CII Reinsurance

Reinsurance
M97 Study text: 2019

2019–
–20
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© The Chartered Insurance Institute 2019
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Print edition ISBN: 978 1 78642 599 7

Electronic edition ISBN: 978 1 78642 600 0
This revised and updated edition printed in 2019
The authors
Mike Spice BA, FCII, Cert PFS has been involved in the reinsurance market for many years with
responsibilities that include the placement and analysis of reinsurance programmes on behalf of leading
composite insurers and run-off management service providers. He has lectured at Cheltenham & Gloucester
College of Higher Education (now University of Gloucestershire). Mike also acts as a tutor for the CII and
assists other market entities in a wide range of training and development activities.
Paul Phillipson, MA (Oxon), Solicitor FCII works at Xchanging Claims Services (XCS), handling reinsurance
claims on behalf of Lloyd’s Syndicates. After graduating, he joined an underwriting box at Lloyd’s before
qualifying as a solicitor in 1998 and practised in the London Market until he joined XCS in 2005. He
contributes to market publications from time to time.
Updater for 2019

2019–
–20 edition
Roland Vella BA, MCIM
Reviewer
The CII would like to thank Eric Alexander, ACII for his assistance with reviewing the first edition of this
study text.
Acknowledgements
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3
About your study text

Welcome to the M97
M97: Reinsurance study text which is designed to support the M97 syllabus,
a copy of which is included in the next section.
Please note that in order to create a logical and effective study path, the contents of this
study text do not necessarily mirror the order of the syllabus, which forms the basis of the
assessment. To assist you in your learning we have followed the syllabus with a table that
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5
Examination syllabus
Reinsurance
Purpose
At the end of this unit, candidates should be able to understand reinsurance and how it
operates.
Assumed knowledge
It is assumed that the candidate already has knowledge of the fundamental principles of
insurance as covered in IF1 Insurance, legal and regulatory or equivalent examination.
Summary of learning outcomes Number of

questions in the
examination*
1. Know the purpose of, and the parties involved in, reinsurance. 4
2. Understand the different types of reinsurance. 3
3. Understand the features and operation of facultative reinsurance. 2
4. Understand the features and operation of proportional reinsurance treaties. 8
5. Understand the features and operation of non-proportional reinsurance 7
treaties.
6. Understand the design and placement of reinsurance programmes. 8
7. Understand legal issues relating to reinsurance. 3
8. Understand reinsurance contract wordings. 5
9. Understand the main features and characteristics of the principal 4
reinsurance markets.
10. Understand the principles and practices of different classes of reinsurance 6
business.
*The test specification has an in-built element of flexibility. It is designed to be used as a guide for study and is not a
statement of actual number of questions that will appear in every exam. However, the number of questions testing each
learning outcome will generally be within the range plus or minus 2 of the number indicated.
Important notes
• Method of assessment:
Mixed assessment consisting of two components, both of which must be passed. One component is a
coursework assignment and one is a multiple choice question (MCQ) examination. The details are:
1. an online coursework assignment using RevisionMate consisting of 10 questions which
sequentially follow the learning outcomes. This must be successfully completed within 6 months
of enrolment; and
2. an MCQ exam at one of the CII’s online centres (paper-based MCQs are available in April and
October for those sitting outside the UK). The MCQ exam consists of 50 MCQs. 1 hour is allowed
for this exam. This exam must be successfully passed within 18 months of enrolment.
• This syllabus will be examined from 1 May 2019 until 30 April 2020.
• Candidates will be examined on the basis of English law and practice unless otherwise stated.
• Candidates should refer to the CII website for the latest information on changes to law and practice
and when they will be examined:
1. Visit www.cii.co.uk/learning/qualifications/diploma-in-insurance-qualification/
2. Select the appropriate qualification
3. Select your unit on the right hand side of the page
Published February 2019 M97

Copyright © 2019 The Chartered Insurance Institute. All rights reserved.
6 M97/March 2019 Reinsurance
1. Know the purpose of, and the parties 6. Understand the design and
involved in, reinsurance placement of reinsurance
1.1 Explain the purpose of reinsurance, programmes
including spreading risk, capacity, financial 6.1 Discuss the factors affecting the design of a
security and capital management. reinsurance programme, including the
1.2 Identify the different parties involved in significance of modelling and actuarial
reinsurance and their various roles. input.
6.2 Discuss how proportional and non-
2. Understand the different types of proportional reinsurance can be combined
reinsurance to make an effective reinsurance
2.1 Outline the main types of reinsurance. programme.
2.2 Explain the difference between reinsurance 6.3 Discuss the material information required
and retrocession. in the placement of reinsurance
programmes.
2.3 Discuss the alternatives to conventional
reinsurance. 6.4 Explain the use of reciprocity.
6.5 Discuss how solvency and security
3. Understand the features and considerations affect reinsurance
operation of facultative reinsurance programmes.
3.1 Explain the main features and operation of
7. Understand legal issues relating to
different types of facultative reinsurance.
reinsurance
3.2 Calculate reinsurance premiums and claims
recoveries for proportional and non- 7.1 Discuss the legal requirements for the
proportional facultative reinsurance. formation of a reinsurance contract.
7.2 Discuss the key issues and reinsurance case
4. Understand the features and law relating to the interpretation of
operation of proportional contractual documents.
reinsurance treaties
8. Understand reinsurance contract
wordings
different types of proportional reinsurance
treaties. 8.1 Discuss the main features of facultative and
treaty wordings.
4.2 Explain the main accounting methods for
proportional reinsurance treaties. 8.2 Describe key clauses used in proportional
and non-proportional wordings.
4.3 Discuss different types of commission on
proportional reinsurance treaties. 8.3 Describe the main treaty exclusions and
their importance.
4.4 Discuss the use of premium and claims
reserves.
9. Understand the main features and
characteristics of the principal
recoveries for proportional reinsurance
treaties. reinsurance markets
4.6 Discuss the use of cession and event limits 9.1 Explain the main features and
in proportional reinsurance treaties. characteristics of the principal reinsurance
markets.
5. Understand the features and 9.2 Discuss the characteristics of hard and soft
operation of non-proportional markets.
reinsurance treaties 9.3 Discuss the management of the
underwriting cycle.
different types of non-proportional
reinsurance treaties.
5.2 Explain the different bases of cover
including risks attaching, losses occurring,
claims made and losses discovered.
5.3 Discuss the various types of premium
calculation used in non-proportional
recoveries for non-proportional
5.5 Discuss the purpose and use of
reinstatements.
5.6 Discuss the use of event limits in non-
proportional reinsurance treaties.
Published February 2019 2 of 4

7
10. Understand the principles and Reading list

practices of different classes of
reinsurance business The following list provides details of further
10.1 Explain the main underwriting reading which may assist you with your studies.
considerations for property and casualty Note: The examination will test the syllabus
reinsurance. alone.
10.2 Explain different reinsurance methods
The reading list is provided for guidance only
applied to property and casualty
and is not in itself the subject of the
reinsurance.
examination.
10.3 Explain the terms and conditions specific
to property and casualty reinsurance. The resources listed here will help you keep up-
to-date with developments and provide a wider
10.4 Describe the main underwriting
coverage of syllabus topics.
considerations, and terms and conditions
specific to marine and aviation reinsurance. CII/PFS members can access most of the
10.5 Apply the principles and practices of additional study materials below via the
reinsurance to property, casualty, marine Knowledge Services webpage at https://
and aviation business. www.cii.co.uk/knowledge-services/.
New resources are added frequently - for
information about obtaining a copy of an article
or book chapter, book loans, or help finding
resources , please go to https://www.cii.co.uk/
knowledge-services/ or email
knowledge@cii.co.uk.
CII study texts

Reinsurance. London: CII. Study text: M97
Insurance, legal and regulatory. London: CII.
Study text IF1
Books (and ebooks)

Carter on reinsurance. 5th ed. Robert Carter et al.
Witherby, 2013.
Imagining the future: how to stay ahead in the
reinsurance game through scenario planning.
Paula Jarzabkowski. London: Cass Business
School, 2013.
Insurance and reinsurance law and regulation:
jurisdictional comparisons. Clive O’Connell.
London: Sweet and Maxwell, 2014.
Making a market for acts of God. The practice of
risk-trading in the global reinsurance industry.
Paula Jarzabkowski. Oxford: Oxford University
Press, 2015.*
Reinsurance arbitrations. Kyriaki Noussia.
Heidelberg: Springer-Verlag, 2013.*
Reinsurance: the nuts and bolts. Keith Riley.
London: Witherby, 2012.
‘Reinsurance’. Chapter – Insurance disputes.
Jonathan Mance, Iain Goldrein, Robert Merkin. 3rd
ed. London: Informa, 2011.
Risk theory and reinsurance. Griselda Deelstra, et
al. London: Springer, 2014.*
The law of reinsurance. 2nd ed. Colin Edelman,
Andrew Burns. Oxford, OUP, 2013.

Factfiles and other online resources Exam technique/study skills

CII fact files are concise, easy to digest but There are many modestly priced guides available
technically dense resources designed to enrich the in bookshops. You should choose one which suits
knowledge of members. Written by subject your requirements.
experts and practitioners, the fact files cover key
industry topics as well as less familiar or specialist The Insurance Institute of London holds a lecture
areas of general insurance, life, and pensions and on revision techniques for CII exams
financial services, with information drawn together approximately three times a year. The slides from
in a way not readily available elsewhere. Available their most recent lectures can be found at
online via www.cii.co.uk/ciifactfiles (CII/PFS www.cii.co.uk/iilrevision (CII/PFS members only).
members only).
The Insurance Institute of London (IIL) podcast
lecture series features leading industry figures and
subject experts speaking on current issues and
trends impacting insurance and financial services.
Available online at https://www.cii.co.uk/
insurance-institute-of-london/ (CII/PFS members
only).
Alternative risk transfer (ART). Alan Punter.
Insurance-linked securities (ILS). Alan Punter.
Recent developments in reinsurance law. Robert
Merkin.
Reinsurance industry in the UK, key trends and
opportunities. ©Timetric Forecast Reports.
Annual. Available for members at www.cii.co.uk/
forecastreports.
Journals and magazines

The Journal. London: CII. Six issues a year. Archive
available online at https://www.thepfs.org/
search-results/?q=the+journal (CII/PFS members
only).
Post magazine. London: Incisive Financial
Publishing. Monthly. Contents searchable online at
www.postonline.co.uk.
Reference materials
Concise encyclopedia of insurance terms.
Laurence S. Silver, et al. New York: Routledge,
2010.*
Dictionary of insurance. C Bennett. 2nd ed.
London: Pearson Education, 2004.
Reinsurance practice and the law. London:
Informa. Updated regularly. Available online on i-
law.com. Access via the CII website on
www.cii.co.uk/lawdatabases (members only).
* Also available as an ebook through Discovery via
www.cii.co.uk/discovery (CII/PFS members only).
Exemplars
Exemplar papers are available for all mixed
assessment units. Exemplars are available for both
the coursework component and the MCQ exam
component.
These are available on the CII website under the
unit number before purchasing the unit. They are
available under the following link www.cii.co.uk/
qualifications/diploma-in-insurance-qualification.
These exemplar papers are also available on the
RevisionMate website www.revisionmate.com
after you have purchased the unit.

9
M97 syllabus
quick-reference guide
Syllabus learning outcome Study text chapter
and section
1. Know the purpose of, and the parties involved in, reinsurance
1.1 Explain the purpose of reinsurance including, spreading risk, 1A, 1E, 1G
capacity, financial security and capital management.
1.2 Identify the different parties involved in reinsurance and their 1B, 1C, 1D, 1E, 1F
various roles.
2. Understand the different types of reinsurance
2.1 Outline the main types of reinsurance. 2A, 2D
2.2 Explain the difference between reinsurance and retrocession. 2B
2.3 Discuss the alternatives to conventional reinsurance. 2C
3. Understand the features and operation of facultative reinsurance
3.1 Explain the main features and operation of different types of 3A, 3C
facultative reinsurance.
3.2 Calculate reinsurance premiums and claims recoveries for 3B

proportional and non-proportional facultative reinsurance.
4. Understand the features and operation of proportional reinsurance treaties
4.1 Explain the main features and operation of different types of 4A, 4G
4.2 Explain the main accounting methods for proportional 4B

4.3 Discuss different types of commission on proportional 4C

4.4 Discuss the use of premium and claims reserves. 4D
4.5 Calculate reinsurance premiums and claims recoveries for 4E

4.6 Discuss the use of cession and event limits in proportional 4F

5. Understand the features and operation of non-proportional reinsurance treaties
5.1 Explain the main features and operation of different types of 5A, 5F
non-proportional reinsurance treaties.
5.2 Explain the different bases of cover including risks attaching, 5B

losses occurring, claims made and losses discovered.
5.3 Discuss the various types of premium calculation used in 5C

5.4 Calculate reinsurance premiums and claims recoveries for 5C

5.5 Discuss the purpose and use of reinstatements. 5E
5.6 Discuss the use of event limits in non-proportional reinsurance 5D

treaties.
Syllabus learning outcome Study text chapter

and section
6. Understand the design and placement of reinsurance programmes
6.1 Discuss the factors affecting the design of a reinsurance 6A, 6B

programme, including the significance of modelling and actuarial
input.
6.2 Discuss how proportional and non-proportional reinsurance can 6A

be combined to make an effective reinsurance programme.
6.3 Discuss the material information required in the placement of 6C

reinsurance programmes.
6.4 Explain the use of reciprocity. 6D
6.5 Discuss how solvency and security considerations affect 6A, 6C, 9E
reinsurance programmes.
7. Understand legal issues relating to reinsurance
7.1 Discuss the legal requirements for the formation of a reinsurance 8A

contract.
7.2 Discuss the key issues and reinsurance case law relating to the 8B, 8C, 8D, 8E, 8F
interpretation of contractual documents.
8. Understand reinsurance contract wordings
8.1 Discuss the main features of facultative and treaty wordings. 7A
8.2 Describe key clauses used in proportional and non-proportional 7B, 7C, 7D
wordings.
8.3 Describe the main treaty exclusions and their importance. 7E
9. Understand the main features and characteristics of the principal reinsurance markets
9.1 Explain the main features and characteristics of the principal 9A, 9B, 9C, 9E, 9F, 9G
9.2 Discuss the characteristics of hard and soft markets. 9D
9.3 Discuss the management of the underwriting cycle. 9D
10. Understand the principles and practices of different classes of reinsurance business
10.1 Explain the main underwriting considerations for property and 10A, 10B, 10C, 11A, 11B, 11C,
casualty reinsurance. 11D, 11E, 11F, 11G, 11H, 11I, 11J,
11K
10.2 Explain different reinsurance methods applied to property and 10A, 10B, 10C, 11A
casualty reinsurance.
10.3 Explain the terms and conditions specific to property and 7D, 10B, 10C, 11A, 11B, 11C,
casualty reinsurance. 11D, 11E, 11F, 11G, 11H, 11I, 11J,
11K, 11L
10.4 Describe the main underwriting considerations, and terms and 12A, 12B, 12C
conditions specific to marine and aviation reinsurance.
10.5 Apply the principles and practices of reinsurance to property, 10A, 10B, 10C, 11A, 11B, 11C,
casualty, marine and aviation business. 11D, 11E, 11F, 11G, 11H, 11I, 11J,
11K, 11L, 12A, 12B, 12C
11
Introduction
The early chapters of this study text provide an overview of the purpose of reinsurance, the
parties involved in the reinsurance transaction and the ways in which reinsurance can be
structured to satisfy the requirements of buyers.
The purpose of reinsurance remains technical, which is to say that it is a mechanism whereby
a buyer, typically an insurer, and otherwise known as a reinsured or cedant, seeks to reduce
the financial consequences of losses resulting from perils it has agreed to insure.
In essence, reinsurance does not limit the insurer’s liability to the entity it has agreed to
insure – the reinsurance contract is legally entirely separate to the insurance contract – but
instead limits its consequences to the insurer by passing it ,in whole or in part, to a reinsurer,
via the reinsurance transaction.
This is done by the insurer entering into an agreement with a reinsurer whereby the reinsurer
agrees to accept a certain fixed share of the insurer’s risk upon the terms set out in the
agreement, in return for payment of a premium at a specified date. The agreement sets out
how much, and when, the premium will be paid by the insurer to the reinsurer.
The decision of the insurer to purchase reinsurance involves consideration of many
important issues.
Chapters 1 and 2 look at how the needs of the insurer are identified and met and how
reinsurance fits the insurer’s corporate strategy and other interrelated issues. Of course,
these needs have to be kept under constant review and other actions considered as
circumstances change.
Chapters 3, 4 and 5 consider the various types of reinsurance available to the insurer and the
strategic purpose of each along with associated advantages and disadvantages.
Chapter 6 looks at the design, construction, pricing and placement of a programme of
reinsurance cover, leaving you with a detailed understanding of current London market
practices. A series of worked examples demonstrate the different characteristics of
combinations of proportional and non-proportional, facultative and treaty, contracts.
As (re)insurance is a ‘promise to pay’, chapter 7 examines the wording of that promise. After
considering the main features of facultative and treaty wordings, the remainder of the
chapter outlines; first, clauses common to proportional and non-proportional reinsurance
contracts and then, separately, clauses which are specific to those types of reinsurance.
Chapter 8 is concerned with the law applicable to reinsurance contacts and highlights issues
that have arisen in the courts with particular reference to their formation, interpretation, and
express and implied terms.
Chapter 9 is an amalgam of topics, including the nature of the reinsurance market, its cycles
and constituents. There are also sections on captives, financial strength ratings and
terrorism.
The remaining three chapters discuss, in turn, the risks inherent in a property, casualty,
marine and aviation account, and underwrite, or reinsure, them.
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13
Contents
1: Purpose of and the parties involved in reinsurance
A Purpose of reinsurance 1/2
B Buyers of reinsurance 1/8
C Motivation for selling reinsurance 1/11
D Sellers of reinsurance 1/12
E Contractual relationship between buyers and sellers 1/14
F Reinsurance brokers 1/15
G When things change 1/19
2: Different types of reinsurance

A Main types of reinsurance 2/3
B Differences between reinsurance and retrocession 2/7
C Alternatives to conventional reinsurance 2/9
D Practical limitations on choice 2/15
3: Features and operation of facultative reinsurance

A Main features and operation of different types of facultative reinsurance 3/2
B Calculation of reinsurance premiums and claims recoveries 3/8
C Case studies 3/13
4: Features and operation of proportional reinsurance treaties

A Main features and operation of proportional reinsurance treaties 4/2
B Main accounting methods 4/16
C Commissions and deductions 4/21
D Premium and claims reserves 4/26
E Calculation of reinsurance premiums and claims recoveries 4/27
F Cession and event limits 4/27
G Case studies 4/28
5: Features and operation of non-proportional

