard L.Webb, Howard N.Anderson, and Peter
R Kensicki, Principles of Reinsurance Vol.1 (Malvern, PA: Insurance Institute of
America, 1955), pp. 5, 148
SOURCE: Webb. B.L; et.al., Insurance Operations, Vol. 2, Second Edition, American
Institute for Chartered Property Casualty Underwriters, Malvern, PA., 1997
Treaty Reinsurance
Treaty reinsurance has become popular with primary insurers because of its
several advantages over facultative reinsurance. As the reinsurer has to necessarily
accept all business that falls within the terms of the treaty, the primary insurer, with
no prior consultation with the reinsurer, can underwrite, accept and reinsure such
business on each application submitted to him. Because of the absence of prior
negotiations with the reinsurer, the transaction cost on each policy is lower under
treaty reinsurance than under facultative reinsurance.
As shown in Fig. 2.1 Treaty Reinsurance is subdivided into
(i) Pro Rata or Proportional Reinsurance Treaties and
(ii) Excess of Loss Reinsurance Treaties
Pro-rata reinsurance whether belonging to property or liability reinsurance involves
sharing of agreed proportion of original premium and the claims. The excess of loss
reinsurance is considered loss effective in this regard. The greater effectiveness of
pro-rata treaties lies in two directions.
(i) The practice of paying ceding commission which is not common under excess
of loss treaties.
(ii) The premium for a pro-rata treaty is likely to be a larger percentage of the of
the original premium that in the case of an excess of loss treaty
There are two kinds of treaties in the pro rata category; namely
a) Quota Share Treaty Reinsurance and
b) Surplus Share Treaty Reinsurance
Similarly there are three general classes of excess of loss treaties (sometimes
referred to as non-proportional treaties). They are
a) Per risk excess treaty or per policy excess treaty
b) Per occurrence of loss treaty
c) Aggregate excess treaty
150
reinsurance Theory
151
Risk Management and Reinsurance
TABLE 2.2
DIVISION OF INSURANCE, PREMIUM AND LOSSES UNDER
QUOTA SHARE TREATY
ABC Insurance Co. XYZ Reinsurance Company Total
(30 percent) (Rs.) (70 percent) (Rs. ) (Rs.)
Policy No.1
Insurance 60,000 1,40,000 2,00,000
Premium 240 560 800
Loss 15,000 35,000 50,000
Policy No.2
Insurance 90,000 2,10,000 3,00,000
Premium 450 1,050 1,500
Loss 24,000 56,000 80,000
Policy No.3
Insurance 1,20,000 2,80,000 4,00,000
Premium 510 1,190 1,700
Loss 27,000 63,000 90,000
It is seen that the share of the primary insurer and the reinsurer in insurance,
premium and loss remains the same in each policy, the rupee amount of retention
by the primary insurer increases as the amount of insurance increases.
The Quota Share Treaty has the main disadvantage of ceding by primary insurer of
a large share of presumably profitable business. Another disadvantage is it is not
effective in stabilizing underwriting results as it does not influence the primary
insurer‘s loss ratio.
Surplus Share Treaty
Surplus share treaty is also a pro-rata or proportional reinsurance. Under a surplus
treaty, the ceding company decides the limit of liability (rupee amount) which it
wishes to retain on any one risk or risks and reinsures only the surplus over and
above its own net retention. If the sum insured under the policy is within the net
retention of the company, there will be no cession to the reinsurer. Thus, the
company will be able to retain for its own account such risks.
It is usually arranged in terms of number of lines of retention. The amount retained
by the ceding company for its own account is called the net retention or a line. Thus
a surplus treaty may be of ten or twenty lines capacity, which means that the ceding
company can assume cover on risks with sums insured ten or twenty times its own
retained line.
152
reinsurance Theory
153
Risk Management and Reinsurance
154
reinsurance Theory
Solution:
Risk Gross sum Retention Cessions to Cessions to
insured [Rs.] [Rs.] 1st surplus 2nd surplus
treaty [Rs.] treaty [Rs.]
1 2,00,000 2,00,000 Nil
2 3,00,000 1,00,000 2,00,000 Nil
3 12,00,000 2,00,000 10,00,000 Nil
4 30,00,000 4,00,000 26,00,000 Nil
5 65,00,000 2,00,000 20,00,000 40,00,000
Balance of Rs. 3,00,000 has to be arranged facultatively.
Excess of loss or non-proportional Treaties
Non-proportional reinsurance arrangements are characterized by a distribution of
liability between the cedant and the reinsurer on the basis of losses rather than sums
insured, as in case of proportional arrangements. In fact, no insurance amount is ceded
under excess of loss treaties; what is ceded is losses and premiums.
As compensation for the cover granted, the Reinsurer receives part of the original
premiums and not part of the premium corresponding to the sum reinsured as in
proportional reinsurance.
The following common characteristics differentiate them from proportional treaties.
1. The size of cession is not determined case by case.
2. Administrative costs are substantially reduced.
3. Usually there is no profit commission.
4. Reinsurance premium is worked out on the basis of exposure and past loss
experience.
There are three general classes of excess of loss treaties.
(i) Per risk or per policy excess
(ii) Per occurrence excess or per loss excess, and
(iii) Aggregate excess
A per risk excess treaty is applicable to property insurance; the retention and limit apply
separately to each risk insured by the primary insurer. A per policy excess treaty
applies to liability insurance; the retention and limit apply separately to each policy sold
by the primary insurer. The retention under each of these policies is specified as a
155
Risk Management and Reinsurance
rupee amount of loss. Further, the reinsurer is obligated for all or part of a loss to any
single exposure in excess of the retention and up to the accepted reinsurance limit.
Per occurrence excess of loss reinsurance gives indemnity against loss sustained
in excess of the net retention of the primary insurer, subject to the reinsurance limit,
irrespective of the number of risks involved in respect of one accident, event or
occurrence. This kind of reinsurance when applied to property coverage is called
catastrophe excess and when applied to liability coverage is called clash cover.
Aggregate excess treaties, also called excess of loss ratio or stop loss treaties are
not common. They are used generally in crop hail insurance and for small insurers
in other lines.
Characteristics of Pro-rata and Excess of Loss Reinsurance:
Pro- rata excess of loss
1. Liability is based on 1. Liability is in excess of the
predetermined percentage. cedant‘s loss retention.
2. It is a proportional treaty. 2. It is a non-proportional treaty.
3. There is sharing of risks. 3. Risks that are above retention
are not covered.
4. This treaty focuses on the 4. This treaty focuses on the size
size of the risk. of the loss.
5. Premium is shared as the 5. Premium is charged as a
percent of original premium percentage on retained
less the ceding commission. premium.
6. Premiums and losses are 6. Settlement of premiums by
settled by account or account and the settlement of
bordereau. losses individually.
156
reinsurance Theory
157
Risk Management and Reinsurance
In an excess of loss cover the rate of premium is 100/70th of the average burning cost
of incurred claims for the current and previous years. Rate to be applied to GNPI.
Solution
Year gnPI Incurred losses to XL loaded BC
cover Paid+o/s losses with 100/70
(1) (2) (3) (4) (5)
(3)/(2)*100
1980 1000000 8000 0.8 1.1143
1981 1200000 20000 1.667 2.381
1982 1500000 40000 2.667 3.810
1983 1800000 50000 2.778 3.969
TOTAL 5500000 118000 2.145 3.064
Hence the rate of premium would be 3.064 and amount of
premium 1,800,000 x 3.064 = Rs. 55,152
Per Occurrence Loss Cover-72 Hour Clause
―Loss Occurrence‖ means all individual losses arising out of and directly occasioned
by one catastrophe. This will be limited to:
72 consecutive hours as regards a hurricane, a typhoon, windstorm, rainstorm,
hailstorm and or tornado
72 consecutive hours as regards earthquake, seaquake, tidal wave, and or volcanic
eruption
168 consecutive hours and within the limits of any one State as regards riots, civil
commotions and malicious damage
168 consecutive hours for any other catastrophe of whatever nature and no
individual loss from whatever insured peril which occurs outside these period or
areas, shall be included in that ―loss occurrence‖
158
reinsurance Theory
159
Risk Management and Reinsurance
160
reinsurance Theory
PML UNDERWRITING
We have discussed about retention and retention limits of the insurance companies
in terms of Sum Insured.
The degree of hazard in respect of fire risk of a first class residential building is less
compared to fire risk in a cotton ware house. Further the frequency of fire losses in
the case of cotton ware houses is much greater than in a residential building. If we
follow ―Sum Insured‖ basis of underwriting the primary insurer will retain the same
volume of sum insured for a superior risk and a hazardous risk. However it will be
advantageous for the primary insurer to retain more on a superior risk where the
chances of total loss is smaller and retain less of hazardous risk.
Therefore, a way has been evolved by companies over a period to relate the retention
to probable maximum loss (PML) estimates rather than to the sum insured. The main
advantage of this basis is that risks are evaluated in terms of their loss potential.
Usually PML assessment will be made by risk engineer after inspection of the various
steps involved in the process and accumulation of risk in an industrial unit.
The advantages of PML underwriting to the primary insurance companies are
1. It gives them greater capacity to handle large risks.
2. It helps them to retain a lot more premium for net account than would be
possible otherwise.
However this method of underwriting on PML basis suffers from following defects:
1. In respect of mega industrial risk, it is very difficult to have an objective
evaluation of the process involved and its impact on PML assessment.
2. Primary insurers will have a tendency to depress the PML estimate so as to
accommodate the values within the automatic reinsurance arrangements.
3. If the evaluation is haphazard or unscientific, it will result in the company
having to carry a liability much in excess of its intention and this may have
serious repercussions on reinsurers as well.
PML underwriting is normally practiced in the case of major fire, Industrial All Risk
and project insurance policies.
161
Risk Management and Reinsurance
COMMON TERMS
It is essential at the outset to understand the meanings of some common terms in
reinsurance.
Bordereau: a report furnished periodically to the reinsurer by the reinsured
providing details of risks, premium and/or losses.
Cede: to give away or transfer all or part of risk to another company or companies.
Line: the amount of retention of the direct insurer; Reinsurer may accept one or
more lines or fraction of a line
Overriding Commission: commission payable to the ceding company in addition
to the original commission to take care of overhead expenses and often including a
profit margin.
Profit commission: an additional commission payable by the reinsurers to the
ceding company as a percentage of profits derived from the business.
Portfolio: the liability of an insurer for the unexpired portion of the policies in force
or outstanding losses or both for a particular segment of the insurer‘s business.
Treaty: an agreement made between the ceding company and the reinsurer under
which the former agrees to cede a portion of risks up to the agreed limit to the
reinsurer who in turn agrees to accept such cessions.
Reinstatement: A provision in an excess of loss reinsurance contract, (specially
catastrophe and clash covers) that stipulates for a reinstatement of a limit that is
reduced by the occurrence of a loss/losses.
Reserves: the portion of premiums/losses retained by the insurer for the due
performance of the obligations of the reinsurer under the treaty.
Retention: the amount of liability the ceding company keeps for its account of a
risk.
Retrocession: when a reinsurer (retrocedent) cedes all or part of the reinsurance
risk it has assumed to another reinsurer (retrocessionaire).
Slip: a document showing details of reinsurance proposed to be offered which is
circulated to the reinsurers by the brokers/ceding company.
162
reinsurance Theory
? Questions
1. ‖Reinsurance requires lot of skill and expertise to operate and
take it to logical business ends.‖ – Discuss.
2. What are the similarities and differences between insurance
and reinsurance?
3. What is a proportional reinsurance treaty? Discuss various
methods of proportional reinsurance contracts.
4. Discuss various types of non-proportional treaties.
5. Bring out the difference between coinsurance and reinsurance.
163
CHAPTER – 3
SPECIAL AREAS OF REINSURANCE
LEARNING OBJECTIVES
Having a closer look at Property and Casualty Reinsurance
Better knowledge of Accident and Liability Reinsurance including
- Motor,
- Personal Accident,
- Burglary,
- Jewelers block,
- Legal exposures to third parties and public,
- From products sold etc.
Understanding of the Life Reinsurance
Property insurance is the business of operational contracts of insurance against risk
of loss of or damage to material property like damage to machinery, buildings,
stock, personal belongings or household goods, money etc.,
The types of property risks amenable to reinsurance are:
Money insurance – all risks
Goods in transit – damages/loss
Business Interruption – effects on turnover/profits
Engineering – risks of collapse of machinery
Fire and Material damages – ‗All Risks‘, riot, earthquake etc.
Theft of Property – Burglary risk
164
Special Areas of Reinsurance
Introduction
Property reinsurance principally deals with many classes of original insurance
business. The reinsurance contracts cover normally all those aspects which are
covered in the original policy which may be physical loss or damage to real and
personal property and the financial consequences arising out of losses/damages in
respect of various areas outlined above.
