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Re Insurance 1
Re Insurance 1
INTRODUCTION TO REINSURANCE
INTRODUCTION
The term ‘Reinsurance, also termed as insurance of insurance’.
Means that an insurer who has assumed a large risk may arrange with
another insurer to insure a proportion of the insured risk. In other words, in
the event of loss, if it would be beyond the capacity of the insurer than this
reinsurance process is restored to. In reinsurance, therefore, one insurer
insures the risk which has been undertaken by another insurer. The original
insurer who transfers a part of the insurance contract is called the
reinsured and the second insurer is called the reinsurer. Of course the
reinsurance has to pay reinsurance premium for risk shifted. For example, a
man wishing to insure his premium for 10 lakhs goes to an insurance
company, which will accept the risk if it is satisfied as to the condition of
the property. But if it its own limit is probably Rs 5 lakhs, it will arrange with
another company to reinsure or to take up so much of the risk as exceeds
its limits, i.e. Rs 5 lakhs, so that if the house is burnt down the original
insurer would pay the owner Rs 10 lakhs. But they would be recouped 5
lakhs, by the reinsurance offices.
To be effective, the reinsurance policy must be formulated after
carefully considering all aspects of the situation to which it is to be applied.
DEFINITION
Reinsurance is a transaction in which one insurer agrees, for a
premium, to indemnify another insurer against all are part of the loss that
insurer may sustain under its policy or policy or policies of insurance. The
company purchasing reinsurance is known as the ceding insurer: the
company selling reinsurance is known as the assuming insurer, or, more
simply, the reinsurer. Reinsurer can also be described as the “insurance of
insurance companies”
Reinsurance provides reimbursement to the ceding insurer for lasses
covered by the reinsurance agreement. It enhances the fundamental
objectives of insurance to spread the risk so that no single entity finds itself
saddled with a final burden beyond its ability to pay. Reinsurance can be
acquired directly from a reinsurance intermediary.
OBJECTIVES OF REINSURANCE
Insurer purchases reinsurance for essentially four reasons:
1)To limit liabilities on specific risks
2)To stabilize loss expanses
3)To protect against catastrophes; and
4)To increase capacity.
Different types of reinsurance contract are available in the market
commensurate with the ceding company’s goals.
1. Limiting liability:
By providing a mechanism in which companies limit loss exposure to
levels commensurate with net asset, reinsurance companies allows
insurance companies to offer coverage limits considerably higher then
they could otherwise provide. This function of reinsurance is crucial
because they allow all companies, large and small, to offer coverage
limits to meet their policyholders’ needs. In this manner, reinsurance
provides an avenue for small-to-medium size companies to compete
with industry giants. In calculating an appropriate level of reinsurance, a
company takes in to account the amount of its available surplus and
determines its retention based on the amt of loss it cam absorb
financially. Surplus, sometime referred to as policyholders surplus, in the
amount by which the asset of an insurance exceeds its liabilities
A company’s retention may range from a few lakhs rupees o
thousand of crores. The reinsurer indemnifies the loss exposure above
the retention, up to the policy limits of the reinsurance contract.
Reinsurance helps to stabilize loss experience on individual risks, as well
as an accumulated loss under many policies occurring during a specified
period.
2. Stabilization:
Insurance often seeks to reduce the wide swing in profit and loss
margins inherent to the insurance business. These fluctuations result, in
part, from the unique nature of insurance, which involves pricing a
product whose actual cost will not be known until sometime in the
future. Though reinsurance, insurance can reduce these fluctuations in
loss experience, thus stabilizing the company overall operating result.
3. Catastrophe protection:
Reinsurance provides protection against catastrophe loss in much the
same way it helps stabilize an insurer’s loss experience. Insurer uses
reinsurance to protect against catastrophes in two ways. The first is to
protect against catastrophic loss resulting from a single event, such as
the total fire loss of large manufacturing plant. However, an insurer also
seeks reinsurance to protect against the aggregation of many smaller
claims, which could result from a single event affecting many
policyholders simultaneously, such as an earthquake as a major
hurricane. Financially, the insurer is able to pay losses individually, but
when the losses are aggregated, the total may be more than the insurer
wishes to retain.