A Main features and operation of non-proportional reinsurance treaties 5/2
B Different bases of cover attachment 5/16
C Premium calculation for non-proportional reinsurance 5/17
D Event limits 5/24
E Reinstatements 5/25
F Case studies 5/27
6: Reinsurance programmes
A Designing programmes 6/2
B Pricing programmes 6/15
C Placing programmes 6/19
D Reciprocity 6/27
7: Contract wordings
A Main features of facultative and treaty wordings 7/3
B Clauses common to proportional and non-proportional wordings 7/10
C Clauses used in proportional wordings 7/20
D Clauses used in non-proportional wordings 7/27
E Treaty exclusions 7/44
8: Legal issues relating to reinsurance

A The law applicable to reinsurance contracts 8/2
B Interpreting contractual documents – key issues and case law 8/8
C Express terms 8/10
D Implied terms 8/18
E Limitation 8/21
F Measures to avoid disputes 8/22
9: Reinsurance market
A Nature of the reinsurance market 9/2
B Global reinsurance markets 9/7
C Captive insurance companies 9/17
D Market cycles 9/20
E Financial strength ratings 9/26
F Mergers, acquisitions and reinsurer failure 9/30
G Terrorism 9/31
10: Property reinsurance

A Reinsuring a property account 10/2
B Underwriting features of proportional reinsurance 10/5
C Underwriting features of non-proportional reinsurance 10/10
Contents 15
11: Casualty reinsurance

A Reinsuring a casualty account 11/2
B Motor 11/7
C Personal accident 11/12
D Employers
Employers’’ liability 11/14
E Workers
Workers’’ compensation 11/17
F Public liability 11/21
G Products liability 11/24
H Professional indemnity 11/26
I Medical malpractice 11/28
J Trade credit, surety, political risks, fidelity insurance and bonds 11/29
K Miscellaneous risks 11/35
L Claims management 11/38
12: Marine and aviation reinsurance

A Reinsuring a marine account 12/2
B JELC Excess Loss Clauses 12/13
C Reinsuring an aviation account 12/15
Self-test answers i
Cases xiii
Legislation xv
Index xvii
Chapter 1
Purpose of and the
1
parties involved in
reinsurance
Contents Syllabus learning
outcomes
Learning objectives
Introduction
Key terms
A Purpose of reinsurance 1.1
B Buyers of reinsurance 1.2
C Motivation for selling insurance 1.2
D Sellers of reinsurance 1.2
E Contractual relationship between buyers and sellers 1.1, 1.2
F Reinsurance brokers 1.2
G When things change 1.1
Key points
Question answers
Self-test questions
Learning objectives
After studying this chapter, you should be able to:
• explain the purpose of reinsurance;
• describe the parties involved in a reinsurance contract, their motivations and contractual
relationships; and
• identify the objectives of contracting parties.
Chapter 1
1/2 M97/March 2019 Reinsurance
Introduction
As a starting point, it is useful to have a benchmark description of what reinsurance actually
means in practice. In their book Reinsurance in Practice, Robert and Stephen Kiln describe
reinsurance as:
• the business of insuring an insurance company or underwriter against suffering too great
a loss from their insurance operations; and
• allowing an insurance company or underwriter to lay off or pass on part of their liability to
another insurer on a given insurance which they have accepted.
Reinsurance has
This description remains true today, although reinsurance has changed significantly since
expanded beyond the book was written. Financial markets have globalised and alternative products to
the conventional
methods of
traditional reinsurance have been developed, meaning developed markets have expanded
passing on beyond the conventional methods by which an insurer passed on part of its contractual
underlying risk
underlying risk. Without departing from the concept of risk transfer
transfer, a range of tools now
provide a variety of alternative options. Within this chapter, and throughout the remainder
of the study text, we will touch on these other elements. We will explore the traditional
concepts of reinsurance alongside alternative risk transfer (ART) strategies, in order to
obtain a broad appreciation of the wider aspects of the reinsurance market and the covers
that are now available.
Reinsurance serves a number of purposes. Its main purpose is a means by which an
insurance company or an underwriter (for instance, a syndicate at Lloyd’s) can reduce –
from the point of view of possible material losses – the financial consequences of the risks it
has accepted as an insurer. An insurer acting as a buyer of reinsurance cover is generally
known as a ‘reinsured
reinsured’, but may also be called a ‘ceding company’ or a ‘cedant
ceding company cedant’. Overall, the
losses are not reduced, but the reinsured benefits from the smoothing effect that the
transfer of any part of the risk has on the material consequences of the loss.
Key terms
This chapter features explanations of the following terms and concepts:
Authorisation Captive insurance Catastrophic loss Cedant

companies
Contractual promise Lloyd’s syndicates Material losses Mutual funds
Portfolio and asset Reinsurance broker Reinsurance pools Risk retention

management
Risk transfer Sidecars Takaful insurance Uncertainty of loss
Underwriting capacity
A Purpose of reinsurance
Consider this
this…
…
What do you think is the purpose of reinsurance?
When considering the purpose of reinsurance, it helps to remember why consumers

purchase insurance.
The motivation for

The purpose and the motivation for purchasing reinsurance are inseparable. This relationship
purchasing is best understood if considered from the viewpoint of both the insurer and reinsurer. An
reinsurance is the
transfer of risk
example would be the transfer of risk. While clearly the purpose of reinsurance, this is also a
motivating point for both insurers and reinsurers. If the cost of reinsurance is low then
insurers look to optimise their transfer of risk by buying more protection and lowering
retention limits.
It is self-evident, although worth emphasising, that the value of the reinsurance purchased
by the insurer is dependent on the reinsurer being able to meet its financial obligations when
a valid claim is submitted for payment. The steps that insurers take to ensure that the
security offered by the reinsurer is fit for purpose are considered in more detail in chapter 6,
section C2.
Chapter 1
Chapter 1 Purpose of and the parties involved in reinsurance 1/3
Question 1.1
What is an insurer’s likely course of action if the cost of reinsurance is high?
A1 Spreads risk
Insurance was developed to cover people for a risk that they could not avoid, to protect
them from the financial consequences of that risk and – in contracts of indemnity – to put
them in the same financial position that they were in immediately prior to the loss.
Reinforce
Remind yourself from earlier studies of the difference between a contract of indemnity
and one offering set benefits.
The risk transfer options available are illustrated in figure 1.1.
Figure 1.1: Risk transfer options
Risk
Avoid Prevent Limit Transfer Accept/retain
Sprinklers/ Solid Put up

Live in a cave Insure
extinguishers construction with a loss
In much the same way an insurance company cannot avoid risk; it must take on risk in order An insurance
to earn premium. This is, after all, the insurer’s core business. Therefore, in a similar way an company must
take on risk in
insurance company will consider its own attitude to risk. order to earn
premium
Figure 1.2: Insurers

Insurers’’ risk transfer options
Risk
Avoid Prevent Limit Transfer Accept/retain
Add Fix retention and Put up

Decline risk Reinsure
warranties limit of insurance with a loss
Losses can arise in different ways. Those which an insurer would wish to avoid or minimise Losses can arise in
by the use of reinsurance may be of catastrophic proportions and stretch the financial different ways
resources of an insurer without reinsurance to breaking point. Reinsurance acts as a cushion
to protect insurers against such eventualities. Bear in mind that a ‘catastrophic loss’ can
catastrophic loss
mean a very large loss on an individual risk, as well as a large loss resulting from an
accumulation of losses arising from a single catastrophic event.
Chapter 1
Consider this
this…
…
Which of the above descriptions of ‘catastrophic loss’ best fits the terrorist attack at the
World Trade Center (9/11)?
We can see from figure 1.2 that reinsurance is only one of a number of ways in which an
insurance company could consider dealing with a risk. However, reinsurance is a vital tool for
an insurer’s handling of risk as it provides a great degree of financial control over the risks
that the company has underwritten. It should be appreciated, however, that some insurers
are more ‘risk averse’ than others, and so will be more inclined to reinsure, while others may
buy less reinsurance or perhaps none at all.
Insurance allows
We have established that insurance is a mechanism that allows the impact of loss to be
the impact of loss spread. Reinsurance serves the same purpose but at a macro level – it is the means by which
to be spread
insurers can spread their losses by transfer of risk to reinsurers. Insurers may not want a
concentration of liability for one type of business, class of risk, geographical area or other
classification. By effecting reinsurance as part of a risk management strategy, the potential
impact of future loss is spread.
A2 Increases capacity
An insurance company’s capacity is its ability to provide a limit of cover in the policy it issues
to its insured. In determining its capacity, the insurance company has to calculate how much
of its capital it is prepared to put at risk. In addition to the capacity it can offer on a single
risk, the insurance company also has to consider the extent to which it takes on
aggregations of liability from writing many risks that are all exposed to the same potential
loss.
Reinsurance
The insurance company is making a promise to pay when an insured event happens, so it will
enables an aim to have a gross capacity, before the application of any reinsurance, that is large enough
insurance
company to offer a
for it to write most of the business it seeks or is offered. An insurance company can offer a
greater gross greater gross capacity than it considers prudent to retain for its net account by paying a
capacity
reinsurer to take on the difference. Its net capacity is the amount it retains for itself after it
has laid off (or passed on) part of its liability to a reinsurer.
In certain classes of business, reinsurance provides a method of increasing an insurance
company’s capacity so it can compete against other insurance companies in a market where
an ability to accept large risks is vital, for example, marine, aviation or space risks. If the size
and capacity of an insurance company means it can cover an entire risk, this will attract
clients or brokers to place business with it. This is because it reduces the administrative
burden of having to place the risk with more than one insurance company and thus
represents a significant economy of scale benefit. It is also easier to track the performance
of, and security offered by, just one insurer.
PRA decides the

An insurance company might be limited in its overall capacity to accept business by
underwriting Solvency II (see chapter 9, section B2) and its regulator’s determination of how much it can
capacity of a
company based on
underwrite on the basis of its available assets. Government regulation of the limits of
its solvency margin capacity applies to the overall amount of premium income written, as well as underwriting
limits. In the UK, the Prudential Regulation Authority (PRA) decides the underwriting
capacity of a company based on its solvency margin (assets over liabilities).
In other countries, such as the USA, the advent of regulations concerning risk-based capital
has helped grow the use of reinsurance. Regulators developed the risk-based capital
method to measure the minimum amount of capital that an insurance company needs to
support its overall business operations. It is used to set capital requirements considering the
size and degree of risk taken by the insurer. By committing to reinsurance, an insurance
company reduces its capital requirements.
Question 1.2
Why would an insured, or a broker acting on behalf of an insured, prefer to use an insurer
that can accommodate the whole of a risk offered?
Chapter 1
If one insurance company does not have enough gross capacity to accept a risk from an
insured, the insured may have to co-insure the risk with one or more other insurance
companies. This is a means of increasing the capacity of a market to underwrite risks, with
each insurance company being limited to the amount it underwrites on the original policy.
Each co-insurer would have a contractual relationship with the insured. This system is
particularly used for covering large industrial risks. The following example contrasts the
different ways that reinsurance and co-insurance work.
Example 1.1
A hotel complex with an overall sum insured of £100mis offered to insurer A, which only
wishes to retain £20mfor its own account. Placement of the risk can be achieved either
with the support of reinsurance or by the use of co-insurance.
Reinsurance allows insurer A to accept the whole risk and pass on £80to one or more
reinsurers. If a loss occurs at the hotel complex, insurer A is fully liable up to a maximum of
£100but it can recover up to £80from its reinsurers. There is no direct contractual
relationship between the hotel complex and the reinsurer(s) and so, in the event that the
reinsurer(s) default on its obligations to insurer A, insurer A would still be fully liable to the
hotel complex up to the total sum insured of £100
In comparison, if co-insurance is used and insurer A wishes to accept no more than £20on
this risk, the hotel complex will have to find other insurers B, C, D and so on to
accommodate the remaining £80in equal or unequal shares. If a loss occurs, insurer A is
only liable up to £20and the hotel complex would recover other shares of its loss from the
other co-insurers. Each co-insurer, including insurer A, has a direct contractual
relationship with the hotel complex, and so, in the event that the co-insurer(s) default on
their obligations, insurer A would only be liable to the hotel complex for its share of £20
A2A Mutual funds/risk retention groups

Some industries set up mutual funds or risk retention groups to manage its risks and
purchase reinsurance directly from the reinsurance market. They do this where there is a lack
of insurance capacity, or where such insurance capacity is only available at prohibitive cost.
Flood Re
Flood Re is a joint initiative between the UK Government and insurers. It is a not-for-profit
scheme funded by insurers which aims to help households situated in flood risk areas find
affordable home insurance.
Flood Re collects an annual tax from home insurers in the UK and places this into a
centrally managed fund. This allows insurers to pass on the flood risk from policies that
are eligible for the scheme to Flood Re. When an insurer pays a valid claim made as a
result of a flood, it is reimbursed from the central fund.
A3 Provides security
Another reason for the purchase of reinsurance is that the insurance company wants to be
relieved of some of the uncertainty of loss
loss. This can be achieved by the purchase of
reinsurance. It is important, of course, to check the security of the reinsurer: it must be able
to pay should a loss occur that is recoverable under the terms of the contract between the
insurer and reinsurer.
Consider this
this…
…
How can an insurer satisfy itself that a reinsurer it intends using will fulfil its commitment
to pay in the event of a reinsured loss?
A4 Increases stability in results

The insurer can also avoid fluctuations in claims levels from year to year and within a year by
the purchase of reinsurance. Again, parallels can be drawn here between the motives that
persuaded the insured to purchase insurance in the first place.
Chapter 1
A5 Increases confidence
Reinsurance is not
We are already beginning to see that reinsurance is not the only option open to an insurance
the only option company that wants to protect its trading position and grow its core business, while seizing
opportunities to expand into new products and markets. Opportunities may exist to transfer
risk into financial markets and investors in insurance companies may invest with
confidence – safe in the knowledge that a number of risk uncertainties have been removed in
this way. This can create a ‘virtuous circle’ for insurers by boosting share price and attracting
more investment. That said, insurers are generally prudent with regard to the choice of risk
transfer vehicles and may, nevertheless, maintain a certain amount of their risk management
in traditional reinsurance carriers.
In years when financial markets have produced diminishing returns, there is a return to the
more traditional forms of reinsurance, despite increases in price. This is because, in a period
of uncertainty, insurance companies seek the comfort of known products with a guaranteed
return; which is to say that if there is a loss then the insurance company is guaranteed
indemnity if it falls under the reinsurance protection.
A6 Portfolio and asset management

Underwriters are
An insurance company’s portfolio is the entire range of risks that it underwrites. It can
increasingly being include motor, household, commercial and professional indemnity among many other
judged by their
gross underwriting
classes. Insurance underwriters are increasingly being judged by their gross underwriting
results results. They aim to achieve a gross profit without reinsurance being in place and use
reinsurance to protect the exposure of their account against any adverse annual fluctuation.
There is also the question of whether a company protects its portfolio overall, or chooses to
consider individual classes of business. Individual underwriters within an organisation used
to purchase reinsurance for their separate classes of business, but reinsurance buying is now
becoming more centralised, with the trend towards cross-class portfolio protection.
Consider this
this…
…
Consider the advantages for an insurer of purchasing cross-class reinsurance to protect
the various facets of its liability account, which would include, but are not limited to:
• employers’ liability insurance;
• public liability insurance; and
• motor third party liability insurance.
Reinsurance is a
In many insurance companies the responsibility for the purchase of reinsurance and
financial tool to portfolio and asset management has moved away from the underwriter to account
manage the
insurance risks
managers, so that more emphasis is given to solvency margins holistically. Reinsurance is a
financial tool to manage the insurance risks, so central control is often exercised at – or close
to – board level, in order to maximise the group financial strength and buying power in the
most cost-effective way. Where risk can be retained safely within the group, account
managers would see this as a better use of group resources than purchasing unnecessary
reinsurance.
A7 Taxation advantages
Insurance companies are taxed on their technical underwriting results: that is, their final
position after taking into account:
• all the premiums received;
• losses and loss settlement costs;
• administration costs;
• subrogation recoveries;
• reinsurance premiums paid; and
• reinsurance recoveries made (included in this result is any reserve for outstanding losses
less any expected recovery for those outstanding losses from reinsurance).
Chapter 1
Therefore, unlike equity returns which are taxable, reinsurance premiums are included within Reinsurance
the underwriting result and as such are tax deductible. This is a consideration for insurance premiums are tax
deductible
companies planning how to resource their company for any exceptional losses that might
arise from their portfolio.
A8 Cash flow advantages

Effectively, an insurer has to maintain a balance between readily realisable assets to pay its
claims liabilities to policyholders as they become due for settlement, and longer-term
investments to maximise growth opportunities. It would, therefore, consider the cost of
reinsurance against the potential gains to be realised from the investments. It would also
have to consider the type of reinsurance bought as to whether, and to what extent, it would
have to release its premium as reinsurance premium and when it could expect to obtain
payment from the reinsurer for claims.
In proportional treaty reinsurance, it is customary for payments between a reinsured and its Refer to
chapter 4 and
reinsurer to be made after a quarterly or a half-yearly technical account has been rendered. chapter 5 for
This details premiums due and claims recoverable during the relevant period, with the proportional and
non-proportional
balance of account being settled by the debtor. Treaties of this type usually contain a reinsurance
provision for the reinsured to receive rapid payment from the reinsurer when a substantial
claim occurs, in order to avoid an adverse effect on the reinsured’s long-term investments. In
non-proportional reinsurance, claims tend to be payable by the reinsurer when the reinsured
submits the claim.
The technical funds of an insurer should be invested in such a way as to achieve the best rate
of return, bearing in mind the:
• quality or security of the investment;
• marketability of the investment;
• currency and duration of the investment in order to match the technical liabilities; and
• investment pattern, which should reflect the need to liquidise cash to satisfy short,
medium and long-term liabilities.
Notwithstanding the advantages investment can bring, it is especially important when
interest rates are at such a low level that the insurer strives to make a profit from its
underwriting activities, rather than expecting investment income to turn a net loss into a net
profit.
A9 Corporate strategy
The extent to which a company will risk its assets – if at all – will have been decided, but
priorities have to be established as to the amount of risk it is prepared to entertain and in
which sectors of its portfolio.
New companies may find themselves risking more than they would choose, and would New companies
probably seek comfort from the arrangement of reinsurance. A new company may be may find
themselves risking
caught between the need to attract potential customers and find its place in the insurance more than they
market to establish its business, and by the practical limitations on how much reinsurance would choose
can be arranged. This depends on operating margins, or profit, which will be low (maybe
non-existent) in the early days. It is also subject to other limitations caused by the need to
comply with the demands of the regulatory authorities.
Be aware
In the UK, the PRA may state that only a proportion of the actual reinsurance arranged
can be taken into account when establishing the necessary level of reserves.
Similarly, an existing insurance company may wish to develop a new product; for example, a
motor insurer might want to expand into household business, or a non-insurance financial
services company might want to offer insurance products. As a case in point several retail
firms have branched out into selling financial services in the UK, either directly or in
partnership with an existing insurance company. In order to do this without affecting its
overall results, it may look for reinsurance to protect the new venture.
Chapter 1
Reinsurance would serve two main aims:

• It would cushion the impact of any adverse results that may occur in this new field, as a
new insurer might have to offer its product at a lower price or with a broader cover; and
• New insurers or those undertaking a new product may benefit from assistance offered by
reinsurers in product development, pricing and staff training, based on their previous
experience of other companies undertaking development in that area. The reinsurance
company would look to build a long-term relationship by providing this assistance and
helping the ceding company to achieve better results.
Some large multinational insurance companies create their own internal reinsurance vehicles
for subsidiary units, to ensure that these units are not too adversely affected by large
catastrophe losses in their market. These internal arrangements retain part of the potential
reinsurance premium within the company.
Question 1.3
What is the inherent danger for a large multinational insurance company in adopting a
strategy of creating their own internal reinsurance vehicles?
B Buyers of reinsurance
The reinsurance markets have a notable feature that distinguishes them from other markets.
That is to say insurers and reinsurers alike will, in varying degrees, operate as both a buyer
and a seller of reinsurance products; needing to buy reinsurance protection for the risks they
write, while offering to sell coverage to others.
B1 Insurance companies
Insurance
Insurance companies form the most important group of reinsurance buyers in terms of the
companies form volume of reinsurance business transacted. It is a very diverse group, ranging from small,
the most important
group of
newly established companies operating in a developing country to the major international
reinsurance buyers insurance groups with annual premium incomes in excess of £1 billion from business
transacted in many different countries.
How much demand these companies place on both their domestic and international
reinsurance markets is influenced by the individual company’s decisions on its own
retentions and reinsurance programme. Other environmental factors also play a part.
Governments may decree that foreign insurers that are not licensed in their country cannot
participate in the domestic insurance market. In such cases, local insurers may place some of
their outwards reinsurances with foreign insurers, so enabling them to achieve access to that
market.
There is a relationship between a number of the factors mentioned in section A and the size,
structure and practices of the local insurance markets in which an insurer is operating.
Be aware
In a country with a small insurance market or with a legal requirement to insure 100% of
cover with a single local insurer, reinsurance is needed to enable the insurer to keep
its retained risk at a manageable level. In large developed markets, such as Germany,
there is often little co-insurance since insurers meet the needs of their large commercial
customers by providing them with enough gross capacity, which is supported by
reinsurance.
B2 Lloyd
Lloyd’’s syndicates
The Lloyd’s market does not consist of a single risk-bearing organisation, but is made up of
many, separate, underwriting operations, known as syndicates.
Chapter 1
The nature of the account written by a Lloyd

Lloyd’’s syndicate can be more complex and varied
than that of a general insurance company and this possibility demands a more sophisticated
approach to buying reinsurance. For example, the account may include direct and
reinsurance acceptances, as well as low-level and high-level ‘per risk’ exposures and
worldwide catastrophe exposures. Therefore, there is a particular need to protect the
account from the risk of accumulations of risks in the one location, the extent of which may
be unknown.
Activity
Visit Wikipedia, the free online encyclopaedia, for details of some of the more bizarre risks
that Lloyd’s of London underwrites, which it would need to protect by the purchase of
reinsurance.
Lloyd’s is dominated by syndicates backed up by corporate capital; the reinsurance needs of

these corporate entities can be said to be similar to those of insurance companies.
Syndicates’ reinsurance buying is generally handled through the intermediary of Lloyd’s
brokers. Much of the reinsurance purchased by Lloyd’s syndicates is placed with companies
in London and the international reinsurance markets, in addition to some placements with
other Lloyd’s syndicates.
Useful website
www.lloyds.com
B3 State-owned insurance corporations

Many countries have established state-owned insurance corporations, especially (but not
only) those with emerging economies and insurance markets. These corporations may be
granted a 100% monopoly of all insurance business; they may receive a compulsory cession
of reinsurance from all the local insurance companies or be the insurer for all organisations
and enterprises in which their government has an interest, while competing with other
insurers for any remaining business. Others may receive no special privileges and have to
compete for business like any other private company. Therefore, the reinsurance needs of
state-owned insurance corporations reflect their market status. Examples of state-owned
insurers in major economies are the General Insurance Corporation of India and the People’s
Insurance Company of China.
Useful websites
www.gicofindia.com
www.picchk.com/brief_e.html
A monopoly state-owned insurance corporation is usually required to meet all of its Required to meet
country’s insurance needs, including cover for such entities as state air and shipping lines. all of its country’s
insurance needs
Consequently, it requires extensive reinsurance facilities to provide the underwriting
capacity for such large risks.
Natural hazards and the associated accumulation of liability are another significant problem
for state-owned insurance corporations. Although they may have been formed to reduce a
country’s dependence on foreign insurers, state-owned insurance corporations will need to
reinsure a substantial part of these liabilities in the international markets. They frequently use
international reinsurance brokers to arrange and place their reinsurance programmes.
B4 Regional insurance corporations

Regional insurance corporations operate in a similar way to state-owned insurance
corporations. They are most prevalent in areas where individual states are united by close
political and cultural bonds.
Example 1.2
Africa Re was established by 36 African member states to transact treaty and facultative
reinsurance cessions. It buys reinsurance cover to protect its property and casualty, plus
life and health interests.
Chapter 1
They are characterised by a common desire to retain premiums within the region and a
belief that local investment should help local economies, rather than act as a feeder for
overseas economies that are already at advanced stages of development. Problems may
occur as a result of a lack of local management and underwriting expertise. Furthermore, in
the absence of a wider spread of risk, accumulations may lead to severe economic problems
in the event of a natural catastrophe.
B5 Takaful companies
Takaful observes
Takaful insurance is an Islamic insurance concept which observes the rules and regulations
the rules and of Islamic law. ‘Takaful’ is an Arabic word meaning ‘guaranteeing each other’. This system is
regulations of
Islamic law
based on mutual cooperation, shared responsibility, joint indemnity, common interest and
solidarity between groups of participants.
Takaful has come into prominence in recent years in the Muslim world because traditional
insurance has some features that are at variance with certain essential values of a financial
contract in Islam. It is, therefore, an alternative means of Muslims obtaining protection
against the risk of loss, with similarities to mutual insurance. Policyholders avoid gambling
on the fortunes or misfortunes of others as money is paid into a communal fund and those
participating take out what they need in the event of a claim. Insurance companies charge a
fee for managing the fund and any monies left over at the end of the year, after payment of
claims and business expenses, are distributed to policyholders. Policies have to be carefully
worded, so that no cover is included for items contrary to the teachings of Islam. During the
development process they are approved by Islamic scholars and Shariah advisory
committees to ensure that they are compliant.
The potential market for products developed to meet the needs of those with specific
religious preferences is vast.
Like insurance companies, a Takaful company needs sound reinsurance arrangements. In this
system, reinsurance is known as reTakaful. In situations where the provision of reTakaful is
inadequate to meet the needs of Takaful operators, the rules of Shariah law may allow them
to deal with conventional reinsurers.
B6 Captive insurance companies

More risks being
Changing risk management practices mean more risks are being retained by organisations
retained by instead of being passed on to insurers. A key mechanism in this shift has been the captive
organisations
insurer: a risk-bearing entity controlled or owned by an organisation whose primary business
is not insurance. The captive then needs reinsurance for the same reasons a primary insurer
does, namely those listed in section A.
Refer to There are isolated instances where an insurance entity enjoys a relationship by ownership
chapter 9,
section C for with a ‘captive’, although this is rare.
more on captives
In recent years, the number of captive insurance companies in existence has grown
significantly, with specialised regional bases being developed to support their operation, for
example, Dublin, Luxembourg and Bermuda. Along with other ART mechanisms, captives
have greatly altered the make-up of the insurance industry landscape.
Activity
Research recent developments in the captive insurance industry and the likely impact of
Brexit. You could use the following websites as starting points: www.cii.co.uk/knowledge
and www.lloyds.com.
B7 Mutual insurance companies

Mutual insurance
Although they have largely disappeared from the insurance arena, passing mention should
companies are be made of mutual insurance companies. Mutual insurance companies are owned by their
owned by their
policyholders
policyholders, who share in the profits of the company by means of lower premiums or
preferential cover. In theory, the policyholders are liable for losses made by the company; in
reality, mutuals are limited by guarantee. This means that the maximum liability of a
policyholder is usually limited to the premium paid. Over the years many mutuals have
become proprietary companies through the process known as demutualisation.
Chapter 1
B8 Reinsurance companies
The term ‘professional reinsurance company’ is used to describe those companies that only
underwrite reinsurance business. As specialist sellers of reinsurance, they obtain business
through brokers, in addition to establishing direct relationships with their clients.
These professional reinsurers need to buy reinsurance protection, known as retrocession
retrocession, for Refer to
chapter 2,
their own accounts. This is needed to provide for liabilities in excess of their own section B for
underwriting capacity and so protect them against potentially crippling losses. retrocession
Consider this
this…
…
Can you think of two companies that could accurately fall under the heading of
‘professional reinsurers’?
B9 Reinsurance pools
Reinsurance pools have been formed on both a national and a regional basis to handle
particular types of reinsurance. Pools are multi-reinsurer agreements under which each
reinsurer in the pool assumes a specified portion of each risk ceded to the pool. They buy
reinsurance as a means of protecting their trading results.
Reinforce
Before you move on, make sure you know the reason why each of the groups of buyers
listed above would want to purchase reinsurance.
C Motivation for selling reinsurance

Later we will examine the various categories of sellers of reinsurance. First, however, in the
same way as we have considered the motivations for seeking reinsurance, we need to
consider the motivations for selling reinsurance.
C1 Profit
Reinsurance is generally a profitable industry over a sustained period – otherwise it would be A profitable
unlikely to exist. Companies endeavour to ensure that their combined ratio is kept industry over a
sustained period
below 100%.
In this context, the combined ratio is a calculation of two ratios for the year added together
to provide a simple indication of current underwriting performance. These ratios are:
• the loss ratio: this is the percentage of incurred losses (may also include loss adjustment
expenses) to earned premiums; and this is added to
• the expense ratio: this is the percentage of incurred expenses to written premiums.
When there have been increasing investment returns available from reinsurance, capital
investment has arisen. This is because investment vehicles have considered the relative
return from reinsurance to be higher than other investment opportunities.
C2 Investment income
Underwriting reinsurance business gives companies income that can be used for investment Refer to
chapter 9,
purposes. Until recently, many companies underwrote reinsurance on the basis that the section D for
investment return on their assets would cover any shortfall in their combined ratios. When market cycles
reinsurance is transacted with market share rather than underwriting profit as the principal
objective, downwards pressure is created on reinsurance pricing.
Companies may also participate in the selling of reinsurance because they consider the
return on equity from it to be stronger than other forms of equity investment. This is
particularly relevant if reinsurance market prices are high when interest rates are low.
Chapter 1
C3 Spread of risk
Insurance companies, in particular those that have their assets strongly linked to one market,
may wish to participate in reinsurance in order to obtain a spread of risk, and thus reduce the
impact of any catastrophe that could occur in their home market. Here we can see that an
insurance company can also assume the role of a reinsurer.
C4 Reciprocity
Companies may underwrite inwards reinsurance as part of a reciprocal arrangement with
other insurance or reinsurance companies. Insurance companies providing substantial
business to a reinsurer may expect business in return by participating in that company’s
outwards reinsurance cover.
C5 National retention of premiums

Some
Some governments, especially in countries with emerging markets, have set up domestic
governments have reinsurance vehicles in order to ensure that not all reinsurance premiums flow from the
set up domestic
reinsurance
country – which could affect the balance of payments. This is a problem because foreign
vehicles reinsurers often demand payment in set currencies (e.g. USD, Euro and GBP), meaning these
currencies have to be bought, potentially adding to an equity debt. By setting up their own
reinsurance vehicle, governments hope to grow a domestic market in reinsurance and
import knowledge of the handling of reinsurance.
Governments may not allow insurance companies that are not licensed in their country to
participate in the domestic insurance market. As a result, companies may only be able to
gain access to that market by selling reinsurance to a domestic company.
C6 Core business
Some companies focus on the selling of reinsurance as they consider this their core business.
Examples of these are the large multinational reinsurance companies. With uncertain stock
market fluctuations, these companies would prefer to concentrate on growing their core
business of reinsurance, rather than experiment with developing new avenues of potential
income.
D Sellers of reinsurance
The sellers of reinsurance are the companies and Lloyd’s syndicates that are in the business
of accepting reinsurance business. As reinsurers they may operate as a leading underwriter,
i.e. setting the price and terms and conditions, or offer supporting capacity for the amount
of reinsurance required by the buyer. If the amount of reinsurance cover required by the
buyer is within the underwriting capacity of the reinsurer, the contract may be accepted
100% by a single reinsurer.
D1 Reinsurance companies
A professional reinsurance company may be a multinational organisation obtaining its
business through a network of branch offices and subsidiary companies in many different
countries. Alternatively, it may be located in only one market while accepting a full
international account, either through reinsurance brokers or on a direct basis with its ceding
companies. While some of these companies may have ownership links with direct insurance
companies, they operate largely on an independent basis.
Another model is where a major direct underwriting group has a subsidiary company that
operates as a professional reinsurer. Part of the function of such subsidiaries is to coordinate
and administer both the inwards and outwards reinsurance interests of the parent company
and other group members.
Chapter 1
Major professional reinsurers are involved with all forms of reinsurance. This is derived from
a variety of sources, using intermediaries as well as direct connections with potential ceding
companies. There are occasions when such reinsurers have to limit their commitments to a
reinsured to control their aggregation of exposure arising from direct insurance writings as
well as from reinsurance acceptances.
Professional reinsurers can build up considerable expertise over a number of years through
the direct links they have with their clients. This gives them the advantage of being able to
offer technical assistance to the client on underwriting, claims handling and accounting and
provide training for the client’s staff.
D2 Lloyd
Lloyd’’s syndicates
Many of the individual syndicates in the Lloyd’s market are important sellers of reinsurance – Rely on Lloyd’s
relying on Lloyd’s brokers to bring in business. Within that market, there are major brokers to bring in
business
syndicates that will quote and lead risks, as well as other syndicates that offer a considerable
amount of supporting capacity.
For Lloyd’s as a whole, the gross written premiums derived from reinsurance represent the
largest single category reported in its market results.
Activity
You can visit www.lloyds.com to see the latest market results.
Apart from the importance of reinsurance business to the Lloyd’s market, you should note
that Lloyd’s has a long-established reputation for the acceptance and development of
various forms of reinsurance.
D3 Direct insurance companies

On a worldwide basis there are many direct insurance companies that also accept significant
volumes of reinsurance business as an adjunct to their main business. The scale and methods
of their involvement with reinsurance business varies as much as the type of company. Some
small domestic insurers may restrict their reinsurance activity to reciprocal exchanges only.
Other domestic insurers are prepared to underwrite an international reinsurance account,
most of which will be acquired through brokers.
Question 1.4
Why might small or medium-sized direct insurers prefer to employ underwriting agents to
control and manage their inwards reinsurance business?
D4 State reinsurance companies

The governments of many countries, particularly those with emerging economies and
insurance industries, have formed State reinsurance corporations to meet the reinsurance
needs for local insurers. Some of these corporations may derive their reinsurance business
from compulsory cessions from the local insurers. Many of them also write international
reinsurance business.
These corporations need to pass on some of their liabilities to the international reinsurance
markets. Sometimes, this is done in the form of reciprocal exchanges. However, the
development of an international account remains an objective for many such companies,
and the option to establish a branch or contact office in one or more of the existing
international markets has been taken by a number of these organisations.
D5 ReTakaful companies
ReTakaful
Reinforce
Before learning about reTakaful companies, remind yourself of the nature of Takaful
insurance which we looked at in section B5.
Chapter 1
ReTakaful, or Islamic reinsurance, is a risk acceptance method in which the Takaful ceding
company resorts to a reTakaful operator to lay off part of an original risk that happens to be
above its normal underwriting limit. The ‘operator’ manages, in a Shariah-compliant manner,
the reTakaful fund, including claims handling, accounting, reserving of policy liabilities and
risk management. In return for carrying out its duties and responsibilities, the operator
receives a fee and a share of the investment income coming from the managed fund.
The fund represents contributions received from participating Takaful insurers out of which
claims, commissions, retrocession costs and other related expenses are paid. The
contributions are for the collective benefit of participating insurers which give up their right
over the contributions in favour of a collective right of compensation against the events
covered by the respective Takaful contracts. Where claims exceed the value of the reTakaful
fund, additional payments will be made from the reTakaful operator’s shareholders’ equity
and carried forward to its extinction by future surpluses.
D6 Reinsurance pools
Reinsurance pools comprise a number of insurance and/or reinsurance companies operating
in a particular country or region. They accept local or regional reinsurance business,
sometimes of a specialist nature, with the business accepted being shared among the
participants of the pool.
D7 Sidecars
Sidecars are So-called ‘sidecars
sidecars’ provide additional capacity to a sponsoring (re)insurer through,
covered in
chapter 2, typically, a fully collateralised quota share arrangement. Third-party investors, such as
section C1D hedge funds and private equity funds, provide these extra resources by being offered debt
in the sidecar. Sidecars are often targeted at specific lines of business and tend to have a
short lifespan, although some are permanently structured to underwrite new business at
each renewal season.
It is generally accepted that sidecars are opportunistic. This is because the supporting
capital markets wish to take advantage of the increased rates available to a sponsor that
often follow major catastrophes. Such arrangements are accepted by financial regulators,
tax authorities and rating agencies.
E Contractual relationship between buyers

and sellers
Before we consider further the purpose of reinsurance and the reasons for its purchase and
sale, it would be useful here to look briefly at the contractual aspects of reinsurance.
An agreement
In essence, a reinsurance transaction is an agreement between two parties: the reinsured
between two and the reinsurer, where the reinsurer agrees to accept a certain fixed share of the
parties
reinsured’s risk upon terms set out in the agreement.
A reinsurance transaction is the buying and selling of contractual promises
promises.
Question 1.5
For its part, what is the reinsured promising to do in a reinsurance contract?
In return for the premium paid by the reinsured, the reinsurer promises to pay claims if
certain specified events take place. This contract is formed into a written document, which is
legally enforceable. The importance of the contract is that it determines how much and
when the premium will be paid, under what circumstances and to what extent a claim will be
paid if it occurs, how long the contract lasts for, and when and how it should end. The
reinsured and all the reinsurers, or their respective agents, will sign and acknowledge the
contract, each for its own part.
Chapter 1
The precise legal technicalities are covered in more detail in chapter 8, but it is helpful here
to recognise that the reinsurance contract and the underlying contract are separate policies
and that the original insured and the reinsurer have no rights or remedies against or to each
other. Finally, note that reinsurance has all the standard requirements of any other contract:
a common reinsurance
offer acceptance consideration
purpose contract
If there is a problem with any of these areas then, potentially, a dispute could arise.
Reinforce
Remind yourself from earlier studies of the formation of a valid contract. Think about how
the various requirements apply to a reinsurance contract.
Bordereaux
The contractual relationship between the insurer and reinsurer may require the insurer to
submit regular bordereaux to the reinsurance company. A bordereaux is a detailed list of
either the:
• risks and related premiums ceded to the reinsurer (a cession bordereaux); or
• claims made on those risks (a loss bordereaux).
The list is prepared on a monthly or quarterly basis and sent to the reinsurer to enable it to
see the names of risks and business ceded, along with associated losses. They are not always
used in the modern reinsurance market.
F Reinsurance brokers
Although not normally an underwriter of risk, the reinsurance broker has a significant effect
and influence on the transaction of reinsurance business. Therefore, we must look at the role
of the broker in relation to the buyers and sellers of reinsurance.
To operate, a broker must have two markets available to them: one in which they can
acquire business and one in which they can place the business so acquired. Without these
two facilities they cannot operate.
Consider this
this…
…
Before you move on, consider the potential differences in the role of a broker and whether
any conflicts of interest may arise when placing business on behalf of:
• an insured with an insurer; and
• an insurer (reinsured) with a reinsurer.
F1 Legal requirements for brokers

