Reinsurance Project PDF

CHAPTER – 1
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
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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
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Introduction to reinsurance
is a long-term, mutually beneficial relationship. The mutual obligations found in the

reinsurance contract are derived from the principles of fairness and good faith,
which culminate in the standard of ‗utmost good faith‘ between the reinsured and
reinsurer. Indeed, reinsurance agreements are often referred to as ‗honorable
engagements‘, generally intended to be viewed as statements of industry custom
and understanding, and concerned above all with perceived intention of the parties
rather than the strict interpretation of contract provisions.
Adverse Selection: conscious and deliberate submission by a reinsured company to
a reinsurer of those risks, segments of risks, or coverage that appear less attractive
for retention by the reinsured.
Primary: In reinsurance, this term is applied to the nouns: insurer, insured, policy
and insurance and means respectively:
1. The insurance company which initially originates the business – the ceding
company;
2. The policy holder insured by the primary insurer;
3. The initial policy issued by the primary insurer to the primary insured;
4. The insurance covered under the primary policy issued by the primary insurer
to the primary insured (sometimes called ‗underlying insurance‘).
Reinsurance premium: Consideration paid by a ceding company to a reinsurer for
the coverage provided by the reinsurer.
Treaty: A reinsurance contract under which the reinsured company agrees to cede
and the reinsurer agrees to assume a particular class or classes Insurance
business automatically.
FUNCTIONS OF REINSURANCE
1. Stabilization of Loss Experience
The primary insurer, despite the best forecast of losses, may yet find the loss ratios
to be erratic, in the sense that there will be some years when the losses are least,
but in other years the losses may be substantial. Such an inconsistent trend may
make the insurance business risks and rather unprofitable. Profits are necessary to
attract and retain capital and to increase the capital and surplus.
When a primary insurer purchases reinsurance, its losses are limited to retention.
With reinsurance, whenever the loss exceeds retention, the primary insurer does
not have to bear the excess loss as it is already reinsured and mathematically the
primary insurer‘s loss level will stabilize at the planned level.
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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.
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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
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very important in all fields of insurance. Reinsurers must be careful in offering

advisory services and have to ensure that they do not reveal proprietary information
obtained through confidential relationships with other primary insurers.
6. Withdrawal from a territory or class of business
Many a time, a primary insurer will be under pressure to withdraw from a region or
class of business. There are strategic disadvantages in pulling out of a territory, as
this is likely to affect its future business.
That is why in the modern day, primary insurers, in spite of pulling out of a region
try to place 100% reinsurance. This process of reinsuring all losses for an entire
class, territory or book of business is known as portfolio reinsurance.
BASICS OF A VALID REINSURANCE CONTRACT
a) Contract of Reinsurance is a contract of insurance.
b) It is a separate contract distinct from original contract of insurance. The
persons or firms insured by the primary insurer are not parties to the contract
and usually have no rights under the reinsurance contract.
c) It is a contract of indemnity on the same risk as the original contract of
insurance.
d) Both contracts are in existence at the same time.
e) There must be transfer of risk from one party to another.
f) Reinsurance must be between two insurance entities.
g) The insurance operators are recognized by regulators.
h) All the transactions between a ceding company and a reinsurer must be
conducted on the principle of ‗utmost good faith‘.
The availability of reinsurance makes it possible for policyholders to obtain all of their
insurance from one insurer instead of buying it in bits and pieces from several insurers.
This simplifies the problems of buying insurance. The availability of reinsurance helps to
maintain the solvency of primary insurers with obvious advantages to policyholders.
Reinsurance makes it possible for small insurers to compete effectively against larger
ones, thus increasing the options available to buyers of insurance.
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? 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.
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CHAPTER – 2
REINSURANCE THEORY
OUTLINE OF THE CHAPTER

 Reinsurance Theory 

 Types/Methods of Reinsurance 

 Proportional and Non Proportional 

 Difference between Coinsurance and Reinsurance 
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.
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reinsurance Theory
b) Security: The cedent company, like a typical policyholder, is equally concerned

with the security and therefore it chooses a standard and established reinsurer.
c) Quality of service: The quality of service offered by a reinsurer also matters a
lot. The insurers and reinsurers have a duty to their respective shareholders
to show profits. Therefore, they are equally concerned with risk they
undertake and its financial consequences.
d) Pricing of the deal: The business offered to a reinsurer depends on the pricing
deal negotiated and settled. Reinsurance comes at a cost to the primary insurer
and a prudent analysis must be undertaken to see that the benefits and costs
involved in taking a reinsurance policy provide protection to the reinsured.
The reinsurers should, at the same time, think in terms of their business prospects
and not ending up in losses. Therefore, they may prefer a retrocession policy to
cover up their risk. A retrocession is placed to afford additional capacity to the
original reinsurer‘s risk. Reinsurers should have strong focus and consider the
industry‘s competition and dynamics to meet the requirements of their customers.
TYPES OF REINSURANCE BUSINESS
There are two approaches that reinsurers adopt for securing business:
1. Direct writing
2. Through Brokers
Reinsurance companies solicit reinsurance business directly through their
employees as well as through reinsurance broking companies.
Similarities and differences between insurance
and reinsurance:
Similarities differences
1. Principle of utmost good faith 1. Liability of reinsurers is
several, not joint.
2. Principle of indemnity 2. Broad scope of reinsurance
agreements.
3. Conditional contracts 3. ‗Follow the fortunes‘ principle.
4. Not a contract of adhesion.
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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.
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reinsurance Theory
Proportional and Non-proportional Reinsurance

Another system of classifying reinsurance is dependent upon the way in which the
obligations under a reinsurance contract are divided between the reinsurer and the
primary insurer. Prorata reinsurance or proportional reinsurance and excess of loss
or non-proportional reinsurance are the two approaches for sharing losses.
Under Pro-rata or proportional reinsurance (also called participating reinsurance) the
premium as well as the losses are shared between the primary insurer and reinsurer in
the agreed proportions. For instance, if the reinsurer covers 25 per cent of the risk
under a given policy, he also receives 25 per cent of the premium and has to pay 25 per
cent of each loss under the policy, irrespective of the size of the loss. Under prorata
insurance treaties, the primary insurer receives from the reinsurer a ceding commission
in order to cover his expenses and possibly an allowance for profit.
Excess of Loss Reinsurance or Non-proprotional
Reinsurance
Under this, no amount of insurance is ceded. This reinsurance arrangement will not
come into effect until the primary insurer has sustained a loss exceeding his
retention under the contract and is covered by the excess of loss agreement.
It is to be noted that both facultative reinsurance and treaty reinsurance can be
written as a pro rata or excess of loss or a combination of the two.
Fig. 2.1 depicts the various ways of classifying reinsurance.
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
Treaty Facultative Financial
Pro-Rata Excess of Loss Pro-Rata Excess of Loss
Quota Surplus Per Risk Per Occurrence Aggregate

Share Share (Per policy) (Catastrophe) Excess
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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
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Quota Share Treaty

In Quota share contracts the cedant binds himself to retain and cede a fixed
proportions of all the business it underwrites up to a fixed amount within the class or
classes subject to the treaty. Even the smallest risks are reinsured.
For example, if the Ceding Company shall retain for own account 40% of all
burglary business, with an underwriting limit of Rs. 50,000 per risk, the Cedant shall
reinsure with the Reinsurer, who agrees to accept a 60% share of all burglary
business. The reinsurer receives the same percentage of the premium less the
ceding commission as it does of the amount of insurance and pays the same
percentage of each loss. In the U.S. Quota Share treaties are much more common
with property coverages than liability coverages.
The advantages of the system are particularly appropriate in the following cases:
1. When a company commences business in a line of business for which no
statistics exist; here the Reinsurer participates in the underwriting of each policy,
large and small, and pays in the same proportion its share of the losses.
2. To simplify administrative work and reduce cost.
3. If the loss ratio is uncertain and cannot be corrected immediately quota share
reinsurance provides relief for a limited period of time.
An example of quota share treaty is given below:
Assume that ABC Insurance Company has purchased from XYZ Reinsurance
Company a quota share treaty a retention of 30 percent and a cession of 70 percent
with a limit of Rs. 8,00,000. Policy No.1 insures a building for Rs. 2,00,000 for a
premium of Rs. 800. A loss of Rs. 50,000 is reported. Policy No.2 insures a building for
Rs. 3,00,000 for a premium of Rs. 1,500. A loss of Rs. 80,000 is reported. Policy No.3
insures a building for Rs. 4,00,000 for a premium of Rs. 1,700. A loss of Rs. 90,000 is
reported. Show how the insurance, premiums, and losses under these policies will be
divided between the primary insurer and reinsurer.
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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.
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The following illustrative example is helpful for our understanding:

ABC insurance company has purchased from XYZ Reinsurance company a surplus
treaty with a retention of Rs. 2,00,000 and a limit of Rs. 20,00,000. This is referred
to as a ten-line surplus treaty. The primary insurer (ABC Insurance Company) will
cede coverage upto ten times the retention amount. The given below illustrate how
the surplus share treaty would apply to the same three policies shown in Table 9.2
TABLE 3.3
DIVISION OF INSURANCE, PREMIUM AND LOSSES
UNDER SURPLUS SHARE TREATY
ABC Insurance XYZ Reinsurance Total
Co. (percent) (Percentage ceded) (Rs.)
(Rs.) (Rs. )
Policy No.1
Insurance 2,00,000 (100%) 0 (0%) 2,00,000
Premium 800 0 800
Loss 50,000 0 50,000
Policy No.2
Insurance 2,00,000 (66.67%) 1,00,000 (33.3%) 3,00,000
Premium 1,000 500 1,500
Loss 53,333 26,667 80,000
Policy No.3
Insurance 2,00,000 (50%) 2,00,000 (50%) 4,00,000
Premium 850 850 1,700
Loss 45,000 45,000 90,000
As is seen in case of Policy No.1, there is no ceding as the amount of insurance is
equal to Rs. 2,00,000 retention. For Policy No.2, the proportion in which premium
and losses are shared between ABC Company and XYZ company is determined by
retention divided by the insurance amount. Similarly with Policy No. 3.
It is again seen that under a surplus share treaty for insurance amounts above the
retention, the rupee amount of retention remains constant while the percentage
retention decreases as the amount of insurance increases.
The main advantage to the primary insurer of the surplus share treaty is the
avoidance of ceding insurance on small loss exposures as he can afford to retain
them. The primary disadvantage in comparison with quota share treaty to the
increased administrative expense.
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Characteristics of Surplus Share Treaty and Quota Share

Treaty
Surplus share treaty Quota share treaty
1. Often property only. 1. Both property and casualty.
2. Sharing of percentage is 2. Sharing of percentage is
variable. fixed.
3. Individual cessions. 3. No individual cessions.
4. Reinsurer‘s premium is the 4. Reinsurer‘s premium is the
percentage of the original percentage of the original
premium less a negotiated premium less a negotiated
ceding commission. ceding commission.
5. Provides large line capacity. 5. Provides a limited line capacity.
6. Premiums and losses are 6. Premium and losses are
settled by account. settled by account.
Given below is an example on calculation of premium in a surplus share treaty.