Though the careful use of reinsurance, the descriptive effect
catastrophes have on an insurer’s loss experience can be reduced
dramatically. The decision a company makes when purchasing
catastrophe coverage are unique to each individual company and vary
widely depending on the type and size of the company purchasing the
reinsurance and the risk to be reinsured.
4. Increased capacity:
Capacity measures the rupee amount of risk an insurer can assume
based on its surplus and the nature of the business written. When an
insurance company issues a policy, the expenses associated with issuing
that policy-taxes, agents commissions, administrative expenses-are
changed immediately against the company’s income, resulting in a
decrease in surplus, while the premium collected must be set aside in an
unearned premium reserved to be recognized as income over a period
of time. While this accounting procedure allows for strong solvency
regulation, it ultimately leads to decreased capacity because the more
business an insurance company writes, the more expenses that must be
paid from surplus, thus reducing the company’s ability to write
additional business.
PURPOSES OF REINSURANCE
"Reinsurance achieves to the utmost extent the technical ideal of
every branch of insurance, which is actually to effect
(1) The atomization,
(2) The distribution and
(3) The homogeneity of risk. Reinsurance is becoming more and
more the essential element of each of the related insurance
branches. It spreads risks so widely and effectively that even
the largest risk can be accommodated without unduly
burdening any individual."
Fundamentals
In the most widely accepted sense, reinsurance is understood to be
that practice where an original insurer, for a definite premium, contracts
with another insurer (or insurers) to carry a part or the whole of a risk
assumed by the original insurer. By insurers we mean all persons,
partnerships, corporations, associations, and societies, associations
operating as Lloyd's, inter-insurers or individual underwriters authorized by
law to make contracts of insurance. We may define insurance as an
agreement by which one party, for a consideration, promises to pay money
or its equivalent, or to do an act valuable to the insured, upon the
happening of a certain event or upon the destruction, loss or injury of
something in which the other party has an interest. The insurance business
is the business of making and administering contracts of insurance.
Insurance contracts are of two types those which engage merely to pay a
sum of money on the happening of an event, or merely to begin a series of
payments on or after the happening of a certain event, are contracts of
investment. Contracts of insurance which engage to pay money or its
equivalent, or the doing of acts valuable to the insured, upon destruction,
loss or injury involving things, are contracts of indemnity.
And so, reinsurance may be second insurance of
(a) Contracts of investment and/or
(b) Contracts of indemnity.
There may exist, therefore, two types of insurance business,
depending upon which of these two organic contracts the business engages
to administer.
HISTORY OF REINSURANCE
Reinsurance has a rather illustrious history eating back 10 the
fourteenth century. Even though there is no authentic information of the
first reinsurance contract, it is widely recognized that Lombardians beggar
Develop the concept of reinsurance in circa 1200 AD and from whence the
concept of reinsurance took ground.
1200-1600 AD
The emergence of the reinsurance concept and its slow pace of
expansion was one of the remarkable features of this time. Marine
business was one of the earliest fields that recognized the need of
reinsurance to protect its business from the dangers and rakes of marine
transport.
1600-1850AD
Though marine insurance nourished during this period in Europe, it
suffered a set back in UK, where it went largely unrecognized except when
the insurer became insolvent or went bankrupt or died. This ban lasted till
1864 and as such there was no recorded reinsurance business in England.
After the great fire of London in 1666, an interest to insure against fire suit
faced and regulators soon made modifications to reduce their losses. In
the year 1776 royal concession was granted to the Royal Chartered Fire
insurance Company of Copenhagen to undertake fire insurance one of the
earliest recorded fire reinsurance transactions place in 1813 when the
Eagle hire Insurance Company of New York assumed all of the outstanding
rim the Union Insurance Company, but it really executed, as the insurer
did not avail this facility and after this the earliest recorded fire insurance
then which was executed dates back to the year I821 between the
National Assurance Company, Paris, France and the assuming reinsurer
the United Proprietors of Belgium.