Consider this
this…
…
Do you think that a reinsurance broker acts on behalf of the reinsured, or on behalf of the
reinsurer?
It is clear in English law that a reinsurance broker acts for the reinsured in negotiating a
reinsurance contract with the reinsurer. This is an important legal point and was illustrated in
Deeny v. Gooda Walker (1995)(1995).
If a potential reinsured provides full information to a reinsurance broker and that broker fails
to pass all material facts to the reinsurer, giving rise to a right to avoid the contract, the
reinsured cannot defend the action for avoidance by reference to the fact that it provided all
information to the broker. Instead, the contract will be avoided and the reinsured must look
to its broker to recover damages for its negligent act and omissions.
Chapter 1
There are circumstances in which a reinsurance broker may, in fact, be an agent for both the
reinsurer and the reinsured. In some circumstances, the reinsurance broker will have
underwriting authority on behalf of a reinsurer (see section F6) while, at the same time, be
the reinsured’s broker for the purpose of placing the risk. In these circumstances, it is
important to look at the act being performed at any given time in order to ascertain whether
the broker was acting as an underwriting agent and therefore for the reinsurer, or as broker
and therefore for the reinsured.
In the UK, brokers

In the UK, brokers must be authorised and regulated by the Financial Conduct Authority
must be regulated (FCA). In the USA, each state has specific laws to regulate the activities of brokerage firms,
by the FCA
although there is limited Federal involvement to identify gaps in the state-based system.
There are other intermediaries operating in the reinsurance market whose primary role is
also the placement of reinsurance business. Like a broker, their role will involve:
• risk managements;
• mid-term changes;
• checking the security ratings of reinsurers;
• claim notification and recovery;
• reviewing client needs;
• negotiating renewal;
• providing market intelligence; and
• issuing some forms of documentation on behalf of reinsurers.
risk
management
issuing
some forms of
mid-term
documentation
changes
on behalf of
reinsurers
providing checking the

market Role of other
security ratings
intelligence intermediaries
of reinsurers
claim
negotiating notification
renewal and recovery
reviewing
client needs
F2 Role of the broker

The traditional role of the broker is the placing of reinsurance business. For this function to
be performed successfully there must be a party wishing to buy and another party wishing
to sell. The broker’s skill is identifying buyers and sellers and negotiating a deal involving the
availability of a product or service at a sufficiently attractive price that both buyers and
sellers wish to strike a bargain.
Chapter 1
Question 1.6
Agents and other intermediaries with non-insurance backgrounds may introduce business
to insurance companies from private individuals and small trading companies seeking
insurance. Why is it likely that only professional reinsurance brokers and other suitably
qualified parties have a role to play in creating reinsurance relationships?
The broker is typically remunerated by a deduction of brokerage from the premium paid to
the reinsurer.
F3 How brokers acquire business

A broker acquires business in the following ways:
• by a direct approach from a ceding insurer that is used to dealing through a broker,
probably because it has a large or complicated reinsurance programme to place that may
need the international connections that the broker has built up;
• through the development of a new form or contract of reinsurance that has been
successfully sold to clients;
• through personal relationships based on past dealings and experience, which lead to an
insurance underwriter offering some of its new or existing business;
• through a long-standing business relationship with a ceding insurer that considers the
broking firm to have a better overall view of international markets, and to be in a superior
position to design and place reinsurance programmes than itself;
• through its level of expertise and contacts with reinsurance markets; and
• from intermediary brokers wishing to place reinsurances or retrocessions on behalf of a
ceding insurer or reinsurer, which it does not have the authority or power to carry out
itself.
F4 How brokers place business

Brokers provide details of their client’s reinsurance to potential markets by means of a ‘slip’,
or in the London Market, by a complete contract. In either case, the document sets out
details of the risk to be placed and it shows the terms and conditions that are to form the
contract between the reinsured and the reinsurer.
Depending upon the location of the broker and the reinsurer, business will be placed in the
following ways:
• locally, with face-to-face negotiation supported by electronic exchanges of data and
telephone calls; or
• internationally, with letters, or increasingly by electronic communication systems (where
they exist) with acceptances, amendments and declinatures being recorded in the
broker’s office. Negotiations with overseas markets may sometimes be by personal
contact, with the broker travelling with all the relevant information to the various markets
that it wishes to use.
Consider this
this…
…
Which medium do you feel is most effective for, say, a broker wishing to place a North
American casualty treaty in the London reinsurance market?
F5 How brokers service clients

clients’’ business
Frequently, the broker will be required to perform the functions of the marketing and
production departments of a professional reinsurer. Therefore, it requires experienced staff
capable of keeping up to date with clients’ businesses and needs.
Table 1.1 demonstrates the actions a broker must be able to perform in servicing its clients’
business.
Chapter 1
Table 1.1: How brokers service clients

clients’’ business
Prepare and collect Claims are negotiated and collected from the markets and reinsurers that
claims were used for placements. The broker will ensure that claims payments are
passed on to the client in a timely fashion without any undue delay.
Provide market Market intelligence is becoming increasingly important for larger clients. All
intelligence have an integral interest in what is happening in the reinsurance industry and
matters that affect it. Brokers’ clients expect to be fully appraised of market
developments.
Arrange reciprocity The broker may also have a role to introduce inwards or reciprocal business
for risks shown to a particular reinsurer. This may be by means of strict
reciprocity, whereby the contracting parties make an agreement to offer a
specified volume of business in return for receiving a comparable volume of
premium from a similar portfolio. Loose reciprocity applies where a general
broad account of reinsurance business is offered in a two-way flow of
business between two insurers.
Check security offered Most clients expect their broker to monitor the performance and suitability
by reinsurers of the markets that are available to write their reinsurances, although many
of the larger buyers do this monitoring themselves. While the viability of
security cannot be guaranteed, brokers are expected to inform clients of
potential problems, using information from internationally recognised
financial rating agencies, where appropriate.
Provide documentary Brokers advise on the preparation of the contract wording for the
and analytical services reinsurance arrangement and obtain the agreement of all the parties
including contract concerned. The larger brokers can also provide actuarial analysis and market
wordings benchmarking data.
Provide risk In addition to basic risk transfer services, brokers help large insurers control
management the total cost of risk by developing bespoke strategic risk management
programmes. These understand business needs and make informed
decisions about risks that go beyond simple identification and evaluation.
Be aware
There are various reinsurance rating agencies that a broker might choose to consult to
check on the financial health of a reinsurer it intends to offer business to on behalf of its
client. Its choice of rating agency will depend on the depth of financial information
required and the size of the reinsurer.
F6 Managing general agent (MGA)

Reinsurance has become an increasingly important business component within the broker’s
role as a managing general agent (MGA). MGAs write insurance business as well as
reinsurance.
MGAs perform certain functions ordinarily handled only by insurers/reinsurers, such as:
• binding coverage;
• underwriting and pricing;
• appointing agents within a particular area; and
• adjusting and settling claims.
Be aware
It is important to note that an MGA can be asked to do all of these services or just some
of them.
The security of the MGA is the insurer/reinsurer sitting behind them: the MGA itself is just
providing a service and is not taking any risk itself.
MGAs can place cover in any market. They also work alongside insurers/reinsurers in
developing programmes. For example, the MGA may identify a market gap where there are
few or no carriers interested in writing a specific line of business. The MGA will structure an
insurance/reinsurance programme aimed at generating an underwriting profit. The MGA will
then offer the programme to potential issuing insurers/reinsurers.
Chapter 1
From an underwriter’s perspective dealing with an MGA lightens their burden; however, it
also means that they have to place a large amount of trust in the MGA to act on their behalf.
This should be carefully considered and a lot of research completed before entering into
these contracts.
F7 Lloyd
Lloyd’’s brokers
Brokers registered by the Council of Lloyd’s are known as Lloyd’s brokers and are permitted
to place reinsurance business at Lloyd’s. To be registered they must satisfy the Council as to
their expertise, integrity and financial standing. Once appointed, the words ‘at Lloyd’s’ can
be used on letterheads and name plates.
The requirements of Lloyd’s are in addition to authorisation by the FCA. Lloyd’s no longer
has its own separate code of conduct for Lloyd’s brokers.
Be aware
Those brokers wishing to place reinsurance business in Lloyd’s markets, but which are not
registered to do so, may negotiate placing arrangements with those that are registered.
G When things change

Reinsurance requirements, as determined by the various underwriting entities that make up
the buyers of reinsurance, can be consistent for several years, but can also change
significantly from one year to the next.
Insurers usually value continuity and a reinsurance programme can often remain in place for
several years with the same panel of reinsurers, with only relatively minor adjustments being
made to the reinsurance structure during that period. This type of continuity can be
interrupted by factors beyond the insurer’s control, for instance, a reinsurer can fail or
change direction. A number of rated and non-rated reinsurers have ceased trading or gone
into liquidation over the last ten years. Reinsurers sometimes decide to pull out of a territory
or class of business and have to advise brokers and reinsureds that they will not be able to
renew their participations in certain reinsurance treaties. An insurer that is forced to make
changes to its panel of reinsurers may also have to accept changes to its reinsurance
programme, as the replacement reinsurers may wish to make changes to the reinsurance
structure and apply new conditions.
Other factors that can trigger changes to a reinsurance structure include:
• Change in senior management
management. The new management could be less risk averse and
decide to reduce the proportion of the insurance company’s premium income that is
passed on to reinsurers by increasing overall retention levels. That would result in higher
retained profits in the good years and increased losses in the bad years, which is very
much the buyer’s choice.
• Change in an insurer situation. A growth in premium income and increased
insurer’’s financial situation
capitalisation could allow an insurer to reduce it dependency on reinsurance.
• Mergers and acquisitions
acquisitions. Two insurance companies, with separate reinsurance
programmes, that merge would usually restructure the reinsurance arrangements and
have just one programme for the combined entity. In recent years a number of the major
insurance companies have acquired smaller companies. The reinsurance protections that
those smaller companies had in place were, in many cases, discontinued and instead
written in-house by the parent company.
• Regulatory changes
changes. Regulatory bodies in each country can change solvency
requirements and the criteria for selecting reinsurers. Certain countries even maintain a
current list of approved reinsurers and placing reinsurance with any reinsurer that is not
on the list is strictly disallowed.
• Change in law
law. Changes in law can have a dramatic impact on claims patterns and
capacity requirements, especially for motor and liability classes where minimum insurance
limits are set by statute.
Chapter 1
Key points
The main ideas covered by this chapter can be summarised as follows:
Purpose of reinsurance
• Provides protection against the consequences of unexpected material losses.

• Spreads risk by involving other insurers and reinsurers throughout a variety of different
geographical areas.
• Increases capacity by permitting an insurer to accept more business than it is comfortable with at a
gross level.
• Provides security by relieving the insurer of some of the uncertainty of loss.
• Increases stability in results by smoothing the net loss experience of the insurer from year to year.
• Increases confidence both on the part of investors in the insurer and customers of the insurer.
• Allows the insurer to manage the performance of its portfolio of risks and that of its asset base.
• Provides tax advantages since premiums ceded to reinsurers are tax deductible.
• Provides cash flow advantages since the insurer can make a cash call upon the reinsurer when
losses occur.
• Influences corporate strategy as assists the insurer in deciding what proportion of its assets it is
prepared to put at risk from one, or a series of related losses.
Buyers of reinsurance
• Insurance companies are the principal customers of reinsurers.

• Lloyd’s syndicates are significant buyers who make demands of reinsurers to deliver sophisticated
solutions to their requirements.
• State insurance companies may, along with regional reinsurance corporations, receive compulsory
cessions from within their geographical or political community and require reinsurance to achieve
balance in their portfolios and an international spread of risk.
• Takaful companies accept insurances from Islamic communities and buy reinsurance from reTakaful
companies or conventional reinsurers if further capacity is needed.
• Captive insurance companies meet the needs of the ‘parent’ organisation.
• Mutual insurance companies are owned by their policyholders.
• Reinsurance companies themselves, along with reinsurance pools, buy reinsurance in order to dilute
accumulations of risk.
Motivation for selling reinsurance
• Reinsurance is sold in order to achieve underwriting profit and to generate premiums that can then
be invested to produce further income.
• In order to achieve reciprocity a company must be prepared to both buy and sell reinsurance.
Sellers of reinsurance
• Sellers of reinsurance tend to mirror the buyers already referred to and are summarised here as:
– reinsurance companies;
– Lloyd’s syndicates;
– insurance companies;
– State-owned reinsurance companies;
– reTakaful companies; and
– reinsurance pools.
Contractual relationship between buyers and sellers
• A reinsurance transaction is an agreement between a buyer and a seller.

• A contractual promise is made where, for its part, the buyer agrees to pay a premium and in return
the reinsurer agrees to make a payment if defined events or occurrences take place.
Chapter 1
Reinsurance brokers
• The broker involved in a reinsurance transaction brings parties together that wish to enter into a
reinsurance contract.
• The broker is usually acting for the party seeking reinsurance but might also be acting for the seller
if, for example, the broker has been given a measure of authority to underwrite and accept risks.
• Brokers acquire business in a number of different ways, including direct approaches to potential
clients and through developing innovative new types of contracts; business can also be obtained
from other brokers.
• Brokers place business both in local markets and internationally.
• In addition to their core business of placing reinsurance they offer a number of ancillary services
including:
– preparing and collecting claims;
– providing market intelligence;
– arranging reciprocity;
– managing general agents
– checking the security offered by reinsurers;
– providing documentary and analytical services; and
– providing risk management.
When things change
• Continuity of reinsurance programme can be interrupted when reinsurers cease trading or pull out
of a territory or class of business.
• The insurer may wish to change its reinsurance programme because it has become less risk adverse
and wishes to increase its overall retention levels, or because increases in premium income and
capitalisation means it can reduce its dependency on reinsurance, or as a result of merger or
acquisition.
• Legislation and regulation can impact on solvency, capacity and claims requirements, which in turn
affects the need for reinsurance.
Chapter 1
Question answers
1.1 The insurer is likely to buy less protection and raise retention limits instead. If the
cost of reinsurance is prohibitively expensive, the insurer might be obliged to limit
the extent of cover it can offer to insureds. In extreme cases, the insurer may
consider withdrawing from that particular market sector altogether.
1.2 The administrative burden of having to place the risk with more than one company is
reduced, as is the claims collection process, thus representing significant economy of
scale benefits. It is also easier to track the performance of and security offered by
just one insurer.
1.3 Excessive retention of risk cuts across one of the basic principles of insurance
practice, that of spread of risk.
1.4 Specialised knowledge and expertise is required to underwrite an inwards
reinsurance account successfully.
1.5 The reinsured is promising to pay a set premium by an agreed date. Sometimes this
is at the start of the contract but more often it is through its duration with a ‘settling
of accounts’ at the end in the form of an adjustment premium.
1.6 Reinsurance, and for that matter retrocession, relationships are several steps
removed from the private individual requiring private car or home insurance, and call
for a level of expertise that an agent with a non-insurance background will certainly
not possess.
Chapter 1
Self-test questions
1. How do Robert and Stephen Kiln describe reinsurance?
2. Why do insurers seek to spread risk?
3. Why are State insurance corporations important buyers of reinsurance?
4. What are the main incentives to sell reinsurance?
5. What is a reTakaful company?
6. How are brokers in the UK and USA regulated?
You will find the answers at the back of the book

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2
Chapter 2
Different types
of reinsurance
outcomes
Learning objectives
Introduction
Key terms
A Main types of reinsurance 2.1
B Differences between reinsurance and retrocession 2.2
C Alternatives to conventional reinsurance 2.3
D Practical limitations on choice 2.1
Key points
Question answers
Self-test questions
Learning objectives
• describe the different types of reinsurance, their main features and characteristics;
• explain the differences between the various methods of reinsurance;
• identify the main features of retrocession and the objectives of contracting parties; and
• describe the alternatives to conventional reinsurance.
Introduction
We have already considered the reasons why insurers contemplate the purchase of
Chapter 2
reinsurance, and the benefits to the insurer (i.e. the reinsured, the cedant or the ceding
company) once the contract of reinsurance has been finalised. In this chapter, we will
examine the different types of reinsurance available to the insurer and the factors that are
taken into account when selecting one type in preference to another.
Each type has its own advantages and disadvantages and these will be considered as we
focus on each type of reinsurance in turn. Reinsurance can be divided into two main types:
• Facultative – the individual reinsurance of large or hazardous single risks, which we look
at in more detail in chapter 3.
• Treaty – a contract that automatically accepts a large number of similar risks.
These types can be further divided into two basic methods:
• Proportional, which will be explained in detail in chapter 4.
• Non-proportional, which will be explained in detail in chapter 5.
These types are subdivided again into various forms as shown in figure 2.1.
Learning point
A third variation of reinsurance, facultative obligatory
obligatory, is shown in figure 2.1; this can be
described as an combination of facultative and treaty. We refer to facultative obligatory
reinsurance again in chapter 3 and chapter 4.
Figure 2.1
Reinsurance
Facultative
Facultative Treaty
obligatory
Proportional Non-proportional Proportional Non-proportional
Quota share Excess of loss Quota share Surplus Excess of loss Stop loss
As the needs of an individual cedant or reinsured have changed or become more complex,
different variations of both methods have developed. These are explored in the chapters
that follow.
Be aware
The term cedant is mainly used in proportional reinsurance.
The term reinsured is more commonly used for excess of loss reinsurance.
We shall also see how the reinsurer uses clauses in contract wordings to limit, define or
extend cover and often to impose obligations with regard to procedural protocol that needs
to be observed. Wordings and clauses in common usage are covered in chapter 7, with
certain class-specific clauses referenced in their associated chapters.
In this chapter, we introduce the various types of reinsurance, explaining the main features
and characteristics of the different methods that are used.
Chapter 2 Different types of reinsurance 2/3
Key terms
Chapter 2
Alternative risk Capital market Catastrophe bonds Facultative obligatory
transfer (ART) reinsurance
Facultative reinsurance Finite risk Industry loss warranties Limits of liability
Retrocession Retrocessionaire Severity Treaty reinsurance
A Main types of reinsurance

