ABC of Reinsurance
What follows is a personal view of the core concepts of reinsurance
Any Q’s please contact me. firstname.lastname@example.org
ABC of Reinsurance
The main aim of these notes
– to explain core reinsurance principles
– to help people, learn, confirm and clarify important concepts of Reinsurance
– to help give a positive start on the Reinsurance Elective for students at CASS
The state of the reinsurance market ?
Like any market, there are times of over and under supply and over and under demand.
At the start of 2017, in general the reinsurance market continued to suffer from over-supply, lessening demand, fewer major catastrophes.
The feeling at the start of 2017 was:
IF there is a market catastrophe of $125bn
– the market might harden
IF interest rates rise substantially
– the market might harden
Rates will continue to soften, terms will continue to widen?
– albeit much more slowly
More mergers and acquisitions in 2017
Some moves towards Reserve Strengthening (not releasing)
A very tough world for smaller and/or weaker reinsurers
However, towards the end of 2018 there was talk of major increases in prices following a series of Major Catastrophes. It is estimated that the total insured losses from Catastrophes in 2017 totalled $140bn, the highest number ever. (Previous highest, 2005 $120bn (Katrina, Rita, Wilma, all U.S. hurricanes.))
2017 included three major U.S. Hurricanes Harvey, Irma, Maria (HIM), Mexican Earthquakes and Californian Wildfires.
The hoped for increases did not materialise.
Excess Capacity – $80bn+ of “new capital” has come into reinsurance over the last 5+ years p.o. $550bn in total. (Different people give different numbers but these will not be that far wrong)
– mainly from US Pension funds – Hedge Funds
– looking a “reasonable return”
There was a “hope” that a great proportion of this Capital would withdraw or not be replaced, following 2017 major U.S. losses. Thus less Capacity (supply) so prices would rise substantially. The Capital is still here in 2018, with definitely more Capital in the wings considering entering the market. 1st April renewals (especially Japan) have been basically flat. Expectations for Florida Catastrophe renewals 1/6 – 1/7. Low increases.
ABC of Reinsurance?
The markets for reinsurance have definitely changed over the past few year. Traditional reinsurers offering traditional products still globally very strong but less traditional reinsurers and less traditional products are on the increase especially for the major insurers who are looking for diversity.
BUT – the core products will all still be in use for many years to come
– it is a big world, with many traditional and smaller insurers, wanting to work with products that they understand and that will work for them
Let’s start, once upon a time
Fixing the retention per risk.
Fixing how much one can afford to lose on one “risk”
N.B. Fixing how much of a loss the reinsured pays before reinsurers pay
= a deductible (Excess of Loss)
Retention and Deductible
Although most people today seem to use the word retention indiscriminately, it is much clearer to use words such as Deductible, Excess, Priority when referring to Non-Proportional (Excess of Loss) reinsurance – everyone will be clear you are referring to Excess of Loss.
Use the word Retention
– do you mean Proportional or Non-Proportional (Excess of Loss) reinsurance?
Decide on a maximum retention per risk
Based on a wide range of things including;
Capital and assets
Management attitude to risk
State of the reinsurance cycle
– reinsurers aggressive and in charge
– reinsurers wanting the business…….
Diversity of Risk, Territory…..
Cost of reinsurance / availability of reinsurance…..
Facultative Reinsurance or Treaty ?
Reinsured believes they will only have very few risks in the year that exceed $100,000
Will decide whether to buy reinsurance or not as each risk is accepted
If reinsurance is sought this would be called Facultative Reinsurance.
The first known reinsurance was covering the insurance of an Italian ship going from Genoa to Sluz in Belgium. approx 1365
The commercial language of the deal was Medieval Latin. It refers to Facultativo which means OPTIONAL
Facultativo (Italian) means optional
Facultative (French) means “optional”
Facultative (English) means “optional”;
Facultative Reinsurance (Optional)
Reinsured (does not have to offer the risk for reinsurance)
Reinsured can choose which reinsurer(s) to offer it to
Reinsurer (does not have to accept it)
– can say, yes, no or maybe if……
Treaty – see later. A contract under which reinsured has to reinsure risks and reinsurer automatically receives a share of all risks as defined.
Proportional or Non-Proportional
(Sharing) or $A xs $B
Proportional, Prop, Pro-rata three terms meaning the same thing – sharing.