Munich insurance company entered into two surplus treaty contracts with the reinsurers.
The first surplus treaty consisted 10 lines with a maximum liability of Rs. 30,00,000.The
second surplus treaty consists of 20 lines with a maximum liability of Rs. 50,00,000.
Risk Gross Sum Retention
Insured (Rs.) Applicable (Rs.)
1 2,00,000 2,00,000
2 3,00,000 1,00,000
3 12,00,000 2,00,000
4 30,00,000 4,00,000
5 65,00,000 2,00,000
Calculate the cessions to first surplus treaty.

Calculate the cessions to second surplus treaty.
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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
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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.
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reinsurance Theory
Characteristics of Non-proportional Treaties:

Per Risk Per Occurrence Aggregate (stop loss)
1. It is negotiated on rate 1. It is negotiated on rate 1. It is negotiated on Rate
exposure basis and exposure basis and there exposure basis and
there is no commission. is no commission. there is no commission.
2. Premiums are 2. Premiums are 2. Premiums are
settled by annual settled by annual settled by annual
adjustment of adjustment of adjustment of
deposit premium. deposit premium. deposit premium.
3. Premium is minimum. 3. Premium is minimum. 3. Premium is minimum.
4. Losses are settled 4. Losses settled by 4. Losses are settled
individually. catastrophe or event. annually.
5. Retention is for each risk 5. Retention is usually 5. Retention and the limit
or building or location. above a minimum of two are stated as a loss ratio.
6. It has per occurrence Full-losses. 6. It has a co-insurance
limitation. 6. It has a co-insurance provision when the
provision when the reinsured shares the loss
reinsured shares the loss above retention.
above retention.
RATING FOR EXCESS OF LOSS COVERS

One concept which is frequently used in calculation of rate for excess of loss covers
(either per risk or per policy) is BURNING COST. The burning cost is computed by the
ratio of actual past losses over some time period, say, five years, to their corresponding
premium (written or earned) for the same period. This ratio is used in assessing a
portfolio of business and in determining rate of premium for renewal. This can also be
termed as experience rating. The burning cost will give the rate of premium, which is
just sufficient to cover the losses suffered by the reinsurers. This is then loaded by the
underwriter for a reserve in case of worsening of loss experience, catastrophic element,
acquisition costs and profit margin. The loading factor normally used is 100/70 or
100/80. An example of burning cost calculation will clarify the concept better.
(GNPI – Gross Net Premium Income; the usual rating base for excess of loss
reinsurance. It represents the earned premium of the primary insurance company
for the lines of business covered net, meaning after cancellation, refunds, and
premiums paid for any reinsurance protecting the cover being rated and gross
meaning before deducting the premium for the cover being rated.)
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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.
Year gnPI Incurred losses

1980 1,000,000 8,000
1981 1,200,000 20,000
1982 1,500,000 40,000
1983 1,800,000 50,000
Minimum rate of premium is 3%. Calculate premium for the year 1983.
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‖
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reinsurance Theory
An example will help to clarify this further:

Shilpa insurance company has taken an excess of loss cover for Rs. 20,00,000 in
excess of Rs. 10,00,000 per event with two reinstatements. A hurricane causes a
loss of Rs. 90,00,000 in a period of 10 days. If there is no hour‘s clause, then the
whole occurrence will be treated as one event and the recovery from excess of loss
reinsurers will be limited to Rs. 20,00,000. In all such events it will become
extremely important to determine the exact date of loss. So, assuming the dates,
which are fixed by the surveyors are correct the position may be as under:
1. First period of 72 hours 30,00,000
2. Second period of 72 hours 35,00,000
3. Third period of 72 hours 20,00,000
4. Fourth period of 24 hours 5,00,000
Calculate reinsurance payment
Solution:
1. Rs.30,00,000 – 10,00,000 = Rs. 20,00,000
2. Rs.35,00,000–Rs.10,00,000=Rs.25,00,000butonly
Rs. 20,00,000 payable since it is the maximum liability per event.
3. Rs. 20,00,000 – Rs. 10,00,000 = Rs. 10,00,000
4. Loss is borne by the company since it is within the deductible.
Thus, the total recovery is Rs. 50,00,000 by treating each 72 hours period as one
event.
Working Excess of Loss Cover
The aim of this cover is to relieve the insurer of losses, which surpass the amount
he has decided to retain for own account on any accepted risk.
Example
The company has decided to retain Rs.1,00,000 on all textile factories in its portfolio
(i.e. Rs.1,00,000 on the sum of the risks which make up each factory – Furniture,
Machines, Raw Materials, Semi Finished and Finished products). It protects its
retention with an excess of loss cover of Rs.60,000 excess Rs.40,000, which
means that the reinsurer pays up to Rs.60,000 after the cedant has paid at least
Rs.40,000. If a loss of Rs.75,000 occurred in a factory, the cedant would pay its
share, i.e. Rs.40,000 and the reinsurer would reimburse him Rs.35,000.
The working of excess loss cover is most commonly used in the fire (and allied
perils) branch as well as marine cargo.
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Cover per event (catastrophe excess of loss)

It offers the insurer protection against the accumulations resulting from numerous
losses caused by the same event (cyclone, earthquake). In general, it protects the
retention against catastrophes.
Example
Storm causes Rs. 1,000 losses of Rs.3,000 on policies covering private houses,
which are all retained within the companies‘ retention. The company having
concluded an excess of loss reinsurance cover on its retention for an amount of
Rs.20,00,000 excess Rs.5,00,000. In other words the reinsurer has to bear
Rs.20,00,000. The total loss would be distributed in the following manner:
Rs.
Total Loss 30,00,000
Cedants loss retention 5,00,000
Reinsurance cover 20,00,000
Balance Non reinsured (amt.- borne by the cedant 500,000
DIFFERENCE BETWEEN COINSURANCE AND
REINSURANCE
Coinsurance, a form of reinsurance, is a system whereby reinsurer shares direct
responsibility for a risk with one or more insurance companies. The Cedent’s
liability is limited to the amount it underwrites on the original policy.
The system is used especially for covering big industrial risks and certainly has
many advantages. However, to apply it to the underwriting of thousands of medium
and small risks would only mean high administrative costs and inconvenience.
In co-insurance the relationships are between the primary insured and each
insurance company separately. If one company/insurer fails to pay its share of a
claim, the others are not liable to pay more than their share of claims. In other
words, their liability is limited to extent of share accepted by them individually.
Reinsurance is basically passing on the risk to some other insurer and therefore it
does not absolve the insurance company from making payment irrespective of
receipt of payment from reinsurer. In reinsurance the reinsured has a contractual
relationship with the reinsurers. The insurer must pay valid claims, even if he fails to
recover from his reinsurers.
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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.
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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.
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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.
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CHAPTER – 3
SPECIAL AREAS OF REINSURANCE

 Special Areas of Reinsurance 

 Property and Casualty Reinsurance 

 Marine and Aviation Reinsurance 

 Accident and Liability Reinsurance 

 Life Reinsurance 
 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 
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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.
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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
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different departments. It is a package cover. It is not a spread of risks of similar

nature but a combination of various exposures, which are competitively priced. This
is normally available under facultative arrangement. The insurer has to select a
combination of facultative and excess of loss covers while ensuring that the net
retention is not unduly burdensome.
CASUALTY REINSURANCE
Casualty insurance is a broad field of insurance and covers whatever is not covered
by fire, marine and life insurers. It includes automobile, liability burglary and theft,
workers compensation, glass and health insurance. It is basically US way of looking
at general insurance and is used synonymous to liability insurance. It covers the
indemnification of the first party – the insured party; in the event that it is legally
liable to pay compensation to a third party. The different considerations of
underwriting that are applicable in the case of property reinsurance are equally
applicable to casualty reinsurance.
MARINE REINSURANCE
The marine risks were one of the earliest known risks, which were covered under
reinsurance. Marine insurance can be done in two ways – cargo and hull; the
former covers the merchandise and the later the body of ship, its machinery etc.,
reinsurance is available separately for each.
In India, section 9 of the Marine Insurance Act, 1963 states that an insurer under a
contract of marine insurance has an insurable interest in his risk and may reinsure
in respect of it. Reinsurance is effected with the objective of:
 Reduction of an underwriter‘s line on any particular risk to a desirable amount
that he can retain on his own account; 

 To offload all or part of an undesirable risk; 

 To protect against catastrophe loss; 

 To increase market capacity by spreading the risk over the international market
and creating reciprocity – an exchange of business for comparable business
from another insurer; 

 To provide an underwriting capacity, which can also mean ability to participate
in risks which are not otherwise available; 

 To stabilize the underwriting results of a company. 
The marine insurance is typical in the sense that the items to be covered under insurance
are mobile and in some cases travel at high speed. Two cargo vessels may be moving in
opposite direction somewhere in the world and in a short time come closer almost bordering
on collision. A marine underwriter may not see the goods / ships that he is
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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
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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
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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
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 
ACCIDENT AND LIABILITY REINSURANCE

An accident is an event, which is wholly unexpected, not intended or designed. It does
not include the cumulative result of a series of small incidents. It may be noted that
while suicide and murder or homicide following grave provocation are not accidents,
homicide or murder without provocation, frostbite, snakebite and drowning are
accidents. The purpose of personal accident insurance is to pay a fixed compensation
for death or disability resulting from accidental bodily injury. The basic coverage of the
policy is, if at any time during the currency of this policy, the insured shall sustain any
bodily injury resulting solely and directly from accident caused by external violent and
visible means, then the insurance company shall pay to the insured or his legal
personal representative(s), as the case may be, the sum or sums set forth in the policy,
if resulting in specified contingencies such as death, permanent disablement etc.
The purpose of Liability Insurance is to provide indemnity to the insured in respect of
financial consequences of a legal liability. Whenever liability arises under Civil Law,
compensation becomes payable. Besides there may be legal costs awarded against the
insured and also legal costs of defense of the claim incurred by the insured. Civil liability
may arise under a) Law of Tort e.g. negligence and b) Statutory Law (Public Liability
Insurance). Liability Insurance comprises the following policies:
171
 Policies under Public Liability Insurance Act, 1991. 