A1 Facultative reinsurance
Consider this
this…
…
Before you move on, what do you know about facultative reinsurance?
Facultative reinsurance was the earliest form of reinsurance. If an individual risk was too Each risk is a
large for an insurer to accept, it would look to reinsure a share of the risk with another separate
reinsurance
insurer or reinsurer and a reinsurance contract was made. The fundamental features of contract
facultative contracts are as follows:
• Facultative means optional, so both parties have a choice as to whether to enter into the
contract or not: the original insurer in determining whether it wishes to buy cover and the
reinsurer in determining whether it wants to accept the risk and at what terms.
• Each risk is a separate reinsurance contract and this is important to note when
considering treaty reinsurance later.
Be aware
Although most risks today are ceded to reinsurance in the form of treaties that provide
automatic coverage, there is still a place for facultative reinsurance, particularly where the
risks have to be considered individually on their own merit because of their size or nature.
For example, a very large electronics factory would be a risk for which facultative
reinsurance could be considered because the original insurer wants to give 100% cover to
its client, but does not have enough automatic capacity available from its treaty
reinsurers.
Question 2.1
What other type of risk might be a suitable proposition for facultative reinsurance?
A1A Uses of facultative reinsurance

Facultative reinsurance could be used in the following circumstances:
• Where the insurer requires capacity beyond its treaties providing automatic Insurers do not
capacity. An insurer would not want to turn away a good risk because it was
underwriting capacity want to reject
good risks because
too large, so it may attempt to obtain facultative reinsurance to cover the excess they are too large
capacity.
• Where the risk is excluded from the insurer reinsurance. Treaty reinsurances
insurer’’s treaty reinsurance
generally have a list of exclusions of business that the reinsurer does not wish to cover.
These might be hazardous risks, risks not fitting the reinsurer’s risk appetite, or areas of
business in which it had a particularly bad experience in the past. For example, some
liability reinsurance treaties exclude directors and officers cover, more so during difficult
economic times. Other problem areas may be geographical, for example, risks may be
excluded that emanate from the USA. Insurers may wish to obtain cover for these risks, in
whole or in part, that are not otherwise covered and so seek facultative protection.
• Where the insurer does not want to cede the risk to its reinsurance treaty or where a
particular risk, although covered under the treaty reinsurance, might lead to losses that
could affect the amount of premium the reinsurer would charge for the entire treaty. A
Chapter 2
facultative reinsurer would be able to judge the potential of the individual risk and charge
an appropriate premium. For example, an insurer has a courier firm as a risk under its
motor account. It realises that the potential losses from this firm could lead to the entire
reassessment of its motor account by its treaty reinsurers and so it looks to reinsure this
particular risk on a facultative basis. The insurer must be certain that it is not in breach of
an obligation to compulsorily reinsure such risks under its treaty, and should seek the
agreement of the treaty reinsurer before obtaining separate facultative cover.
• Where the original risk is hazardous
hazardous. Certain risks are hazardous and, especially in local
markets, the insurer may not have the experience of the potential of these risks. A
reinsurer could have a more global perspective and experience from other markets, which
might help in the rating and consideration of the risk. For example, a property insurer in
Senegal might only have one fireworks factory as a risk but by seeking facultative
reinsurance, they might be contacted by a reinsurer that also reinsures firework factories
in Europe and the rest of Africa and could offer them expertise as to rating and what sort
of warranties might be applicable.
• Where there are unique commercial, financial or strategic reasons
reasons. These considerations
vary between insurers and geographical locations, but there might be pressure on
insurers to accept business either for commercial or political reasons that they might
otherwise not have considered due to nature or size.
• Where the insurer is new to a particular market segmentsegment, the reinsurer may not offer a
treaty facility until it is confident that the insurer’s underwriters are competent in the
disciplines concerned.
• Where there are elements within the account to be reinsured that have a greater level
lines. A facultative carve-out may be appropriate, as the overall
of risk than the remaining lines
cost of purchasing reinsurance would be less than if a rate applicable to the most
hazardous elements of risk was applied to the entire account. We refer to this again in
chapter 4, section A1B.
Be aware
The entire local market might support a large or complicated risk as it is in the national
interest, e.g. a dam. However, they might not want to put this through to their treaty
reinsurance because if a loss did occur, it would affect the rates for the country’s entire
insurance industry, so affecting their market development. They would perhaps want this
to be reinsured facultatively.
A1B Advantages and disadvantages of facultative reinsurance

Advantages
The advantages of facultative reinsurance are as follows:
• Risks are considered individually. Reinsurers can negotiate a suitable premium for the
actual risk concerned rather than having to consider it as part of an overall portfolio
of risks.
Consider this
this…
…
Why do you think this is an advantage to the reinsurer?
• Facultative insurance increases the insurer’s competitive edge within its chosen market.
• There is a freedom for the insurer to offer any risk which may then be accepted or
declined by the reinsurer. The individual examination of the risk with the option to accept
or decline allows the reinsurer to select a portfolio of risks which corresponds to their
underwriting policy.
• The exposures to an insurer’s treaty reinsurance could be protected by facultative
reinsurance of particular risks to ensure a better overall result and lower reinsurance cost
in the long-term.
• An insurer might benefit from the specific knowledge of the facultative reinsurer with Insurer might
regard to the nature and potential of the risk. benefit from the
specific knowledge
• There is an opportunity for both parties to develop a successful and mutually-beneficial
Chapter 2
of the facultative
relationship. The reinsurer can begin to understand the insurer’s underwriting methods reinsurer
and abilities and the insurer to consider what areas that they could develop with the aid of
reinsurance.
• A successful facultative relationship with a reinsurer might be a precursor to the insurer
offering it a place on its schedule of treaty reinsurers.
Disadvantages
The disadvantages of facultative reinsurance are as follows:
• As risks are considered individually, the insurer cannot be certain of the placement of the
facultative reinsurance and this could affect its ability to underwrite the underlying risk.
• The administration involved is labour-intensive and expensive, so if many similar risks are
to be reinsured, it can be more cost-effective for the insurer to arrange automatic treaty
protections.
• Delay in issuing a policy can create problems with clients and affect the insurer’s chances
of securing their participation on the original risk. For example, a reinsurer might insist on
a survey and certain recommendations from the survey being carried out before it
commits to cover.
• The insurer may need to disclose full information regarding its underwriting of the risk.
This could be a problem if the reinsurer is also seen as a competitor in that field. However,
in practice, facultative reinsurance is often undertaken by the reinsurer based on a
minimum disclosure of information if a suitable level of trust exists between the
contracting parties to the reinsurance arrangement.
• There is the possibility of the reinsurer exercising a certain amount of influence over the
insurer’s underwriting by asking them to improve the risk offered or influencing unduly
their assessment of the premium on the original risk.
• The insurer may lose control over the handling of the risk. For example, it may not be Refer to chapter 7
for clauses
allowed to agree policy amendments without the prior agreement of the reinsurer.
Reinsurers may control the handling of any claims by the use of a ‘claims cooperation’ or
‘claims control clause’.
A2 Treaty reinsurance
Consider this
this…
…
From what you have read about treaty reinsurance so far, what do you think its main
advantage could be?
With facultative reinsurance, the insurer has to place all the risks individually, with the
possibility that any one could be rejected by the reinsurer. To combat this, a solution that
obliges the insured to cede a fixed amount of its business to the reinsurer, which the
reinsurer is obliged to accept, has been developed. This is treaty reinsurance and the terms
and limitations of the treaty wording are agreed between the insurer and reinsurer in
advance.
Consider this
this…
…
A treaty is a formal agreement between two parties for the provision of automatic
reinsurance coverage. Can you think of a reason why a treaty has to be arranged in
advance?
A2A Uses of treaty reinsurance

The treaty is the contract that outlines the terms and the share of the risks that are to be Treaty outlines the
placed with a reinsurer. For example, a motor insurer insures 100,000 drivers each with their terms and shares
of risk
own vehicle; if it were to reinsure all of these on a facultative basis that would mean
producing 100,000 reinsurance contracts, each of which would have to be agreed with the
reinsurer. Instead, just one reinsurance treaty is organised. By agreeing to this contract, the
insurer knows that it has a reinsurer which is automatically on cover.
Details on the exact workings of treaties are dealt with in chapter 4 and chapter 5.
A2B Advantages and disadvantages of treaty reinsurance

Advantages
Chapter 2
The advantages of treaty reinsurance are as follows:

• The reinsured has automatic reinsurance cover and so problems associated with the
individual consideration of risks on a facultative basis do not apply.
• The reinsured receives a contribution towards costs for proportional treaties in the form
of ceding commission.
• The reinsured can receive an additional contribution if the business is profitable for
proportional treaties in the form of profit commission.
• Administration is quicker and easier than for facultative reinsurance.
• Accounting procedures can be simplified by the use of quarterly accounting.
• As treaties generally deal with a large number of homogeneous risks, computer
technology can be used for data storage and analytical techniques.
Disadvantages
There is no freedom of choice since both parties are tied into the contract. The treaty cannot
be cancelled before the end of the period, unless a specific cancellation provision is agreed.
Therefore, there has to be a degree of trust in the underwriting ability of the original insurer.
Example 2.1
Insurer Y wishes to reinsure part of its line on an aerosol manufacturer’s factory to
reinsurer Z under its treaty but Z has excluded such risks from the treaty. Options
available to Y are to:
• reduce its gross acceptance of the original risk to a net line without reinsurance;
• buy facultative cover; or
• see if Z is prepared to cover the risk under the treaty as a special acceptance.
A disproportionate amount of premium may have to be ceded to reinsurers on small, good

risks that an insurer would otherwise prefer to retain net for its own account. As we will see
in chapter 4, this problem can sometimes be overcome by arranging specific types of
surplus treaties, where the reinsured has the option to vary its retention according to its
perception of the quality of the risks ceded.
A3 Distinctions between proportional and

non-proportional methods of reinsurance
Both treaty and facultative reinsurance can be divided between proportional and
non-proportional reinsurance. The different types and how they operate are explained in the
next chapters, but we provide a basic introduction here.
Proportional reinsurance
An insurer cedes a
Proportional reinsurance is where an insurer cedes a proportion of a risk to the reinsurer
proportion of a risk which accepts that share in the risk, receives the same share of the premium and pays the
same share of the claim. So, if the reinsurer accepts 20% under what is termed a ‘quota
share’ of the insurer’s motor account, it would take 20% of the premium and pay 20% of the
claims. The key points to bear in mind are as follows:
• The original limits of liability
liability, premium and claims are shared between the insurer and
reinsurer in an agreed proportion.
• The treaty is said to ‘follow the fortunes’ of the coverage provided in the original policy.
• Proportional reinsurance can be regarded as a partnership between the insurer and the
reinsurer.
• There can be an administrative burden as the reinsured portion of each individual policy
has to be calculated.
• Large premium incomes are generated but profit margins are often small.
• It sometimes contains catastrophe exposure, for which it is difficult to quantify the
probable maximum loss.
• Technically, the exposures are unlimited – that is to say every risk ceded has a claim
potential to the full amount reinsured.
Non-proportional reinsurance
In the case of non-proportional reinsurance, the reinsurer only pays losses when they exceed
a specified retention by the reinsured; this retention is most often expressed as a monetary
Chapter 2
amount.
Example 2.2
An insurer’s motor account is protected by a reinsurance of £100,000 excess of £50,000.
The reinsurer will indemnify the insurance company for a loss once a loss exceeds
£50,000, but only up to the maximum indemnity of £100,000, in excess of £50,000.
Any amount in excess of £150,000 would be the original insurer’s responsibility.
The key points to bear in mind are as follows:

• The retention of the reinsured is a monetary barrier before the reinsurers become
involved.
• The relationship between insurer and reinsurer tends to be shorter-term than in
proportional treaty relationships.
• The excess of loss premium is calculated for the limit of liability of the treaty, whereas in
proportional reinsurance the reinsurer receives a proportion of the original premium from
each policy written.
• Non-proportional reinsurance is easy to administer as individual policies do not have to be
considered separately.
• The premium incomes may be small relative to the level of liability accepted, but the profit
margins can be large.
• The loss frequency will vary depending upon the retention and be rated accordingly.
However, underwriting measures taken by the reinsurer can be used to limit exposure.
Examples are the selective use of reinstatement conditions or the use of exclusions. We
will look at these aspects again in chapter 7.
Activity
It is useful to understand the ‘inverted’ relationship between frequency and severity. Using
a graph consisting of a vertical (y) axis representing frequency or probability, and a
horizontal (x) axis representing severity, draw a curve plotting the characteristics of, say,
satellite reinsurance losses.
B Differences between reinsurance and

retrocession
As we saw in chapter 1, reinsurance companies both sell and buy reinsurance. Reinsurers Reinsurers
themselves need to purchase reinsurance to ensure that they do not assume too much risk themselves need
to purchase
from one particular location or specific risk. Such reinsurance is known as ‘retrocession
retrocession’: a reinsurance
transaction whereby a reinsurer cedes or passes to another reinsurer all or part of the
reinsurance it has itself assumed.
The risk is transferred as follows:
Client Insurer Reinsurer Retrocessionaire
The risks accepted by the insurance industry can be spread either by:
• using co-insurance to share risks among many insurers; or
• using reinsurance to lay off, or pass, part of the insurer’s liability to reinsurers, which in
turn can retrocede their own assumed exposures.
Retrocession may be done on a risk-by-risk basis, known as facultative retrocession, or
through automatic reinsurance by way of proportional or non-proportional treaties.
Question 2.2
As a reminder, what is the main advantage of spreading risk as widely as possible?
The difficulty of monitoring accumulation of exposure is accentuated if the monitoring

process is extended into the acceptance of retrocession business.
Chapter 2
The retrocession
The retrocession (or ‘second tier’) market is often said to drive the reinsurance market, just
market is often as the reinsurance market sometimes drives the insurance market, by bringing about
said to drive the
reinsurance market
changes in underwriting practices. One way in which retrocessionaires can influence the so-
called ‘first tier’ reinsurance market is by imposing restrictions on the number of
reinstatements available under protections of portfolios of inwards catastrophe excess of
loss reinsurance programmes covering original insurance business. The result is that the
original reinsurer is then unsure whether it should allow reinstatement of a loss in the same
event, which could exceed the cover that it is able to buy.
Practice differs between markets. For instance, it is quite common to restrict reinstatement
for the same event in the North American market, but less so in all other international
Be aware
This environment is in a constant state of evolution and you should keep up to date with
the latest changes.
The principal objectives for a reinsurer when deciding whether to buy a retrocession
programme are the same as those of an insurer seeking reinsurance.
Objectives for a
reinsurer when
deciding whether
to buy a
retrocession
programme
increase give greater
acceptance stability to
capacity its results
limit the
exposure to loss
A reinsurer will usually have retrocession treaties with a number of different reinsurers.
These may be Lloyd’s syndicates and other insurance or reinsurance companies, which will in
turn provide the reinsurer with additional capacity. In some cases these retrocession
contracts are set up in a loose form of reciprocity: a two way exchange of reinsurance
business.
Be aware
Just as we saw in chapter 1 that buyers of reinsurance can also be sellers, you should also
note that a seller of a retrocession may also take on the role of a buyer in a separate
transaction.
Retrocession
Retrocession contracts are standard reinsurance contracts and are traded in global
contracts are reinsurance markets. London, in common with other international markets, has a substantial
traded in global
reinsurance
retrocession market, which sometimes can lead to complications. With numerous
markets interwoven relationships, it can be hard sometimes to determine exactly the amount of risk a
reinsurer may have accumulated from a particular geographical location or type of business.
B1 Retrocedants and retrocessionaires

The purchaser of retrocession business is known as the retrocedant
retrocedant. A retrocedant needs
cover to protect its own writings, or its book of inwards business.
The accepter of retrocession business is known as the retrocessionaire
retrocessionaire. Retrocession is the
means by which a reinsurer can expand its book of business, and obtain business from a
country in which it has no direct acceptances. A European reinsurer could develop a Far
Eastern account in this way. You will appreciate that the retrocessionaire is further removed
from the original insurance business than the reinsurer.
B2 Features of retrocession
When underwriting a reinsurance account to its ceding company, or reinsured, a reinsurer
Chapter 2
receives little or no information about the individual risks retroceded to it. The reinsurer is
aware of the ceding company’s underwriting limits and can control the amount of
reinsurance cover it provides; this can be by a limit per risk or per event.
The reinsurer is likely to be accepting reinsurances from a number of different ceding It can be difficult
companies, thereby taking on a considerable accumulation of exposure. This can be for the reinsurer to
calculate its total
exposure to the same risk or to the same event, since many of the ceding companies could exposure precisely
be hit by the same loss. It can be difficult for the reinsurer to calculate its total exposure
precisely.
Since retrocession business is more remote from the original business, it becomes more
problematic for the following reasons:
• For proportional retrocessions, the premium received will have been reduced from the
original premium by the deduction of commission, reinsurance commission, overriding
commissions and possibly brokerage.
• For non-proportional retrocessions, the premium received will have been influenced by
assumptions made by the reinsurer concerning risk premium and catastrophe loss
provision, to which the retrocessionaire has had no direct influence or input.
• It becomes more difficult for the retrocessionaire to identify its exposures.
Activity
Here is a list, in random order, of the various parties we know are involved in insurance
and reinsurance relationships:
Reinsurer; Cedant; Insured; Retrocessionaire; Insurer; Retrocedant.
Draw a diagram that shows the relationship between each entity, identifying any dual
roles. Ask a colleague to review your diagram to confirm its accuracy.
C Alternatives to conventional reinsurance

Recent capital market valuations and significant aggregated liability and terrorism-related
losses, have placed pressure on the insurance market’s ability to meet the growing risk
transfer demands of its largest corporate customers. Such pressure has affected the balance
between the supply of, and demand for, reinsurance capacity and reinsurers often have
difficulty in satisfying the demand for cover. As a result a need for alternative ways to
transfer risk and its consequences has evolved.
Although the most popular method for an insurer of transferring risk to an outside party ART has no strict
continues to be conventional reinsurance, alternative risk transfer (ART ART) has become definition
increasingly important as another way to transfer risk. ART has no strict definition, although
it is often said to be ‘a non-traditional way of dealing with a risk transfer problem’. There is
some argument as to its nature and whether it should be included as a form of reinsurance at
all. One opinion is that ART is a risk transfer to the capital markets
markets. The use of capital
markets in the risk transfer process is an area under continuous development. It attracts
interest from banks and other financial institutions, such as hedge funds, that have the
balance sheet capacity to trade risk that almost exactly counters other risk offered to them
in the course of their core business. The widest definition of ART includes any cover
containing an element of financial risk, and this is the definition we will use here so that all
factors that may impact on reinsurance are considered.
Be aware
Any insurance-linked security that allows investors in capital markets to take a more
direct role in providing insurance and reinsurance protection, and that brings about a
convergence of insurance and capital markets, can be considered as an ART instrument.
ART is a set of risk-financing techniques. Traditional techniques were once limited in their
application to traditional single class insurance risks, such as property. The alternative
techniques combine with the traditional to offer a powerful ‘tool-kit’ for meeting more broad
Chapter 2
risk-financing needs, including the financial management of risks that have not traditionally
been insured.
An ART solution is likely to contain several risk-financing techniques. ART solutions are
hugely varied and often developed uniquely to solve a specific problem. They enable
companies to select the most appropriate risk finance and acquire contingent capital at an
economic cost.
Be aware
Contingent capital is debt that transfers into equity when there is a crisis or certain
triggers are met, such as the occurrence of a natural disaster. It is represented by funds
that become available under a pre-negotiated agreement if a specified contingency
occurs. Contingent capital is useful when a company would otherwise find it difficult to
raise capital.
Insurance-linked securities provide a mechanism within the financial system to transfer

insurance risk to capital markets and supply protection to investment portfolios. The
financial system benefits from the presence of insurance-linked securities, as well as other
forms of ART. As a result of securitisations, derivatives and swap structures, insurers are
better positioned to spread their risks across the broad spectrum of the capital markets, as
opposed to relying on reinsurance or capital reserves. This allows for efficient use of capital
and adds liquidity to the financial system. Ultimately this benefits the individuals and
institutions seeking insurance protection. Capital market participants benefit from a
diversity of risks and returns that are not dependent on the usual factors.
In common with conventional reinsurance, an ART product requires an event to take place
that triggers a payment by the investor to the insurer. This could be:
• a single trigger, such as an earthquake achieving a pre-agreed measure on the
Richter Scale;
• a dual trigger, such as windstorm in the Gulf of Mexico bringing about a fluctuation in oil
prices outside of predetermined parameters; or
• other convoluted combinations of events leading to multi-triggers, and so on. See
section C1G.
C1 Development and features of ART