All premiums and claims are shared in proportion to the %age allocation of the risk
The allocation of risk is based on the amount of the Sum Insured (in this example)
– allocation could be based on the PML (Probable Maximum Loss…..)
Sum Insured (SI) 1,000,000
Reinsured decides to retain $100,000 – Needs to reinsure $900,000
Reinsured is retaining 10% of the risk $100,000/$1,000,000
Reinsurer is receiving 90% of the risk $900,000/$1,000,000
Any premium paid under the insurance would be split 10% – 90%
Any claim paid under the insurance would be split 10% – 90% – irrespective of its size
In this example they have decided on Proportional Facultative
Split 100,000 x 12,000 900,000 x 12,000
The reinsured has spent money on marketing, a claims division…..thus reinsurers agree to allow the reinsured to deduct a pre agreed amount as Reinsurance Commission – say 25%
The expression “reinsurers pay commission” is often heard. This is not technically correct. The reinsured deducts commission from the premium due to the reinsurers.
The Facultative Account (often referred to as a Closing or Closing Instruction) would look like this.
Premium (OGP*) due to reinsurers 10,800
Less 25% Commn 2,700 – kept back by the reinsured to cover acquisition costs…..
Prem paid to reinsurers 8,100
and IF there was a RI broker involved
Less 10% Brokerage 1,080
Due to reinsurers 7,020
N.B. If there was a broker involved the broker would receive brokerage as a % of $10,800,
Traditionally proportional Brokerage is on the same percentage as the Commission
*OGP stands for Original Gross Premium – the Original Premium paid by the Original Insured to the insurer.
A Claim ?
There is a claim of $4,500 on the policy, which has an excess of $500
Claim Paid on insurance – $4,000 ($4,500 – $500)
Share paid by reinsurers 90% = 3,600
OG or ON ?
OGP (Original Gross Premium)
OGR (Original Gross Rate)
Reinsurers get their percentage share of the premium paid by the insured to the reinsured , less Commission (as in the example above)
ONP (Original Net Premium)
ONR (Original Net Rate)
Reinsurers get their percentage share of the premium paid by the insured to the reinsured after local deductions
e.g. OGP 12,000
Local Agent Commission 1,200
90% Reinsurance 9,720
Less Commission 20% 1,944
In this scenario Reinsurance Brokerage if any, would be on $9,720
Or perhaps the reinsured might consider a different approach. They still need Facultative Reinsurance but might consider a different approach. Reinsurance $A in excess of $B
Non Proportional, Excess of Loss, X/L, XOL, ELC (Excess Loss Contract)
Five terms basically meaning the same thing
– NOT sharing
Using the numbers above, reinsured would have;
Deductible (Excess, Priority) of $100,000
Cover of $900,000
This would be expressed as $900,000 xs $100,000
Any losses on the insurance below $100,000
– no claim on the Facultative
Any losses on the insurance above $100,000
– reinsurers would pay the amount above the deductible
Claim $80,000 fgu (from ground up) = no claim
Claim $200,000 fgu (from ground up) = claim – $100,000 to the reinsurance
The premium charged ?
Based on reinsurers expectation of loss/losses
– nothing to do with sharing of the risk or sharing the premium
– as this is a Price for an amount of Cover – there is normally no Commission deducted on an X/L Contract
Step 4 – Proportional Treaty
A change of plan – the reinsured is finding themselves placing quite a few facultatives which are basically very time consuming to organise and administrate
A contract under which the reinsured must cede (give) risks to the reinsurer(s) within the terms of the Treaty and the reinsurer must accept them e.g. To reinsure all engineering risks, located in China with a Sum Insured greater that $1,000,000, up to $10,000,000
N.B. The reinsured has become financially stronger so decides it can afford to lose a maximum of $600,000 but needs to workout how much automatic capacity it needs to replace as many facultatives as possible. The reinsured has to understand its full portfolio of risks. It will organise a list of all the risks in the Property Account (or whichever account is being analysed) showing their Sums Insured (SI) – The Risk Profile
Almost all risks in the Risk Profile are below a SI $4,000,000.
If there any risks above $4,000,000 in the year – they will have to revert to using facultative for the portion over $4,000,000
The reinsured is getting more comfortable with risk
It is financially stronger. It is placing too much Facultative (High Administration….)