Under the provisions of the Insurance Act 1938, a fixed percentage of each and every
risk underwritten in India should be reinsured with GIC of India. This is called ‗Statutory
Cessions‘ and currently it is 10%. After meeting this mandatory requirement any surplus
is ceded to others. The net retention of each company, after statutory cessions, is
protected by Excess of Loss cover arrangements made by each company.
Certain important areas are explained here.
ENGINEERING REINSURANCE
The engineering insurance normally covers the machinery – erection to operation.
The protection of insurance is provided at construction stage and operational stage.
Construction Stage
1. Contractors‘ All Risk insurance (CAR)
2. Erection All Risk insurance (EAR)
3. Marine Cum Erection insurance (MCE)
4. Contracts Works insurance (CW)
5. Advance Loss of Profits (ALOP)/Delay in Start Up (DSU) insurance
The construction stage policies are issued for the period of the project and they are
all one-time policies.
Operational Stage
1. Machinery Insurance (MI)/Machinery Breakdown Insurance (MB)
2. Boiler and Pressure Plant (BPP) insurance
3. Machinery Loss of Profits (MLOP) insurance
4. Contractors‘ Plant and Machinery (CPM) insurance
5. Civil Engineering Completed Risks (CECR) insurance
6. Electronic Equipment (EE) insurance
7. Deterioration of Stocks (DOS) insurance
The operational stage policies are annual policies renewable at expiry.
165
Risk Management and Reinsurance
In engineering insurance even though claims are small there is a risk of catastrophe.
There could be claims following accidents to plant and machinery, damage to property,
interruption in production on account of many factors involving machinery. Fire or floods
can also cause damage to machinery. Mumbai floods (2005) is an example, which
affected many factories in Raighad district of Maharashtra.
The usual reinsurance methods adopted for engineering reinsurance are Facultative
reinsurance, Treaty reinsurance (Quota Share treaty and Surplus Treaty) and Excess of
Loss reinsurance. The highly exposed risks should be covered under Facultative
reinsurance and the most frequent method is the surplus – quota share or surplus.
The ceding company has to basically think about its retention strategy for reinsurance
program. The factors that need consideration to draw out a proper retention strategy
are – size of the portfolio, probability of loss, size of loss, capital, reserves and rate of
return, premium rates, cost of reinsurance and investment policy. By evaluating the
types of risks underwritten and the hazard in their locations, a ceding company sets
different retentions according to the degree of exposure to loss involved. Evaluating
risks in this manner is called setting up a table of limits.
Usually the reinsurer provides the policy wordings and rating guidelines with the
corresponding underwriting instructions. If an insurer wants to accept any risk outside
the scope of the rating principles, the insurer should obtain the reinsurer‘s approval.
The reinsurer may also reserve the right to take part in the claims settlement.
FIRE REINSURANCE
The Proportional Treaty agreement is well suited for fire reinsurance in view of the
large number of risks involved. For ceding company the result net of reinsurance
remains stable over a period of time. The net retained business can be
appropriately covered. In an year of higher than average losses in large risks, a
larger recovery can be made from reinsurers.
Fire insurance risk business is vulnerable to losses arising on a single large risk
from natural perils and to an abnormal increase in aggregate losses during a
particular period. Therefore, it would be necessary for an insurer to avail of any
of the main forms of excess of loss covers as follows:
Facultative excess of loss to limit commitment on a single risk.
A working ‗risk‘ excess of loss treaty as an alternative to proportional treaty.
A catastrophe excess of loss cover to protect against accumulation of losses
from one event on net account.
ALL RISKS PROPERTY PACKAGE REINSURANCE
This is normally obtained to cover a range of diverse activities. It deals with multi-line/
multi-location/ multi-occupancy exposures which is otherwise reinsurable under
166
Special Areas of Reinsurance
167
Risk Management and Reinsurance
insuring and only good faith forms the bedrock of their business to avoid frauds etc.,
The range of values and items requiring marine insurance is enormous and amounts
may at times be colossal. The vessels and cargoes can be totally lost and the insurer,
unless he goes for reinsurance, can land in bankruptcy after a major loss.
The better way for a reinsurer to reduce the impact of war risks is to reinsure on a
proportional basis and protect the retained amount by seeking protection under an
aggregate excess loss cover relating to all losses taking place during a particular year.
Sometimes it is difficult to get claims settled easily, on account of administrative and
legal hassles. And to tackle such situations tonners have come into existence. They
were developed in the reinsurance market as a means of purchasing reinsurance
exceeding an aggregate value of insurance or a certain tonnage. However tonners
could not survive on account of legal problems.
CARGO REINSURANCE
Cargo risks are normally covered from initial warehouse to the final destination and
the risk exposure is less if an event occurs outside the coverage. The reinsurer
should be able to pinpoint the actual cargo and the risks insured. The cargo
business is normally covered by Marine open Covers. The insurer would
automatically accept from his assured all shipments falling within the scope of the
Open Cover up to an agreed amount per vessel/conveyance. It is quite possible
that, when a number of open covers are issued, several clients may be shipping full
lines perhaps by the same vessel, and an insurer may not know the full extent of his
cargo commitments on a vessel before the risk commences. Often the name of the
carrying vessel may not be known, or known only after completion of the voyage.
Therefore, problems arise in accumulation control.
While containerization with several high limits can be aggregated on a single ship,
and thus reduce the incidence of theft, there are instances where the whole
container along with the cargo have been robbed thereby leading to more
complicated problems like major claims. The combination of cargo and hull
insurance values are, at times, so fabulous that it becomes impossible for a single
reinsurer to assume the total loss and hence go for sharing or retrocession.
It is not possible for an underwriter with general cargo account to protect himself against
unduly large commitments on any particular vessel by means of facultative reinsurance
alone. Facultative reinsurance is effected only in special cases for specific risks, while
general protection is obtained by treaty reinsurance arrangements. The underwriting of
cargo insurance calls for care in choosing the retention limits considering the premium
income for the year. It should bear a reasonable ratio to the total income so as to protect
against the company‘s profit being wiped off with a single loss. Alternatively,
Quota Share arrangements can be sought when there is a need to create reciprocal
treaties. For valuable items like diamonds and gold, it is usual to reinsure these risks
168
Special Areas of Reinsurance
separately under Surplus and other treaties and facultatively when the treaty limits
are exceeded.
In recent times, non-proportional reinsurance gained popularity as there is increasing
use of Excess of Loss treaty under which a company can fix a limit up to which it can
absorb all the risks. Only when the net loss exceeds this pre-determined retention limit
does the reinsurer‘s role comes into play. On the other hand, an Excess of Loss Treaty
may protect the ceding company‘s gross lines/net lines after cessions to Surplus/Quota
Share. Normally, the Excess of Loss reinsurance is placed in layers. It protects the
ceding company‘s net retained account where the ceding company‘s basic reinsurance
arrangements are on proportional basis, to reduce the impact of accumulations and
catastrophe exposures.
HULL REINSURANCE
Hull risks cover the body of a ship, its machinery, docks and also others like
vessels, coasters, barges and yachts etc. However it mainly deals with items
relating to body of a ship. Hull insurance broadly falls into two categories viz.,
ocean-going vessels, including bulk carriers, and tankers and local crafts such as
barges, lighters, launches, tugs, dredgers, trawlers etc., Marine cargo business in
most of the countries around the world is ocean transit and air-transit but in India
the inland transit like rail, road or water ways constitute a substantial portion.
In hull insurance, the insurer is certain of his commitments as the value of each vessel
or fleet can be clearly estimated as a result of which open covers ( as in cargo
insurance) can be avoided. In case of total loss the demand is for facultative
reinsurance in hull reinsurance. Depending on the gradation of the vessel, the cedent
should determine his retention limits, taking into account the various aspects of the
vessel like age, performance, sea-worthiness etc. Above the net retention limit, excess
of loss facility should be obtained to reinsure the risk. As with cargo interests, the
present trend is away from proportional treaties towards excess of loss methods of
protection. However, even though Quota Share and Surplus treaties are encouraged,
the emphasis is growlingly on excess of loss arrangements, particularly for ‗catastrophe‘
covers. Wherever the excess of loss is the selected method of protection, the
agreement is to pay the excess of an ultimate net loss to the ceding company in respect
of each and every loss or series of losses arising out of the same ‗loss occurrence‘.
It is suggested that the hull insurer should take care to obtain reasonably high
reinsurance limits since the hull policy may cover liability risks in addition to physical
damage to the vessel. He should endeavor to obtain most extensive coverage at a
cost which leaves him scope for making profits on his retained portion.
AVIATION REINSURANCE
As the capital required in aviation is high, very few private entrepreneurs enter this area
and it is dominated by government undertakings. Insurance in the aviation faces
169
Risk Management and Reinsurance
peculiar challenges because of fabulous amounts involved and the loss of human
life adding to the monetary commitment under accepted policies. The aviation
insurance market is truly international as risks are placed in all countries through
exchange of reinsurance. This makes for a competitive and free market on
worldwide basis. In order to limit their risks insurers have always shown a tendency
to spread risks as widely as possible. Even though initially London was the nerve
center of aviation insurance, slowly it is giving way to countries in Europe like
France, Germany and Switzerland. Reinsurance plays a major part in aviation
insurance, as around 80 per cent of any aircraft will be reinsured.
According to Economic Times, Dec. 14, 2001 - the year 2001 turned out to be the
worst in aviation insurance history. The aviation insurance business has received
claims amounting to $ 4.8 billion during the calendar year, which has been enough
to wipe out at least four years of average premium income. Hull claims which
represent claims on account of damages to the aircraft, account for less than half a
billion dollars. Most of the claims ($4.3 bn) are on account of liability claims, which
mostly include compensation to relatives of passengers killed in air crashes. Airline
losses have not stopped with the September 11, 2001 incident. After the terrorist
attacks in US there have been five major incidents in
November 2001 itself. Indian Airlines, which renewed its policy after the attacks,
had to pay a renewal premium of $17 million, which is $3 million higher than the
rates for the previous year.
Aviation insurance encompasses three areas – Hull, Liability and Personal
accidents. Broadly it covers loss of/or damage to the aircraft, third party liability and
passenger liability. In aviation insurance, facultative covers are normally sought
because of the changes in aircraft sizes and passenger liability. The reinsurer often
places certain clauses under the facultative cover:
To control claims negotiation and settlements;
To determine the details of the original policy wordings;
To discover the original policy rates or premiums.
A reinsurer involved in airlines business faces the problems of accumulation of risk.
This occurs in two ways. The first is the risk of two or more aircraft being at the same
place. Whether on ground, at airports or while flying along the air corridors, there is a
risk of collision. The second type of accumulation arises from insurance policies,
particularly those for airline hull and liability and aviation products liability. These
accumulations are severe and unquantifiable and only an actual loss evidences the
potential. This calls for maintenance of detailed records in a comprehensive manner so
that sufficient levels of excess of loss or other suitable cover may be put in place.
The underwriting of aviation insurance needs a closer scrutiny due to high values in
insurance and reinsurance.
170
Special Areas of Reinsurance
The main forms of coverage for airline risks are placed on a policy for the operator‘s
whole fleet. There used to be separate policies for hulls and liabilities but over the
years combined hull and liability policies came into vogue to save on administrative
costs. Hull war risks are normally covered under a separate insurance policy where
the values are the same as under the Hull All Risks. This coverage can also be
provided on the Hull All Risks policy as a separate section. In many insurance
markets, aviation business is pooled. These pools are formed by local companies to
unite their efforts to solve technical and capacity problems.
Normally the reinsurers exclude the following under the policies:
Hull war is not generally acceptable under treaties. It is protected under a
separate reinsurance program
Policies exceeding a period of twelve months
Inward Treaties
Tonners
Brokers, binders and Line Slips: except line slips where risk are rated by a
leading London underwriter
Profit commission. Good Experience Return or Deductible Insurances
171
Risk Management and Reinsurance
172
Special Areas of Reinsurance
173
Risk Management and Reinsurance
been developed. Under this arrangement, the ceding company pays the reinsurer a
proportionate part of the gross premium, as under the conventional coinsurance plan, less
commissions and other allowances, premium taxes and overhead allocable to reinsured
policies. At the end of each policy year, the reinsurer pays to the ceding company a reserve
adjustment that is equal to the net increase in the reserve during the year, less one year‘s
interest on the total reserve held at the beginning of the year. The net effect of the plan is to
return to the ceding company the bulk of the funds developed by its policies. Modified
coinsurance can be considered as yearly renewable term on a calendar year basis because
the reinsurer, after paying the reserve adjustment, cash surrender values, and commissions
and allowances, is left with only the risk premium.
Aside from the reserve adjustment, the modified coinsurance plan follows that of
the regular coinsurance plan.