Capital markets and the insurance industry have long held a mutually beneficial relationship.
Insurers provide risk protection to individuals and companies, while capital markets provide
the insurance industries with numerous options to earn investment profits and manage
reserve funds.
Insurers are among the largest purchasers of fixed-income securities from capital markets.
This has provided capital markets with substantial liquidity, enhanced trading efficiencies
and lowered borrowing costs for both government and corporate debt issues.
Provide insurers
Imbalance in the insurance and reinsurance industries has caused new financial products to
with better tools to be created within capital markets. These provide insurers with better tools to manage risk
manage risk
and investors with new investment opportunities. Traditionally, primary and secondary
insurance markets have managed risk by holding capital in reserve or by financing risk
positions through reinsurance. However, capital held in reserve cannot be used to fund
business expansion and new ventures, leading to stagnation. The desire to free capital,
combined with concerns over the reinsurance industry’s ability to provide future coverage,
has given insurers the incentive to look for risk management alternatives.
Insurance-linked securities serve to manage and hedge various insurance risks, while
increasing the availability of capital by drawing on alternative sources of funding. Like most
other markets, insurance-linked securities were adversely affected by the global financial
credit crisis, but have proved to be more resilient as issuances continue to grow, despite
there being some weaknesses in certain individual sectors .
To begin with, insurance-linked securities were simple fixed income structures that allowed
insurers to manage catastrophic risks. Over time, they have become more complex and have
evolved into a discrete asset class, having great appeal to a wide range of investors and
Chapter 2
providing insurers with a broader choice of risk management tools. Insurance-linked
securities include derivatives, catastrophe bonds
bonds, contingent capital contracts, industry loss
warranties, reinsurance sidecars and catastrophe futures, which further converge capital
warranties
and insurance markets. We will look at the features of these products later in this chapter.
There are two segments which make up the ART market:
ART market
Risk transfer
through alternative Alternative
carriers products
The market for alternative carriers consists of self-insurance, captives and other loosely-
defined risk retention groups.
Captives
The use of captives increases dramatically when insurance markets harden. Many Refer to chapter 1,
section B6 for
multinational corporations already ‘parent’ a captive. Captive insurance companies captives
represent an alternative form of risk financing.
The captive must be adequately capitalised, so that it holds sufficient funds to meet all
foreseeable losses within the capacity allocated to risk by its parent. The decision to proceed
with the formation of a captive needs to consider the cost and availability of that capital, as
well as those costs associated with set-up, management and maintenance. Costs will be
highest where the decision is taken to locate ‘offshore’, although there will likely be tax
advantages to mitigate such costs.
It may be several years before the accounting of the captive’s insurance transactions allows
the release of profits to its ‘parent’ and so the establishment of the captive must be seen as a
long-term investment. Further capital will be needed if losses prove to be worse than
anticipated and any future decision that is taken to close the captive could involve running-
off of claims over a prolonged period before closure. Additionally, the captive must satisfy
financial regulatory standards and local financial and corporate governance regulations.
Essentially, when market conditions soften, the reasons that were so persuasive in validating
the formation of the captive may have been overtaken. We will consider captives in more
detail in chapter 9, section C.
Question 2.3
From what you learned in chapter 1, what does the term ‘captive’ imply?
Difference between ART and reinsurance

The key difference between ART and the traditional insurance marketplace is that insurance ART is intended to
and reinsurance markets provide catastrophic risk coverage, whereas the capital markets supplement
reinsurance
provide additional financial capacity for insurance coverage through self insurance.
However, ART is intended to represent an integrated approach to supplement reinsurance
needs, rather than to be a replacement.
These capital market risk-based products are also designed to deal with catastrophe risks.
Many are specifically designed to fit the individual requirements of a particular organisation
and need to have the capacity and flexibility to cover a complexity of risk exposures or
spread of risk. The following is a general review of the market and its opportunities for
transferring risk.
C1A Catastrophe bonds

Catastrophe bonds are capital market alternatives to traditional catastrophe reinsurance.
Chapter 2
Catastrophe bonds are used by insurers to purchase supplemental protection for high-
severity, low probability events. They are risk-linked securities that transfer a defined set of
risks from the sponsoring insurer to investors, through fully collateralised special purpose
vehicles.
Catastrophe bonds are structured to offer beneficial yields that attract investors with higher
risk appetites. They usually include a limited range of perils, such as hurricanes, windstorms
and earthquakes. Key investors in catastrophe bonds include hedge funds, insurers,
reinsurers, banks and pension funds and these receive a regular payment in the form of a
‘coupon’ in addition to the release of the original investment when the bond reaches
maturity.
The bondholder agrees that if a catastrophe costs the insurance or risk-bearing community
as a whole more than a pre-agreed amount, it will write off or defer payments for the capital
and/or the interest due on the bond. The company that issues the catastrophe bond can, in
the event of a major loss ‘trigger’, write down the value of the liability in its books and release
funds to pay claims. The trigger can also be activated by reference to a sliding scale of actual
losses arising from the defined catastrophic event experienced by the insurer.
Although catastrophe bonds do not share the flexibility of conventional reinsurance
contracts, their attractiveness lies in the:
• lack of any close correlation with stock market or economic conditions;
• diversification benefits they offer; and
• strong returns compared to other investment opportunities.
They play an important role in bringing additional capacity into reinsurance markets thereby
protecting an insurance company’s balance sheet.
C1B Contingent capital contracts

Financing
Contingent capital contracts are financing agreements, sometimes referred to as CoCos,
agreements arranged before a loss takes place. Should a named event or ‘trigger’ occur, the contract
arranged before a
loss takes place
converts into equity as the financier provides the insurer with the amount of capital
determined by the size of the catastrophic loss. The terms of the contract are arranged
during a prior time of normal benign activity when the insurer, which is not having to
negotiate from a position of weakness, can arrange access to funds at favourable rates. If no
catastrophic events occur, there is no exchange of funds. Such contracts provide balance
sheet protection and place the insurer in a strong position allowing it to benefit from
premium increases after the named event has occurred.
C1C Industry loss warranties (ILWs)

Industry loss warranties (ILWs) are reinsurance contracts where payouts are linked to a
predetermined trigger of estimated insurance industry losses. They are swap contracts,
which are based on insurance industry indices rather than insurer actual losses. Payment of
the warranty is made based on whether the covered insurance industry, rather than the
individual insurer, suffers a predetermined level of loss due to natural catastrophes.
Example 2.3
An insurer has exposure to hurricanes in Florida. It could buy an ILW for hurricane activity
in that region, which is triggered if the total industry-wide insured loss is in excess of
US$15 billion but less than US$25 billion. The insurer pays a premium to the reinsurer or a
hedge fund and in return could receive the limit amount if losses exceed the predefined
amount, or warranty.
An ILW can sometimes have additional clauses that must be met for a payout to be made,
for instance, as well as the industry loss the insurer must experience a specified amount of
loss itself.
In addition to the ‘prior’ cover already described, other types of ILWs include:
• live ILWs, which can be traded while an event is occurring;
Chapter 2
• dead ILWs, which can be purchased if an event has already happened but the final loss
amount is unknown; and
• back-up covers, which protect against follow-on events such as flooding in the aftermath
of a severe storm.
C1D Reinsurance sidecars

These are limited purpose companies created to work in tandem with the reinsurance Sidecars also
covered in
coverage provided to an insurer. Sidecars are capitalised with debt and equity financing chapter 1,
from capital markets and are liable for only a portion of risk underwritten. Investors’ funds section D7
are used to underwrite all, or a portion, of an existing policy. Sidecars allow insurers to write
more business while limiting their liabilities. Sidecars relate to defined and limited risks, are
privately financed, and dissolve after a set period of time.
C1E Catastrophe futures

The value of a catastrophe futures contract is determined by an insurance index that tracks
the amount of claims paid out during a given year or time period. When catastrophe losses
are higher than a predetermined amount, the futures contract increases in value and the
insurer makes a gain. Conversely, if losses are lower, the contract falls in value and the
insurer makes a loss. As the value of the contract increases, the insurer can realise a gain in
the short term on encashment, which can be used to offset any losses it has incurred.
C1F Insurance derivatives

A derivative is a ‘forward’ contract that enables a party to buy or sell a specified asset at a
specified time in the future at a pre-agreed price. This brings certainty that future trading
will be fixed at pre-agreed rates or within determined margins.
The insurance derivative is a development of this concept. Its worth depends on the
valuation of financial instruments, events or conditions. They allow insurers to transfer
insurance risks to capital markets without having to provide prior liquidity against the
maximum liability that could exist in the event of a catastrophe. Their value is derived from a
market loss index, which uses statistics to reflect the losses incurred by the insurance
industry, for example, as a result of severe weather.
The attractiveness of insurance derivatives is that they shift risk more efficiently than
institutional methods, avoid the contractual costs of traditional insurance and reinsurance
methods, and create liquid markets for trading. Derivatives allow insurers to purchase
protection from new pools of investors.
C1G Multi-trigger policies

Under a multi-trigger policy a claim is incurred only if one or more downside incidents occur
or flow from an original event, all within a pre-defined range of dates. For example, business
interruption coverage may be included, which acts as a secondary trigger if an insured event
occurs and the insured revenue falls by a predetermined percentage.
Clearly, there are pricing advantages, as a claim only results if there are sufficient events of
loss or damage to meet all of the policy’s criteria and trigger points. All losses below the
predetermined financial threshold would not be recoverable. This type of arrangement is
suitable where an insurer has determined its risk appetite and, having decided which events
carry the largest negative effects, seeks protection to meet those resultant cumulative
losses.
C1H Catastrophe Risk Exchange (CATEX)

The Catastrophe Risk Exchange (CATEX) is an electronic system where insurers can trade
insurance risk and reduce their exposure to huge losses caused by catastrophes. Licensed
risk bearers exchange or ‘swap’ catastrophe exposures offered by subscribers, allowing
insurers and reinsurers to adjust their underwriting portfolios in response to actual events as
they occur. Insurers and reinsurers may exchange, for example, a Japanese earthquake risk
for a Caribbean hurricane risk. Parties would benefit by reducing their exposure to the
swapped risk, which would then free risk capital for other opportunities.
C2 Finite risk solutions

Finite risk
The term finite risk is used to differentiate risk-based products from the investment-only
Chapter 2
reinsurance type products. Finite risk reinsurance combines risk transfer and risk financing while
combines risk
transfer and risk
operating over periods longer than one year. A sum of money is paid that will cover most
financing expected losses over, say, a period of ten years. Buyers will usually gain a rebate if the losses
do not reach the expected level of required funding. The risk is then spread over the good
and, possibly, bad years, rather than taking an annual assessment of the loss profile, which is
often too short-term. The transfer of risk usually covers only one risk type, and all premiums
and claims are usually monitored by the insurer or the party bearing the transferred risk on
an ‘experience account’. The advance payment may be significant and represent a loss pre-
funding portfolio, rather than a true premium payment.
The value is gained from a consistency of cost over the contracted parameters and the
removal of risk from the balance sheet because the exposure is secured. There may be
substantial profit rebates, and investment income is earned on the fund and shared between
the parties according to prior agreement. Since the buyer of a finite risk programme is
financing a large part of its own risk, it will want to participate in the programme’s
favourable development.
Predictability of loss experience is achieved over time because losses are smoothed over the
duration of the contract. Risks that could otherwise be uninsurable may be included, so risks
that the conventional insurer would otherwise decline can be packaged into one contract.
The advantages
The advantages include economies of scale together with the opportunity to charge a
include economies premium for catastrophe loss spread over a period longer than one year. This arrangement
of scale
appeals to parties who face high premiums in conventional insurance markets and want to
reduce costs by removing the annual renewal cycle.
To summarise, these finite risk reinsurance contracts have certain characteristics in common:
• they provide a risk financing mechanism for near certain events;
• the pricing takes the time value of money into account as investment income is allowed
for in the pricing calculation;
• the reinsurer’s maximum liability is limited, being closely related to the premium paid;
• the reinsured usually participates in losses and benefits from better than expected loss
experience;
• the contracts are usually multiple year; and
• transaction costs are lower than for traditional contracts.
Reinforce
Make sure you know the difference between a catastrophe bond and a catastrophe future.
C3 Advantages and disadvantages of capital market

solutions
Advantages
The advantages of using capital market solutions are as follows:
• Investors are attracted to the diversification benefits and above average yields of
insurance-linked securities.
• Returns of insurance-linked securities are independent of factors affecting traditional
financial markets and their returns typically exceed similarly rated investment assets.
• The weak correlation of these financial instruments with traditional financial markets
enables investors to achieve greater portfolio diversification and higher yields.
• Capital markets have the potential to be price competitive relative to reinsurers in the
longer term.
Disadvantages
The disadvantages of using capital market solutions are as follows:
Chapter 2
• Investments in insurance-linked securities expose investors to risks that are not typically
associated with traditional investment classes.
• Traditional reinsurers tend to take a long-term view. In contrast, capital markets often
require a more immediate return and could withdraw their support at critical times.
• Transactional costs can be high, particularly for smaller trades.
C3A Risks of insurance-linked securities

As we have seen, insurance derivatives and other financial instruments are designed to
transfer or hedge primary and secondary insurance risks amongst capital market
participants. The appropriateness of these ART strategies depends on the situation and the
size of the purchaser. Table 2.1 shows the risks carried by insurance-linked securities.
Table 2.1: Risks of insurance-linked securities

Liquidity risk The uncertainty that results from the inability to buy or sell an investment.
Basis risk Occurs when the cash flow from the hedging instrument does not perfectly
offset the cash flow from the instrument being hedged.
Moral hazard Takes place when one party transfers risk to another party, and the party
ceding the risk has less incentive to ensure that the risk is managed as
efficiently as possible.
Adverse selection Occurs when both sides of the transaction do not have access to the same
information.
Credit or Arises when the counterparty to a transaction may not be able to honour
counterparty risk their side of the obligation due to financial hardship or some other cause.
C3B Summary
The convergence of the insurance and capital markets has created an alternative channel for
insurers to transfer risk, raise capital and optimise their regulatory reserves.
It also offers capital market investors a source of relatively liquid investments with limited
correlation to the traditional financial markets. Without insurance-linked securities, insurers
would be forced to hold more capital in reserve, carry greater amounts of risk on their
balance sheets and accept greater exposure to the volatile price fluctuations of the
reinsurance market. This would limit their financial flexibility to move into more profitable
lines of business. It would also be to the detriment of investors, as it provides an alternative
asset class offering diversification benefits and returns that are historically above
similarly-rated structures.
Remember that the use of capital markets can be expensive and complicated, and is unlikely
to be attractive for any but the largest exposures faced by insurers and reinsurers.
D Practical limitations on choice

The previous sections show a wide variety of reinsurance arrangements from which, in
theory, an insurance company could choose. Practical application, however, can narrow the
available options.
The insurance company seeking reinsurance needs to ensure that the protection for any
specific class or classes of business provides the required coverage and capacity. It also
needs to ensure it does so at an affordable cost, which allows acquisition and administration
costs to be covered and provides the company with a good probability of making a profit.
Each reinsurer writes business in accordance with the criteria and underwriting philosophy
set by senior management. This will cover the classes of business and territories that the
reinsurer will either cover or exclude, reinsurance pricing criteria, which is usually built into
pricing models, and specific exclusions for each class or category.
For a reinsurance contract to be completed there needs to be a match between the

demands and needs of the ceding company or reinsured and the reinsurer’s appetite for the
class of business and the reinsurance structure offered. The two do not always meet.
Chapter 2
Some reinsurance market sectors only write excess of loss reinsurance treaties. An insurer
that has decided on a proportional reinsurance treaty programme would not make any
progress by approaching a selection of such reinsurers. The minimum prices that reinsurers
may require for an excess of loss programme could be too high for an insurance company
and an alternative solution would be needed.
The parties usually involved in structuring and placing a reinsurance programme are the
insurance company, the reinsurance broker and reinsurers for the class and territory. All
parties need to apply a high degree of market knowledge, expertise and reasonableness to
match the insurance company’s requirements and preferences with the reinsurers’
underwriting criteria.
Key points
Chapter 2
Main types of reinsurance
• Facultative reinsurance:
– Each risk considered is a separate insurance contract and insurers can offer, and reinsurers can
accept, at their option.
– Although most reinsurance is conducted under treaty, facultative reinsurance offers flexible
solutions in one-off circumstances.
– Its advantages include the ability to negotiate tailor-made cover and premiums that exactly
match the risk that is offered.
– Its disadvantages include lack of certainty and high administration costs.
• Treaty reinsurance:
– Obligations are imposed on the insurer to offer and the reinsurer to accept business that falls
within the treaty agreement.
– It is used where blocks of business can be placed with a reinsurer knowing that pre-agreed
automatic cover is available.
– Ceding and profit commission contribute to a lessening of the cost of this type of reinsurance to
the insurer.
– Treaties represent binding arrangements that remove the element of choice from both parties;
treaties can be cost-ineffective on occasions when the insurer is obliged to cede risks it would
rather retain.
• Distinctions between proportional and non-proportional methods:
– Facultative and treaty reinsurance can both be arranged on proportional and non-proportional
bases.
– Proportional reinsurance implies that the insurer cedes an agreed percentage/proportion of the
risk and the reinsurer receives a corresponding share of the premium (less commission) and pays
the same share of any loss.
– Non-proportional reinsurance only requires the reinsurer to pays losses which exceed a specified
monetary retention by the reinsured, and the reinsurer’s premium is not proportional to its
potential liability.
Differences between reinsurance and retrocession
• Retrocession refers to a transaction whereby a reinsurer cedes or passes to another reinsurer all or
part of the reinsurance it has itself assumed.
• The difficulty of monitoring accumulation of exposure is accentuated when extended into the
acceptance of retrocession business.
• The retrocession market drives the reinsurance market and its influence affects both reinsurance
and insurance markets.
Alternatives to conventional reinsurance
• ART has no strict definition, although it is often described as a non-traditional way of dealing with a
risk transfer problem.
Chapter 2
• An ART solution is likely to contain several risk-financing techniques.