 Public Liability for Industrial and Non-Industrial risks. 

 Products Liability. 

 Professional Indemnities for Doctors, Chartered Accountants, Solicitors etc. 

 Employer‘s Liability (Workmen‘s Compensation Policy). 

 Directors and Officers Liability policy. 

 Vendors of Software Liability. 

 Stock Exchanges, Banks and Financial Institutions Liability etc. 
The form of reinsurance, in these cases, normally adopted is mostly the Quota Share in
conjunction with a working excess of loss. Personal accident requires reinsurance for
high net worth individuals and for accumulation as in a single aircraft. These are
addressed through a combination of working and catastrophe excess of loss
reinsurances. In India, it is not the practice to include personal accident insurance for
excess of loss covers and these risks were entirely retained by the local insurers.
Catastrophes like Gujarat earthquakes, Mumbai floods and terrorist attacks on
WTC made insurers to reconsider this approach.
Experience of other insurances differs from country to country. The risk of burglary
exposure, for example, is attended to differently within a country and between
countries. At one extreme a simple guard provides security and considered as
adequate and at the other extreme there is electronic surveillance, frisking and
restricted access as can be observed in software companies. The Law and Order
situation differs depending upon the seriousness and extent of attention by political
leadership and government. The values involved and size of assets involved are
material to consideration given these variations.
In case of software exports, particularly to USA, for example a different situation
arises wherein the overseas vendor requires insurance protection for a fabulous
amount. Indian market requires reinsurance to support the transaction. Reinsurers
will provide protection if they have investigated the proposal and found the risk as
reinsurable. The risk is evaluated on the basis of reliability of Indian exporters and
the jurisdiction of USA, litigious country. Detailed proposals are required to be
completed for all professional, public and product liability covers. The information as
provided is scrutinized for vulnerable risk exposures. The cover is negotiated with
appropriate restrictions and rating.
LIFE REINSURANCE
Life reinsurance differs from other classes of reinsurance. The nature of risks assumed
by the life insurance has necessitated the development of various forms of reinsurance.
172
The proportion of total life insurance premiums reinsured is small in comparison

with most of the non-life insurance classes. The demand for life reinsurance arises
on account of a) difference in the number of deaths and b) death strain. Life
insurer‘s mortality risks arises on account of uncertain calculations of death claims
made by him with the help of mortality tables. However in practice, the actual
number may differ resulting in wide dispersion. Such divergence will have impact on
the earnings of a Life Insurance Company.
The cost to a life insurance company in case of a claim is the sum assured plus
bonus, if allowed. Cost minus reserves applicable to the policy gives the amount of
‗Death Strain‘. This results in creating an impact on operating results. Life insurers
generally seek reinsurance to reduce the impact of such death strain on operating
results of the company.
Three life reinsurance plans are in general use under both facultative and automatic
agreements.
Coinsurance Plan: The reinsurer assumes a proportionate share of the risk
according to the terms that govern the original policy. The reinsurer is liable for an
amount determined by the size of the insurance assumed in relation to the original
insurance amount. Thus, if the reinsurer has accepted one -half of the original
insurance, it becomes liable for one-half of any loss. In return for this guarantee, the
reinsurer receives a pro-rata share of the original premium less a ceding
commission and allowance. These payments reimburse the direct-writing company
for an appropriate share of the agent‘s commissions, premium taxes paid, and a
portion of the other expenses attributable to the reinsured policy. Also, the reinsurer
reimburses for a proportionate share of any dividends paid. In general, the
reinsurance contract is a duplicate of that entered into between the direct-writing
company and the policy owner. The ceding company and the reinsurer share the
risk (premiums and claims) according to agreed proportions; with the reinsurance
rates derived from the original rates charged the policy owner.
Yearly Renewable Term Plan: Under this the reinsurer assumes the reinsured policy‘s
net amount at risk in excess of the ceding company‘s retention. The ceding company
pays premium on a yearly renewable term basis. This plan is particularly appropriate for
smaller ceding companies because it results in larger assets for these companies and
is simpler to administer than coinsurance plan. Thus, for policies with declining net
amounts at risk, decreasing amount reinsurance is purchased every year. If a loss
occurs, the reinsurer is liable for the amount that it assumed that year and the ceding
insurer is liable for its retention plus the full reserve on the reinsured portion of the
policy. Premium rates for yearly renewable term reinsurance are established
independently of the premium charged to the policyholder.
Modified Coinsurance Plan: In the interest of permitting a company to retain control
over the funds arising out of its own policies, a modified coinsurance plan has
173
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
? 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
 Reinsurance Regulations and Law in India 

 Reinsurance Contracts Treaties 

 Treaty Wordings 

 Arbitration and Mediation 
 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
 The intermediary must make full written disclosure

of: Any control over the broker by a reinsurer,
Any control of a reinsurer by the intermediary,

Any retrocession of the subject business placed by the intermediary,
andCommissions earned or to be earned on the business.
 Records of all transactions must be retained for at least ten years after the expiration 
of all reinsurance contracts.
REINSURANCE REGULATIONS IN INDIA

In India, the Insurance Regulatory and Development Authority (IRDA) has
prescribed regulations for the reinsurance sector for general as well as life
insurance and we summarize below these regulations. (The test of the Regulations
is reproduced in Annexure I to the Chapter)
The IRDA (General Insurance-Reinsurance) Regulations, 2000 are as follows.
 The first chapter defines such special terms as cession, facultative, Indian
reinsurer, pool, retrocession, retention, and treaty. 

 The second chapter describes the procedure to be followed for reinsurance
arrangements: 

i) Clause 3-1 states the objectives of a reinsurance program as;
■ To maximize retention within the country;
■ Develop adequate capacity;
■ Secure the best possible protection for the reinsurance costs incurred;
■ Simplify the administration of business.
ii) Clause 3-2: Every insurer shall maintain the maximum possible retention
commensurate with its financial strength and volume of business. The Authority may
require an insurer to justify its retention policy and may give necessary directions to
ensure that the Indian insurer is not merely fronting for a foreign insurer.
iii) Clause 3-3: Every insurer shall cede such percentage of the sum insured on
each policy for different classes of insurance written in India to the Indian
reinsurer as may be specified by the Authority in accordance with the
Insurance Act, 1938 in this regard.
iv) Clause 3-4: The reinsurance program of every insurer shall commence from
the beginning of every financial year and every insurer shall submit to the
Authority, his reinsurance programs for the forthcoming year, 45 days before
the commencement of the financial year.
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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
xiii) Clause 4: Inward Reinsurance Business: Every insurer wanting to write

inward reinsurance business shall have a well-defined underwriting policy for
underwriting inward reinsurance business. The insurer shall ensure that
persons with necessary knowledge and experience make decisions on
acceptance of reinsurance business. The insurer shall file with the Authority a
note on its underwriting policy stating the classes of business, geographical
scope, underwriting limits, and profit objective. Any change in underwriting
policy shall also be filed.
xiv) Clause 5: Outstanding Loss Provisioning: Every insurer shall make
outstanding claims provisions for every reinsurance arrangement accepted on
the basis of loss information advices received from Brokers/Cedants and
where such advices are not received, on an actuarial estimation basis.
In addition, every insurer shall make an appropriate provision for incurred but not reported
(IBNR) claims on its reinsurance-accepted portfolio on actuarial estimation basis.
It is interesting to note that the IRDA‘s rules for reinsurance of life business are almost
wholly along the lines of its regulations in the matter of general insurance business
.In other words, the general prescription seems to be that there will be maximum
retention within the country and overseas placements of reinsurance will be based
on satisfactory rating of those reinsurers, either according to Standard & Poor or
other reputed rating agencies.
IRDA has issued fresh guidelines on Insurance and Reinsurance of General
Insruance Risks in September 2006 in the context of impending abolition of tariffs.
The guidelines are given as Annexure – II to the Chapter.
Reinsurance Contracts and Treaties
An insurance is a transfer, a business and a contract: a transfer of risks from the
insured to the insurer, a business, meaning a commercial activity with profit as the goal,
and a contract, meaning an agreement enforceable at law. Written agreements are
more easily enforceable than verbal ones and so every insurance contract is written,
satisfying all the legal principles on which insurance is founded and the points of law to
satisfy the definition of a legal contract. These legal features of a contract are:
 There must be consensus ad idem, namely, that there must be identity of views
between the contracting parties. 

 The parties to the contract must not have any legal disabilities, that is, say, they
must not be minors. 

 There must be consideration for the contract as a contract without consideration
is void ab initio (from the beginning). 

 There must be an offer from one party that must be accepted by the other party
to result into a contract. 
180
Reinsurance is similar to an insurance contract and hence it is important that the

wordings of the reinsurance agreement are agreed between the cedant and the
reinsurer before hand. The contract may relate to one particular reinsurance and be
expressed in a reinsurance policy, or as was often called in fire insurance, a
guarantee policy but nowadays is more commonly called as facultative reinsurance.
Or it may provide for the reinsurance of a number of risks and be expressed in the
form of a treaty. The insured under the direct policy has no interest in or right over
the reinsurer since he has no privy of contract. The reinsurer is certainly liable in
respect of his share of any claim made by the insured, but his liability is to the
insurer and to the insurer only. The insured may have an interest indirectly in
knowing that his insurer is supported by sound reinsurers.
In recent years the increasing complexities in reinsurance has demanded for a
greater degree of attention to the problems of disclosure and materiality. The
ordinary rule as to disclosure of material facts operates only up to the time the
contract is concluded but under a treaty something more may be required.
Other than facultative reinsurances, all other agreements between the ceding primary
insurer and the reinsurer are by means of written and agreed treaties and therefore, the
treaty wordings have come to occupy an important place in the study of reinsurance.
However, it is recognized that the treaty wordings are not standardized and different
countries and reinsurers have adopted their own typical wordings for treaties. At the
same time, the general conditions are fairly uniform for all treaties but the special
conditions are distinct exercises depending on particular needs of the contracting
parties and also the individual classes of insurance. Again, the proportional and non-
proportional treaties have separate distinct wordings, which have some special features
characteristic of the type of treaty. One other interesting feature of all treaty wordings is
that they include agreements on the follow-up accounting procedures, which actually
make implementation of the treaty much easier.
We give below the treaty wordings generally followed by the insurers in India.
PROPORTIONAL TREATY WORDINGS