Validation of the reinsurance contract by the Supreme Court of New
York boosted a number o\ reinsurance contracts contracted. In l883 the
Supreme Court gave its consent in the case between New York Browery
Insurance Company, the cedent, and the New York Fire Insurance
Company, the reinsurer. This case acted as a catalyst for the emergence of
reinsurance companies and thus began a new era in the reinsurance
sector and in \S4A the current system of life reinsurance took seed. The
first life treaty as such dates back to 1858.
CHAPTER 2
PRINCIPLES OF REINSURANCE
WHAT IS REINSURANCE?
When you look at the risks that insurers take on, it is not surprising
that they themselves might want to have insurance. When insurers insure a
risk again, it is called reinsurance.
REINSURANCE IN INDIA
Reinsurance in India dated back to the 1960’s. After independence
there was rapid development of the insurance business. With various
sectors growing in the post independence era the need for reinsuring the
development work was also felt. Since reinsurance industry has negligible
presence in India after independence, the domestic requirement of
reinsurance was netted from mostly was foreign markets mainly British and
continental. For undertaking reinsurance by Indian entities meant drain of
precious foreign exchanged earned by the country. To prevent the outflow
of foreign exchange, in year 1956 Indian Reinsurance Corporation, a
professional reinsurance company was formed by some general insurance
companies. This company started receiving the voluntary quote share
cession from member companies.
Selection of Customers:
In the reinsurance industry business is acquired in two ways. One is
when a customer directly approaches the reinsurance for ceding their
claims and the other method is when the reinsurer gets their business from
the reinsurance broker appointed by he customer. In certain parts of the
world, reinsurance accepts business routed only through a reinsurance
broker. The important thing to be noted here is that it is not the quantum
of business generated by the reinsurer but the customer for whom they are
undertaking the business. Some go that extra mile by going to their
business and accordingly tailor their policies to fit their needs and business.
The more the reinsurance knows about the business nature of their clients,
they can serve them.
WHY REINSURANCE?
Risk managers and other buyers of insurance rarely think about how
reinsurance affects their company or the insurance they purchase for their
company. Insurance buyers mainly focus on the direct insurers – the
primary, excess, and umbrella carriers that provide the coverage. Smart
insurance buyers look for A--rated or better insurance companies with long
histories. Other buyers rely on their brokers to put together the best quality
insurance program with the best insurance security available. After all, the
insured must rely on the insurance policy issued by the direct insurer.
But what stands behind the A--rated carrier or the high quality
program for a complex risk? The answer is “Reinsurance”. Commercial
insurance cannot exist without reinsurance. The quality of the reinsurance
security purchased by the direct insurer is what helps to insure that loss will
be paid. Quality reinsurer provides special expertise to their direct insurer
client and assists the direct insurer in providing the best possible protection
and risk management for the direct insurer’s own client. Some large
professionals reinsure help small insurance companies expand into new
areas and provide them with technical, actuarial, and claims expertise and
training
FUNCTIONS OF REINSURANCE
1. Risk transfer
The main use of any insurer that might practice reinsurance is to allow
the company to assume greater individual risks than its size would otherwise
allow, and to protect a company against losses. Reinsurance allows an
insurance company to offer higher limits of protection to a policyholder than
its own assets would allow. For example, if the principal insurance company
can write only $10 million in limits on any given policy, it can reinsure (or
cede) the amount of the limits in excess of $10 million.
Reinsurance’s highly refined uses in recent years include applications
where reinsurance was used as part of a carefully planned hedge strategy.
2. Income smoothing
3. Surplus relief
4. Arbitrage
TYPES OF REINSURANCE:
There are two kinds of reinsurances, treaty reinsurance and
facultative reinsurance.