• Insurance-linked securities provide a mechanism within the financial system to transfer insurance
risk to capital markets.
• In common with conventional reinsurance, an ART product requires an event to take place that
triggers a payment by the investor to the insurer.
• Securitisations are better positioned to spread their risks across the broad spectrum of capital
markets.
• Insurers have been among the largest purchasers of fixed-incomes securities from capital markets.
• Imbalance in the insurance and reinsurance industries has given rise to new financial products
created within capital markets, providing insurers with better tools to manage risk and investors
with new investment opportunities.
• Insurance-linked securities include:
– derivatives;
– multi-trigger policies;
– catastrophe bonds;
– contingent capital contracts;
– industry loss warranties (ILWs);
– reinsurance sidecars; and
– catastrophe futures.
• Captive insurance companies represent an alternative form of risk financing.
• The key difference between ART and the traditional insurance marketplace is that insurance and
reinsurance markets provide catastrophic risk coverage whereas the capital markets provide
additional financial capacity for insurance coverage.
• An advantage of capital market solutions is that investors are attracted to the diversification
benefits and above average yields of insurance-linked securities.
• A disadvantage of capital market solutions is that transactional costs can be high, especially for
smaller trades.
• The convergence of the insurance and capital markets has created an alternative channel for
insurers to transfer risk, raise capital and optimise their regulatory reserves.
Practical limitations on choice
• The insurance company seeking reinsurance needs to ensure that the protection available provides
the required coverage and capacity at an affordable cost.
• Each reinsurer writes business in accordance with the criteria and underwriting philosophy set by
senior management.
• The parties involved need to apply a high degree of market knowledge, expertise and
reasonableness to match the insurance company’s requirements and preferences with the
reinsurers’ underwriting criteria.
Question answers
2.1 Any large, complex or extra-hazardous risk could fall under this heading. Examples
Chapter 2
include large construction projects such as dams or skyscrapers, scientific research
establishments or nuclear power stations.
2.2 So that no single loss or loss event should unduly adversely affect any one insurer or
reinsurer.
2.3 An insurance company established with the specific objective of financing risks
emanating from its parent company which owns the captive. If the captive only
insures its parent and affiliates it is called a pure captive.
Self-test questions
1. State three circumstances in which facultative reinsurance might be used.
Chapter 2
2. State three disadvantages of facultative reinsurance.

3. State three advantages of treaty reinsurance.
4. Explain briefly the differences between proportional and non-proportional
reinsurance.
5. What is the key difference between reinsurance and retrocession?
6. What is ART? Give examples.
7. What is CATEX?

Features and operation of
3
Chapter 3
facultative reinsurance
outcomes
Learning objectives
Introduction
Key terms
A Main features and operation of different types of facultative 3.1
reinsurance
B Calculation of reinsurance premiums and claims recoveries 3.2
C Case studies 3.1
Key points
Question answers
Self-test questions
Learning objectives
• describe the features of facultative reinsurance;
• distinguish between facultative proportional and facultative non-proportional reinsurance
and how each operates;
• outline the various definitions of premium income used in reinsurance and how they apply
to reinsurance programmes;
• calculate reinsurance premiums and claims recoveries; and
• differentiate between the premium and claims calculations for proportional and non-
proportional types of facultative reinsurance.
Introduction
In chapter 2 we saw that facultative reinsurance relates to a specific individual risk, which the
insurer can choose to offer to the reinsurer, which in turn is then free to accept it, or not. In
this chapter we will look at the characteristics of facultative reinsurance in both its
proportional and non-proportional forms. At the end of the chapter we provide two case
studies to illustrate how facultative reinsurance works in a practical situation.
Key terms
Chapter 3
As original Claims recoveries Common account Compartmentalisation
Consideration Deductible Estimated maximum Excess of loss

loss (EML)
Exposure Facultative non- Facultative obligatory Facultative proportional

proportional reinsurance reinsurance
reinsurance
Original risk Premium Retained share Retention
A Main features and operation of different

types of facultative reinsurance
Important to
Facultative placements, especially those made on a proportional basis, often follow the
establish exactly terms, conditions and exclusions of the original insurance policy. Thus it is important to
the coverage
under both policies
establish exactly the coverage under both the facultative reinsurance policy and the original
insurance policy.
The term ‘as original’ under a facultative placement could cover all aspects of the original
as original
policy, including any claims settlements that follow any original settlements made by the
original insurance company. Such settlements might not strictly be within the intention of
the original insurance coverage and the corresponding facultative contract, so disputes
could arise. The term ‘as original’ remains a contentious and problematic area so it makes
sense for facultative underwriters to identify the terms, conditions, exclusions and
warranties applying to the original policy at the time of acceptance. The consequences and
remedies for breach of such terms would also need to be established. It is, therefore, implicit
that the main objective of placing facultative reinsurance is to cover what is covered by the
original insurance so there should be no gaps in cover. The expression ‘back to back’
conveniently captures the intention of the placement in this respect.
Activity
‘Facultative’ is a key word in this part of your study text. Be sure that you know its
meaning in a reinsurance context. Try searching online for a definition if it is not in your
usual reference dictionary.
Facultative reinsurance and the insurer

insurer’’s requirements
There could be several reasons why an insurer, or any type of ceding company, needs to
obtain facultative reinsurance. The starting point is establishing the class of business for the
risk concerned, the limit and retention of any treaty that may be in place for that class and
the scope and exclusions applicable to that treaty.
Chapter 3 Features and operation of facultative reinsurance 3/3
Example 3.1
An insurer is seeking facultative reinsurance for a carpet manufacturer in Italy, with a sum
insured of €20m. The reason for the need for facultative reinsurance could be either the:
• insurer does not have a property or fire treaty in place and they currently rely entirely
on facultative reinsurance for the small number of property risks they write;
• insurer has a property treaty, but the total capacity under the treaty plus the insurer’s
retention comes to a figure that is well below the €20m required, so facultative
reinsurance is needed to top up the treaty capacity;
Chapter 3
• risk is considered to be in the higher risk categories and the insurer wishes to protect
the portion of the risk retained under a proportional treaty, or protect the cession made
to the reinsurer; or
• territorial scope of the treaty does not cover Italy and the risk would therefore be
excluded.
Once the reasons for requiring facultative reinsurance have been established, the next step
is for the insurer to decide which type of facultative reinsurance would be the most suitable
solution. We will go into more details about the different types of facultative reinsurance in
the other sections. In general terms, however, the direction is usually set by the type of
reinsurance treaty the insurer has for the class. If an insurer has a proportional treaty and
needs top up capacity, then proportional facultative would most probably be the best route.
If an insurer has an excess of loss treaty, then a facultative excess of loss layer could be used
to provide top up cover, which comes into effect above the limit and retention of the treaty.
Alternatively, in the same situation, the insurer may opt to use proportional facultative
reinsurance to reduce the size of the monetary exposure, so that the risk falls within the
excess of loss treaty limit after facultative reinsurance.
We will cover other examples in more detail in the case studies in section C.
A1 Facultative proportional reinsurance

Facultative proportional reinsurance permits the insurer to pass on a fixed, or quota, share
of the liability it has accepted on a particular risk by ceding a share to one or more
reinsurers. It is important to remember that the ceding insurer pays a share of the premium
less commission to the reinsurer and in return recovers the same share, or proportion, of the
original claim from the reinsurer in the event of a loss. The effect of this is that the insurer,
otherwise known as the reinsured, cedant or ceding company is limiting its exposure to its
retained share
share.
Example 3.2
A property underwriter wants to write a department store in Manchester with a total sum
insured value of £40m. He only has authority to write risks valued up to £15m and the
insurer has a maximum retention of £1.5m for the risk category and a maximum cession to
a surplus treaty of £13.5m, giving £15m automatic capacity. He asks his reinsurance
department to obtain facultative reinsurance for £25m, which equates to 62.50%
of whole.
Once facultative reinsurance has been secured, the underwriter can bind the risk. The
100% premium and any losses for the risk are shared proportionately in accordance with
the percentage apportionment:
Reinsured’s retention: £1.5m 3.75%
Cession to surplus treaty: £13.5m 33.75%
Facultative reinsurers: £25.0m 62.50%
Totals £40.0m 100%

A £6m loss occurs following a fire that causes damage to buildings and contents.
The reinsured pays its £225,000 3.75%
retention:
The reinsured then recovers: £2,025,000 33.75% from the surplus treaty
£3,750,000 62.50% from facultative reinsurers
Totals £6,000,000 100%

Chapter 3
A2 Facultative obligatory reinsurance

Facultative obligatory reinsurance combines some of the features of both facultative and
treaty methods of reinsurance. An obligation is placed upon the reinsurer to accept a
cession once the insurer has decided to cede a risk. The insurer is, however, free to choose
whether or not to cede. These arrangements are now relatively rare, as most reinsurers
would prefer to either write a fully obligatory treaty under which all risks are ceded or have
the option to decline risks. Facultative obligatory reinsurance is covered in more detail in
chapter 4, section A3.
A3 Facultative non-proportional reinsurance

Consider this
this…
…
Having just learned about facultative proportional reinsurance, in what way would you
expect facultative non-proportional reinsurance to differ.
In facultative non-proportional or excess of loss reinsurance, the reinsured retains a fixed

monetary amount on a particular risk and arranges excess of loss protection with the
reinsurer to pay any claim amounts exceeding that fixed monetary retention
retention, up to a further
defined monetary amount. A fixed premium is paid by the reinsured to the reinsurer, usually
at inception or by instalments. This method allows the reinsured to select a monetary
retention, also known as a deductible or excess, below which it will retain all losses, but
above which its reinsurer provides full reimbursement up to the monetary amount, or limit,
selected by the reinsured. The main advantage to the reinsured is that it can control the
amount of premium it is required to pay for such excess of loss protection, which will not be
on a ‘contributing’ or sharing basis as is the case with proportional reinsurance.
This type of business is described as non-proportional because the reinsurer does not
receive a fixed proportion of the premium in relation to the risk, nor does it take a proportion
of the claim. Once the claim exceeds a set limit, e.g. a retention of £250,000, the reinsurance
contract is obliged to respond to the amount of loss in excess of that retention up to the
limit of the reinsurance.
Example 3.3
Non-proportional reinsurance has been arranged for £500,000 excess of £250,000.
Loss £500,000 less reinsured’s retention £250,000 = £250,000 paid by reinsurers.
Reinsured’s share of loss = 50%.
Reinsurer’s share of loss = 50%.
However, if the loss were £625,000 less retention £250,000 = £375,000 paid by reinsurer.
Reinsured’s share of loss = 40%.
Reinsurer’s share of loss = 60%.
A3A Features of facultative non-proportional reinsurance

Reinsured may
Besides buying facultative excess of loss reinsurance for its own protection, the reinsured
protect the cession may decide it also wants to protect the cession made to its proportional treaty reinsurers.
made to its
proportional treaty
This is referred to as protecting the ‘common account’ and so benefits both the reinsured
common account
reinsurers and its proportional treaty reinsurers to the full sum insured potential of the original risk
risk. An
example of how this works can be seen in figure 3.1.
Figure 3.1: Protecting the common account

(i) TSI (total sum insured) (ii) TSI
Fac. excess
protecting Fac. excess
Pro rata
cedant’s for common
treaty
retention account
Chapter 3
Cedant’s Cedant’s Pro rata
absolute net absolute net treaty
retention retention
0 Retained Ceded to 100% 0 20% 100%

by cedant pro rata
treaties
20%
(say)
In part (i) the reinsured (or cedant) has bought facultative excess of loss reinsurance to
protect its retention under a proportional treaty. In part (ii) the reinsured has extended the
same excess of loss reinsurance to protect the common account.
The protection could be relatively inexpensive and the reinsured might decide to pay for
such protection itself rather than asking the reinsurer to contribute.
Be aware
Some proportional treaty reinsurers might not accept common account protection as it
could significantly affect the proportional treaty loss experience. Therefore, the ceding
insurer should ensure that this method is acceptable under the terms and conditions of its
treaties before arranging the cover.
Question 3.1
It seems surprising that a reinsured would want to incur this extra cost. What would its
motivation be to do so?
The reinsured should still ensure that facultative excess of loss reinsurance is permitted
under the terms of its automatic proportional treaties. This is because any payment for such
facultative reinsurance would reduce the premium shared with reinsurers under the
proportional reinsurance.
Facultative reinsurance arranged on a non-proportional basis is often ceded in layers. The
layers are defined in terms of amounts of insurance, so that the reinsurer or reinsurers only
pay out if the total claim suffered by the insurer exceeds a stated amount, known as the
retention. One reinsurer will receive all reinsurance up to the limit of the first layer. A second
reinsurer will receive all reinsurance in excess of the first layer up to the limit of the second
layer, and so on, depending on the number of layers.
For example, the insurer may be prepared to accept a total loss up to $20m, and purchases a
layer of reinsurance of $4m in excess of a $1m retention. Further layers of cover are then
purchased from other reinsurers until the total cover required of $20m has been
accommodated.
Structurally, the coverage could look like this:
Reinsurer C covers $10m
Reinsurer B covers $5m
Reinsurer A covers $4m
Insurer retains $1m

Chapter 3
Various levels of loss would be allocated as follows:

• A loss of $750,000 would be retained by the insurer in its entirety.
• A loss of $3m would be retained $1m by the insurer with the remaining $2m recovered
from reinsurer A.
• A loss of $7m would be retained $1m by the insurer with $4m recovered from reinsurer A
and the remaining $2m recovered from reinsurer B.
• A loss of $16m would be retained $1m by the insurer with $4m recovered from reinsurer A,
$5m recovered from reinsurer B and the remaining $6m recovered from reinsurer C.
Another factor which causes an increasing use of facultative excess of loss reinsurance is the
development of captive insurance company business. As we have already seen in chapter 1,
section B6 and chapter 2, section C1, a captive is a risk bearing company operated primarily
for the purpose of underwriting in whole, or in part, directly or indirectly, the insurances of its
parent company. This implies that the parent company’s primary business is not that of
insurance.
Be aware
There is an increased tendency for powerful multinational organisations to form their own
insurance subsidies, due to:
• some aspect of their risk exposures having predictable loss patterns;
• a preference for their risks to be rated on their own experience, rather than that of the
wider market; and
• the inability to achieve the insurance products they require at an acceptable price
through traditional insurance markets.
Captives are Having direct access to reinsurance markets gives captives the advantages of making best
discussed in
detail in use of the parent group’s risk control programme and the avoidance of the frictional costs
chapter 9, and overheads associated with doing business with a conventional insurer.
section C
Limits the captive’s

Reinsurance is purchased to limit the captive’s exposure to a tolerable level. Given the
exposure to a nature of a captive’s portfolio where the spread and balance of the account is limited,
tolerable level
maintaining an acceptable level of exposure is usually best achieved through the use of
excess of loss reinsurance.
It is important to remember that a facultative excess of loss is a placement where the insurer
retains a greater share of the original premium income compared to proportional
reinsurance. However, if its assessment of the likely loss pattern proves inaccurate in
frequency and severity terms, this will be small compensation for the level of losses retained.
Facultative excess of loss reinsurers might also be able to offer more capacity, since they
would not be involved in any loss frequency at an attritional, or low, level. Additional
capacity could be provided at a reduced premium if the excess of loss exposure was
considered to be remote. If the profile of the account is such that only a few risks provide an
unacceptable level of additional exposure, the insurer may elect to reinsure them separately
as facultative excess of loss risks.
Consider this
this…
…
In what situations might this be the case?
Facultative excess of loss reinsurance is appropriate when:

• additional capacity is required to handle risks exceeding its existing treaty limits; or
• no automatic cover is in existence for the particular class of business concerned; or
• the insurer does not want to expose its treaties to a certain risk; or
• certain risks are specifically excluded by the treaty reinsurers.
However, when opting for the use of the facultative excess of loss method, the reinsured
must still consider the disadvantages we looked at in chapter 2. Treaty excess of loss, with
its automatic protection and simplicity of operation, may still be a more attractive option.
Chapter 3
A3B Application of facultative non-proportional reinsurance
Business can be placed facultatively, on either a proportional or non-proportional basis, and
the factors influencing the decision of any insurer to opt for either type of protection are
very similar.
Electing to place risks on an excess of loss basis is more beneficial administratively than on a
proportional basis. However, it means that the insurer could be liable for a number of losses
that otherwise would have been shared with its proportional reinsurers.
Example 3.4
risk: £60m which is shared equally between insurer A and insurer B with £30m
Original risk
each.
Insurer A has a surplus reinsurance treaty of nine lines with a retention of £3m so its gross
automatic capacity is its retention of £3m plus 9 lines of £3 in other words (£3m plus
£27 £30
Insurer B has facultative excess of loss reinsurance of £27m excess of £3m. This means
that the facultative reinsurance would pay any loss incurred by insurer B that exceeds
£3m up to a total of £27m (i.e. giving B cover for any original loss it sustains up to £30m).
When any loss to this original risk occurs, whether partial or total, insurer A can expect to
recover 90%, or 27/30 from its surplus reinsurer. Conversely, insurer B’s facultative excess
of loss reinsurance will only allow a recovery of any claim where B’s share exceeds £3m.
Consider the following three losses:
Loss 1: £2m
Insurer A can recover 90% of its £1m share, so £900,000.
Insurer B recovers nothing because its £3m retention (or deductible) is not exceeded.
Loss 2: £5,500,000
Insurer A can recover 90% of its £2,750,000 share, so £2,475,000.
Insurer B again recovers nothing because its £3m retention (or deductible) is not
exceeded.
Loss 3: £8m
Insurer A can recover 90% of its £4m share, so £3,600,000.
Insurer B can recover £1m because its £3m retention (or deductible) has been exceeded
by this amount.
It is apparent from example 3.4 that facultative excess of loss reinsurance is inappropriate
for insurer B if it expects to experience many losses at the lower level.
Estimated maximum loss (EML)
This is a calculation with particular relevance to property insurance underwriting. It is Enables insurer to
intended to enable the insurer to calculate the extent of a worst case loss, which is calculate the
extent of a worst
potentially less than the maximum value at risk. case loss
The EML is one of the many factors used in arriving at the premium and deciding how much
of the risk to accept, and then retain. It is a reflection of the maximum amount the insurer,
and ultimately the reinsurer, expects to lose in the case of one incident. It may be the total
sum insured, but is often less because of risk characteristics, such as incombustible materials
used in construction, the installation of sprinklers, the distribution of the risk over a wide area
and the ‘compartmentalisation
compartmentalisation’ of the premises into separate fire risks. For example, a
factory could comprise three separate units, where each unit has a sum insured of £3m. If
there is space of at least 12 metres between each unit, the estimated maximum loss would be
assumed to be £3m rather than £9m, because of the unlikelihood of a fire travelling between
Chapter 3
each unit.
The EML calculation is not scientific, but can be a useful tool in assisting insurers and
reinsurers in arriving at an estimate of how much they can expect to lose and, therefore, how
much of the risk they may reasonably decide to accept. As far as the original insured, the
client, is concerned, the insurers are liable for the whole risk.
Question 3.2
An original insured has a risk valued at £10m which is written 100% by the insurer.
The EML is determined at 60% by the insurer, which then decides to buy a facultative
excess of loss reinsurance for £3m excess of £3m.
The insured has a loss giving rise to a valid claim of £7m. The insurer has no other
reinsurance on this risk.
How much does the insured recover?
How much of the loss is borne by the insurer, bearing in mind the error it has made in its
EML calculation, and how much by its reinsurer?
Retention
Other factors that influence the retention in a facultative arrangement are:
• the class of risk in terms of its vulnerability (the insurer will tend to retain more of the
‘good’ risks than the ‘bad’);
• any other commitments on the risk;
• exposures from other nearby risks; and
• particular features of the risk that make it more or less attractive.
B Calculation of reinsurance premiums and