1. Operative Clause
―The Company binds itself obligatorily to cede and the Reinsurer binds itself
obligatorily to accept by way of reinsurance a percentage stated in the schedule of
the first surplus over and above the amount retained by the Company for its own
account on all insurances and /or facultative reinsurances written in the Fire
Department of the Company and emanating from all parts of the world except the
United States of America and Canada. Within the scope of this Agreement, the
Company may cede hereunder on any one risk up to ……… times its net retention
and not exceeding an amount equivalent to Rs…………
181
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.‖
3. “Follow the Fortunes” Clause

―All acceptances hereunder shall be at the same gross rates, terms and conditions
as the ceding company and to follow the settlement of the Company, and the
Reinsurer shall follow the fortunes of the Company in regard to the cessions in
which the Reinsurer by virtue of this Agreement takes part.‖
4. “Exclusions” Clause
―In no event shall this Agreement protect the Company in respect of: War and Civil
War Obligatory Reinsurances.
Any loss or liability accruing to the Company, directly or indirectly and whether as
Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the
purpose of covering Atomic or Nuclear Energy risks.‖
5. Accounting Clause
―Accounts embodying all transactions under this Agreement shall be rendered
quarterly by the Company to the Reinsurer as soon as possible after the close of
each quarter which shall be deemed to close on the 31st March, 30th June, 30th
September and 31st December respectively.
The Reinsurer shall confirm the accounts within fifteen days of receipt and the balances
on either side shall be paid within fifteen days after receipt of such confirmation.‖
6. Commission and Profit Commission
The Reinsurer shall pay to the Company a commission as specified in the Schedule
upon the net premiums (gross premiums less returns and cancellations) together with
an additional commission, as specified in the Schedule, on the profits derived from this
Agreement and computed at the 31st December in each year as follows:
Income
1. Premium reserve for previous year
2. Losses outstanding for previous year
3. Net premiums for the current year
182
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
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.
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 If during the period of this Agreement, postal and/or telegraphic communications

should be rendered impossible as a consequence of war, warlike operations,
blockade, revolution, civil war or other similar event for a period exceeding thirty 
(30) days, the Company shall be entitled to terminate this Agreement forthwith
without giving notice.
Either party shall have the right to terminate this Agreement immediately by
giving the other party notice:
 If the performance of the whole or any part of this Agreement be prohibited or
rendered impossible de jure or de facto in particular and without prejudice to the
generality of the preceding words in consequence of any law or regulation
which is or shall be in force in any country or territory or if any law or regulation
shall prevent directly or indirectly the remittance of any or all or any part of the
balance or payments due to or from either party. 

 If the other party has become insolvent or unable to pay its debts or has lost the
whole or any part of its paid up capital or has had any authority to transact any
class of insurance withdrawn or cancelled or suspended or made conditional. 

 If there is any material change in the ownership or control of the other party. 

 If the country or the territory in which the other party resides has its head office or is
incorporated shall be involved in armed hostilities with any other country whether
war be declared or not or is partly or wholly occupied by another power. 

 If the other party shall have failed to comply with any of the terms and
conditions of this Agreement. 
During the term of a notice of cancellation and until its expiry the reinsurers shall
accept new cessions and renew existing cessions in the same manner and in all
respects as if no such notice has been given.‖
Non-Proportional Contract Clauses
Some typical wordings are given below:
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.
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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.
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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
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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. 
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 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
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.
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CHAPTER – 5
REINSURANCE ACCOUNTING
AND FINANCIALS
 Reinsurance Accounting and Financials 

 Special Nature of Reinsurance Accounts 

 Main Types of Reinsurance Arrangements 

 Closing of Annual Accounts 
 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
reinsurance techniques must be understood and appreciated with reference to the

class of business, the type or combination of types of reinsurance methods used
and the forms of arrangements as placed directly or through brokers. Legal issues
and tax matters are significant to reinsurance accounting. Mind-blowing perils like
natural perils such as devastating floods, chilling windstorms and life shattering
earthquakes became insurable because of sharing of risk through reinsurance. It is
not profit or earnings that can count in these risks since one loss in 25 to 30 years
can wipe out the entire profits accumulated over a period of time. It is reinsurance
that is so special to motivate insurers to venture into these kinds of businesses.
A long-standing relationship with the reinsurer can be maintained only if proper
accounts are rendered by the ceding company. The actual must be reconciled with
past trends for renewal of the reinsurance business.
MAIN TYPES OF REINSURANCE ARRANGEMENTS
Proportional Treaty Accounts
Most of the present day treaties are ‗blind‘ – meaning thereby that the ceding company
supplies no details of individual cessions to the reinsurer. The reinsurer receives
quarterly or periodical accounts that give details about the premium, claims etc., There
is no standard format of the treaty contract. A specimen is given below:
The first step in reinsurance accounts is preparation of treaty accounts.
Ceding Company : ABC insurance Company
Treaty : First Surplus Fire Treaty
Period : 1st Quarter 2008
Reinsurer : XYZ Reinsurance Ltd.
Reinsurer‘s share : 1% Currency US$
100% account Debit Credit
Premiums 60000
Portfolio premium entry at 1-1-2008 70000
Portfolio loss entry at 1-1-2008 24000
Commission at 45% 27000
Taxes and Charges 1800
Excess of loss premium 450
for common account @ .75%
Claims paid 35000
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Reinsurance Accounting and financials
Common account excess of

Loss recoveries 0
Premium reserve retained @40% 24000
Premium reserve released 0
Interest on reserve released 0
Tax deducted on interest 0
Credit for cash loss paid 2000
Balance due to reinsurers 67750
Total 156000 156000
Balance due to XYZ Reinsurance Co. Ltd. @1% 677.50
Some ceding insurers divide the account into two parts- the first part called the
technical account showing items relating to the reinsurer‘s share of the technical
result for the period and the second part called the financial account which include
the balance brought forward from previous account, premium and loss reserves and
interest thereon, loss settlements made, cash loss credit and the final balance
which is due for settlement. It is not necessary that all the items appearing in the
above specimen should appear in the account for each accounting period. For
example, portfolio premium and loss entries will appear in the first quarter‘s account
and portfolio premium and loss withdrawals in the last quarter account.
Premiums
The premium may change according to local practice, the terms of contract or the class
of business. In some markets gross premium may be subject to deduction of such items
as license fees, fire brigade charges, local taxes etc., while in some other cases it may
be separately accounted. With marine and aviation business, it is usual for premiums to
be accounted net of original acquisition costs and therefore only subject to a relatively
low reinsurance overriding commission. Provision is made for payment of a minimum
and deposit premium based upon an estimated total net premium and the deposit
premium will be subject to an adjustment premium when the ceding insurer‘s final
premium income becomes known. The deposit premium is usually paid in quarterly
installments. It can also be paid annually in advance.
Brokerage
Where a reinsurer receives a share of a treaty through a broker, he will normally agree
to pay brokerage. The broker will either include his brokerage in the actual statement of
account for the business or render a separate statement for brokerage due. The
percentage of brokerage payable is applied to the premiums written on a gross, net or
partial net basis and this must be clearly stipulated in the treaty agreement.
193
Non-proportional Treaty Accounts

The requirements for preparation of accounts under non-proportional treaties vary
from proportional treaties and simple in nature. Losses are usually dealt with on a
cash loss basis and are payable by individual reinsurers upon the rendering of
appropriate information by the ceding insurer. Therefore accounts under non-
proportional treaties are substantially in respect of premiums. They are not subject
to premium or claim reserves or profit commission.
Premium
The premiums to be paid by cedent to reinsurer is based on the rate specified in the
contract and the rate will be applied to the ceding insurer‘s total net premium after
ceding to proportional reinsurances.
Example:
From: Broker
Reassured: ABC Insurance Co.
Ltd. Fire Excess of Loss Cover
2004 10,000,000 XS 5,000,000
The following premium will be credited in your books. Please make necessary
entries in your books.
Currency: U.S. $
Minimum & Deposit Premium 2007 300,000
Less: Brokerage @10% 30,000
270,000
Payable in 4 Equal installments of 67,500
On 1st January, 2007
On 1st April, 2007
On 1st July, 2007
On 1st October, 2007
Your 10% share amounts to 6750
Payable in 4 equal installments of 1687.50
194
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
Calculate Profit Commission
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
Closing Proportional Treaty Accounts

A reinsurer finds a major problem with preparation and rendering of proportional treaty
accounts by insurers to reinsurer. It consequently leads to problems of ascertainment of
profit or loss on each of its acceptances at the end of the financial year. Certain classes
of business such as marine, motor and other liability business with a long tail present
problems in estimating outstanding provisions for claims. Thus only two quarters
premiums and claims may be advised and accounted for in the books of reinsurer for a
particular year and the remaining two quarters would get accounted in the following
year. Therefore, it may not be possible to match the accounted figures with the treaty
year results. But over a period, these two sets of figures should match with each other,
unless outstanding claims provisions made in the books of the reinsurer are
substantially different from the actual outstanding claims.
Closing Non-proportional Treaty Accounts
The treaty year is the same as the reinsurer‘s accounting year in case of non-proportional
accounts. The main problem with this is the long duration of claims reporting with eventual
cost of claims not being known for many years. Many reinsurers overseas operate their
non–proportional account on funded basis to overcome the above problem. Each year the
fund is examined to ensure its adequacy with regard to outstanding claims.
Any deficit arising in the fund must be replaced by a transfer from revenue reserves.
In assessing surplus, each treaty year would normally be assessed after three
years, and any surplus arising then would be transferred to revenue reserves. A
surplus is not normally removed from a fund until three years after the year to which
it relates, since there would be inadequate information available before the
expiration of three years.
Closing of Annual Accounts
Every insurance company while closing its annual accounts at the end of the year
examines all claims outstanding with respect to inward treaties in the books in order
to make a reasonable estimate for provisions to be made in the revenue account so
that it can present as accurate as possible. Based on the estimates made for gross
claims, the company will work out the outstanding claims position in respect of its
various outgoing treaties, which will be included in the annual accounts as well as
advise to the respective reinsurers.
197
? 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

 Reinsurance Administration 

 Claims Settlement 

 Claims Reporting and Claim Reserving 

 Claim Developmental Analysis 
 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
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
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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
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.
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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

 Reinsurance Markets 

 Reinsurance Brokers 

 Global Reinsurance Markets 

 Regional Reinsurance Corporation 

 Indian Reinsurance Market 

 Role of Captives 
 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
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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
GLOBAL REINSURANCE MARKETS