Wants to share all risks in this class(es) with reinsurers – would call this Treaty a Quota Share Treaty
Want to retain a Max Share of $600,000 per risk
Most risks up to up to $4,000,000
100% Limit for 1 risk $4,000,000
Retain $600,000 Reinsure $3,400,000
This Treaty would be called a 85% Quota Share (Q/S) Treaty
Thus every premium and every claim on every policy in this account up to a SI of $4,000,000 will be shared 15% – 85%
N.B. IF Retention had been $1,000,000 and Reinsured amount $3,000,000 it would have been called a 75% Q/S 3,000,000/4,000,000 = 75%. 75% of every risk up to $4,000,000 would have been split 25% 75%.
Under the 85% Q/S
Retained Premium $900 (15%) Treaty (85%) Premium $5,100
HOWEVER there will also be Commission to deduct say 20% $1,020
Reinsurers will therefore get $4,080
If there was Reinsurance Brokerage this would be deducted from $5,100
As the reinsured (the insurer) has costs to acquire business; advertising, marketing, local brokerage, claims dept…..reinsurers allow the reinsured to deduct a percentage of the original premium to cover such costs
– this figure is totally negotiable.
This calculation would be done for every risk written in the quarter and shown as;
Balance due from/to reinsurers
N.B. If this Treaty had been placed via a broker the brokerage – say 2.5% would be based on the total premium figure (before commission).
But a risk of $5,000,000 ?
Retention Treaty Facultative
600,000 3,400,000 1,000,000
12% 68% 20%
So, a Q/S Treaty is not quite as it seems. It is a fixed share of every risk (in the defined class(es) up to a pre-agreed amount. As soon as the Sum Insured is larger than this limit, the percentages will reduce
Other Proportional possibilities
In the future, as the company gets stronger they might decide that they want to keep all the comparatively small risks themselves and only reinsure risks larger than their retention – so move from a Q/S Treaty to a Surplus Treaty might be proposed.
Surplus – a share of “larger” risks only
What does the word Surplus mean ?
– in addition to
– over and above
A Surplus Treaty provides automatic reinsurance in addition to (Surplus to) the RETENTION
How does a Surplus Treaty work ?
Retention $600,000 per risk
All risks up to $600,000 will fall 100% into the retention
For historic reasons the retention is referred to as a “line” – “Line” = retention
Original Acceptance $ 1,000,000
Amount it needs to Reinsure – the “Surplus” (what is left) $ 400,000.
The important difference between Q/S and a Surplus is the “flexibility” available to the reinsured under the Surplus.
All “small” – “good” risks should fall within the retention under a Surplus, but have to be shared under a Quota Share.
All risks with a sum insured equal or below the retention are retained.
Any Surplus is placed with Treaty reinsurers and where necessary (Treaty Limit not large enough), with facultative reinsurers.
On a Surplus Treaty – 1 Retention = 1 line
Grade Retention 9 Line (9 x retention Treaty) Treaty Max Automatic Underwriting Capacity
A1 100,000 900,000 1,000,000 (9 lines and retn.)
On a Surplus Treaty 1 Retention = 1 line
Grade Retention 9 Line Treaty Max Automatic (max cession)
A1 100,000 900,000 1,000,000 (9 lines and retn.)
A2 80,000 720,000 800,000 (“ “ “ “ )
A3 60,000 540,000 600,000 (“ “ “ “ )
A4 40,000 360,000 400,000 (“ “ “ “ )
A5 20,000 180,000 200,000 (“ “ “ “ )
Treaty RI and Fac
Still placing more Facultative
What to do?
Increase number of lines
Place a 2nd Surplus
Retention 15 Line S 20 Line S
100,000 1,500,000 2,000,000
Even if an insurer has a Surplus Treaty to take out risks larger than their retention , when they start having to place too many facultatives, they could consider increasing the number of lines, increasing the retention or the possibility of another Surplus in addition to absorb the facultatives. A 2nd Surplus will still based on the size of the initial retention on the risk.