A key element, under life reinsurance, is in assessing the true value of assets
recoverable from a reinsurer. A direct insurer who relies too heavily on one reinsurer
faces a substantial risk of default. A life insurer who totally depends on reinsurance and
retains a small percentage of his total portfolio is generally considered to be an
increased risk to the insuring public. Very little reinsurance is affected by Life Insurance
Corporation of India. Its reinsurance is a surplus treaty, which takes sum insured
exposures on individuals in excess of US $ 100,000. The substantial part of LIC‘s
business is not reinsured. Key man insurance, and accumulation are two risk exposures
of significance to a life insurer for arranging his reinsurance.
Key man insurance protects business debts of a firm, which is dependant on a key
individual for continuing its business. In view of which the sum insured would not be
related to the value of a person but the value of loss to his firm in case of his leaving the
company and the premium is paid by the firm is treated as business expense.
This has become a big controversy in India and IRDA suspended operation of this
policy for some time.
Accumulation is when several people are affected by a loss and there is an
accumulation of insured persons; also, where several policies arranged in respect
of one and the same individual are affected, one speaks of a policy accumulation.
Accumulation control is therefore essential to determine need for reinsuring.
174
Special Areas of Reinsurance
? Questions
1. What are the special areas of insurance? Highlight their
treatment.
2. Explain engineering reinsurance at (i) construction stage, and
(ii) operations stage.
3. Write short notes on a) fire reinsurance, and b) casualty
reinsurance.
4. ―Marine insurance can be done in two ways – cargo and hull‖.
Explain them.
5. ―The aviation insurance market is truly international as risks
are placed in all countries through exchange of reinsurance‖.
Outline the procedure in aviation insurance.
6. ―The proportion of total life insurance premiums reinsured is small
in comparison with most of the non-life insurance classes‖. Why
reinsurance of life insurance is not popular? Trace out reasons
and explain the process of reinsurance of life insurance.
175
CHAPTER – 4
REINSURANCE REGULATIONS
AND LAW IN INDIA
OUTLINE OF THE CHAPTER
Reinsurance Regulations and Law in India
Reinsurance Contracts Treaties
Treaty Wordings
Arbitration and Mediation
LEARNING OBJECTIVES
Getting acquainted with Reinsurance Regulations in India
Knowing IRDA Regulations
Understanding Principal contract related strategies
Appreciating Salient features of Arbitration
Understanding Treaty Wordings
REINSURANCE REGULATIONS AND LAW IN INDIA
The law of reinsurance is based primarily on the law of contract. In India, IRDA has
prescribed regulations for the reinsurance sector for general as well as life insurance.
The principal contract related statutes and regulations govern the insolvency, offset and
intermediary clauses, which appear in both treaties and facultative certificates.
Treaty wordings are reinsurance agreements entered into in writing between the
ceding insurer and his reinsurer and embody the terms and conditions of the treaty.
Until recently, reinsurers were not subject to the extent of regulations generally imposed
on the insurers, that is, until a few scandals involving some reinsurers and reinsurance
brokers rocked the industry. The reasons that have resulted in regulating insurers
chiefly were to protect insured from unfair trade practices of some insurers and also
possible insolvency of insurers, apart from unreasonable premium rates.
However, recently many countries have felt the need to impose some regulations
on reinsurers for the overall health of the insurance industry.
For instance, in the U.K., the Department of Trade requires the primary insurers to
annually report on the following:
a) The names and addresses of all reinsurers to whom business has been
ceded during the year;
176
Reinsurance regulations and law in india
b) Any connection (other than the reported reinsurance) between the primary
insurer and any of its reinsurers;
c) The amount of premium payable to each reinsurer; and
d) Any indebtedness of a reinsurer to the primary insurer at the end of the year.
The reinsurance rules relating to the Indian context are discussed separately in the
next section.
In the United States, reinsurers as well as licensed alien reinsurers have to keep
solvency margin almost along the lines prescribed for primary insurers and must
follow reserves, investment, capital and surplus requirements and annually or
sometimes every quarter file financial statements with State regulatory authorities.
Pricing is not directly regulated though the regulation of primary insurer‘s rates
could affect the reinsurance pricing.
Another important regulation relates to a contingency when a primary insurer goes
bankrupt. The regulation by means of an insolvency clause provides that the insolvency
of the primary insurer will not affect the liability of the reinsurer for losses under the
reinsurance contract: the reinsurer will make payment to the liquidator or the receiver of
the insolvent primary insurer for the benefit of their creditors, namely the insured.
Another important regulation is through an intermediary clause whereby the risk of
insolvency of the reinsurance broker is passed on to the reinsurer so any default by
the reinsurance broker either to transmit the reinsurance premium to the reinsurer
or pass on reinsurance claims payments to the primary insurer will be made good
by the reinsurer since it is now established that the reinsurance broker is an agent
of the reinsurer and not the primary insurer.
Reinsurance brokers are regulated much less in the U.S. However, some States,
notably, New York, have required reinsurance brokers to be licensed. According to
New York Regulation 98, the following regulations apply to the reinsurance brokers:
Reinsurance intermediaries act in a fiduciary capacity for all funds received in
their professional capacity and must not mix them with other funds without the
consent of the insurers and reinsurers they represent;
Reinsurance intermediaries shall have written authorization from the insurers
and reinsurers they represent, spelling out the extent and limitations of their
authority;
The written authority above must be made available to the primary insurers or
reinsurers with which the intermediary deals;
No licensed intermediary shall procure reinsurance from an unlicensed
reinsurer unless the reinsurer has appointed an agent for the service of process
in New York;
177
Risk Management and Reinsurance
v) Clause 3-5: Within 30 days of the commencement of the financial year, every
insurer shall file with the Authority a photocopy of every reinsurance treaty slip
and excess of loss cover note in respect of that year together with the list of
reinsurers and their shares in the reinsurance arrangement.
vi) Clause 3-6: The Authority may call for further information or explanations in
respect of the reinsurance program of an insurer and may issue necessary
directions.
vii) Clause 3-7: Insurers shall place their reinsurance business outside India with
only those reinsurers who have over a period of the past five years counting
from the year preceding for which the business has to be placed, enjoyed a
rating of at least BBB (with Standard & Poor) or equivalent rating of any other
international rating agency. Placements with other reinsurers shall require the
approval of the Authority. Insurers may also place reinsurances with Lloyd‘s
syndicates taking care to limit placements with individual syndicates to such
shares as are commensurate with the capacity of the syndicate.
viii) Clause 3-8: The Indian reinsurer shall organize domestic pools for
reinsurance surpluses in fire, marine hull and other classes in consultation
with all insurers on basis, limits, and terms, which are fair to all insurers and
assist in maintaining the retention of business within India as close to the level
achieved for the year 1999-2000 as possible.
ix) Clause 3-9: Surplus over the domestic reinsurance arrangements class wise
can be placed by the insurer independently with any of the reinsurers
complying with sub regulation (7) subject to a limit of 10% of the total
reinsurance premium ceded outside India being placed with any one
reinsurer. Where it is necessary in respect of specialized insurance to cede a
share exceeding such limit to any particular reinsurer, the insurer may seek
the specific approval of the Authority giving reasons for such cession.
x) Clause 3-10: Every insurer shall offer an opportunity to other Indian insurers
including the Indian reinsurer to participate in its facultative and treaty
surpluses before placement of such cessions outside India.
xi) Clause 3-11: The Indian reinsurer shall retrocede at least 50% of the
obligatory cessions received by it to the ceding insurers after protecting the
portfolio by suitable excess of loss covers. Such retrocession shall be at
original terms plus an overriding commission to the Indian reinsurer not
exceeding 2.5%. The retrocession to each ceding insurer shall be in
proportion to its cessions to the Indian reinsurer.
xii) Clause 3-12: Every insurer shall be required to submit to the Authority
statistics relating to its reinsurance transactions in specified forms together
with its annual accounts.
179
Risk Management and Reinsurance
181
Risk Management and Reinsurance
The Company shall be the sole judge of what constitutes one risk and unless
otherwise hereafter provided shall fix its net retention without reference to the
Reinsurer in accordance with the usual net retentions of the Company.‖
2. “Attachment of Cessions” Clause
―The liability of the Reinsurer in respect of reinsurance allotted hereunder shall commence
simultaneously with that of the Company as soon as the retention of the Company on any
one risk as defined by its limits, records, practice or instructions is exceeded.‖
182
Reinsurance regulations and law in india
Outgo
Premium reserve of 40% of the net premium for the current year.
Commission, taxes, fire brigade charges etc.
Losses paid during the year.
Reinsurers‘ expenses being 5% of item 3 of ―Income‖.
Losses outstanding at the end of the current year.
Deficit, if any, from the previous year‘s profit commission statement.
The excess, if any, of Income over Outgo shall be deemed the net profit of the
Reinsurer and profit commission shall be calculated thereon.
In the event of termination, profit commission on the net profit in respect of the year
in which such termination takes place shall be calculated in like manner. Thereafter,
when the whole of the liabilities hereunder have been liquidated a final profit
commission statement shall be rendered to include all transactions subsequent to
the date of termination and the profit commission share on the preceding account
shall be adjusted accordingly.‖
7. Loss Advices and Accounting of Losses
Preliminary loss advices shall be sent by the Company to the Reinsurer in respect of all
losses where the proportion of the reinsurers sharing in the Agreement is estimated to
exceed the amount stated in the Schedule. Furthermore, the Company shall furnish the
Reinsurer an estimate of outstanding losses as at 31st December of each year.
When the proportion of a loss and/or expenses falling upon all the reinsurers
sharing in this Agreement amounts to or exceeds the amount specified in the
Schedule, the reinsurers shall be liable to pay their proportions within 21 days of
demand. The Company shall debit all other losses and/or loss expenses in the
accounts of the quarters in which the losses and/or loss expenses are settled.
Any loss or claim or compromise thereof and all expenses including fire extinguishing
expenses shall be settled by the Company without reference to the reinsurer and such
settlements including ex-gratia payments shall in all cases be unconditionally binding
upon the reinsurer. The Company at its sole discretion may commence, continue,
defend, compromise, settle or withdraw from any actions, suits and prosecutions and
generally do all such matters relating to any loss or claim which in its judgment may be
advantageous and the payment of all expenses and allowances in connection therewith
shall be shared by the reinsurer in proportion to its participation.
The Reinsurer shall share in proportion to its participation in all amounts which may
be recovered by the Company in respect of any loss or claim.‖
183
Risk Management and Reinsurance
8. Reserves Clause
―The Company shall be entitled to retain Premium Reserve at the percentages
specified in the Schedule as security for the due performance of the obligations of
the Reinsurer under this Agreement. The Premium Reserve shall be retained at the
percentage specified in the Schedule in each quarterly account and shall be based
upon the net premiums of the relative quarter and of the three preceding quarters
after deduction of the reserve of the corresponding quarter of the previous year.
The Company shall pay to the Reinsurer interest on premium reserve at the rate
specified in the Schedule less tax, such interest to accrue from the date on which
the respective amounts are credited to the premium reserve.‖
9. Premium and Loss Portfolios
―The Company may at its option require the Reinsurer to assume liability for its
proportion of risks current at the date of this Agreement in consideration for which the
Company shall credit the Reinsurer with an amount equal to a percentage as
specified in the annexed Schedule of the net premiums without deduction of
commission appearing in the four quarterly accounts immediately preceding the
date on which this Agreement commences.
In the event of the Company exercising the aforementioned option, the Reinsurer shall
also be credited with the proportion of 90% of the estimated losses outstanding as at
the date of inception for which the Reinsurer shall assume liability for all settlements of
such losses outstanding. Should the total payments in respect of such losses differ
materially from the amount credited to the Reinsurer in accordance herewith, the
Company shall have the right to effect the appropriate adjustment.
The term ‗net premium‘ in the aforementioned paragraph is understood to mean
original gross premiums less only return premiums. The provisions of this Article
may also be applied in the event of any increase or decrease of the Reinsurer‘s
proportion under this Agreement.‖
10. Commencements and Termination Clause
―This Agreement shall incept on the date stated in the Schedule and shall remain in
force indefinitely, but either party shall be at liberty to terminate it as at 31st
December in any year by giving not less than 90 days ‗previous notice in writing.
Unless the parties otherwise agree, the Reinsurers will remain liable for all
reinsurances ceded under this agreement until their natural expiry.
In the event of war (whether declared or not) arising between India and the country
in which the Reinsurers reside or carry on business or are incorporated, this
Agreement shall be automatically terminated forthwith.
184
Reinsurance regulations and law in india
1. Terms of Agreement
―This Agreement shall apply only to losses occurring during the period commencing
on the date stated in item … of the Schedule and expiring on the date stated in item
….. of the Schedule, both days inclusive.
