Risk Management and Insurance

Chapter Eight
Re-Insurance
8.1 Meaning of Re-Insurance
Re-insurance is a process of shifting part or all of the insurance originally written by one

insurer to another insurer. The insurer that originally writes the business and shifts it to the

other insurer is called ceding company/ principal insurer/ original office. The insurer that

accepts part or all of the insurance ceded by the ceding company is called re-insurer. The

amount of insurance retained by the ceding company is called net retention/ retention limit.

The amount of insurance ceded to the reinsurer is called cession.

8.2 Reasons for Re-Insurance

 To increase underwriting capacity

 For stability of profit

 To provide protection against catastrophic loss

 Other reasons like retiring from insurance business and obtaining underwriting

advice & assistance from the reinsure

8.3 Types of Re-Insurance

There are two principal types of reinsurance; facultative and treaty reinsurances

1. Facultative reinsurance

Facultative reinsurance is an optional case by case method used when the principal insurer

receives an application that exceeds its net retention. Before the policy is issued, the primary

insurer shops around for reinsurance and contact several reinsurers with which it did

business. In this process both the ceding company and the reinsurer are under no

obligation to cede and accept insurance. However, if a willing reinsurer is found, the ceding

company and the reinsurer enter in to a valid contract and the policy can then be written.
In other words facultative reinsurance is necessary if the principal insurer receives an

application that requires a face value/amount that exceeds the maximum retention of the

insurance company. Hence, before the policy is accepted, the primary insurer determines if

reinsurance can be obtained. If reinsurance is obtained, the policy can be written; if not it

has to be rejected unless the applicant is willing to get the coverage up to the insurance

company’s maximum retention and the rest from other insurers.

The main advantage of facultative reinsurance is its flexibility. It can be arranged in such a

way that can fit any kind of case. The major pitfall is that there is uncertainty and delay.

This means the ceding company can’t know in advance whether it will find a willing

reinsurer or not. There is also further problem of delay since the policy will not be issued

until reinsurance is obtained from a willing reinsurer.

2. Treaty reinsurance

The ceding company and the reinsurer have agreed to cede and accept insurance business

respectively. All business that fall within the scope/range of their agreement will be

automatically reinsured according to the terms of the treaty. The advantage of treaty

reinsurance to the primary reinsurer is that it is automatic; it avoids uncertainty and delay

involved in facultative reinsurance.

The major disadvantage to the reinsurer is that it could be unprofitable since the reinsurer

have no knowledge about the individual applicant and rely on the underwriting judgment

of the primary insurer and the primary insurer may accept and cede unprofitable insurance

to the reinsurer.

There are several types of treaty reinsurance arrangement; which include

A) Quota share treaty: under this treaty the ceding company and the reinsurer agreed to

share premiums and losses on some proportion expressed in terms of percentage. In this

arrangement the ceding company’s retention limit is expressed in terms of percentage not

in terms of birr amount.

B) Surplus share treaty: under this treaty the reinsurer agrees to accept insurance in excess

of the ceding company’s retention limit up to some maximum amount. The retention limit is

referred to as a line and is stated as a birr amount. The retention limit is referred to as a line

and is stated as a birr amount. For example, assume that apex fire has a retention limit of

birr 200,000(called a line) for a single policy, and that four lines, or birr 800,000 are ceded

to general reinsurance. Assume that a birr 500,000 property insurance policy is issued and

a loss of birr 5000 occurred. The contribution summarized as follows:

Apex fire birr 200,000(one line)

general reinsurance 800,000(four line)

Total underwriting capacity birr 1,000,000

For birr 500,000 policies

Apex fire birr 200,000(2/5)

general reinsurance 300,000(3/5)

For birr 5,000 losses

Apex fire birr 2,000(2/5)

general reinsurance 3,000(3/5)

C) Excess of loss treaty: designed largely for catastrophic protection. Losses in excess of

retention limit are paid by the reinsurer up to some maximum limit. The excess of loss

treaty covers;

1. A single exposure

2. A single occurrence, such as a catastrophic loss from a windstorm, or

3. Excess losses when the primary insurer’s cumulative losses exceed a

certain amount during some stated time period, such as a year.

Example; Assume that the reinsurer agrees to pay for all losses in excess of birr 50,000 up

to a further birr 200,000. The way in which various losses are divided is shown below:

Loss direct insurer excess treaty

Birr 10,000 birr 10,000 nil

50,000 50,000 nil

100,000 50,000 50,000

300,000 100,000 200,000

D) Reinsurance pool: is an organization of insurers that underwrites insurance on a joint

basis. Reinsurance pools have been formed because a single insurer alone may not have the

financial capacity to write large amounts of insurance, but the insurers as a group can

combine their financial resources to obtain the necessary capacity.