1. Treaty reinsurance:
This kind of reinsurance requires that the reinsurer will assume part
or all of a ceding company’s responsibility for certain sections or classes
of business in accordance with the terms of the policy. It is an obligatory
contract as the ceding company has to cede the business and the
reinsurer is obliged to assume the business as per the treaty. It is the
preferred type of reinsurance when groups of homogenous risks are
considered.
2. Facultative reinsurance:
A. PROPORTIONAL REINSURANCES:
It is different in that not every risk is ceded but only those that exceed
certain predetermined amounts.
B. NON-PROPORTIONAL REINSURANCE:
a) Excess of loss:
It covers a single risk or a certain type of business.
Catastrophe reinsurance is a type of excess of loss reinsurance.
It provides the captive with a great deal of flexibility.
These are the various types of reinsurances. There are firms that
offer their services as well as their products to help new business start up
flourish and succeed.
DOUBLE INSURANCE
When the amount for which a subject matter is insured is more than
its actual value it is called as over insurance. For over insurance, the only
criterion is the amount of insurance. It can even be with one insurer alone.
For Example:
1) EXTERNAL INSURANCE
2) INTERNAL INSURANCE
Physical damage:
As the new economy’s dominated by computer-base operations,
physical damage losses caused to computerand networks, damage caused
to the infrastructure of the c-commerce business due to power failures or
power surges leading to network or system failures, etc., will become
commonplace.
Business interruption:
These costs may include remediation costs and the addition of
hardware and software such as routers, firewalls and upgrade anti-virus
programs. A mere difficult coverage question arises when business
interruption leads to third party liability.
Privacy issues:
Among the e-commerce risks that have garnered significant publicity
are those concerning rights of privacy. These risks are similar to the
traditional risks inherent in the banking, financial services, and medical
industries. Because so much more personal and financial data is
collected today and stored electronically this issue has become the focal
point for market regulators, governments and also for consumer advocacy
groups.
Reinsures can expect to see third party liability claims arising out of
e-commerce and related websites risk in coming years. Medical, legal,
accounting, and financial services websites are just a few examples of
Internet sites distilling advice, displaying advertising, and encountering
negligence claims for erroneous information posted on the Sites.
Hackers:
E-commerce business activities require that key information and
business processes exist in digital |form and be accessible through web
portals and websites. Should the security of their servers be breached,
these insured and their customers and business partners could suffer
significant harm
Viruses:
With new kind of viruses hitting the www everyday, the potential
damage they can wreck on an e-commerce business is of significant level.
The damage of "I Love You" bug outbreak in 2000 has experts put it may
had caused a worldwide economic impact of $8.75 billion. I he mid-2001
"Code Red" attacks am estimated to have cost $2.62 billion worldwide.
CHAPTER 3
REINSURANCE UNDERWRITING
INTRODUCTION
● Reinsurance brokers
Domestic business has various advantages like low acquisition costs,
easy manageability etc and further it is free from ether complications like
adverse fluctuation of foreign exchange, economic instability of the
country etc. It suffers from the drawbacks of low volume and spread of
business, which is essential to build up a stable and profitable portfolio.
Further, the expertise and experience of the reinsures that are spread
across the globe are also denied in case of domestic business. Or the other
hand, overseas business has the advantages of wide geographical spread
but the cost of maintenance may be higher. Further, other complications
like difference in language, legal systems, market practices and exchange
control regulations may surface hence, a healthy balance of domestic and
overseas business will enable the reinsurer to develop a strong, stable and
profitable portfolio. Retrocession treaties among various reinsures could be
a source of underwriting international business with a balanced
geographical spread. But the company should closely watch for higher
costs of acquisition and low profitability. One possible solution to
overcome these difficulties is to develop business through intermediaries
or brokers, subject to cost of brokerage, delays in remittances and
underwriting being in control. Another aspect which has to be considered
in finalizing a reinsurance contract is the class and spread of risks. The
reinsurance company will have to make a selection of risks depending on
the size and intensity. A single aviation portfolio may consist of a very small
number of large risks, whereas there can be several small household
burglary accounts with limited risk exposure. Similarly, even within a class,
mere can be variation in risk exposure, like fire policy for residential
dwellings as against that of a large industrial undertaking or industrial
complexes. Hence a proper balance will have to be struck between various
classes; and within a class, between various risks
CLASSES OF BUSINESS POLICY
It is of paramount importance for an underwriter to know at the
outset as to what classes of risks are to be covered viz. Property, Casualty,
etc. It must be ensured that the particular class is a genuine insurance risk
which can be defined and quantified properly so that premium
considerations do not lead to avoidable conflicts. Further, within the class,
method of reinsurance whether proportional/non-proportional,
facultative/treaty etc., lias to be selected, depending on the reinsurer
choice as well as suitability.