In this example
Risks up to 100,000 into retention
100,000 up to 1,600,000 into 1st Surplus
1,600,001 up to 3,600,000 in 2nd surplus
Larger than 3,600,000 would need Fac
Retention 15 Line (Retention) 1st Surplus 20 Line (Retention) 2nd Surplus Facultative
Sum Insured 100,000 1,500,000 2,000,000
1,000,000 100,000 900,000
2,000,000 100,000 1,500,000 400,000
(5%) (75%) (20%)
4,000,000 100,000 1,500,000 2,000,000 400,000
2.5% 37.5% 50% 10%
All premiums( less Commission) would be split in these percentatges
The only other form of proportional treaty is called a Facultative Obligatory Treaty?
A contract with a very confusing set of words.
Facultative Obligatory Treaty
Facultative – optional for reinsured to decide whether to utilise it or not
Obligatory – for the reinsurer to accept whatever risks are ceded (given) under the Treaty
Treaty – a contract
A variation of a Surplus
Works in exactly the same way as a Surplus – EXCEPT that the reinsured does NOT have to cede risks above its retention to the Fac Oblig
BUT if the risk is ceded, reinsurers MUST accept it
– a dangerous treaty for reinsurers.
e.g. Sum Insured $4,100,000
MUST MUST MAY
10 Line 1st S 20L 2nd S 10L Fac Oblig
1,000,000 2,000,000 1,000,000
MUST MUST MAY
10 Line 1st S 20L 2nd S 10L Fac Oblig FAC
1,000,000 2,000,000 0 1,000,000
In other words the Reinsured can cede nothing or whatever it likes up to X times its retention BUT the reinsurer must accept whatever is ceded.
The most dangerous product for a reinsurer ?
An unlined Fac Oblig
No relationship between Retention and Cession
– just a Treaty Limit per risk
Make a full cession!
Catastrophes and Proportional Treaties – Reinsurers Exposures to Catastrophe
Reinsurers need to be able to control their own exposures to Catastrophes so impose certain rules, especially in a hard market..
N.B. A reinsurer has unlimited exposure to one event under a Proportional Treaty – a fact which international reinsurers have a habit of forgetting from time to time!
I cede to you 60% of the premium on a risk, you should pay 60% of any claim ?
I cede to you 60% of the premium on a 1,000 risks, and they are destroyed in an earthquake you should pay 60% x 1,000 claims!
Therefore Reinsurers will consider imposing two possible limitations.
– Cession Limit
– Aggregate Limit – any one event (Event Limit)!
Please note that the Thai Flood Losses in 2011 (estimated insurance loss $12bn) STRONGLY impacted on this this area in 2012 – there is a lessening impact as the market has softened since then
The total Sums Insured that can be ceded under the Proportional Treaty for all risks, for that specific peril, e.g. Flood in the year is $800,000,000
IF after a major loss reinsurers decided to inspect the reinsured’s records and find that the Cession Limit had been exceeded and was actually $1,000,000,000 they would have the right to apply average to the total of all the losses under the treaty, from this peril, from this event.
i.e. only 800,000,000/1,000,000 x actual loss to treaty
It is essential that accurate data entry and reporting is carried out.
Sometimes people use the Cession Limit words to mean Treaty Limit – be careful!
A Cession limit (all risks), will be a very large number
A Treaty limit – will be a comparatively much smaller number
The second limitation
Aggregate Limit per event – even though, in theory at least the reinsured has paid XX% of the premium for each risk ceded to a proportional Treaty, treaty reinsurers, may (as is common in many Catastrophe Regions) apply an Aggregate Limit / Event Limit
Aggregate Limit/Event Limit
The Maximum amount that can be claimed from any one event e.g $12,000,000 under a proportional treaty.
If the loss from all the cessions to the Treaty from one event exceed $12,000,000 the balance will fall back onto the reinsured’s retained account. (Called “Spillover”)
It will NOT fall on Cat X/L unless this has been specifically agreed by Cat X/L reinsurers at the start of the reinsurance contract
In 2012 after the Thai Floods in 2011 – the event limit in many cases was only 2/3 times the Treaty Limit for 1 risk. As the Market softens – Limits are getting larger – possibly now 5/7 times Treaty Limit, or even being omitted!
