Types and techniques of reinsurance

Reinsurance is basically a form of coverage

intended for insurance providers. Generally
speaking, this type of policy reduces the losses
sustained by insurance companies by allowing
them to recover all, or part, of the amounts they
pay to claimants. Reinsurers help insurance
providers avoid financial ruin in case a huge
number of policyholders turn out to make their
claims during catastrophic events. Below are some
of the major types of reinsurance policies.

1. Facultative Coverage

This type of policy protects an insurance provider

only for an individual, or a specified risk, or
contract. If there are several risks or contracts that
needed to be reinsured, each one must be
negotiated separately. The reinsurer has all the
right to accept or deny a facultative reinsurance
proposal.
Facultative reinsurance is coverage purchased by
a primary insurer to cover a single risk or a block
of risks held in the primary insurer's book of
business. Facultative reinsurance is one of the two
types of reinsurance, with the other type being
treaty reinsurance. Facultative reinsurance is
considered to be more of a one-off transactional
deal, while treaty reinsurance is more of a long-
term arrangement.
Facultative reinsurance is usually the simplest way
for an insurer to obtain reinsurance protection;
these policies are also the easiest to tailor to
specific circumstances

2. Reinsurance Treaty

Unlike a facultative policy, a treaty type of

coverage is in effect for a specified period of time,
rather than on a per risk, or contract basis. For the
duration of the contract, the reinsurer agrees to
cover all or a portion of the risks that may be
incurred by the insurance company being covered.
Types of Treaty Reinsurance

A reinsurance treaty is merely an agreement in

between two or more insurance companies
whereby one (direct insurer) agrees to cede and the
other or others (reinsurer) agree to accept
reinsurance business as per provisions specified in
the treaty
Types of Treaty Reinsurance are;
1. Quota Share,
2. Surplus,
3. Excess of Loss,
4. Excess of Loss Ratio (Stop-Loss)
5. pools
1. Quota Share Treaty Reinsurance
This type of treaty requires the direct insurer to
cede a predetermined proportion of all its business
accepted in a certain class to the reinsurer(s), and
the reinsurer(s) also agrees to accept that
proportion in return for a corresponding proportion
of the premium
2. Surplus Treaty Reinsurance
The important feature here is, this that the direct
insurer agrees to reinsure only the surplus amount,
after its retention,
and the reinsurers agree to accept such cessions,
usually up to a predetermined upper limit. Surplus
treaties are usually arranged in lines, each fine
being equal to insurer’s own retention.
This means that the insurer can automatically
make a gross acceptance of the risk to the extent of
his own retention, plus, the amount of retention
multiplied by the number of lines for which treaty
has been made
Excess of Loss Treaty Reinsurance
The approach of the reinsurance arrangement is
quite different here from those methods already
discussed.
Under this system, unlike facultative, quota or
surplus, the sum insured does not form any basis
and it is not expressed in terms of proportion or
percentage of the sum insured.
Here, the insurer first decides as to how much
amount of loss he can bear on each and every loss
under a particular class of business.
The arrangement is such that if a loss exceeds this
predetermined amount then only reinsurers will
bear the balance amount of loss. Nothing is
payable by the reinsurers if the amount of loss falls
below this selected amount.
There may usually be an upper limit of liability of
the reinsurers beyond which they will not pay
4. Excess of Loss Ratio Treaty Reinsurance
This type of arrangement is also known as STOP
LOSS reinsurance and is a bit different from the
Excess of Loss arrangement, even though both
basically base on loss rather than sum-insured.
Here,
a relationship is usually drawn in between the
gross premium and the gross claim over a year in a
particular class of business.
The ceding company decides a gross loss ratio up
to which it can sustain.
The arrangement with the reinsurers is such that if
at the year-end it is found that the total of all losses
within the class has exceeded the predetermined
loss ratio then the reinsurers will pay the balance
loss so as to keep the loss ratio of the ceding
company within the ‘predetermined ratio. The
treaty may contain an upper limit also
5. Pools Treaty Reinsurance
Pools are basically treaties, either quota share or
surplus, in the sense that under these arrangements
various member countries or member companies
join their hands together beforehand for sharing
each other’s premium as well as claim.
These pools usually operate in respect of
especially hazardous classes of business or where
the market as a whole is weak to absorb the risk.
In such circumstances,
Such pools providing mutual support become very
useful

3. Proportional Reinsurance

Under this type of coverage, the reinsurer will

receive a prorated share of the premiums of all the
policies sold by the insurance company being
covered. Consequently, when claims are made, the
reinsurer will also bear a portion of the losses. The
proportion of the premiums and losses that will be
shared by the reinsurer will be based on an agreed
percentage. In a proportional coverage, the
reinsurance company will also reimburse the
insurance company for all processing, business
acquisition and writing costs. Also known as
ceding commission, such costs may be paid to the
insurance company upfront.

4. Non-proportional Reinsurance

In a non-proportional type of coverage, the

reinsurer will only get involved if the insurance
company’s losses exceed a specified amount,
which is referred to as priority or retention limit.
Hence, the reinsurer does not have a proportional
share in the premiums and losses of the insurance
provider. The priority or retention limit may be
based on a single type of risk or an entire business
category.
5. Excess-of-Loss Reinsurance

This is actually a form of non-proportional

coverage. The reinsurer will only cover the losses
that exceed the insurance company’s retained
limit. However, what makes this type of contract
unique is that it is typically applied to catastrophic
events. It can cover the insurance company either
on a per occurrence basis or for all the cumulative
losses within a specified period.

6. Risk-Attaching Reinsurance

Under this type of contract, all policy claims

that are established during the effective period
of the reinsurance coverage will be covered,
regardless of whether the losses occurred
outside the coverage period. Conversely, no
coverage will be given on claims that originate
outside the coverage period, even if the losses
occurred while the reinsurance contract is in
effect.

