CHAPTER 7

RE-INSURANCE

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 Defining Re-insurance
• It is a financial transaction by which risk is
transferred (ceded) from an insurance company
(cedant) to a reinsurance company (reinsurer) in
exchange of a payment (reinsurance premium).

• Providers of reinsurance are highly professional

reinsurers which are entities exclusively
dedicated to the activity of reinsurance.

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 Meaning of Reinsurance and related terms
Reinsurance
– is an arrangement by which the primary
insurer that initially writes the insurance
transfers to another insurer (called the
reinsurer) part or all of the potential losses
associated with such insurance.
Direct (primary) insurers
– these are ordinary insurance companies
who transact insurance with the general
public.
Ceding company
– the party that is transferring all or part of its
business to a reinsure. 3
Reinsurers
– The insurer that accepts part or all of the insurance
from the ceding company.
– large companies which specialized in reinsurance and
do not write any direct insurance.
– They are usually international organizations.
Cessions:
– is the amount of insurance ceded to the
reinsurer.
Line or retention
– the amount of insurance (portion of risk)
retained by the ceding company for its
account.
Retrocession
– the process by which a reinsurer passes on
risks to another reinsurer.
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Loss Adjustment expenses (LAE)
– the expenses of settling claims including
legal and other fees and the portion of
general expenses allocated to claim
settlement costs.
Advantage of Reinsurance
– Security and stability of profits
– Increasing underwriting capacity
– Providing protection against catastrophic
losses
– Retiring from underwriting
– To obtain underwriting advice
– Macro benefits
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1. Security and stability of profits
• Reinsurance is used to stabilize profits.
• An insurer may wish to avoid large
fluctuations in annual financial results.
• Loss experience can fluctuate widely
because of social and economic conditions,
natural disasters, and chance.
• Reinsurance can be used to stabilize the
effects of poor loss experience.
2. Increasing underwriting capacity
• Reinsurance can be used to increase the
insurance company’s underwriting
capacity to write new business.
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3. Providing protection against catastrophic losses
- The reinsurer pays part or all of the losses that
exceed the ceding company’s retention up to
some specified maximum limit.
4. Retiring from underwriting
- Reinsurance permits the insurer’s liabilities
for existing insurance to be transferred to
another carrier; thus, policyholders’ coverage
remains undisturbed.
5. To obtain underwriting advice from reinsurer
6. Macro benefits
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 Types of Reinsurance
• There are two types of reinsurance
arrangements:
Facultative and Treaty reinsurance
1. Facultative reinsurance
– Is a specific reinsurance arrangement on optional
basis (the ceding company and the reinsurer may or
may not agree on the arrangement).
– It is case-by-case method used when the ceding
company receives an application for insurance that
exceeds the retention limit.
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 Facultative cont’d …..
• Under this agreement, both the primary insurer
and the reinsurer retain full decision-making
powers with respect to each insurance contract.

• As each insurance contract is issued, the

primary insurer decides whether or not to seek
reinsurance, and the reinsurer retains the
flexibility to accept or reject each application for
reinsurance on a case-by-case basis.
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Advantage of facultative reinsurance
– Flexibility (it can fit any kind of case)
Disadvantage of facultative reinsurance
– It involves substantial administrative cost
in the process of finding a willing reinsurer
– There is delay, since the policy will not be
issued until reinsurance is obtained
– It is uncertain
– Unreliable: In times of bad lose experience
the reinsurance market tends to dry up (it
will be difficult to find a willing reinsurer)
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 Treaty reinsurance
• Under this form, an agreement is made
between the primary insurer and the
reinsurer to the effect that all risks within
certain parameter will be offered to the
reinsurer and the insurer cannot decline the
risk.
• It is automatic or obligatory throughout the
term of the agreement.
• The treaty is signed in advance and the primary
insurer writes any insurance without consulting
the reinsurer as far as it is within the agreement.
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 Advantage of treaty reinsurance
• It is automatic and no uncertainty involved
• No delay in writing insurance
• It is economical because it is not necessary to
search for reinsures before the policy is written
Disadvantage of treaty reinsurance
• Could be unprofitable to the reinsurer
• If the primary insurers consistently cede
unprofitable business to its reinsurers, the ceding
insurers will find it difficult operate since
reinsurers will not want to do business with
them.
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 Types of reinsurance treaties
1. Quota-Share Treaty Under this method, the
ceding company and reinsurer agree to share
premiums and losses based on pre-agreed
percentage (proportion).
2. Surplus-Share Treaty Under this method the
reinsurer agrees to accept insurance in excess
of the ceding insurer’s retention limit, up to
some maximum amount.
– The retention limit is referred to as a line and
is stated as a dollar amount.

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 EXAMPLE
• Apex Fire Birr 200,000 (one line)
• General Reinsurance 800,000 (four lines)
• Total underwriting capacity Birr 1,000,000
• Birr 500,000 policy
• Apex Fire Birr 200,000 (2/5)
• General Reinsurance 300,000 (3/5)
• Birr 5,000 loss
• Apex Fire Birr 2,000 (2/5)
• General Reinsurance 3,000 (3/5)
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3. Excess-of-Loss Reinsurance
– This method is designed largely for protection
against a catastrophic loss.
– The reinsurer pays part or all of the loss that
exceeds the ceding company’s retention limit
up to some maximum level.
Loss Direct Insurer Excess Treaty
Birr 10,000 Birr10,000 Nil
50,000 50,000 Nil
70,000 50,000 Birr 20,000
100,000 50,000 50,000
250,000 50,000 200,000
300,000 100,000 200,000

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