Now the reinsurance markets are able to penetrate much faster across the world
and new markets are emerging with the advancement of technology and availability
of Internet. In fact even the US insurers buy more than half of their reinsurance
requirements from non-admitted alien reinsurers, who are located in many countries
of the world, including Russia and China. However, Britain, Bermuda and
Switzerland together account for the largest share. The reinsurance industry all
over the world generates approximately $150 billion in ceded premiums. More than
75 percent of the ceded premiums originate from North America and Western
Europe. The North American market represents the largest single source providing
more than 50 percent of the total. Asian market is a follower of trends and attitudes
developed in advanced countries. Regional integration worked well in Europe.
However, integration has yet to take shape in Asia.
Almost all global and regional reinsures of the west got impacted on account of
WTC attack losses, which were estimated at around $ 80 billion.
In the world of reinsurance, it would be interesting to observe at global level, two
reinsurance companies namely Munich Re (Germany based) and Swiss Re
(Switzerland based), which have more than a century of history of operations to
their credit, have developed phenomenally.
MUNICH RE: The business generated by this company is dependant on the
domestic insurance sector and most of its business is generated internally from the
German market. The focus has slowly shifted to outside markets after exploiting the
German markets to the full extent.
SWISS RE: It occupies a prominent position in the Swiss insurance market and is very
popular name in the world of insurance. It is one of the oldest reinsurance firms in the
world. Since the Swiss market is of small size, the business generated by this company
depends to a certain extent on the domestic markets and the rest is generated from the
international markets. As an international player it has withstood the intense competition
in the field and expanded across the global markets.
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Reinsurance Market
The following exhibit shows the world‘s 20 largest reinsurers, ranked by

consolidated gross premium written in 2006.
Insurance Company Company at Domicile

Swiss Re Switzerland
Munich Re Germany
Berkshire Hathaway Group United States
Hannover Re Germany
Lloyds of London United Kingdom
RGA Reinsurance Co. United States
Everest Re Group United States
Transatlantic Hlds Inc Group United States
Scor Group France
Partner Re Group France
XL Capital United States
Korean Reinsurance Co. Korea
London Reinsurance Co. United Kingdom
Assicurazioni Generali SpA Italy
Odyssey Re Group United States
Scottish Re Bermuda
Mapfre Spain
Aegon Netherlands
Converium Group Switzerland
Renaisance Re Bermuda
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
The London Market

The reinsurance market in London consists of the Lloyd‘s, other reinsurers in
London, Direct insurers accepting inward reinsurance business, underwriting
agents and brokers writing reinsurance on behalf of other insurers, and contact
offices writing business for overseas insurers for placement in the London market.
Of late, there has been a marked trend in the formation and development of Regional
and State Reinsurance Corporations such as Caisse Centrale De Reassurance in
France, the Instituto Nationale de Assicurazioni in Italy and the Asian Re in Bangkok.
CONSTITUENTS OF A REINSURANCE MARKET
1. Insurers (Reinsured)
2. Reinsurance Brokers
3. Reinsurers – Reinsurance Reinsurer (Retrocedant)
4. Reinsurer of Reinsurer (Retrocessoionaire) – Retrocession
5. The Arbitration Factor
6. Infrastructure Facilities
7. Domestic Markets
8. The Location Advantage
9. The Role of Foreign Reinsurers
Several factors characterize advanced reinsurance markets in the world. Let us
discuss some of the main features:
Stability factor
The performance of reinsurers depends on many factors such as economic, social
and political stability. If the economy is turbulent, then there will be an adverse
affect on the performance of reinsurance companies. There should also be a
consistency not only in regulatory environment but also in legal environment so that
it would be helpful for the augmentation of the reinsurance market.
As reinsurance is not a daily business, both the parties to the reinsurance contract
should be sure that the market remains stable and they are not affected by the
changes in the market.
Availability of Knowledge Capital
For the reinsurance market to be thriving, there should be personnel with widespread
knowledge about the industry. Tasks, like underwriting which the reinsurer has to take
on, depend upon the proficient knowledge of the staff possess.
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Reinsurance Market
Matured Financial Markets

The scope for the reinsurers to raise the required resources depends upon the
maturity of the country‘s financial markets. If the financial markets are matured,
then reinsurance markets will be very much benefited. The reinsurers can easily
access the market and can maintain their business.
The Role of Economy
The economies, which have high inflation, are not favored as it adversely affects
the reinsurer‘s costs like staffing cost etc. Reinsurers are prone to setting up their
shops in a steady market.
The Arbitration Factor
In reinsurance if any dispute arises then it is referred to arbitration. If the market
provides good arbitration facilities with appropriate legal framework, then the
disputes between the parties can be settled easily. Hence, arbitration plays a very
significant role in the development of reinsurance industry.
Infrastructure Facilities
As reinsurance is a global industry and reinsurance players are from developed
countries, the markets should have excellent infrastructure facilities.
Domestic Markets
If the insurance players generate good business in the domestic market reinsurers
will be interested in expanding their operation. And domestic insurers will get
competitive terms for their placement. Professional reinsurers are normally
interested in developing insurance in underdeveloped countries if the legal system
and regulatory environment is not adverse.
Locational Advantage
Location plays a very important role in case of reinsurance business. If the country
has well-developed reinsurance market, then reinsurance business can be
expanded to the countries that are less developed.
Role of Foreign Reinsurers
If there are foreign players in the reinsurance market then it would be helpful for the
domestic players in that they would have better knowledge of various techniques
like underwriting, marketing etc. of the foreign players. This would lead to the
development of the domestic reinsurance industry.
209
REGIONAL REINSURANCE CORPORATION

To take care of domestic needs, two reinsurance corporations were formed in the
country, which would be helpful for the growth of the domestic reinsurance industry.
They are:
1. State Reinsurance Corporation
2. Regional Reinsurance Corporation
The setting up of a Regional Reinsurance Corporation is equally important as setting up
of a State Reinsurance Corporation, since the regional Reinsurance Corporation is set
up based on the geographical factor. Generally, a regional reinsurance corporation
caters to the needs arising among a group of neighboring countries. These corporations
were proposed to be set up across the different developing nations of the world. For
example one such corporation is the Asian Reinsurance Corporation, set up in
Bangkok. The major participants of this corporation are India, China, Bhutan, Thailand,
Philippines, Afghanistan, South Korea, Bangladesh and Sri Lanka.
The setting up of a regional reinsurance corporation mainly depends on certain
common features, which the member countries must have due to the binding proximity
with or to each other. The common features of these countries are as follows:
1. Common physical boundaries among the member countries.
2. Well-developed communication between member countries.
3. Well-developed economic trade ties between member countries, leading to
free flow of trade.
4. Common customs, ethnic identity and language.
The regional reinsurance corporations have the liberty to choose their own market
place to locate their headquarters. The setting up of headquarters depends largely
on factors such as well-developed accessibility, excellent communication facilities,
well-established commercial backup etc. The backing of good banking system will
enable the corporation to have smooth functioning.
The regional reinsurance corporations end up with a good business in hand by
involving compulsory cessions from its members. On the other hand, the
corporations can get exposed to risks arising from member nations. In order to
avoid such happenings they get protection through retrocession covers from other
markets. The regional reinsurance corporations manage their portfolio, which is
spread over different countries through various retrocession covers, which are:
 Proportional covers 

 Non-proportional covers 

 By trading outward covers through traders and generating inward covers. 
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Reinsurance Market
 Non-reciprocal inward reinsurance accounts, a part of which may be retroceded

back to the member nations. 
Under the regional reinsurance corporations reinsurance cover may be issued to
the domestic company too.
Characteristics of a regional reinsurance corporation
The two main characteristics of a regional reinsurance corporation are:
1. The company is owned through a non-insurance business group with
common interest. The interest may be of a single – parent shareholder or a
group of shareholders.
2. As the name goes all the risks written are ‗captive‘. The risks are somehow related to
the shareholders or to the third party risk which the shareholders control.
INDIAN REINSURANCE MARKET

In India prior to nationalization, there were 44 foreign insurers and 63 domestic
companies operating. As there was no reinsurance market in India they used to
access the international reinsurance industry for their reinsurance needs.
After nationalization of the insurance industry, five companies started taking care of
the general insurance needs. They are:
1. General Insurance Corporation of India
2. National Insurance Company Limited
3. The New India Assurance Company Limited
4. Oriental Insurance Company Limited
5. United India insurance company Limited
General Insurance Corporation of India (GIC) (with its subsidiaries) has been the
erstwhile monarch of non-life insurance for almost three decades. After the change
in the role as ‗national reinsurer (National Re), the GIC delinked its subsidiaries and
entry of foreign players through joint ventures have changed the outlook of the
whole general insurance industry in India.
Prior to nationalization, there were 55 non-life domestic insurers and each company
had its own reinsurance arrangement. After nationalization, all these companies
were brought under the aegis of GIC and four subsidiaries were formed, with GIC
as holding company. There was a huge jump in the Indian reinsurance market and
GIC became the ‗National Reinsurer‘.
GIC undertakes both domestic reinsurance and international reinsurance. Domestic
reinsurance is provided to the direct general insurance companies in the domestic
211
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
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Reinsurance Market
the additional facilities to insurers besides managing obligatory cessions by

participating in a) companies surplus treaties; b) market surplus treaties; and c)
facultative acceptances protecting their net account through excess of loss
arrangements. GIC as a member of the Federation of Asian Insurers and
Reinsurers (FAIR) Pool is able to extend additional facilities in the Indian market.
CAPTIVE INSURANCE COMPANIES
Captive insurers operate from such tax havens as Bermuda, catering to the reinsurance
requirements of parent companies situated in Europe, America and elsewhere.
The insurance companies formed by large commercial or industrial establishments,
essentially to take care of their own insurance needs, are called captives. These
captives play a major role in fulfilling the insurance needs of the parent companies
and help the money flow inside the periphery of the business group. The captives
form their bases in places where the investors are given tax concessions by the
local governments. There are over 4000 captive insurers operating world-wide with
nearly 35% of them located in tax havens like Bermuda, Luxembourg, Guernsey,
Cayman Islands, Bahamas, Hawaii, Isle of Man, Barbados, Dublin, Vermont,
Singapore and other locations.
The captives were established since 1960‘s but there was good development since
a decade ago.
A captive insurance company normally provides coverage at a lower cost compared
to the companies in insurance industry generally. The stocks controlled by the
company depend on either one interest or a group of interests covered related to
the business operations. The captive insurance company can be a non-resident,
non-admitted or a foreign insurer.
Types of captives
The various kinds of captives can be branched out as follows:
Single Parent Captives
Single parent captives are also called ‗pure‘ captives. These provide coverage to
single owners who hold the company. A risk manager or finance officer at the
parent company monitors them.
Association captives
An established association generally forms this kind of captive. The coverage is
provided to its members. In this the ownership vests with the association or the
individual members. The financial expert at the association level looks after the
operation or this responsibility is outsourced to a management company, consultant
or a broker.
213
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. 
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Reinsurance Market
 Availability of incentives for loss control. 