7. Loss-occurring Coverage

This is a type of treaty coverage where the

insurance company can claim all losses that
occur during the reinsurance contract period.
The important factor to consider is when the
losses have occurred and not when the claims
have
 Nature of reinsurance risk

• No characterised risk associated with

proportional reinsurance as the ceding
insurer and the reinsurer automatically
share all premiums and losses covered by
the contract.
• On the other hand, a great deal of
uncertainty characterised the risk
associated with excess of loss reinsurance as
the level of risk is dependent on the nature
of the reinsurance undertaking.
• Excess of loss reinsurance, is characterised
by relatively low and unstable claims
frequency and very high but unstable loss
severity.
• The long tail lines i.e. lines of insurance in
which liability is slowest to manifest itself or
develop, create the worst problems for
reinsurer.
• Insurance loss costs are determined by a
combination of frequency, severity and the
valuating insurance risk depends on the law
of large no.s, which is often not applicable
 to reinsurance as reinsurance underwriter
depends much more on professional
judgement and experience to evaluate the
nature of the exposure.
• Reporting delays create serious problems
for all insurers, but marked differences
exist in reinsurer loss development pattern.
• All insurers and reinsurers set aside loss
reserves for claims, which have been
incurred but not reported.
• IBNR represent a “best guess estimate” of
future loss payments.
• Impact of inflation results in raised
settlement cost as the cost of living, no. of
claims paid, and large jury verdicts
increase, the impact of same is more
pronounced on reinsurers as their losses
develop much more slowly and may not be
capped to a retention limit.
• In many instances the reinsurer may not
become aware for years, of a loss it will
ultimately pay thus inflation has a drastic
impact on the reinsurer.
Reinsurance exposure of gic portfolio
• After the nationalisation of insurance
business, GIC was made responsible for
 reinsurance protection.

• 20% of the small risks and medium risks in

a fire portfolio are currently ceded to GIC.
• 25% of the listed risks are also ceded
subject to the maximum of Rs. 50 crores.
• In market place, 30% of each risk is ceded
to pool and retroceded back which is fully
retained by the companies, subject to a
monetary limit of Rs. 750 crores Probable
Maximum Loss.
• The net retention of GIC is Rs. 125 crore
(maximum) and Rs. 15 crore (absolute).
Reinsurance Regulation

Regulation of reinsurance companies is not as developed as regulation of direct writing

insurance companies. Reinsurance companies typically do not deal directly with the
policyholder public, so the consumer-based reasons for insurance regulation typically do not
apply to reinsurance companies. Also, because reinsurance is typically an insurance company
to insurance company transaction, regulation of policy forms and contract wordings is
typically not necessary. Reinsurance also has to be flexible to deal with the ever-changing
reinsurance marketplace. Restrictive regulation would preclude the ability of reinsurers to
adapt when necessary to provide the capital support essential to their customers.

Nevertheless, reinsurance companies are insurance companies, and in the United States, they
must be licensed in a specific state (domicile) and must comply with their home state's laws
and regulations. Also, reinsurance companies are required to comply with financial reporting
and financial regulation because maintaining the solvency of reinsurance companies is
critically important to maintaining the solvency of insurance companies that purchase
reinsurance. Moreover, reinsurers, if not directly licensed in multiple states, may be
authorized or accredited to reinsure companies licensed to do business in that state.

Reinsurers not located in the United States often reinsure insurance companies writing
business in the United States. Non-US reinsurers typically are permitted to do that because
they have met certain financial and regulatory requirements (accredited) or because they have
posted collateral or security to ensure that any obligations to their reinsureds will be paid.
Regulation of reinsurance of business
1. Section 34F of the insurance act, 1938 gives
power to IRDA to issue directions regarding
reinsurance treaties.
2. Section 101A of the insurance act, 1938
specifies that every insurer shall cede such
percentage of premium under every policy
written in the country to the “National
Insurance” or may be specified by IRDA in
 consultation with the Reinsurance Advisory
Committee.
3. Section 101B deals with the constitution of
the Reinsurance advisory committee.
4. Section 101C pertains to the powers of
IRDA to examine the reinsurance treaties of
insurers.

IRDA insurance regulations require every

insurer to draw up its reinsurance programme
keeping in mind the following objectives:

1. Maximize retention within the country.

2. Develop adequate capacity.
3. Secure the best possible protection for the
reinsurance cost incurred.
4. Simplify the administration of business.

It require every insurer to maintain the maximum

possible retention commensurate with its financial
strength and vol. of business. Under the
regulations, every insurer shall file its reinsurance
programme with authority 45 days prior to
commencement of financial year and copy of
treaty slips and cover notes within 30 days of
beginning of the financial year. The insurers are
required to place their reinsurance business outside
India with only those reinsurers having a rating of
at least BBB or its equivalent. Surplus over and
above the domestic reinsurance arrangements class
wise can be placed with the reinsurers subject to a
limit of 10% of the total reinsurance premium
ceded outside India being placed with any 1
reinsurer. Lastly, every insurer is required to
submit to the authority statistics relating to its
reinsurance transactions.
Issues and challenges in Indian reinsurance
The Indian reinsurance market at this juncture
is at the crossroads of becoming an industry on
par with the best international standards or
turning into a regional market. At the forefront
are issues and challenges which would require
the combined efforts of all the stakeholders viz.,
the regulator, the insurers and the reinsurers to
take it to higher levels.
• Obligatory cessions.
• Retentions.
• Alternative risk transfer.
• Foreign reinsurers.
• Detariffing.
• Recoverables.
.