Unless special permission was sought and given the reinsured would NOT be allowed to add any unprotected part of the loss (Spillover) to their retained losses when calculating how much they could collect from Catastrophe Excess of Loss (X/L) Reinsurance
We can now concentrate on the retention and;
How much protection do we need for an “event”, (Earthquake, hurricane, flood………)
To pay $Y,000,000 in excess of $Z,000,000 any one event
In the Q/S example above, there is a retention of 15% of every risk up to $4,000,000
Let’s assume that the only risks the reinsured accepts are;
100 risks SI 4,000,000 = Total SI $400,000,000
Retention on every risk 15% Total Retained Risk SI $ 60,000,000
Estimated Maximum Loss EML from an event 30%
– Catastrophe Cover Required $18,000,000
What deductible ?
A figure that will not destroy the reinsured especially if they have more than one event loss in a year
– nor a figure that is very too low – the cost of buying cover in excess of this amount would be prohibitive – so, say $2,000,000
N.B A typical Cat X/L deductible is often somewhere between 2 to 5 retentions
– in this case between $1,200,000 to $3,000,000 (2 x $600,000) (5 x $600,000)
The reinsured might therefore buy Catastrophe X/L for;
– $16,000,000 xs $2,000,000 – in layers
Traditionally this would be placed in layers
e.g. $3,000,000 xs $2,000,000
$5,000,000 xs $5,000,000
$8,000,000 xs $10,000,000
The Hurricane Happens!!
The Q/S pays 85% of each individual claim
The reinsured accumulates together all of the 15% shares on each policy
IF total comes to more than $2,000,000 the excess (balance) comes from Cat X/L reinsurers – assuming reinsured has bought enough cover!
N.B. IF the loss to the Q/S exceeds the event limit of $12,000,000 the extra amount un-claimable from the Q/S (Spillover) cannot be added to all the retained losses from the event to form part of the claim from Cat X/L reinsurers – unless this has been pre-agreed.
Any thing else to consider?
What is an event ?
There is a specific clause in Cat X/L that limits the amount of time that can be claimed for a specific event as far as reinsurers are concerned – The so called “Hours Clause”. This clause has in the past few years been widened in terms of length allowed for an event. 72 hours for most perils and 168 for Fire and Flood in general seems to have now become 168 for everything apart from Flood which may well be 504 hours.
e.g. A hurricane.. Records have to be kept on date and time of loss. The reinsured will add up all the losses from the event and chose the 168 hours where the cumulative total comes to the most – if the hurricane blows for longer than 168 hours the reinsured is allowed to start again – with a 2nd deductible or even a 3rd – assuming they have sufficient reinstatement(s)
Reinstatement (Re-buying of cover)
Cat X/L will normally have a reinstatement(s) provision pre-agreed at the start of the year – The methodology for calculating the reinstatement premium differs in one area from insurance.
Commercial Insurance and Reinstatement
Claim to the insurance $500,000
Date of Loss 1/10/18
Policy incepts 1/1/18
Pro-Rata for amount Pro-Rata for Time (left to run) Premium
Claim $500,000 x 3 months x $20,000 = $2,500
Cover $1,000,000 12 months
Thus the insured would pay $2,500 to rebuy (reinstate) $500,000 of cover for the last 3 months of the year to bring the available coverage back to $1,000,000. In many cases in insurance this AP (Additional Premium) is not charged (Commercial Pressure).
Catastrophe Reinsurance and Reinstatement
It is normally the case that the date of loss is ignored and a percentage inserted in its place.
It is often the case in Cat X/L that only 1 reinstatement is given
So as an example
Cover $16,000,000 xs $2,000,000
Premium for the reinsurance $700,000
Reinstatement 1 x Limit (Max)
Claim from one event $10,000,000 fgu (from ground up) = $8,000,000 to the layer ($10,000,000 – $2,000,000)
Date of loss – 1/9/2018
What would the reinstatement calculation be?
Pro Rata for amount 100% for Time Premium
8,000,000 x 100% x 700,000 = $375,000
Thus the cover has been put back to $16,000,000 but the Date of loss has been ignored (x 100%) – if time had been taken into account the 100% would have been replaced with 4/12 (buying cover for the last 4 months of the year.
What does 1 reinstatement mean? – Can only claim once in the year ? NO!
It means that the full amount of cover can only be reinstated once
$16,00,000 of cover
1 reinstatement means that the reinsured can claim $32,000,000 in a year
Premium for $16,000,000 of cover
Reinstatement premium for a further $16,000,000 of cover
This reinsured has 1 reinstatement in its Cat Programme. To ensure simple budgeting of reinsurance costs they might consider taking out a Reinstatement Premium Protection Cover.