If the Agreement should expire or be terminated while a loss occurrence covered
hereunder is in progress it is understood and agreed that, subject to the other
conditions of this Agreement, the Reinsurers hereon are responsible as if the entire
loss or damage has occurred prior to the expiration of this Agreement, provided that
no part of that loss occurrence is claimed against any renewal of this Agreement.
185
Risk Management and Reinsurance
In the event of this Agreement not being renewed, this Agreement, at the option of
the Company (provided it is exercised on or before the expiry date hereof and
provided there is prior agreement of both parties to the additional premium
payable), shall be extended to apply to any loss occurrence or loss occurrences:
Which are covered by any policy or policies of insurance or insurances, the
inception date or dates of which fall prior to the expiry date of this Agreement.
And which take place during the twelve months period immediately following the
expiry date of this Agreement.‖
2. Insuring Clause
―The Reinsurers hereby agree to indemnify the Company for that part of the
ultimate net loss which exceeds the amount stated in item … of the Schedule on
account of each and every loss occurrence and the sum recoverable under this
Agreement shall be up to but not exceeding the amount stated in item … of the
Schedule, ultimate net loss on account of each and every loss occurrence.
The underlying loss stated in item … of the Schedule shall be retained net by the
Reinsured subject only to underlying excess catastrophe reinsurances as specified
in item … of the Schedule.‖
3. Definition of loss occurrence has been dealt with earlier.
4. The term ‗ultimate net loss‘ shall mean the sum actually paid by the Company
in respect of any loss occurrence including expenses of litigation, if any, and
all other loss expenses of the Company (excluding, however, office expenses
and salaries of the company) but salvages and recoveries, including
recoveries from other retrocession, other than underlying reinsurances
provided for herein, shall be first deducted from such loss to arrive at the
amount of liability, if any attaching hereunder.
5. Net Retained Lines
―This Agreement shall only protect that portion of any insurance or reinsurance
which the Company retains net for its own account combined with cessions made
by them to their Quota Share Reinsurers. Reinsurer‘s liability hereunder shall not be
increased due to the inability of the Company to collect from any other Reinsurers
(other than the aforesaid Quota share Reinsurers) any amounts which may have
become due from them whether such inability arises from the insolvency of such
other Reinsurers or otherwise.‖
6. Premium clause
―The Company shall pay a Deposit Premium of the amount stated in item … of the
Schedule and same shall be paid in the manner prescribed in item … of the
Schedule.
186
Reinsurance regulations and law in india
As soon as possible after the expiry of this Agreement, the above Deposit Premium
shall be adjusted to an amount equal to the rate stated in item … of the Schedule
applied to the Company‘s premium income, as defined hereunder, subject,
however, to a Minimum Premium of the amount stated in item … of the Schedule.
The payment of any adjustment due between the parties shall be made at once.‖
7. Reinstatement Clause
―In the event of any portion of the indemnity given hereunder being exhausted, the amount
exhausted shall be automatically reinstated from the time of commencement of any loss
occurrence to the expiry of this Agreement and a pro rata additional premium calculated on
the premium hereunder in the manner stated in item … of the Schedule shall be paid by the
Company upon the amount of such loss reinstated, but nevertheless the Reinsurer‘s liability
shall never be more than the limit of liability as stated in item … of the Schedule in respect
of any one loss occurrence not more than the amount as stated in item … of the Schedule,
in all, during the term of this Agreement.‖
8. Inspection Clause
―The Reinsurers may at any time during normal working hours inspect and take copies
of such of the Company‘s records and documents which relate to business covered
under this Agreement. It is agreed that the Reinsurers‘ right of inspection shall continue
as long as either party has a claim against the other arising out of this Agreement.‖
10. Errors and Omissions Clause
―No error or inadvertent omission on the part of the Company shall relieve the
reinsurer of liability in respect of losses hereunder provided that such errors and/or
omissions are rectified as soon after discovery as possible.‖
11. Alterations Clause
―This Agreement may be altered at any time by mutual consent of the parties by
Addendum and such addendum shall be binding on the parties and be deemed to
be an integral part of this Agreement.‖
12. Set-off Clause
―If during the currency of this Agreement any balances under any other treaty or
treaties between the Company and the Reinsurer remain unpaid by one party, the
other shall be entitled either to: Retain the balance due hereunder until full payment
has been made under the other treaty or treaties; or Set off such balance against
the amount due from the other party.‖
13. Underwriting Policy Clause
―The Company undertakes not to introduce any change in its established acceptance
and underwriting policy in respect of the classes of business to which this Agreement
187
Risk Management and Reinsurance
applies without prior approval of the Reinsurers and any reinsurance arrangements
relating thereto shall be maintained or be deemed to be maintained unaltered for
the purpose of this Agreement.‖
14. Intermediaries Clause
―All correspondence and settlement of accounts pertaining to this Agreement shall
be through the intermediaries specified in item … of the Schedule.‖
15. Arbitration clause for disputes
―Incase of any disputes between the company and the reinsurers regarding the
interpretation of the agreement or the rights with respect to any transaction involved
either before or after the termination, disputes as such shall be dealt with the single
arbitrator appointed in writing by both the parties. If incase of any failure to agree
upon the single arbitrator it can be referred to two arbitrators of which one is
appointed in writing by each of the parties. Incase of any disagreement between the
two arbitrators an umpire is appointed by the arbitrators.
These arbitrators or the umpire are required to be appointed in 30 days after such a
requisition of arbitrators made by the parties. These are appointed in writing by the
chairman of the Bombay Regional Committee of the tariff advisory committee. Such
appointed arbitrators or umpires are required to interpret their agreement as an
honorable engagement and make their award and serve the purpose.
The decision of these arbitrators or the umpires is final and binding as the case may
be inclusive of allocation of costs on both the parties. This clause is present in
every treaty.
Arbitration and Mediation
Arbitration means the reference of a matter in disputes to the judgment of a person
selected by the parties to the dispute. Arbitration is thus a private process of
resolution of disputes and it is commonly resorted to because it is less formal, less
expensive and less time consuming than proceedings in law. More commonly, the
arbitration process has employed private bodies to settle controversies in which the
decision reached is final and binding. In spite of the best care taken to prepare the
contract documents certain disputes may arise leading to unnecessary litigation. To
address such problems normally arbitration clause is incorporated in the contract.
The companies involved in reinsurance business may prefer independent
arbitration to avoid impact on reputation and public gaze.
The salient features of arbitration:
No difference shall be referable to arbitration if the company has disputed or not
accepted liability under the policy.
The arbitrators are normally experts in the practice area of dispute.
188
Reinsurance regulations and law in india
A sole arbitrator may be agreed to by the parties in writing; if not agreed, each
party can approach an arbitrator after receipt of written notice of the other party.
The place and time of the arbitration can be arranged to suit the parties.
Any disagreement between the two arbitrators shall be referred to an umpire
and such umpire is generally appointed before entering in to the agreement.
The agreement cannot extend to disputes between the parties for which some
other contractual mechanism is established to resolve such disputes.
The Arbitration Clause
It should be well drafted considering all the matters and its ramifications. It should
contain, inter alia, the manner of appointment of arbitrator, his qualifications and
experience, the period for which the appointment has to be made, and the cost of
arbitration, which will be at the discretion of arbitrator (s).
Arbitration is governed by law which is known as Arbitration Act 1940 which was
subsequently repealed by the Arbitration and Conciliation Act, 1996 which is ‗ an Act to
consolidate and amend the law relating to domestic arbitration, international commercial
arbitration and enforcement of foreign arbitral awards as also to define the law relating
to conciliation and for matters connected therewith or incidental thereto‘.
Unless otherwise agreed, the arbitration tribunal shall consist of persons with no
less than ten years experience in insurance or reinsurance field.
The tribunal shall have all powers to make orders in respect of pleadings, discovery,
inspection of the documents, examination of witnesses etc., All costs of arbitration shall
be fixed by the tribunal and it will also decide by whom it is to be paid.
The award of arbitration tribunal shall be in writing and binding upon the parties who
agree to carry out the same. If any of the parties fails to carry out any award the
other party may apply for its enforcement to a court of competent jurisdiction.
Majority of the reinsurance contracts/treaties contain arbitration clauses so that disputes
can be avoided at a later date and settled amicably and privately. When interpreting
reinsurance contracts, the starting point, should be to look at the tribunal, which will
resolve any disputes between the parties and the law, which will be applied.
The arbitration law may vary from country to country and therefore parties must be
clear as to which law they are applying.
Finally it is to be stated that at times some arbitration can become as complex and rigid
in its formality and costs, as any proceedings in a court of law. It is a matter of dispute
whether to go court or seek arbitration as the best forum to resolve disputes.
During the enforcement there are difficulties that some people challenge an arbitration
award. There are those who plead that the courts have wider coercive powers and that
litigation makes for greater certainty. The general criticism against arbitration is that it
189
Risk Management and Reinsurance
is fraught with complexity, costs and delay. The competent man constituting arbitration
tribunal is more important in case of reinsurance as it has universal dimensions.
Mediation
The mediation process involves the use of an impartial third party to encourage a
satisfactory compromise to the dispute. The mediator, typically an experienced trial
attorney or retired judge, who has no binding authority, uses his/her skills to diffuse
the dispute or find alternative solutions. Mediation is fast developing method in the
resolution of reinsurance disputes, particularly in the London Market. In the last 20
years the number of reinsurance disputes going to litigation/arbitration have been
growing phenomenally. Therefore, an alternative and quick method was evolved.
There are very few issues, which are unsuitable for mediation. Most of the
mediations involve rights of avoidance, issues of coverage, construction issues and
issues as to the conduct of intermediaries.
As the mediation is another successful mode to operate, the ceding companies and
reinsurers are likely to consider the inclusion of ‗mediation clause‘ in their wordings.
However mediation process itself is not cheap, as perceived by some, but its speed
is the key to achieving cost advantage. The mediation can succeed provided that
certain precautions are taken and where the parties engage in the process in good
faith the results are reassuring.
? Questions
1. Explain the role of IRDA in regulating insurance industry in India.
Do you find it effective? If not, suggest the areas that need to
be reexamined and strengthened.
2. What are the legal features underlying insurance contracts?
3. Explain important treaty wordings.
4. Explain arbitration and mediation. Which one do you prefer
and why?
5. Write short notes:
(i) Attachment of Cessions clause
(ii) Follow the Fortunes clause
(iii) Exclusions clause
(iv) Commission and profit commission
(v) Reserves clause
(vi) Commencement and Termination clause.
190
CHAPTER – 5
REINSURANCE ACCOUNTING
AND FINANCIALS
OUTLINE OF THE CHAPTER
Reinsurance Accounting and Financials
Special Nature of Reinsurance Accounts
Main Types of Reinsurance Arrangements
Closing of Annual Accounts
LEARNING OBJECTIVES
To understand the primary Objective of the reinsurance accounting
To come to know Reinsurance accounting as concerned with
- technical
- financial
- legal and
- underwriting aspects
introduction
The objective of the reinsurance accounting is to record the business, control the funds
and maintain proper books and records for the benefit and information of all
stakeholders both internal and external. Special nature of Reinsurance Accounting is
concerned with technical, financial, legal and underwriting aspects of reinsurance.
Premiums, expenses and losses will have effects on both sides of a treaty but these
have to be considered on all overall basis of reinsureds and reinsurers. It is imperative
for reinsurance firm to have proper accounting and financial management so that it can
safely settle accounts and create confidence with regulators. The insurance regulators
in countries all over the world, including India, have prescribed regulations for insurance
and reinsurance accounts and methods of treating certain assets and liabilities. In this
connection, IRDA regulations relating to various items need to be examined.
SPECIAL NATURE OF REINSURANCE ACCOUNTS
Reinsurance accounting is comprehensively connected with technical, financial,
legal and underwriting aspects of reinsurance. The significance of accounting for
191
Risk Management and Reinsurance
192
Reinsurance Accounting and financials
193
Risk Management and Reinsurance
194
Reinsurance Accounting and financials
Foreign Exchange
Normally the unit of currency expressed in treaty agreements is the domestic
currency of the ceding company concerned. For the purpose of conversion of
various foreign currencies, companies adopt rates of exchange at the average rates
for each quarter for compliance with AS-11. This is used at the time of transfer of
their share of premium or recovery of claims from the reinsurer.
Calculation of Profit Commission
We have read about commission in the first chapter on reinsurance. Commission is received
when the primary insurer cedes premium to reinsurers. Over and above this commission
some treaties also allow for profit commission. This commission is based on the profits of
the treaty. Profit commission is an additional percentage payable to a ceding insurer on
profitable treaties in accordance with an agreed formula. It is therefore an incentive for
ceding insurers to produce profitable business. Profit commission will be worked out on
accounting year basis in the case of clean cut treaties (Fire and Accident Proportional
treaties) and on underwriting year basis in the case of others.