The captives adopt their own methods in order to protect their business exposures.
 They generally retain smaller losses in their own account and they reach out for
excess of loss exposure in cases of larger loss exposures. 

 In order to spread their portfolio in a better way, they write inward reinsurance
business. 

 There is a reinsurance pool organized for their clients. 

 There is also a reciprocal and non-reciprocal reinsurance arrangement. 
? 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

 Inward Reinsurance 

 Objectives 

 Business Strategy 

 Retrocession Arrangements 

 Reciprocal Trading 
 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.
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Inward reinsurance
OBJECTIVES of inward reinsurance

Any reinsurance company would, in addition to ceding their business, also accept
some reinsurance business. Some of the reasons why companies go for inward
reinsurance are as follows:
 To increase the gross premium and net retained premium 

 To achieve a lower expense ratio by maintaining the volume of premium income
as ceding reduces the premium income 

 To obtain a better and wider spread of business 

 To counteract the drain of foreign exchange caused by ceding of premium 

 To earn an investment income which may be derived from the cash flow. 
After examining all the pros and cons a company has to devise an appropriate
corporate strategy for its underwriting policy. It can write lines for its net account or
it can write larger shares and create a retrocession treaty to take care of the surplus
over its net retention.
Some considerations the company should keep in mind while finalizing its inward
insurance programme for the year are as follows:
 Treaty or facultative: Facultative involves more administrative work as each
offer will be scrutinized. Treaty is less expensive but it requires a thorough
knowledge of the market and treaty clauses. 

 Territorial scope: If the company wants a greater geographical spread then it
should underwrite foreign business keeping in view the political and economic
conditions of the country. 

 Direct or brokers: If the company has experienced staff direct business can be
solicited. However, this will involve travel expenses to procure business. So
initially it is better to place business through a broker. 

 Class of business: The company should decide whether it wants to underwrite
property business, which is on an annual basis, or casualty business. 

 Acceptance limits: Keeping in mind the financial standing and premium income
of the company, the acceptance limit should be large enough to make it
attractive for the brokers and ceding companies to offer business. 

 Finally, IRDA has brought in certain norms for acceptance of inward business,
which have to be adhered to while designing the inward programme. 
217
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
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

 Reinsurance Practice 

 Setting Retention 

 Setting Reinsurance Limits 

 Cost of Reinsurance 

 Reinsurance Negotiations 

 Reinsurance Commissions 

 Designing and Arranging of a Reinsurance Program 
 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
The primary insurers benefit from a well-planned and well-executed reinsurance

program in more ways than one. Reinsurance helps stabilize loss experience,
provide capacity and provide surplus for growth. Reinsurance is especially useful in
financing catastrophic losses. A good reinsurance program can only be executed
with assistance from reinsurers, brokers and consultants. A reinsurance plan must
take into account the primary insurer‘s needs and be based on a thorough
understanding of the reinsurance market. By the primary insurer‘s needs, we mean
how much large line capacity is desired, how much stability of losses is expected,
or in other words, what is the variance in expected losses and how much surplus
relief is needed. There are two considerations to be taken:
 Firstly, the primary insurers must continue to be solvent, and 

 Secondly, primary insurers must be able to pursue the future growth plans. 
The management‘s attitude to the stability of losses must be considered. For
example, in the case of mutual insurers, the policyholders may be prepared to
accept lower short-term profits and hence greater loss ratio volatility than stock
insurers. While the reinsurers look at the underwriting profit, the primary insurer
must also consider the stability of investment profit when designing the reinsurance
program since that would make variations in underwriting results more acceptable.
In practice, most primary insurers try to be specific in fixing their goals. Such goals
might include, say,
 Not allowing increase in the net loss ratio to exceed five percentage points on
account of catastrophic losses: 

 Providing a single risk capacity of at least Rs.10 billion for commercial property
insurance and Rs.5 billion for commercial liability insurance, and 

 Automatic treaties or increase the surplus by Rs.5 billion. 
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
Kinds of Insurance Written

Based on the insurance written by the primary insurer, it is possible to gauge the
stability of loss frequency and of loss severity. In practice, there cannot be a
specific type of reinsurance that tackles the impact of loss frequency. On the other
hand, having an aggregate excess treaty (since it puts a cap on the primary
insurer‘s loss ratio) can reduce the impact of severe losses. However for large
individual losses, both surplus and per risk excess treaties are effective.
Exposures subject to catastrophic loss: The primary insurer must assess the
history of catastrophic losses both in terms of individual natural disasters and in
terms of geographical distribution of its insured properties. Usually, however,
reinsurers themselves have such historical records and are in a better position to
price reinsurance for different primary insurers.
Volume of Insurance written: If the primary insurer has written a large volume of
business, then the Probable Maximum Loss (PML) is predictable with some
accuracy since the law of large numbers will operate. However, this is a gamble
since the law of large numbers is inapplicable in the case of catastrophes.
Available Financial Resources: There are two possible scenarios. In the first, the
primary insurer with a weak surplus position needs a highly stable net loss ratio and
might require the use of pro-rata reinsurance to provide surplus relief. On the
contrary, the primary insurer with a very strong surplus position can risk a more
volatile net loss ratio. However, the quality of the surplus as indicated by the
invested assets is also important.
Stability and Liquidity of Investment Portfolio: This is an every day investment
consideration since investment of funds must also consider the need for liquidity at
short notice; that means, investment must be in readily marketable securities.
Besides, since return is not a more important consideration than liquidity,
investment must not be in shares or stocks with wide fluctuations in the short term.
Growth Plans: A rapidly growing insurer needs surplus relief more than an insurer
with less rapid growth. In this process, many profitable lines will be ceded to
reinsurer in the short run but that is a strategy for surviving in the long run while
achieving the growth potential.
SETTING RETENTIONS
The choice of retention depends on the type of treaty, which, in turn, depends on
the needs of the primary insurer. The setting of retention varies depending on the
type of treaty. In other words, the basic reason for choosing one type of treaty in
preference to another is supported by the following example. For example, if the
primary insurer prefers a pro-rata treaty when compared to an excess treaty the
reason could be that a pro-rata treaty provides surplus relief. Therefore, the
important factor in the setting of retention must be the amount of relief needed.
223
The amount of surplus relief received will be a function of the percentage of

premiums ceded and the percentage ceding commission received.
On the other hand, the principal purpose of an excess of loss treaty is to stabilize loss
exposures, besides providing large-line capacity. It may be seen readily that providing
large-line capacity is a function of treaty limit rather than the retention. Therefore, the
true consideration in setting the retention of an excess of loss treaty is the size of loss
the primary insurer can absorb without affecting the policyholder‘s surplus or the net
loss ratio. That amount, in turn, is a function of the premium volume and the
policyholder‘s surplus of the primary insurers. It is logical that the primary insurer should
retain that part of its aggregate losses that is reasonably stable and predictable and
should cede that part that is not reasonably stable. Losses are stable and predictable
when the maximum probable variation is not likely to affect the insurer‘s loss ratio or
surplus beyond expectations and hence unacceptable to the management. Hence,
retention is related first to the frequency of losses and secondly to the probability of a
very large loss occurring. In all these calculations, the cost of reinsurance and the role
of reinsurers in setting retentions cannot also be overlooked. For example, reinsurers
sometimes insist on a lower retention than what is designed by the primary insurer.
Retention also depends on the number of treaties the primary insurer may carry.
SETTING REINSURANCE LIMITS
There should be fairly high limits to cover a good majority of the loss exposures and the
limits must be considered along with retention. Large limits are sought especially in pro-
rata and per risk or per policy excess treaties. Setting the reinsurance limits depends on
cost considerations since reinsurance costs increase in direct proportion to reinsurance
limits, keeping the retention constant. However, the treaty reinsurance costs must be
weighed against other recurring costs in facultative placements such as the premium,
administrative expense and inconvenience and uncertainty associated with facultative
reinsurance. However, while setting the reinsurance limits only the volume of the
premium is considered and not the premium loading.
Limit Setting for a Catastrophe treaty is even more difficult in practice since one cannot
predict a large loss merely based on historical records. Therefore, in reinsuring
catastrophes, concentration of loss exposures must be carefully analyzed.
In the case of aggregate excess treaty, the reinsurance limit must be set at an
amount adequate to cover the higher loss ratio that the primary insurer may expect
to sustain, but the reinsurance premium for such a limit must be acceptable.
To estimate a large loss in future is not easy. However, there will be greater variation in
loss ratios for a property insurer than for a liability insurer and it is clear that the
variance in the loss ratios is, in part, a function of the lines of insurance written.
It is also understood that there will be greater variation in loss ratios for a similar
insurance with a lower premium volume. Similarly, a primary insurer who is having a
224
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
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
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
DESIGNING OF AND ARRANGING A

REINSURANCE PROGRAM
Both the parties to the contract should have a proper understanding regarding underwriting
of business. The insurer needs thorough knowledge about the reinsurance and also the
insurer should design a reinsurance plan for his business. Therefore, the insurer as well the
reinsurer while considering large business, should know the following:
1. Sources of business.
2. Different classes of reinsurance or insurance.
3. Geographical distribution of business.
4. Identification of exposures.
1. Sources of Business
A reinsurer should identify the areas where he can get business. Reinsurer can
acquire his business from different sources such as
1. Domestic Direct Insurance Companies
2. Foreign Direct Insurance Companies
In case of domestic direct insurance business, foreign exchange will not have any
effect on the business. Acquisition costs are low in this type of company .It can also
be easily manageable.
In case of foreign direct insurance business acquisition costs are high; maintenance
costs are also high. It is difficult to adapt to different market situations prevailing in
different countries.
2. Classes of Reinsurance
As the characteristics of different classes of reinsurance vary, necessary study
must be done. The type of reinsurance required for the insurer depends upon the
exposures involved. The reinsurance program should be prearranged for each
class of insurance separately.
3. Geographical distribution of business
Since the risk factors affecting the loss experience vary for every region. The
results will be more stable if the portfolio is distributed broadly. There will be growth
in business if the economy is growing steadily.
4. Identification of Exposures
While designing a reinsurance program, risks that are involved in a portfolio should be
studied. This helps the reinsurer in building risk profile. The major factor in deciding
228
retention is the underwriting criteria, which are applicable to a particular class of

business.
The company should protect its retained portfolio of business so that the
underwriter can distribute his acceptances to the company‘s reinsurance protection.
REVIEWING A PROGRAM
Reinsurance companies should review their reinsurance program to approve
changes in the type of business, inflation, regulation, loss experience etc.
Review program for non-proportional contracts are generally done annually.
In case of proportional contracts, review or renewal starts earlier and should
consider the following while reviewing its reinsurance business.
1. When to change a reinsurer?
2. Changes in underwriting the policy and its business.
To decide whether to continue with the existing reinsurer the following should be
given utmost importance:
 Technical competence 

 Reputation 

 Financial strength 

 Long-term relationship with the company (can be obtained by continuing with
one reinsurer) 

 Adequate reinsurance protection must be given by the company 
Indian Reinsurance Program

As outlined earlier, following are the objectives of the common reinsurance
program, which was in effect from 1973:
1. Maximize retention within the country.
2. Develop adequate capacity.
3. Secure the best possible protection for the reinsurance costs incurred.
4. Simplify the administration of business.
Both the parties should take into account all the above factors while designing a
reinsurance programme.
229
Given below is a case study of a small insurance company.