Thus in the example above – claim of $8,000,000
Collect $8,000,000 from Cat X/L reinsurers – less $375,000 reinstatement premium
Collect $375,000 from Reinstatement Premium Protection Reinsurers
Per risk X/L
Retention as earlier 15% of Max $4,000,000 = $600,000
Reinsured is happy to retain 15% of every risk up to $4,000,000 but is concerned that a loss on a large risk could unbalance the results – so has bought a Per Risk X/L for $150,000 xs $450,000 per risk.
Insure a house $1,000,000
Retention 15% = loss $150,000
No claim on the Risk X/L (below the deductible of $450,000
Insure a factory SI $4,000,000
Retention = 15% = loss of $600,000 fgu
Claim on Risk X/L 150,000 ($600,000 – $450,000)
This product is likely to have;
– aggregate limit any one event
– very limited – this is not a Cat X/L
– aggregate any one year
– 2 or so times the event limit ?
A summary of the ABC ?
Decide Retention per risk
Only a few risks larger than the retention = Facultative
Proportional = sharing of risk, premiums, costs, claims
Non-Proportional = A xs B (Cover xs Deductible) for a price
Many risks larger than the retention – want to share risks, premiums, claims
Decide to SHARE ALL RISKS = Quota Share (Q/S) Treaty
– automatic reinsurance for all risks
Decides to keep all smaller risks = Surplus Treaty
– automatic reinsurance for all risks larger than the Retention
– amount that can be ceded (given) to the Treaty based on a pre-agreed multiple of the retention (Line)
Retention getting larger – keeping more risk
Concerned that an individual RISK loss will unbalance their results = Per Risk X/L
– cover xs deductible any one RISK
– very low limit any one event
– pays for risk losses NOT Catastrophe Losses
Retentions will accumulate in a catastrophe = Catastrophe X/L
– protection any one event
The other core reinsurance products;
Stop Loss (Excess of Loss Ratio Cover)
The reinsured has moved into a new class
Wants protection at the end of the year IF loss ratio worse than x%
Think of it as an Excess of, Loss Ratio Cover
e.g. Cover 10% Loss Ratio xs 70% Loss Ratio
Losses (as defined) $6,900,000 = 69% = No Claim
Premiums (as defined) $10,000,000
10% Loss Ratio xs 70% Loss Ratio
Losses (as defined) $ 7,500,000 = 75% = 5% Claim (75% – 70% deductible)
Premiums (as defined) $10,000,000
5% of what can be collected from reinsurers?
5% of PREMIUM = $500,000
In many cases the contract will say;
To pay 95% of; (95% of = co-reinsurance – want some of the loss to be paid by the reinsured)
e.g. 10% Loss Ratio in excess of 90% Loss Ratio
= Loss Ratio 60%
No claim as falls below deductible of 90%
= Loss Ratio 95%
Claim as Loss Ratio falls above deductible of 90%
Losses 95% of premiums $9,500,000
Deductible 90% of premiums $9,000,000
Claim on reinsurers 5% of premiums $500,000
Reinsurers will pay 95% of $500,000
Lastly the Aggregate X/L
Same basic purpose as the Stop Loss (Excess of, Loss Ratio Cover) but based on $ not Loss Ratio
To pay if losses in the aggregate in the year exceed $xx,xxx,xxx up to a further $yy,yyy,yyy
– a variation of the Stop Loss except, cover and deductible are in $
If an underwriter would want to protect their Loss Ratio they would consider a Stop Loss. If a Finance director wanted to protect the company against a financial hit of more than $xx,xxx,xxx they would consider an Aggregate X/L
And lastly, lastly!
A trendy newer product
Catastrophe Aggregate X/L
To pay if the accumulation of individual event losses (as defined) that are larger than $50,000,000
exceed in the aggregate in the year $200,000,000
Cover up to a further $300,000,000 in the aggregate in the year
Event Loss 1) $40,000,000 – not accumulated (below $50,000,000)
Event Loss 2) $150,000,000 – accumulated
Event Loss 3) $60,000,000 – accumulated
Total of Event Losses – accumulated $210,000,000
Claim $10,000,000 ($210,00,000 – Deductible $200,000,000)
Hope that this helps