Accounting Year basis
A profit commission on an ‗Accounting Year‘ basis requires all transactions for the same
treaty period, without reference to underwriting year, to be included in the same profit
commission statement. Items to include on debit side – commissions, claims,
Miscellaneous charges, premium reserve carried forward, loss reserve carried forward,
allowance for reinsurer‘s expenses and profit for the year and credit side
– premium reserve brought forward, loss reserve brought forward and premiums. A
profit commission on accounting year basis would not be adjusted in subsequent
years as long as the treaty continues without cancellation.
Underwriting Year basis
A profit commission on an ‗underwriting year‘ basis requires all transactions of an
underwriting year, without reference to accounting year, to be accounted to the
same year for the purpose of determining the profit of that underwriting year. Given
below is an example on calculation of profit commission (PC), which will help in
understanding the concept better.
ABC INSURANCE LTD.
MARKET FIRE POOL Rs.
Profit as at 31/03/2004 207,161,000
Premium 767,898,000
PC Terms 15% Pc on Profit Up to 10% of Premium
& 75% of balance
195
Risk Management and Reinsurance
Answer
15% PC up to 10% on Premium
10% on Premium 76,789,800
@15% on above 11,518,470 (A)
75% of Balance
Profit 207,161,000
Less 10% Premium 76,789,800
Balance 130,371,200
@75% on Balance 97,778,400 (B)
Commission (A+B) 109,296,870
FORMAT OF ANNUAL ACCOUNTS
The format to be followed by the respective reinsurer for preparing revenue
accounts at the end of year published reports in different countries is prescribed by
the local insurance laws. In India, Revenue Account as well as Balance Sheet
should be prepared as per Insurance Act and IRDA Regulations. The Insurance
Regulatory and Development Authority (Preparation of Financial Statements and
Auditor‘s Report of Insurance Companies) Regulations, 2000 covers the whole
gamut of preparation of final accounts of, not only insurance companies, but also
reinsurance companies. There is a provision for audit of annual accounts and
specified number of copies to be furnished to the IRDA.
The ceding company‘s accounting year may differ from that of the reinsurer
because of the time required to transfer information for a given period of cover. For
reinsurers wishing to calculate their results more rapidly, estimates are made for the
accounts of ceding companies for the last sum received by the insurer or reinsurer
as a consideration for covering risk.
The reinsurance companies are required to maintain the following records, inter
alia, others.
a) Record of insurance companies with which common and facultative
reinsurance arrangements of reinsurance treaties are entered into.
b) Record of facultative reinsurance ceded and accepted.
c) Information on security level of reinsurers is to be monitored and maintained.
d) Total placement to each reinsurer is required to be monitored and reported to
IRDA.
196
Reinsurance Accounting and financials
197
Risk Management and Reinsurance
? Questions
1. What is the objective of reinsurance accounting? In what way
is it different from other accounting?
2. Explain proportional treaty accounting, giving example.
3. With the help of a hypothetical example, explain non-
proportional treaty accounting.
4. Explain the different methods of calculation of profit
commission.
5. Which agency prescribes the format of Annual Accounts for
reinsurance companies and what are its special features?
198
CHAPTER – 6
REINSURANCE ADMINISTRATION
LEARNING OBJECTIVES
Understanding Claim settlement, claims reporting and claim reserving
To get acquainted with Inspections and auditing by Reinsurers
introduction
Reinsurance administration deals with the routine details of handling a case from the
stage the ceding company seeks reinsurance. Ceding company and reinsurer have
several mutual obligations and expectations in the administration of the reinsurance
business. There is expectation of the other to conduct business in an orderly and ethical
manner, to establish and maintain a clear, accurate exchange of information, and not
fail to provide all those services, which are contractually arranged.
For the success of a reinsurance program, both the primary insurer and the
reinsurer must make joint efforts. They both have duties as well as rights under the
treaties or let us say, reinsurance contracts.
Role of the primary insurer
The primary insurer must conduct his underwriting operations satisfactorily within
the guidelines and expectations of the treaty so that the reinsurer has no surprises
coming in the form of large losses. Moreover, the primary insurer must notify
promptly all large losses and the reinsurer must be given the opportunity to
participate in investigation of such losses.
The primary insurer has the freedom to underwrite individual risks and adjust
individual claims once clear cut underwriting policies are contemplated under a
treaty. We conventionally use a phrase ―FOLLOW THE FORTUNES‖, it means the
reinsurer is normally bound by the primary insurer‘s actions in the underwriting and
claims matters.
199
Risk Management and Reinsurance
The primary insurer must have a good or well designed information system to be able to
furnish all necessary information in time for the reinsurer to be able to control losses
wherever possible and to discharge their obligations under the treaty professionally.
The more important data that should be capable of being made available from a good
information system used by the primary insurer will include the following:
Direct premium data to calculate the reinsurance premium payable to the
reinsurers;
Data for individual losses needed to apply treaty limits and excess retentions;
Codes for catastrophe losses;
Codes for identifying occurrences under casualty ‗clash‘ coverage;
Data to determine the portion of policy(ies) ceded to each surplus share
reinsurer;
Separate data on retention, limits, rates, and the reinsurer involved for each
facultative placement;
Information on risks included in the treaty but not ceded for preserving
profitability of the treaty;
Data on risks excluded under the treaty but underwritten by the primary insurer
so as not to include the same in the reinsurance bordereau.
An accurate and efficient information system helps the credibility of the primary
insurer and helps the renewal of treaties. The primary insurer must make available
his books of account for inspection if required by the reinsurer.
The primary insurer must send quarterly bordereaux to the reinsurers, which
contain detailed statistics of premium, commission and losses paid and outstanding
as at the end of each quarter. However, in the modern day, most primary insurers
send a current account statement to the reinsurers, giving details of premiums
ceded, ceding commission, net premiums ceded, losses paid, loss expenses paid
and losses outstanding and also a summary from which the amount due to the
reinsurer will be evident.
A final point in the matter of dispute resolution is that whereas in former times,
disputes between the primary insurers and reinsurers were generally resolved
through direct negotiations or arbitration, nowadays, both the parties are not averse
to go to courts to resolve disputes.
Role of the reinsurer
One would think that the reinsurers have very little to do except collecting reinsurance
premium, and paying claims and brokerage commission to brokers and ceding
commission to the primary insurer. Maybe this is so when the treaty relationship is
200
Reinsurance Administration
smooth. In fact, some reinsurers minimize their work by preferring large retentions
with the possibility of no claims being presented at all.
On the contrary, the reinsurers may be engaged in auditing the underwriting and
claims practices of the primary insurer so as to ensure that these are done
satisfactorily and as expected. Again, whenever the losses are large, the reinsurers
may like to participate in the in the claims settlement process. Normally reinsurers
incorporate claims –control or claims cooperation clause in the facultative contracts
for claims the exceeding prescribed limit (major claims). Many a time, the primary
insurers, both on underwriting and claims issues, openly consult the reinsurers.
We have already seen how the reinsurers, not only help in stabilizing loss
exposures but also positively assist the primary underwriters in underwriting by
sharing their expertise.
CHAIN OF ACTIVITIES
The chain of activities in administration would include:
Negotiating and drafting treaties:- the product features must be properly
understood at the time of negotiation so that treaties signed are free from
disputes subsequently.
Underwriting cases:- wherever there are any special terms & conditions in
underwriting they should be brought to the notice of reinsurer, particularly in
case of automatic reinsurance.
Paying premiums:- the agreed premiums need to be properly calculated and
paid to reinsurer.
Modifying policies:- whenever there are changes in policies both insurer and
reinsurers should maintain reinsurance in force on mutually agreed and fair
terms.
Paying Claims:- the reinsurer will pay his share of claim to the ceding company
in a single amount or as per agreement provided that all conditions are properly
complied with.
Recapturing Coverages:- whenever a ceding company raises its retention limit,
the insurer should inform a reinsurer of his intention to recapture ceded
business if the insurer intends to that. If the insurer fails to inform reinsurer the
insurer will forfeit its right to recapture the reinsured coverage.
Evaluating in-force reinsurance:- periodical review of reinsurance is required to
see that every thing is moving according to agreed treaty provisions.
201
Risk Management and Reinsurance
CLAIM SETTLEMENT
A broker or the cedent notifies the claim to reinsurer on a daily basis, by post or
electronically. The procedure differs from treaty to treaty based on individual
agreements. If it is a pro-rata treaty, the primary insurer sends monthly bordereau
to the reinsurer, detailing the premiums due to the reinsurer and claims due from
the reinsurer. The primary insurer will remit the difference to the reinsurer when the
premiums exceed the losses and if the losses exceed the premiums, the reinsurer
remits the difference to the primary insurer. If at any time, there are some
exceptionally large losses, then it is the convention for the reinsurer to remit the
losses to the primary insurer before the end of the reporting period.
In the case of excess loss treaties, as soon as losses exceed the retention,
intimation is given and the reinsurer pays on being given proof of settlement, which
is simply a statement of losses paid by the primary insurer, together with estimates
of current reserves.
In the case of aggregate excess loss treaties, the reinsurers are known to make initial
payments say sixty days after the end of the accounting year. If it is clear that the losses will
exceed the retention, then payments may be made before the end of the year.
CLAIMS REPORTING
Claims administration presupposes the primary reinsurer to maintain proper claim
records so that it can estimate its liabilities on individual contracts . In order to
properly monitor recording of claims information is made in proper format. At times
it may so happen, due to poor maintenance of records, lot of time may pass
between the date of loss occurrence and date of claim notification to the reinsurer.
Proper recording facilitates determination of funds, which will be needed to meet
the company‘s obligations. Claims administrator will be able to cull out all the
information like – cedent, broker, peril class of business, location of cedent, period
of cover, sum insured, limit, and reinsurance arrangements – from records
whenever a claim is received. The data required can be obtained in coded format to
avoid inconsistencies. There could be cases where lot of supplementary information
is required, particularly in respect of serious and large claims. Here the objective is
to collect more information on those cases that materially have an effect on the
overall results of the treaty. By providing comprehensive information the insurer can
avoid possible points of difference and confusion with reinsurer. If the reinsurer has
his own proportional retrocession treaties, then accounting information relating to
claims can be built up as a part of processing retrocession accounts. However,
where the reinsurer has his own excess of loss protection covering a specific class
of business or the whole account, then he is concerned with aggregations of
specific claims arising from several treaties, proportional or non-proportional. In
such cases it will have to maintain a record of all claim advices from specific claims.
202
Reinsurance Administration
CLAIM RESERVING
The reserves are meant to meet claims in future and the reserves need to be
maintained by cedent company and reinsurer. Every insured risk needs to be supported
by maintenance of reserves. They have to be maintained on an ongoing basis and
when risks are reinsured, the reinsurer also agrees to establish reserves for its
proportionate share of each risk. Reserves are calculated basing on estimates of
expenditure in case of likely claims. The insurance company sets reserves to meet
indemnity costs. In addition to such reserves, reserves for defense and loss adjustment
expenses are also posted by the insurance company. The reinsurer sets reserves for
the economic damage posted by the ceding carrier. The ceding carrier normally settles
the claims and reinsurer helps him to do this job efficiently. The ceding carrier should
settle the entire claim in fairness to his reinsurers. The total reserve exists at all times in
the books of the ceding carrier. Normally reinsurers do not set reserves below the
amount reported by the cedent. If the reinsurer wants to post a larger amount, the
excess amount is considered as an additional case reserve and such reserve is in the
reinsurer‘s books but not posted in the cedent‘s books.
Incurred But Not Reported (IBNR)
It denotes the liability for future payments on losses, which have already occurred but
have not yet been reported in the reinsurer‘s records. This definition may be extended
to include expected future development on claims already reported. Thus, technically
IBNR covers the field from:
a) those individual losses that have occurred but have not been reported to the
insurer or reinsuerer.
b) That amount of loss that may arise from a known loss which has been
reported as an event but which has not been recorded in full to its ultimate
loss value (known as loss development).
Sometimes, reinsurers may end up with overpayment of claims. Such payments
can be avoided by addressing senior management focus and initiating proper
claims handling methods.
? Questions
1. What is the role of primary insurer and reinsurer in case of
reinsurance administration?
2. Explain the chain of activities involved in reinsurance
administration.
3.Explainclaimsettlement and claim reporting activities.
203
CHAPTER – 7
REINSURANCE MARKET
LEARNING OBJECTIVES
To get to know the Reinsurance market all over the world
To understand Reinsurance brokers and their functions
To understand Global Reinsurance Markets
introduction
Reinsurance Market is spread all over the world with major reinsurers being
concentrated in Europe and West. Reinsurance Brokers are intermediaries between
insurers and reinsurers and they operate on a large scale and present in all
developing markets. Players like Munich Re, Swiss Re and Berkshire Hathaway,
the leading players in the world, dominate global Reinsurance Markets.