REINSURANCE REGULATION
INTRODUCTION
● Disclosure
● Security
This increased regulation has resulted from the regulators’ realization
that the solvency of primary insurers often depends on their ability to
collect under their reinsurance agreements. Since primary insurers cede
more than $50 billion in premiums in any given year to reinsures, the ability
to collect under reinsurance agreements is a very serious issue.
DISCLOSURE
In fact, the new part 1 requires, for each reinsured, that the following
disclosures be made:
Under the law, if security is not deemed to exist, then a credit for
reinsurance against loss reserves is not allowed the ceding company. The
effect on the ceding company in the event that security is not seen to exist
is a charge against its surplus. Since surplus is the vital ingredient in an
insurer’s ability to write business, this is a significant issue.
(3) Every insurer shall cede such percentage of the sum assured 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
provisions of Part IVA 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, his reinsurance programmes for the forthcoming year, 45
days before the commencement of the financial year;
(7) Insurers shall place their reinsurance business outside India with only
those reinsures 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
reinsures 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.
(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. 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
reinsures 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.
(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 to the Indian Reinsurer.
CHAPTER 5
3. The economic and trade ties between the member countries being well-
developed, free flow of trade exists between them.
4. The member countries may share some common customs, language and
identity.
1. Give valuable suggestions and help the reinsured tide over the crisis:
2. Helping clients in seeing up a suitable reinsurance
program.
3. Organize training program for the executives of the reinsured
companies.
Thus, over the years the reinsurance industry has matured in terms of
improved development services and policies offered to the clients. But, it is
to he noted here that the development of reinsurance market is restricted
mostly to the developed economies. Developing economics like India, a few
South East Asian countries, etc, have just recently started their long march
towards the development of more mature Reinsurance market domestically.
CHAPTER 6
REINSURANCE IN INDIA
Until GIC was notified as a National Reinsurer, it was operating as a
holding / parent company of the 4 public sector companies, controlling
their reinsurance programmers’. GIC would receive 20% obligatory cession
of each policy written in India. Since deregulation, GIC has assumed the role
of the markets only professional re-insurer. In order to focus on
reinsurance, both in India and through its overseas offices and trading
partners, GIC has divested itself of any direct business that it wrote prior to
November 2000, with the temporary exception of crop insurance. It
currently manages Hull Pool on behalf of the market, which receives a
cession from writing companies and after a pool protection the business is
retro-ceded back to the member companies. GIC also manages the
.Terrorism Pool... Not more than 10% of reinsurance premium to be placed
with one re-insurer.
REINSURANCE REGULATION
The placement of reinsurance business from the Indian market is
now governed by Reinsurance Regulations formed by the IRDA. The
objective of the regulation is to maximize the retention of premiums within
the country and to ensure that IRDA has issued the following instructions:
Placement of 20% of each policy with National Re subject to a monetary
limit for each risk for some classes. Inter-company cession between four
public sector companies. . Indian Pool for Hull managed by GIC. . The treaty
and balance risk after automatic capacity are to be first offered to other
insurance companies in the market before offering it to international re-
insurers. . Each company is free to arrange its own reinsurance program,
which has to be submitted to the IRDA 45 days before commencement. .
No re-insurer will have a rating of less than .BBB from Standard and Poor’s
or an equivalent rating from AM Best.
THE PROBLEM
THE SOLUTION
THE RESULTS