Name: Mumbai Insurance Co. Ltd.
Authorised Capital: Rs. 100 crores
Paid up Capital: Rs. 25 crores
Commencement of Operations : 1st April, 2001
Business operations : Initially the company wants to write Fire business
only in Mumbai. Later on it plans to expand its
operations to other classes and other areas of
Maharashtra.
Underwriting guidelines:
Fire: Type of Business accepted – private dwellings,
office premises, retail outlets, wholesale outlets
and non-hazardous mfg business.
Sum Insured : not more than Rs.10 crores.
Construction, coverage & rates as per Indian tariff.
Projected Gross premium Income
Year Premium Rs. (crores)
2001-02 17.50
2002-03 40.00
2003-04 60.00
2004-05 80.00
2005-06 100.00
Design a reinsurance programme for the company for the year 2001.
Solution: This involves:
1. Fixing the net retention per policy/risk for the company.
2. Choosing the right method of insurance for the company and fixing the limits.
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
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
? 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
1. A primary insurer – Prose covers an insurance risk of Rs. 500 lakh.

Prose retains 10% of the risk to retention and cedes the balance 90% to
X Reinsurers and X in turn retrocedes 50% of his acceptance (45% of
100%) to Y. Calculate the net claim of each assuming that a claim has
been reported for Rs. 50 lakhs.
Solution:
Prose:
Total claims : 50,00,000
Less: recoverable from reinsurer : 45,00,000
--------------
Net claim 5,00,000
---------------
X Reinsurer:
Share of claim from Prose : 45,00,000
Less: recoverable from retrocessionaire : 22,50,000
--------------
22,50,000
--------------
Y Retrocessionaire:
Share of loss from X : 22,50,000
2. A pru life company keeps the first Rs. 2,00,000 of each claim and cedes
the next 5,00,000 to the reinsurer.
 Calculate the cedent‟s retention and ceding amount on a policy of Rs.
4,00,000. 

 Calculate the retention and ceding amounts on a Rs. 5,00,000
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
3. Prudential insurance was reinsured by swarn reinsurance. The contract

consisted of five surplus lines of each Rs. 2 million. The retention of
prudential insurance is Rs. 2 million. The risk written and the sum
insured by prudential insurance were as follows:
Risk sum insured
1 Rs.15,000,000
2 Rs.12,000,000
3 Rs.30,000,000
4 Rs.18,000,000
5 Rs.25,000,000
Calculate the shares of both the prudential insurance and swarn
reinsurance. Solution:
Risk Sum insured Retention Percentage Reinsurers Percentage
amount [%] amount [%]
1 Rs.15,000,000 Rs. 2,000,000 13.33 Rs.13,000,000 86.67
2 Rs.12,000,000 Rs. 2,000,000 16.67 Rs. 10,000,000 83.33
3 Rs.30,000,000 Rs. 2,000,000 6.67 Rs. 28,000,000 93.33
4 Rs.18,000,000 Rs. 2,000,000 11.11 Rs.16,000,000 88.89
5 Rs.25,000,000 Rs. 2,000,000 8 Rs.23,000,000 92
4. Shah insurance entered into a contract with the Brit Reinsurance
Company. The reinsurance arranged was for Rs. 13,00,000 in excess of
Rs. 3,00,000 per risk. The claims received were as follows:
Claim Amount of claim
1 Rs. 3,00,000
2 Rs.10,00,000
3 Rs.14,00,000
4 Rs.11,00,000
Calculate the retention by shah insurance company.
Calculate the recovery from Brit Reinsurance Company.
234
Solution:
Claim Payment to Retention Recovery from Brit

insured [Rs.] amount [Rs.] reinsurance [Rs.]
1 3,00,000 3,00,000 Nil
2 10,00,000 3,00,000 7,00,000
3 14,00,000 3,00,000 11,00,000
4 11,00,000 3,00,000 8,00,000
5. The Stag insurance company entered into a reinsurance contract with

the Delite Reinsurance Company regarding the commercial property
reinsurance. The insurer enters into a ten-line surplus treaty. The
company also retains up to the following:
Offices Rs. 5,00,000
Retail outlets Rs. 6,00,000
Warehouses Rs. 7,00,000
Factories Rs. 4,00,000
Miscellaneous Rs. 3,00,000
Calculate the maximum coverage under the
reinsurance. Solution:
The maximum coverage under the treaty is as follows:
Particulars Retention [Rs.] Ten-line surplus limit. [Rs.]

Offices 5,00,000 50,00,000
Retail outlet 6,00,000 60,00,000
Warehouses 7,00,000 70,00,000
Factories 4,00,000 40,00,000
Miscellaneous 3,00,000 30,00,000
235
6. The „Time‟ insurers are retaining the following amounts in commercial

property account and enter a five-line first surplus treaty and six-line
second surplus treaty. The company‟s retention is Rs. 2,00,00,000 on
any risk. The sum insured is given as follows:
Risk sum insured [Rs.]
1 8,00,00,000
2 7,00,00,000
3 10,00,00,000
4 15,00,00,000
5 12,00,00,000
Solution:
Risk Sum insured Company‟s First surplus Second surplus
[Rs.] retention [Rs.] treaty share [Rs.] treaty share [Rs.]
1 8,00,00,000 2,00,00,000 60000000 Nil
2 7,00,00,000 2,00,00,000 50000000 Nil
3 10,00,00,000 2,00,00,000 80000000
4 15,00,00,000 2,00,00,000 100000000 30000000
5 12,00,00,000 2,00,00,000 100000000 Nil
7. The people‟s insurance company underwrites its fire business on PML
basis. Find how a risk with the sum insured of Rs. 1100 crores is placed
on the following reinsurance facilities. The risk engineers have assessed
the PML of the risk as Rs.110 crores (10%).
Maximum retention Rs.3 crores regardless of the risk
First surplus treaty 20 lines with a maximum limit of 30 crore PML
Second surplus treaty 40 lines of Rs. 50 crores PML
Third surplus treaty 10 lines with a limit of 10 crore PML
Solution:
PML = Rs. 110 crores
Net retention = Rs. 3 crores PML
First surplus treaty = Rs. 30 crores PML
Second surplus treaty = Rs. 50 crores PML
Third surplus treaty = Rs. 10 crore PML
The balance i.e. the facultative reinsurance = Rs. 17 crores PML
236
8. The Stump insurance company has a gross retention of Rs. 50,00,000

including 50% of quota share treaty and a 10 line surplus treaty. The
balance will be placed on facultative terms. Assuming that the company
has accepted a risk of Rs.10,00,00,000 and the risk suffered a loss of
Rs.1,20,00,000, allocate the loss to the reinsurer.
Solution:
Reinsurance distribution:
(Rs.)
Net retention - (2.50%) - 25,00,000
QST - (2.50%) - 25,00,000
Surplus Treaty - 10 lines (25%) - 2,50,00,000
FAC (70%) - 7,00,00,000
-----------------
10,00,00,000
Allocation of Loss:
Loss amount – Rs.1,20,00,000
(Rs.)
Net retention - (2.50%) - 3,00,000
QST - (2.50%) - 3,00,000
Surplus Treaty - (25.00%) - 30,00,000
Facultative - (70.00%) - 84,00,000
------------------
1,20,00,000
------------------
9. Pallavi insurance company has taken an excess of loss cover from Ram
reinsurance company paying 30,00,000 excess of 20,00,000 with a provision
for two reinstatements at 60% of final earned premium. A loss occurred and
the cover should entail a recovery of 100,000. Calculate the reinstatement
premium payable to the reinsurers. Earned premium is 80000 for the year.
Solution:
100,000
——————— * 80,000 * 60/100 = 1,600
30,00,000
237
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:
Claim Payment to Retained by Recovery from

insured ceding company excess of
loss Reinsurers
1 1,00,000 1,00,000 nil
2 2,00,000 1,00,000 1,00,000
3 3,30,000 1,00,000 + 30,000 2,00,000
Will the reinsurer pay for all the claims, if claims payment is -100000, 200000,
330000?
Solution:
As the recovery from the reinsurers is limited to Rs. 2,00,000 per risk, so for claim 3
the ceding company will retain the balance 30,000. So the ceding company‘s net
retained loss will be Rs. 1,30,000 in case of claim 3.
In this case there is inadequate protection due to incorrect estimation of the
exposure per event.
11. In an excess of loss cover, the rate is 100/60th of the average burning cost of
incurred claims for the current and previous years, subject to a minimum rate
of 3% and a maximum rate of 7%. Rate to be applied on GNPI. Calculate the
premium for the year 1991.
Year gnPI Incurred losses to cover
1989 4,00,000 20,000
1990 8,00,000 30,000
1991 10,00,000 15,000
22,00,000 55,000
Solution:
55,000
Burning cost = ——————— * 100 = 2.5%
22,00,000
Rate = 2.5 * 100/60 = 4.167%
238
Excess of Loss Premium payable for year 1991 = 4.167% *