Market is a place where buyers and sellers interact with each other or an
arrangement which facilitates interaction between buyers and sellers to do the
business, which includes exchange of goods and services for money. A strong
insurance and reinsurance market is an essential element of economic progress as
industry can take calculated risks with a backup support of insurance. The global
insurance industry is being shaped by a number of external drivers of change.
Reinsurance is sold by a reinsurance Company and bought by ceding company.
It is difficult to define the boundaries of reinsurance market in a geographical sense but
the reinsurance is spread over the different parts of the world. Since it is usual that
reinsurance acceptances may not be completed within the local market, the world
reinsurance market must be used. Presently, clients are not contended with only
204
Reinsurance Market
traditional reinsurance solutions. Some of them wish to take a more far reaching
and all-embracing view of risk management.
REINSURANCE BROKERS
Just as there may be brokers for primary insurers who act as intermediaries between
the insured and the insurer, there are reinsurance brokers who are go-betweens to
primary and reinsurers. The percentage commission paid by the reinsurers to the
reinsurance brokers is relatively small, compared to the commission paid to the
insurance brokers and is sometimes as low as one percent of the reinsurance premium.
When there are reinsurance brokers, the premium payments and loss payments as
well as premium refunds pass through them. When primary insurers do not have
expertise to place reinsurance directly, they need the services of the reinsurance
brokers. Large reinsurers also use reinsurance brokers as a matter of course.
However, if primary insurers go direct to reinsurers, they may be able to reduce the
reinsurance cost to some extent.
Although reinsurance brokers obtain their commission from the reinsurers, they
have a duty to observe the principle of utmost good faith, which means they must
reveal to the reinsurers all material facts concerning the risks, which they obtained
from the primary insurers. The market share of the reinsurers combined in the
United States is estimated at 75%, which shows the predominance of the
reinsurance brokers in the reinsurance market. Generally, reinsurance brokers
handle treaty reinsurances in preference to facultative reinsurance.
Reinsurance Pool: A reinsurance pool (or syndicate or association) is an
association of reinsurers banded together to underwrite reinsurance jointly. Some
pools write reinsurance for only members. Some others write for non-members as
well. Industrial insurers may form a pool to write specific risks that require large
capacity. Specialized pools are also formed for energy insurance and the like.
205
Risk Management and Reinsurance
206
Reinsurance Market
From this exhibit, it is obvious that there is a certain geographic diversity in top
reinsurers, with 5 headquartered in the United States, 2 each in Germany, UK, and
Switzerland and France and the rest in other parts of the world.
Reciprocity: There is a practice of reciprocal reinsurance among primary insurers,
whereby two or possibly more primary insurers enter into an agreement under
which each cedes to the other an agreed percentage of its business. In most
reciprocal reinsurance arrangements, similarity of business is a prime
consideration. Again normally, they do not compete in the same market area. In the
modern day, reciprocal reinsurance is not widely practiced.
207
Risk Management and Reinsurance
208
Reinsurance Market
209
Risk Management and Reinsurance
211
Risk Management and Reinsurance
market. GIC, as per IRDA statute, receives cession of 10% on each policy. As per IRDA
regulation GIC will retrocede at least 50% of the obligatory cessions received to the
ceding insurers after protecting the portfolio by suitable excess of loss covers. Such
retrocession will be at original terms plus an overriding commission to National Re not
exceeding 2.5%. The retrocession to each ceding insurer will be in proportion to his
cessions to National Re. It leads many of domestic companies‘ treaty programs and
facultative placements. GIC is also emerging as an international player in the
reinsurance market by providing reinsurance facilities to companies in Afro-Asian region
– SAARC countries, South East Asia, Middle East and Africa.
Following are excerpts from IRDA Annual Report
The reinsurance program of each non-life insurer is required to be guided by the
basic tenets of maximizing retention within the country; developing adequate
reinsurance capacity; securing the best possible protection for the reinsurance
costs incurred; and simplifying the administration of business. Every life insurer is
required to draw a program of reinsurance in respect of lives covered by it. The
profile of the reinsurance program, duly certified by the Appointed Actuary, is
required to be filed with the IRDA, giving details of the reinsurer(s)with whom the
insurer proposes to place business. Every insurer is required to furnish the
reinsurance program to the IRDA at least forty-five days before the commencement
of each financial year. In addition, every insurer is required to file copies of the
treaty slips and cover notes, furnishing details of the proportionate share of the
reinsurers, within 30 days of the commencement of the year. The Authority
reserves the right to seek any clarifications and if necessary, give directions.
The Authority is particularly concerned that insurers while ceding abroad do so only
after utilization of the national capacity and on competitive international terms. Also, the
business placed with any one re-insurer should not be excessive. Thus, every insurer is
required to offer an opportunity to other Indian insurers, including the Indian reinsurer to
participate in its facultative and treaty surpluses before placing such cessions outside
India. Insurers are also required to place their reinsurance business outside India with
only those re-insurers who have over a period of past five years counting from the year
preceding for which the business has to be placed, enjoyed a rating of at least BBB
(with Standard & Poor) or equivalent rating of any other international rating agency.
Placement with any other reinsurer requires approval of the Authority. Surplus over and
above the domestic class-wise reinsurance arrangements can be placed by the insurer
independently subject to a limit of 10 percent of total reinsurance premium ceded
outside India being placed with any one reinsurer. Where it is necessary to cede a
share exceeding such limits to any particular reinsurer, the insurer needs to seek the
specific approval of the Authority.
Introduction of brokers has helped the direct insurers to secure facultative placements abroad,
especially in aviation, energy and petrochemical risks. GIC, the national re-insurer, extends
212
Reinsurance Market
213
Risk Management and Reinsurance
Industry captives
An industry captive is owned by industries with similar specific insurance problem.
The shareholders to whom the company is required to report appoint a board of
directors.
Agency captives
An agent or group of agents owns this type of company. These are formed such
that their clients can participate in the programs.
Rent-A-Captives
The risks of the members are insured by this type of captive. The investment
income and underwriting profits are returned to the insureds. Certain companies
rent their surplus to institutions in order to establish a self-insurance program but
not their own captive.
Protected cell companies
These are special category of rent-a-captives. They shield their capital and surplus from
other renters in the captive as long as the rent-a-captive ‗s owner remains solvent.
Benefits of captives
The corporations and groups who want to take financial control and manage risks
by underwriting their own insurance than paying premiums to the third-party
insurers can opt for captives. Captive is nothing but a tool to such organizations.
The benefits of captives are as follows:
Provides insurance for certain exposures, which other insurance companies
might not provide.
Enables retention of the premiums within the group by the parent company.
Operating costs are reduced.
There is an improved cash flow.
There is an increase in coverage and capacity.
Better investment as well as investment income.
There is a direct reach to wholesale reinsurance markets.
There is flexibility in underwriting and funding.
There is a greater control over claims.
Availability of smaller deductibles for operating units.
There is an additional negotiating leverage with underwriters.
214
Reinsurance Market
? Questions
1. ―Reinsurance Market is spread all over the world with major
reinsurers being concentrated in Europe and West‖. Explain
global reinsurance market.
2. What is Regional Reinsurance Corporation? Explain its
features.
3. Explain the main features of Indian reinsurance market.
4. What do you understand by term ‗captives‘? Discuss briefly
various types of captives.
5. Outline the benefits of captives.
215
CHAPTER – 8
INWARD REINSURANCE
LEARNING OBJECTIVES
To understand the features Inward Reinsurance business
To get familiarized with Retrocession Arrangements
Understanding the essentials of Reciprocal Trading
introduction
In recent times, the trend of direct insurers undertaking inward business is on the rise
as it results in increase of gross premium and net retained premium. Inward
reinsurance business is defined as ―the insurance business taken up by a direct insurer
or reinsurer from the cedent in turn for share in the premium volume generated by the
cedent or on a fee basis‖. The growing reinsurance market kindled new hopes for many
insurance companies, which traditionally carry insurance business, to undertake inward
reinsurance business along with their main line of business. In a retrocession
arrangement a reinsurer (the retrocedent) cedes all or part of the reinsurance risk it has
assumed to another reinsurer (the retrocessionaire).
As the market for inward reinsurance is yielding attractive returns, many kinds of
companies all over the globe are jumping into the fray of inward reinsurance.
However, the company taking up inward reinsurance should look at its competence
in terms of market knowledge, research facilities, sound actuarial practices and
knowledge of changing risk profiles in the market.
216
Inward reinsurance
217
Risk Management and Reinsurance
BUSINESS STRATEGY
A business strategy is required to support any insurer or reinsurer to transact
reinsurance business and all logistical help should be available to carry out the
task. Intimate knowledge of the international markets, skills in reinsurance area are
basically essential in restricting or excluding acceptances.
The reinsurer should study the market conditions with due focus on expected
spread of risks and volume of business. There has been dramatic changes in the
methods and forms of reinsurance at international level compared to traditional
methods of doing business. The reinsurance capacity has undergone rapid
changes and the capacity is also available from capital markets.
Reinsurer should aim at writing a large line to attract business with quality and to keep
his costs of acceptance economical. Nearly 90 percent of global reinsurers depend on
some form of retrocessional protection as a means both to cede a portion of their risk
and to stabilize their earnings. The reinsurer has to cope with financial problems like
delayed remittances and exchange of losses. Besides the tool of credit rating, gathering
information first hand would assist for diligence in writing inward reinsurance.
Some important dimensions in business strategy are as follows:
1. The companies should have clarity on the basis of underwriting – should it be
reciprocal or non-reciprocal?
2. An insurer or reinsurer accepting reinsurance business has two options open
to him – gross or net lines. He can write such shares as can be retained by
him without retrocession or he can write larger shares and create a
retrocession treaty to take care of the surplus over his net retention.
3. Undertaking facultative reinsurance business involves more administrative
work and the amount of premium is relatively small and the insurer needs to
have thorough knowledge of tariffs and other market conditions. In treaty
reinsurance business the premium volumes can be built up.
4. Insurers need to be clear on how much will be proportional and what amount
will be non-proportional. Reinsurance companies should exercise the choice
carefully.
5. Opting for wider geographical areas and spread will result in growing volumes
and at the same time bring new types of business. Therefore, the market
conditions will certainly impact the profitability of the reinsurer.
6. Reinsurer can procure business from various sources. It can be by granting
an underwriting or binding authority to another company or agency to write
business. It may accept business through brokers.
218
Inward reinsurance
7. The acceptance limit should be sufficiently large to make it more attractive for
the ceding companies and brokers to offer business. Companies need to stay
within their financial limits to avert any kind of financial crisis subsequently.
8. The company should lay down guidelines for accepting business.
RETROCESSION ARRANGEMENTS
A retrocession is both the unit of insurance that a reinsurance company cedes to a
retrocessionaire and the document used to record the transfer of risk from a reinsurer to
a retrocessionaire. After making acceptance, decision, underwriting decision has to be
taken. The accepting insurer or reinsurer may retain it wholly for his net account or
retrocede a part of the acceptance to a retrocession arrangement, if any, or even
arrange a specific retrocession on an individual acceptance with another reinsurer.
Retrocession is required by a leads underwriter who lead quotes on a reinsurance proposal.
The larger is his acceptances, the higher is the confidence of his underwriters.
Retrocession is also required to support reinsurance offers, which may otherwise be
scarce in the absence of retrocession. When there is excess capacity, lead underwriters
yield to broker pressure to offer lower and retrocession support is in offing.
RECIPROCAL TRADING
The mutual exchanging of reinsurance, often in equal amounts, from one party to
another, the object of which is to stabilize overall results, is the essence of reciprocity.
Ceding insurers tend to protect the experience of the treaty by not fully utilizing the
treaty capacity for more serious risks or arranging an excess of loss cover to protect
the treaty portfolio to take the benefit of reciprocal reinsurance trading. These
parties are ready to offer adjustments in commission, profits and reciprocity terms
to keep the treaty exchanges balanced.
The benefits that accrue from reciprocal exchange are:
a) it enables the ceding insurer to add to his net premiums and net profits;
b) it provides a wider spread for the net retained portfolio of the insurer with an
improved balance thus ensuring greater stability in profits.
The reciprocal reinsurance trading is very much prevalent in fire insurance and it is
not that much evident in cargo business, barring a few instances. Reciprocal
reinsurance tends to take place in the same area of both the insurers.
One can think of more than 100 percent premium reciprocity to balance the exchange
of profits when dealing with markets of lower average profitability. It can be said that a
ceding insurer with a treaty carrying an average 10 per cent profitability can expect to
receive 200 percent premium reciprocity from a reinsurer whose treaty has an average
profitability of 5 percent. However, the reciprocating insurer has a much better balance
for his treaty and is able to conclude short of 100 percent profit reciprocity
219
Risk Management and Reinsurance
in consideration for the steady results. Profit is normally subject to fluctuations and
therefore, accepting a large premium reciprocity from a treaty may be fraught with
danger. It is preferable to increase profit commission to reduce the net profit ceded.
A large premium reciprocity adds to the net premium of the ceding insurer and has
other advantages flowing from it such as creation of larger reserves and reduction
of tax on profits consequently.
Finally one should consider the impact of brokerage cost on the result of reciprocal
profit from the inward treaty when examining the terms of any treaty exchange
through intermediary.
REGULATIONS
IRDA regulations state that all life and non-life insurers in India can write inward
reinsurance business from other domestic insurers and from overseas, provided
that they have a well-defined underwriting policy. The insurer shall ensure that
decisions on reinsurance business are exercised by persons with necessary
knowledge and experience. The insurer shall file with the IRDA a note on his
underwriting policy stating the classes of business, geographical scope,
underwriting limits and profit objective. The insurer is also required to file any
changes to the note as and when a change in underwriting policy is made.
? Questions
1. What is inward reinsurance? Explain its objectives?
2. What considerations an insurance company should keep in
mind while finalizing its inward insurance programme?
3. Explain the role of business strategy in case of inward
reinsurance.
4. Outline the concept of Reciprocal Trading.
220
CHAPTER – 9
REINSURANCE PRACTICE
LEARNING OBJECTIVES
Fixing the goals of reinsurance
Factors determining the reinsurance needs of a primary insurer
Choice of retention
Setting the reinsurance limits
Determining the reinsurance cost
Information required in reinsurance negotiations
Examining typical questions to consider in assessing the underwriting policy of
a primary insurer
Understanding the kinds of commission involved in reinsurance transactions
Underwriting factors that a reinsurance underwriter must consider
Designing of and arranging a reinsurance program
Understanding Indian Reinsurance Program
introduction
In practice, there cannot be a specific type of reinsurance that tackles the impact of loss
frequency. The factors determining the reinsurance needs of a primary insurer are
many. In practice, most of the primary insurers try to be specific in fixing their goals and
therefore negotiate on limits, commissions and work on cost of reinsurance.
221
Risk Management and Reinsurance
The factors determining the reinsurance needs of a primary insurer are many. But
the more important of them are the following:
Kinds of Insurance written
Exposures subject to catastrophic loss
Volume of Insurance written
Available Financial Resources
Stability and Liquidity of Investment Portfolio, and
Growth Plans
222
reinsurance Practice
223
Risk Management and Reinsurance
224
reinsurance Practice
business in major parts of the country will be less vulnerable to loss ratio fluctuation
than a regional insurer.
In the exercise of setting the reinsurance limit, the terms of several treaties must be
compared and the limits kept flexible. For example, the limit for an aggregate excess
treaty can be lowered if adequate catastrophe reinsurance is carried. Again the limit of
a catastrophe can be lower if it applies only to the retention of the primary insurer after
recoveries from pro - rata reinsurance, rather than to the direct losses.
COST OF REINSURANCE
The reinsurance cost includes the premium paid to the reinsurer and losses
recovered or to be recovered under the reinsurance agreement. A primary insurer
should pay its own losses and the reinsurer‘s expenses and profit under any treaty,
if the treaty is continued over a fairly long period. That is why the amount included
in the premium for the reinsurer‘s expenses and profit is an important factor in
assessing the reinsurance cost.
There is a certain loss of investment income to the primary insurer, since reinsurance
involves transfer of some loss reserves and unearned premiums from the primary insurer to
the reinsurer. Consequently, the assets offsetting these reserves are invested. And such a
transfer of assets results in loss of investment income to the primary insurer. Such a loss of
investment income may be greater under a pro-rata treaty than under the excess treaty
since the reinsurance premium for a pro-rata treaty is usually greater. Thus, the loss of
investment income may also become an additional cost of reinsurance. The cost of
administering the reinsurance program varies depending upon the type of reinsurance. For
instance, since facultative placements are individual and separate, the cost of administration
in these cases is greater than in the case of treaties. Like-wise, pro - rata treaties cost more
to administer than excess treaties.
Finally, the profit or loss on insurance assumed under reciprocal arrangement must
also form part of the reinsurance cost.
REINSURANCE NEGOTIATIONS
Negotiations depend on several factors but chiefly the nature of the primary insurer
and the reinsurer and the kind of reinsurance transacted.
Information needed: The primary insurer must first compile some basic necessary
information. The favorable reinsurance terms and rates depend on the
thoroughness of the data compiled by the primary insurer.
The information required in reinsurance negotiations is different for treaties and for
facultative reinsurance. In treaties, the reinsurer will look for information concerning
the management and underwriting operations of the primary insurer. But in
facultative reinsurance negotiations, the details of individual loss exposures are
more important than the general operations of the primary insurers.
225
Risk Management and Reinsurance
Before signing a reinsurance treaty, the reinsurer must be satisfied about the
integrity of the primary insurer, his management characteristics, underwriting
policies, underwriting results and financial condition. The moral hazard of the
primary insurer must be considered since numerous frauds have occurred.
The underwriting staff of the primary insurer must have demonstrated capability and
experience. In the event of the primary insurer becoming insolvent, depending on
the cut through endorsements in place, the policy holders will have direct access to
the reinsurers and if in the meanwhile, the courts have given awards, compelling
the reinsurers to deposit their share of loss, the reinsurers will be facing double
liability and this could injure their financial interests. Besides, a reinsurance treaty
signifies a long-term relationship and the primary insurer‘s bankruptcy may lead to
disastrous situation.
The underwriting policies and underwriting results of the primary insurer are
important considerations in every reinsurance negotiation. Here are some typical
questions to consider in assessing the underwriting policy of a primary insurer.
1. What are the classes of business the primary insurer is writing?
2. Is the primary insurer basically concentrating on personal lines, commercial,
industrial or others?
3. What is his geographic area of operation?
4. How satisfactory are the primary insurer‘s underwriting guidelines?
5. Are there gross line limits and net line limits in keeping with his financial
strength?
6. Are the primary insurer‘s loss control and loss adjustment practices adequate
for the classes of business written?
7. Have the primary insurer‘s underwriting results been satisfactory in the lines
covered by the proposed reinsurance treaty?
8. Does the primary insurer anticipate any substantial changes in his
management, marketing or underwriting practices?
9. Are the primary insurer‘s rates adequate for the risks covered under the
treaty?
Reinsurers are also interested in ascertaining the terms of other reinsurances the
primary insurer is having. The idea is to find out if reinsurance is sought only for the
benefit of the primary insurer or if it also protects the interests of the reinsurer.
Again, the most recent loss experience of the primary insurer is to be considered as
that will reflect the underwriting policy, that tells of the selection of risks, rating and
commission terms. It is not the level of the loss ratio that is important but the reinsurer is
interested in knowing about its stability or volatility over time. Distribution of both
226
reinsurance Practice
losses and amounts of insurance by size must also be considered, especially for
arranging a per risk or per policy excess treaty.
Since reinsurance negotiations are two-sided, even the primary insurer must collect
enough information, concerning the solvency of the reinsurer, his satisfactory
claims practices, the competitiveness of rates and also the licensing in the territory
where the primary insurer operates.
REINSURANCE COMMISSIONS
There are two kinds of commission involved in reinsurance transactions, namely:
Ceding commissions paid by the reinsurer to the primary insurer, and
Brokerage commissions paid by the reinsurer to the reinsurance broker.
Ceding commissions are said to compensate to some extent the initial costs of
acquisition of the primary insurer as well as the cost of servicing the business. The
negotiation of the ceding commission depends on the administrative expenses of
the primary insurer as well as the reinsurer‘s estimate of the premium volume and
the loss experience expected under the treaty being negotiated and also in practice
the market situation of demand for and supply of reinsurance. Treaties also provide
for retrospective adjustment of the ceding commission based on a variance of the
loss ratio from expected loss.
Brokerage commission varies between 2% and 5% of the reinsurance premium for
pro rata treaties and 5% and 10% for Excess of Loss (EOL) treaties.
DESIGNING A REINSURANCE PROGRAMME
Underwriting factors that a reinsurance underwriter must consider:
The reinsurance underwriter must assess the loss exposures that are covered by
the ceding company and he must also assess the explicit terms of that coverage.
The following are the underwriting factors to be considered by the reinsurance
underwriter about the primary insurer:
1. Financial status
2. Loss exposure
3. Coverage
4. Risk retained
5. Premium pricing
227
Risk Management and Reinsurance
228
reinsurance Practice
229
Risk Management and Reinsurance
1. Net Retention
Maximum net retention per risk is normally not more than 5% of the paid up capital and
free reserves in the case if fire business. However the loss retention per event should
not be more than 1% (paid up capital+reserve). In the case of small companies whose
portfolios are still unbalanced have to fix retentions related to their financial capacity:
They may be forced to put at risk a proportionately more significant portion of their
capital than the larger companies i.e. up to 5% of capital and free reserves.
230
reinsurance Practice
Keeping this in mind, the net retention per risk for this company is fixed at 4% of its
paid up capital and loss retention at 1%.
Paid up Capital - Rs. 25 crores
Net Retention per Risk - Rs. 1 crore (@ 4%)
Net loss retention per event Rs. 25,00,000
2. Reinsurance Protection
Since this is a newly formed company with no previous underwriting experience, it
is advised that the company should initially arrange a Quota Share Treaty (with 10
lines).
Net Retention = Rs. 1 crore
Obligatory cession to GIC – 10% (Statutory)
Maximum surplus Reinsurance acceptance limit = Rs. 10 crores.
The total automatic capacity available for the company would be Rs.12.22 crores as
detailed below:
Obligatory Cession - 10.00% 1.22 Cr
Net retention - 8.18% 1.00 Cr
Quota share treaty - 81.82% 10.00 Cr
----------- ------------
100.00% 12.22 Cr
Premium for QS Treaty (2001-02) = Rs. 14.3185 crores
(81.82% of Rs.17.50 crores)
Premium for Net Retained A/C = Rs. 1.4315 crores (8.18% of Rs.17.50)
When the company‘s income increases in the following years, it may review net
retention limit. Later on the company may decide to switch over to a surplus treaty. The
company should also protect its net retained account (premium Rs.1.35 crores) under
an excess of loss arrangements against catastrophic losses such as earthquake,
hurricane, windstorm, rainstorm, riot, civil commotion, malicious damage etc.
The company may avail excess of loss cover for a limit of Rs.10 crores with a loss
deductible of Rs. 25 lakhs.
Thus one must review the Reinsurance programme every year with actual losses
incurred especially catastrophe losses, regulations, inflation, changes in type of
business etc.
One should also decide when to change a reinsurer keeping in mind the changes in
its underwriting policies
231
Risk Management and Reinsurance
? Questions
1. The factors determining the reinsurance needs of a primary
insurer are many. Explain the important of them.
2. ―The setting of retention varies depending on the type of
treaty‖ Explain.
3. Explain the concept of Reinsurance Negotiations and its
implications.
4. Outline the process involved in designing a reinsurance
program.
5. Discuss the objectives of Indian reinsurance program.
232
CHAPTER – 10
Illustrations on reinsurance
policy. Solution:
On the policy amounting Rs.4,00,000, the cedent keeps 2/4 i.e. ½ of the
claim. i.e. Rs. 2,00,000 and the reinsurer has ½ i.e. Rs. 2,00,000.
On the policy amounting Rs. 5,00,000 the cedent keeps 2/5 of the claim.
i.e. Rs.2,00,000 and the reinsurer has 3/5 i.e. Rs. 3,00,000.
233
Risk Management and Reinsurance
234
Illustrations on reinsurance
Solution:
235
Risk Management and Reinsurance
237
Risk Management and Reinsurance
10. Suresh insurance company writes fire business consisting of simple risks.
The Insurance Company is ready to bear any claim up to Rs. 1,00,000.
So, the company arranges an excess of loss arrangement treaty to meet
the balance of any claim in excess of Rs. 1,00,000 per risk up to further
2,00,000. The following are the details of the claims:
238
Illustrations on reinsurance
239
Risk Management and Reinsurance
Annexure - 1
INSURANCE REGULATORY AND
DEVELOPMENT AUTHORITY (GENERAL
INSURANCE - REINSURANCE) REGULATIONS, 2000
In exercise of the powers conferred by section 114A of the Insurance Act, 1938,
sections 14 and 26 of the Insurance Regulatory and Development Authority Act,
1999, the Authority, in consultation with the Insurance Advisory Committee, hereby
makes the following regulations, namely:-
CHAPTER – I
PRELIMINARY
Short title and commencement
1. (1) These regulations may be called the Insurance Regulatory and Development
Authority (General Insurance - Reinsurance) Regulations, 2000.
(2) They shall come into force on the date of their notification in the Official
Gazette.