10,00,000 = 41670
12. In an excess of loss cover, the rate is 100/80th of average burning cost
of incurred claims for the following years, subject to a minimum rate of
2% and a maximum rate of 5%. The claims incurred are as follows:
Year gnPI Incurred losses to cover
1980 4,00,000 25,000
1981 12,00,000 12,000
1982 15,00,000 10,000
31,00,000 47,000
Calculate the premium for the year
1981? Solution:
47,000
Burning cost = ———————— *100 = 1.51%
31,00,000
Rate = 1.51% * 100/80 = 1.89%
Since the rate obtained is less than the minimum rate i.e. 2%, therefore minimum
rate will apply.
14. Consider an excess of loss cover paying 30,00,000 excess of 20,00,000 with
provision of two reinstatements at 60% of final earned premium. The
contract period is 1-1-1991 to 31-12-1991 and the loss has occurred on 31-4-
1991. A loss of 60,000 should be recovered. Calculate the reinstatement
premium payable to the reinsurer? Earned premium is 80000 for the year.
Solution:
60,000 (Loss recovery)
—————————————— * 80,000 * 60/100 = 960
30,00,000 (Cover limit)
239
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
(g) ‗Retrocession‘ means the transaction whereby a reinsurer cedes to another

insurer or reinsurer all or part of the reinsurance it has previously assumed;
(h) ‗Retention‘ means the amount which an insurer assumes for his own account.
In proportionate contracts, the retention may be a percentage of the policy
limit. In excess of loss contracts, the retention is an amount of loss;
(i) ‗treaty‘ means a reinsurance arrangement between the insurer and the
reinsurer, usually for one year or longer, which stipulates the technical
particulars and financial terms applicable to the reinsurance of some class
or classes of business;
(j) Words and expressions used and not defined in these regulations but
defined in the Insurance Act, 1938 (4 of 1938) or the General Insurance
Business Nationalisation Act, 1972 (57 of 1972) or Insurance Regulatory
and Development Authority Act, 1999 (41 of 1999), rules made thereunder
shall have the meanings respectively assigned to them in those Acts or
rules as the case may be.
CHAPTER – II
Procedure to be followed for reinsurance arrangements
(1) The Reinsurance Programme shall continue to be guided by the following
objectives to;
a) maximise retention within the country;
b) develop adequate capacity;
c) secure the best possible protection for the reinsurance costs incurred;
d) simplify the administration of business.
(2) Every insurer shall maintain the maximum possible retention commensurate
with its financial strength and volume of business. The Authority may require
an insurer to justify its retention policy and may give such directions as
considered necessary in order to ensure that the Indian insurer is not merely
ponting for a foreign insurer.
(3) Every insurer shall cede such percentage of the sum assured on each policy or
different classes of insurance written in India to the Indian reinsurer as may be
specified by the Authority in accordance with the provisions of Part 1VA of the
Insurance Act, 1938.
(4) The reinsurance programme of every insurer shall commence from the
beginning of every financial year and every insurer shall submit to the
Authority, this reinsurance programmes for the forthcoming year, 45 days
before the commencement of the financial year;
241
(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.
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annexure - I
Inward Reinsurance Business

4. Every insurer wanting to write inward reinsurance business shall have a well-
defined underwriting policy for underwriting inward reinsurance business. The
insurer shall ensure that decisions on acceptance of reinsurance business are
made by persons with necessary knowledge and experience. The insurer
shall file with the Authority a note on its underwriting policy stating the process
of business, geographical scope, underwriting limits and profit objective the
insurer shall also file any changes to the note as and when a change in
underwriting policy is made.
Understanding Loss Provisioning
(1) Every insurer shall make outstanding claims provisions for every reinsurance
arrangement accepted on the basis of loss information advices received from
Brokers/ Cedants and where such advices are not received on an material
estimation basis.
(2) In addition, every insurer shall make an appropriate provision for incurred not
reported (IBNR) claims on its reinsurance accepted portfolio on actuarial
nation basis.
243
ANNEXURE – II
020/NL/IRDA/06 15th Sep

`06. To
CEOs of All Insurance Companies &
The Principal Officers of All Broking Companies
GUIDELINES ON INSURANCE AND

REINSURANCE OF GENERAL INSURANCE RISKS
With the abolition of tariffs in the near future, competition will extend not only to
service matters but also to pricing of products. In order to ensure that the business
is transacted along proper lines, it is important to set out the rules of conduct that
should be followed by both insurers and brokers in the matter of insurance and
reinsurance of general insurance risks, especially those with high sums insured.
Insurers are advised to ensure that the procedures as set out in these guidelines
note are followed in their competition for business.
Attention of all licensed brokers is invited to the Code of Conduct specified in Schedule
III of the IRDA (Insurance Brokers) Regulations 2002 and in particular, para 1 of the
Code of Conduct. All brokers are hereby required to ensure strict adherence to the
practice stated in this guidelines note and in the Code of Conduct. Prior approval of
IRDA should be obtained by application supported by valid reasons for any
variations from the practice stated here.
1. Where a client invites more than one broker to submit terms for its
insurance requirement:
(a) A broker shall not block capacity with one or more insurers in anticipation
of being invited to quote terms for insurance requirements of a client,
where the client has not yet decided as to which brokers should be
invited to quote terms.
(b) Once the client has selected the brokers who should be invited to quote
terms, all other brokers should withdraw from the market. They should
also immediately advise any insurers with whom they have been in touch
to propose terms, about their not being invited to quote terms.
(c) Brokers who are invited to quote terms should obtain a written appointment
letter to develop terms. Where the client has given oral instructions to quote,
the broker should record the fact of its being invited to quote terms, in a
letter to the client. (Refer paras 2(f) and 2(h) of Code of Conduct).
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
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
3. Documentation and post-insurance servicing of the direct insurance

client:
(a) Once the direct insurance client gives orders to bind the cover, the
broker should obtain a letter of cover or cover note or insurance policy
from the insurer or insurers concerned and submit them to the client
before commencement of risk.
(b) The broker should ensure payment of premium in a timely manner in
compliance with Sec 64VB of the Insurance Act. The broker should
explain to the client, the importance of compliance with policy conditions
and warranties by the client during the policy period. Where the insurer
issues only a cover note or letter of cover, the broker should follow up for
issue of the formal policy document without delay. The broker should
scrutinize all these documents to ensure that they are in conformity with
the terms and conditions quoted and accepted by the client. Likewise,
the broker should ensure timely payment of reinsurance premium on any
reinsurance placed through it and follow up for the formal reinsurance
document in a timely manner.
4. Placement of facultative reinsurance:
(a) A composite insurance broker or reinsurance broker shall not enter the
reinsurance markets either to develop terms for reinsurance cover or to place
reinsurance on any risk without the specific written authorization of the insurer
insuring the risk or insurer who has been asked to quote terms for the risk.
(b) A reinsurance broker or a composite broker shall not block reinsurance
capacity in anticipation of securing an order to place reinsurance.
(c) The broker shall provide to the insurer, a true and complete copy of the
reinsurance placement slip to be used, before entering the market. The
broker shall incorporate any modifications or corrections proposed by the
insurer in the placement slip.
(d) The broker shall put up to the insurer, all the terms (including the
reinsurance commission and brokerage allowed) obtained by it from various
reinsurers and indicate the share the lead reinsurer is willing to write at those
terms and the expectation of the broker about placement of the required
reinsurance at the terms quoted, with acceptable reinsurance security.
(e) The broker shall furnish to the insurer, a true copy of the placement slip
signed by the lead reinsurer quoting terms, indicating thereon, the signed
line of the reinsurer.
(f) Where reinsurance on a risk is proposed to be placed with different
reinsurers at different terms, the fact that terms for all reinsurers are not
uniform, shall be disclosed to reinsurers suitably.
247
(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
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.

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CHAPTER – 1

is a long-term, mutually beneficial relationship. The mutual obligations found in the

very important in all fields of insurance. Reinsurers must be careful in offering

OUTLINE OF THE CHAPTER

b) Security: The cedent company, like a typical policyholder, is equally concerned

Proportional and Non-proportional Reinsurance

Treaty Facultative Financial

Pro-Rata Excess of Loss Pro-Rata Excess of Loss

Quota Surplus Per Risk Per Occurrence Aggregate

Quota Share Treaty

The following illustrative example is helpful for our understanding:

Characteristics of Surplus Share Treaty and Quota Share

Given below is an example on calculation of premium in a surplus share treaty.

Calculate the cessions to first surplus treaty.

Characteristics of Non-proportional Treaties:

RATING FOR EXCESS OF LOSS COVERS

Year gnPI Incurred losses

An example will help to clarify this further:

Cover per event (catastrophe excess of loss)

OUTLINE OF THE CHAPTER

different departments. It is a package cover. It is not a spread of risks of similar

ACCIDENT AND LIABILITY REINSURANCE

 Policies under Public Liability Insurance Act, 1991. 

The proportion of total life insurance premiums reinsured is small in comparison

 The intermediary must make full written disclosure

REINSURANCE REGULATIONS IN INDIA

xiii) Clause 4: Inward Reinsurance Business: Every insurer wanting to write

Reinsurance is similar to an insurance contract and hence it is important that the

PROPORTIONAL TREATY WORDINGS

3. “Follow the Fortunes” Clause

 If during the period of this Agreement, postal and/or telegraphic communications

reinsurance techniques must be understood and appreciated with reference to the

Common account excess of

Non-proportional Treaty Accounts

Calculate Profit Commission

Closing Proportional Treaty Accounts

OUTLINE OF THE CHAPTER

OUTLINE OF THE CHAPTER

GLOBAL REINSURANCE MARKETS

The following exhibit shows the world‘s 20 largest reinsurers, ranked by

Insurance Company Company at Domicile

The London Market

Matured Financial Markets

REGIONAL REINSURANCE CORPORATION

 Non-reciprocal inward reinsurance accounts, a part of which may be retroceded

INDIAN REINSURANCE MARKET

the additional facilities to insurers besides managing obligatory cessions by

 Availability of incentives for loss control. 

OUTLINE OF THE CHAPTER

OBJECTIVES of inward reinsurance

OUTLINE OF THE CHAPTER

The primary insurers benefit from a well-planned and well-executed reinsurance

Kinds of Insurance Written

The amount of surplus relief received will be a function of the percentage of

DESIGNING OF AND ARRANGING A

retention is the underwriting criteria, which are applicable to a particular class of

Indian Reinsurance Program

Given below is a case study of a small insurance company.

1. A primary insurer – Prose covers an insurance risk of Rs. 500 lakh.

3. Prudential insurance was reinsured by swarn reinsurance. The contract

Claim Payment to Retention Recovery from Brit

5. The Stag insurance company entered into a reinsurance contract with

Particulars Retention [Rs.] Ten-line surplus limit. [Rs.]