Definitions
2. In these regulations, unless the context otherwise requires:—
(a) ‗Act‘ means the Insurance Regulatory and Development Authority Act,
1999 (41 of 1999);
(b) ‗Authority‘ means the Insurance Regulatory and Development Authority
established under sub-section (1) of section 3 of the Act;
(c) ‗cession‘ means the unit of insurance passed to a reinsurer by the insurer
which issued a policy to the original insured and, accordingly, a cession
may be the whole or a portion of single risks, defined policies or defined
divisions of business, as agreed in the reinsurance contract;
(d) ‗facultative‘ means the reinsurance of a part or all of a single policy in which
cession is negotiated separately and that the reinsurer and the insurer have
the option of accepting or declining each individual submission;
(e) ‗Indian re-insurer‘ means an insurer who carries on exclusively reinsurance
business and is approved in this behalf by the Central Government;
(f) ‗Pool‘ means any joint underwriting operation of insurance or reinsurance
in which the participants assume a predetermined and fixed interest in all
business written;
240
annexure - I
241
Risk Management and Reinsurance
(5) Within 30 days of the commencement of the financial year, every insurer shall
file with the Authority a photocopy of every reinsurance treaty slip and excess
of loss cover covernote in respect of that year together with the list of
reinsurers and their shares in the reinsurance arrangement;
(6) The Authority may call for further information or explanations in respect of the
reinsurance programme of an insurer and may issue such direction, as it
considers necessary;
(7) Insurers shall place their reinsurance business outside India with only those
reinsurers who have over a period of the past five years counting from the
year preceding for which the business has to be placed, enjoyed a rating of at
least BBB (with Standard & Poor) or equivalent rating of any other
international rating agency. Placements with other reinsurers shall require the
approval the Authority. Insurers may also place reinsurances with Lloyd‘s
syndicates taking care to limit placements with individual syndicates to such
shares as are commensurate with the capacity of the syndicate.
(8) The lndian Reinsurer shall organise domestic pools for reinsurance surpluses in
fire, marine hull and other classes in consultation with all insurers on basis, limits
and terms which are fair to all insurers and assist in maintaining the retention of
business within India as close to the level achieved for the year 1999-2000 as
possible. The arrangements so made shall be submitted to the Authority within
three months of these regulations coming into force, for approval.
(9) Surplus over and above the domestic reinsurance arrangements class wise
can be placed by the insurer independently with any of the reinsurers
complying with sub-regulation (7) subject to a limit of 10% of the total
reinsurance premium ceded outside India being placed with any one
reinsurer. Where it is necessary in respect of specialised insurance to cede a
share exceeding such limit to any particular reinsurer, the insurer may seek
the specific approval of the Authority giving reasons for such cession.
(10) Every insurer shall offer an opportunity to other Indian insurers including the
Indian Reinsurer to participate in its facultative and treaty surpluses before
placement of such cessions outside India.
(11) The Indian Reinsurer shall retrocede at least 50% of the obligatory cessions received
by it to the ceding insurers after protecting the portfolio by suitable excess of loss
covers. Such retrocession shall be at original terms plus an over riding commission to
the Indian Reinsurer not exceeding 2.5%. The retrocession to each ceding insurer
shall be in proportion to its cessions in the Indian Reinsurer.
(12) Every insurer shall be required to submit to the Authority statistics relating to
its reinsurance transactions in such forms as the Authority may specify
together with its annual accounts.
242
annexure - I
243
Risk Management and Reinsurance
ANNEXURE – II
244
annexure - II
(d) Every broker invited to quote terms should fully comply with para 4 of the
Code of Conduct. The broker should clearly distinguish between
information provided by the client and information provided by the broker
based on its own study of the risk.
(e) Where the client has specified the terms of the insurance cover required
by it, the broker shall develop terms on the basis specified by the client
and not any other basis (which may be patched up without the
knowledge of the client) to provide the required cover. However, it is
open to the broker to discuss with the client and agree with the client to
develop terms on any other basis.
(f) It is open to the broker to ask more than one insurer to quote terms. The
broker shall furnish full information on a common basis to all the insurers.
This does not prevent the broker from providing supplementary
information to an insurer in response to questions raised by that insurer.
(g) Where an insurer is asked to quote terms by more than one broker in
respect of the same risk, the insurer shall quote the same terms to all the
brokers. However, if a broker seeks quotes from the insurer on a different
basis, the insurer shall be free to quote terms on the basis requested by
that broker without having to advise those terms to all the other brokers.
(h) Where an insurer is approached by a broker to quote terms for a
particular account, the insurer should not approach the client directly to
quote terms and eliminate the broker.
(i) Where a client has also asked an insurer to quote terms directly to it, the
insurer may quote terms directly to the client and if any broker
approaches it for terms, the insurer should inform the broker that it is
quoting directly to the client.
(j) Where terms are developed on a ―net rate‖ basis, the broker shall advise
the client the full facts, namely, the net rate and the addition made for
brokerage.
(k) Where the insurer needs to develop terms from the reinsurance markets
before quoting its terms to the client, the insurer shall be free to use the
services of any reinsurance broker of its choice.
(l) A composite broker shall not go to the reinsurance markets to develop terms in
respect of cases referred to in (k) above, without the written prior authorization of
the insurer invited to quote terms for the insurance. Paras 2(i) and 2(j) of the
Code of Conduct are relevant in this connection. It is important to emphasize
that placement of reinsurance is entirely within the purview of the insurer and
neither the direct broker nor the client can direct the insurer where to place
reinsurance and how much to reinsure. This does not prevent the client or the
245
Risk Management and Reinsurance
broker from enquiring about the insurer‘s own retention on the risk and
the reinsurances that it will place and the security rating of reinsurers to
be used, as a part of its examination whether to accept the insurer for its
insurance requirements.
(m) Where reinsurance terms are developed as part of the process of quoting
terms for direct insurance, the broker who is instructed to develop terms
shall truthfully communicate to the insurer on whose behalf the
reinsurance terms are developed, the basis of the quotation, the rates
and terms and the list of reinsurers with written lines and the extent of
likely support at those terms.
(n) A composite broker or reinsurance broker shall not put conditions of
minimum percentage of reinsurance placement as part of the quotation
or allow such terms to be put in by the client or foreign co-broker or
reinsurers. This does not prevent a lead reinsurer quoting terms subject
to his being offered a minimum stated line on the risk. It shall be open to
the insurer to instruct the broker not to offer the risk to a particular
reinsurer or to specified reinsurer‘s specified markets.
(o) A broker shall not put up terms developed within its own office (desk
quotes) but not received from an insurer, as insurance premium terms. If
a broker is responding to an enquiry about the likely insurance cost, it
should make it clear when indicating the premium cost that it is not a
quotation but only a non-binding indication of the likely cost.
2. Where a client retains one broker to develop terms from several
insurers:
(a) The broker shall select the insurers to be invited to quote terms, entirely
from the point of view of the client and in the best interests of the client.
(b) The broker shall provide information on a common basis to all insurers
invited to quote. However, it may provide further clarifications or additional
information in response to queries of an insurer that is invited to quote.
(c) The broker shall not first develop terms from foreign markets and then go
round locating insurers willing to front the business at those terms.
(d) The broker shall not go round looking for insurers to be invited to quote
terms, on the basis of a minimum reinsurance order as a condition of
giving an opportunity to the insurer to write a share of the risk.
(e) The terms put up to the client by the broker should include the original letters
of quotation from the insurers and the recommendation of the broker should
be properly documented with reasons in support of the recommendation.
246
annexure - II
(g) Once the insurer has accepted the reinsurance terms quoted, the broker shall
place the required reinsurance cover and shall keep the insurer informed about
the progress of placement from time to time. In selecting the reinsurers to whom
the risk is offered, the broker shall be mindful of the need to use only such
reinsurers who are rated BBB or higher by a recognized credit rating agency, as
required by Regulation 3(7) of IRDA (General insurance
– reinsurance) Regulations 2000. Where the reinsurance is over-placed, the
signing down shall be done in consultation with the insurer in a manner
consistent with good market practice. The ceding insurer shall have the right
to tell the broker not to use a specific market or reinsurer or reinsurers.
(h) Immediately after completion of placement of reinsurance, the broker
shall issue a broker‘s cover note giving the terms of cover and the names
of reinsurers and the shares placed with each of them. The cover note
shall contain a listing of all important clauses and conditions applicable to
the reinsurance and where the wordings of clauses are not market
standard, the wordings to be used in the reinsurance contract shall be
attached to the broker‘s cover note.
(i) The broker shall follow up the cover note by a formal signed reinsurance
policy document or other acceptable evidence of the reinsurance
contract signed by the reinsurers concerned, within one month of receipt
of reinsurance premium.
(j) The broker shall have a security screening procedure in-house or follow
credit ratings given by recognized credit rating agencies and answer without
any delay, any questions raised by the insurer about the credit rating of one
or more reinsurers. Where the insurer declines to accept a particular
reinsurer for whatever reason and asks the broker to replace the security
before commencement of risk, the broker shall do so promptly and advise
the insurer of the new reinsurer brought on the cover.
5. Placement of Treaty or Excess of Loss Reinsurance:
(a) A composite insurance broker or reinsurance broker invited to place a
proportional treaty shall prepare the treaty offer slip and supporting
information with the cooperation of the insurer and secure the insurer‘s
concurrence to the slip and information before entering the market.
(b) Where a reinsurance treaty is placed at different terms with different
reinsurers, the fact that such is the practice shall be made known to all
the reinsurers suitably.
(c) Where a reinsurer accepts a share in a treaty subject to any condition,
the conditions shall be made known to the ceding insurer and its
agreement obtained before binding the placement.
248
annexure - II
(d) The broker shall advise the progress of placement of the treaty from time
to time. Immediately after completion of placement, the broker shall issue
a cover note setting out the treaty terms and conditions and list of
reinsurers with their shares. Where a treaty is over-placed, the broker
shall sign down the shares in consultation with the insurer in a manner
consistent with good market practice.
(e) The broker shall secure signature of formal treaty wordings or other
formal reinsurance contract documentation within three months of
completion of placement.
(f) The broker shall have a security screening procedure in-house or follow
credit ratings given by recognized credit rating agencies and answer without
any delay, any questions raised by the ceding insurer about the credit rating
of one or more reinsurers. Where the insurer declines to accept a particular
reinsurer for whatever reason and asks the broker to replace the security
before commencement of the reinsurance period, the broker shall do so
promptly and advise the insurer of the new reinsurer brought on the cover.
6. Handling of reinsurance monies:
Every broker shall abide by the provisions of Regulation 23 of the IRDA
(Insurance Brokers) Regulations 2002.
7. Co-broking:
(a) It is open to a client to appoint more than one broker to jointly handle the broking
of its insurance requirements depending on the skills that the brokers may bring
to the activity and to decide the manner in which the brokerage payable on the
business may be shared among them. However, it is not permitted for one
broker to appoint another broker to handle the broking of an account that has
been given to that broker to handle by the client.
(b) Each of the direct insurance co-brokers shall be brokers who are
licensed to broke the class of business concerned and each co-broker
shall be responsible to ensure that these guidelines are complied with.
(c) The manner in which the brokerage is shared among the co-brokers shall
be disclosed to the insurer on request. The insurer will be guided by the
instructions of the client with regard to payment of brokerage to each co-
broker for his share or to the lead co-broker who will then be responsible
to pay the other co-brokers.
(d) Each of the co-brokers on a reinsurance placement shall also be
responsible to ensure that these guidelines are complied with by
themselves and any foreign brokers used by them.
(e) Where a reinsurance placement is co-broked with a foreign reinsurance
broker, the licensed broker in India shall only use reinsurance co-brokers
249
Risk Management and Reinsurance
who agree to comply with the requirements of these guidelines and shall be
responsible to secure compliance with these guidelines to the extent applicable, by
the foreign reinsurance co-broker. The name and other particulars of the foreign
reinsurance co-broker shall be disclosed to the insurer.
8. Reinsurance brokerage:
(a) Where the brokerage charged for a particular case exceeds the normal level of
brokerage for such transaction, the fact should be disclosed to the insurer before
binding cover. For this purpose, the normal level of brokerage shall be taken to be
2.5% on reciprocal proportional treaties, 5% on non-reciprocal proportional treaties,
10% on excess of loss covers and 5% on facultative placements.
(b) For the purpose of sub-para (a) above, payments of all nature in respect of the
particular account, such as risk inspection fees or risk management fees or
administration charges, etc., shall be aggregated.
9. Insurer‟s right to develop business directly:
Nothing contained in these guidelines shall be interpreted as prohibiting an insurer from
approaching a client directly to service its insurance requirements. However, an insurer
shall not go to a client who has already decided to use a broker for its insurance
placement and has appointed a broker and such broker has approached the insurer for
terms.
10. Effective date
These guidelines shall come into effect from 1st October, 2006 and shall apply to any
insurances where the process of placing insurance or negotiating terms of insurance is
initiated after that date, including renewals in respect of insurances expiring after that
date.