claims recoveries
Premium is the
The reinsurance premium is the price of the cover charged by the reinsurer in consideration
price of the cover for offering to underwrite the risk. In all contracts of reinsurance, the premium is a reflection
of the original insurer’s risk passed to the reinsurer. The basis on which the reinsurance
premium is calculated varies according to the type of reinsurance contract.
B1 Facultative proportional
The premium is the financial consideration paid by the ceding insurer to the reinsurer in
consideration for the acceptance of the risk reinsured under the contract.
When a risk is reinsured on a proportional basis, premium and claims calculations are
straightforward because the liability is being shared in a fixed proportion between the
reinsured and its reinsurer and the likelihood of loss is the same for both. Consequently, the
original premium for the risk is also shared between the parties concerned in the same
proportion as the liability. For example, if a reinsurer assumes 50% of the liability, it will
expect to receive 50% of the premium, less commission, and will expect to pay 50% of any
claims up to the policy limit. Thus, the reinsurer will be liable to pay its percentage share of
any partial losses.
Question 3.3
Reinsurer R accepts 10% of a facultative proportional reinsurance with a sum insured of
£50m at an original gross rate of 2‰ (per mille). What is the gross premium due to R?
B2 Facultative non-proportional
Unlike proportional reinsurance, where the premium paid by the reinsured bears a
proportional relationship to the risk reinsured, the dynamics of non-proportional premium
Chapter 3
assessment are different.
Consider this
this…
…
Why do you think this is so?
When the reinsurance is placed on an excess of loss basis, this would not be an equitable
manner in which to allocate the premium as the potential distribution of losses would not be
the same.
Example 3.5
A food processing plant is valued at £50m. The insurer seeks facultative excess of loss
reinsurance broken down into three layers:
1st layer £9.5m excess of £500,000.
2nd layer £20m excess of £10m.
3rd layer £20m excess of £30m.
Reinsurers participating on the third layer are liable for an amount equivalent to 40% of
the total value (£20m part of £50m). However, they cannot be exposed to a loss unless it
exceeds £30m.
Experience tells us that there is a considerable difference in relationship between the total
number of claims (the frequency of loss) and the size of claims that occur (the severity
of loss).
Although the example provides a monetary limit equal to 40% of the total value of the risk, it
is unlikely that the actual claims experience affecting this layer will be 40% of the total claims
experience. Only rarely will a loss occur that gives rise to a claim at this level. This reaffirms
the belief that primary placements are much more likely to be affected by claims. The
reinsurance underwriter costing the provision of cover at lower levels of the programme
must account for this fact in their probability of loss calculations. We will use this example of
the food processing plant to discuss further aspects as we go through this chapter.
Research shows that the reinsurer’s claims experience on any one risk decreases Reinsurers of the
significantly as the excess or deductible retained by the reinsured increases. Consequently, top layers of the
programme will be
the amount of the original premium to be paid to excess of loss reinsurers relative to the risk less exposed
they undertake, reduces as the excess or deductible increases and according to whether any to a loss
lower layers exist beneath them. Reinsurers of the top layers of the programme are less
exposed to a loss and, therefore, should expect to receive a lower premium than those on
the bottom layers. We can say that the relationship between the insurer’s deductible and
that part of the total original premium required by the reinsurer is inverse.
The relationship between the sum insured, the premium and the likelihood of loss can be
expressed in graphical terms (see figure 3.2).
Figure 3.2: Relationship between sum insured, premium and

likelihood of loss
100%
% of If the amount of the deductible = A

premium (F) then the % of the premium for reinsurers = B
Chapter 3
income
(D)
(B) 5%
(E) 25% 50% 100%

(C) (A)
Deductible as a %
of the value at risk
Here the percentage of original per risk premium due to reinsurers is represented on the
vertical axis of the graph, with the percentage of the total value of the risk represented on
the horizontal axis. Having selected the deductible required, the premium due to reinsurers
for their exposure can be read from the graph. In our example, a reinsurance with a
deductible of 50% of the sum insured (shown as A in figure 3.2) would require a premium
equivalent to 5% of the original pure risk premium (shown as B).
Question 3.4
Refer again to figure 3.2.
a. If reinsurer C, shown on the horizontal axis, accepts a deductible of 25% of the sum
insured, estimate the premium equivalent of the original premium income, as a
percentage (shown as D on the vertical axis) that it would require for its
participation.
b. Estimate the size of the deductible as a percentage of the sum insured that reinsurer
E (shown on the horizontal axis) is prepared to accept, and the premium equivalent
of the original premium income (shown as F on the vertical axis) as a percentage,
that it would require for its participation.
The shape of the curve in the example must be carefully calibrated, taking into account
many factors such as actual loss frequency and size, construction, EML level, sprinkler
protection, use and occupancy and so on. Should the curve be inaccurately compiled, any
subsequent allocation of premium might be inaccurate and leave some reinsurers with too
much or too little premium.
If the risk is to be reinsured in a number of layers, as in the case of our food processing plant,
then the premium for each layer can be determined by taking the difference between the
premium due for the various levels of deductible. Figure 3.3 explains this in more detail.
Figure 3.3: Premium of each layer

100%
% of If the amount of reinsurance required

premium = the difference between A and X
income then the % of the premium for that exposure
= the difference between B and Y
B
Chapter 3
Y
0% A X 100%
Total value of risk

or reinsurance
We can see that the layer of cover represented by the gap between A and X on the
horizontal axis needs to be funded by a level of premium equivalent to the gap between Y
and B on the vertical axis. To place approximate figures on this assumption, we can say that
the cost of this £10 m (A to X) layer of cover will cost 15% (Y to B) of the total premium.
Although we are using examples that relate to material damage risks, liability classes of
business are also placed on a facultative excess of loss basis and the relationship between
the levels of deductibles and the reinsurance premiums due will be similar.
Bear in mind that our comments may reflect one underwriter’s view of the link between
premium and risk. Others may have different opinions which would affect the shape of the
curves shown in figures 3.2 and 3.3. Nevertheless, the principle remains the same.
Activity
Using the graph in figure 3.3 as a template, draw a right angle, similar to A to B, that
represents a third layer of cover sitting about X. Assess the approximate value of the
cover provided by your layer and the premium attributable to it.
In every case, the underwriters must aim to obtain a premium that is sufficient to cover the Underwriters must
anticipated cost of claims, together with commissions (brokerage) payable to brokers and aim for a premium
that covers the
other intermediaries plus other business acquisition expenses. It may also be prudent to anticipated cost of
make some form of allowance or loading in respect of their own expenses. claims
We have previously suggested that facultative reinsurance business is a useful supplement

to other forms of reinsurance and this is certainly true of facultative excess of loss. Let us
consider how it can be used in tandem with facultative proportional reinsurance to give the
insurer more choice of exposure patterns.
In the case of our food processing plant, the insurer could meet its objective of a maximum
retained amount per claim of £500,000 by combining proportional and excess of loss
protection. For example, the insurer could retain 10% of the original risk and reinsure 90% on
a pro-rata basis. It could then seek to purchase excess of loss protection for, say, 10% of £5m
excess of £5m and 10% of £40m excess of £10m which would provide protection up to a
total loss. The overall effect would be to reduce the company’s maximum net exposure to
£500,000, being 10% of the first layer deductible. Figure 3.4 shows how this would look as a
diagram.
Figure 3.4: Combining proportional and excess of loss protection

retained
£50m
Excess
reinsurance
2nd layer
90% pro rata
reinsurance
Chapter 3
£10m
Excess
reinsurance
1st layer
£5m
£0m
0% 10% 100%
Table 3.1 shows how the loss would be allocated should a loss of £8m occur with the above
reinsurances in place.
Table 3.1: Allocation of loss (£8m)

Proportional £7.2m (90% of £8)
facultative reinsurers
Insurer retains (gross) £800,000 (10% of £8m)
1st layer reinsurers pay £300,000 (10% of £3m)
2nd layer Nil

reinsurers pay
Insurer retains (net) £500,000 (the difference between its gross retention and its excess of loss
recovery)
Table 3.2 shows how the loss would be allocated should a loss of £15m occur with the above
reinsurances in place.
Table 3.2: Allocation of loss (£15m)

Proportional £13.5m (90% of £15m)
facultative reinsurers
Insurer retains (gross) £1.5m (10% of £15m)
1st layer reinsurers pay £500,000 (10% of £5m)
2nd layer £500,000 (10% of £5m)

reinsurers pay
Insurer retains (net) £500,000 (the difference between its gross retention and its excess of loss
recovery)
C Case studies
In this section we have provided two practical case studies that illustrate the way facultative
reinsurance operates.
C1 Proportional facultative with a proportional

reinsurance treaty
An insurance company writing contractor’s all risks and erection all risks (CAR/EAR) has a
Chapter 3
CAR/EAR surplus treaty with a maximum retention of US$1m and a maximum cession limit
to the treaty of US$14m. The insurance company has been asked to insure a new project by
one of its main construction clients. The project is the construction of a new regional airport
and the contract value is US$62m. This is a valuable client and the insurer wants to avoid
allowing other competitor insurers to get involved, so the insurer wants to write this risk
100% and not participate as one of several co insurers.
The insurer’s maximum automatic capacity is US$1m retention plus US$14m that can be
ceded to the treaty, being US$15m in all. The insurer needs proportional facultative
reinsurance for the remaining US$47m in order to be able to write this risk 100%. For
facultative placements, the reinsured’s retention, plus the amount ceded to the treaty, are
usually added to constitute what is called a gross retention. In this case, the gross retention
is US$15m.
The solution is to proceed with a facultative reinsurance placement in accordance with the
following slip. (Note that we provide an outline of the slip only and the actual slip will contain
full details of the project and reference to various clauses.)
Reinsured: Dalkara Insurance Company
Original insured: KKR Constructions
Type: CAR facultative reinsurance, single project
Class: Contractor’s All Risks
Period: 10 January 2019 to 30 November 2023
Project: Construction of new airport near Elbourg City
Contract value: US$62m
Gross retention: 24.19% of whole
Original gross US$280,000

premium:
Commission: 30% on gross
Brokerage: 5% on gross
Order hereon: 75.81% of whole
The original gross premium of US$280,000 is allocated proportionately in line with the
applicable percentages for the placement.
Reinsured: 1m/62m = 1.61% Retained premium: US$ 4,508
Surplus treaty US$14/62m = 22.58% Ceded premium: US$ 63,224

reinsurers:
Facultative US$47/62m = 75.81% Ceded premium: US$212,268

reinsurers:
Totals US$62m = 100% US$280,000
In this example the reinsured is only retaining US$4,508 out of the total gross premium of
US$280,00.
The reinsured will, however, receive ceding commissions from both the surplus treaty and
facultative placement. If we say that ceding commissions are 35% on the surplus treaty and
30% on the facultative placement total commissions would be:
Surplus treaty: 35% × US$ 63,224 = US$22,128
Facultative: 30% × US$212,268 = US$63,680
That would give a total receivable commission of US$85,808.

If we assume that the reinsured has to give 20% commission to the producing agent the
payable commission would be US$56,000 (20% × 280,000).
Chapter 3
The reinsured’s total retained earnings on this risk would be:

Retained premium: US$ 4,508 PLUS
Commission receivable: US$85,808 LESS
Commission payable: US$56,000
Net retained earnings: US$34,316
Loss example under this arrangement

A US$10m loss occurs following an explosion in the main building, which was close to
completion after three years of construction work.
The reinsured pays its retention: US$ 161,000 1.61%
The reinsured then recovers: US$2,258,000 22.58% from the surplus treaty
US$7,581,000 75.81% from the facultative reinsurers
Total US$10,000,000 100%
C2 Facultative excess of loss with an excess of loss

treaty programme
Middlewitch Insurance Company has an excess of loss reinsurance programme, which
protects its general liability account. The reinsurance programme includes coverage for
products liability and covers losses that arise as a result of exports to other countries. A
specific clause, however, excludes all losses arising out of exports to North America.
The liability excess of loss programme has three layers:
• £4,000,000 excess of £1,000,000 any one loss occurrence.
• £5,000,000 excess of £5,000,000.
• £10,000,000 excess of £10,000,000.
The programme therefore provides £20m of ground up cover.
Middlewitch has been asked by one of its main producing brokers to write a combined
public and products liability policy for a specialist manufacturing company that exports to
North America. The required policy limit is £20m.
The excess of loss reinsurance programme has sufficient vertical cover to absorb the £20m
limit for this policy, but full coverage cannot be provided due to the North American
exclusion clause.
Facultative reinsurance is required before Middlewitch can write this policy. A suitable
solution is to obtain facultative excess of loss (XL) for £19m excess of £1m. Due to the size of
the policy the facultative excess of loss would probably need to be split into two layers:
• 9m xs £1m; and
• £10m xs £10m.
Two layers would help with the placement, as most reinsurers would choose to write one
layer or the other. A £19m layer could be too big a stretch for some reinsurers to base their
lines on. The premium for the original policy would be based on the manufacturer’s turnover
and the policy limit. The premium for each facultative excess of loss layer would be based on
the original premium, adjusted to allow for the retention and the limit for the layer in relation
to the total sum insured.
Outline slip for the first facultative XL layer is as follows. (Again the slip is in outline only. The
full slip will contain detailed information and refer to various clauses.)
Reinsured: Middlewitch Insurance Company
Original insured: Bridge Marine Ltd
Business Manufacturers of specialist equipment for maritime transport

description:
Type: Liability facultative excess of loss reinsurance
Chapter 3
Period: Losses occurring during the period 1 February 2019 to 31 January 2020
Class: Public and products liability
Territorial scope: UK, but worldwide in respect of products manufactured in the UK and exported
to other countries
Limits: £9,000,000 any one loss or loss occurrence, excess of £1,000,000
Gross premium: £54,000
Brokerage: 10%
Order hereon: 100%
Ceding commissions are not usually payable on facultative excess of loss placements and
deductions from the premium would generally be for brokerage only.
Different insurers and reinsurers use different pricing models. The following is by way of
example only.
If we take the 100% original premium to be £150,000 and the cost of the two facultative
excess of loss layers combined to be £74,000, Middlewitch’s retained premium is £80,000.
Retained earnings on this risk would be £80,000 less, say, £26,250 commission to the
producing broker (17.50% of £150,000), which equals £ 53,750.
Key points
Main types and operation of facultative reinsurance
• It is important to establish exactly the coverage under both the original insurance policy and the
facultative reinsurance policy since the latter is usually designed to follow the terms, conditions and
exclusions of the original insurance policy on a ‘back to back’ basis.
• ‘As original’ terms under facultative reinsurance could cover all aspects of the original policy and
can lead to disputes between insurers and reinsurers if all terms and conditions, including
Chapter 3
exclusions and warranties, are not clearly defined and understood at the time of the facultative
placement.
Facultative proportional reinsurance
• Facultative proportional reinsurance allows the insurer to pass on a fixed share of a risk by ceding
to one or more reinsurers. The ceding insurer pays a share of the premium less commission and in
return recovers the same share of the original claim from the reinsurer in the event of a loss.
• The premium for the risk is shared between the parties concerned in the same proportion as the
liability, so if a reinsurer assumes 50% of the liability, it will receive 50% of the premium and pay
50% of claims up to the policy limit.
Facultative obligatory reinsurance
• Facultative obligatory reinsurance combines some of the features of both facultative and treaty
methods of reinsurance.
Facultative non-proportional reinsurance
• Facultative non-proportional reinsurance is otherwise known as facultative excess of loss

reinsurance.
• The ceding insurer chooses a fixed monetary amount, otherwise known as the excess or deductible,
to retain on a particular risk and arranges facultative excess of loss reinsurance to pay any claim
amounts exceeding that fixed monetary amount up to a further defined monetary amount which
serves as the limit of cover.
• The ceding insurer may also decide to buy ‘common account’ protection if it wants to protect the
cession made to its proportional treaty reinsurers too. This benefits both the reinsured and its
proportional treaty reinsurers to the full sum insured potential of the original risk, so long as the
limit of the reinsurance is sufficient.
• Captive insurance companies purchase facultative excess of loss reinsurance as a means of
achieving acceptable levels of exposure.
• Facultative excess of loss reinsurance allows the ceding insurer to retain more of the original
premium income compared to facultative proportional reinsurance.
• Facultative excess of loss reinsurance is suitable when:
– additional capacity is required to handle risks exceeding existing treaty limits; or
– no automatic cover is currently in existence for the particular class of business concerned; or
– the ceding insurer does not want to expose its treaties to certain risks; or
– certain risks are specifically excluded by the treaty reinsurers.
• EML is important in determining the premium and deciding how much of the risk to accept and
retain.
Calculation of reinsurance premiums and claims recoveries
• The reinsurance premium is the price of the cover charged by the reinsurer in consideration for
offering to underwrite the risk.
• Premiums for facultative excess of loss reinsurance are not proportional to values at risk because
the potential distribution of losses is unlike that found under facultative proportional reinsurance.
Question answers
3.1 Any recoveries might protect the proportional treaty against hazardous risks and
ensure that in the long-term the price for renewal of the treaty would more likely be
lower. The improved pricing would be implemented by enhanced ceding commission
or profit commission payable under the proportional treaty.
3.2 The insured recovers its valid claim of £7m. The facultative excess of loss reinsurer
pays the full limit of £3m. Insurer C bears the £3m retention plus the unreinsured £1m.
C could have bought a further layer for an amount in excess of £6m to pay for any
Chapter 3
failure in the EML calculation.
3.3 The calculation of the gross premium due to R is as follows: £50m @ 2‰ (per mille) =
£100,000 for 100%. R’s 10% share is £10,000.
3.4 a. 25% of premium income needed.
b. Reinsurer E is prepared to accept a deductible of 12.5% and will require 50% of
the original premium income for its participation.
Self-test questions
1. What is meant by the term ‘as original’ under a facultative placement?
2. What do we mean by ‘common account’ protection?
3. Why would an insurer decide to insure on a facultative excess of loss basis?
4. What is EML?
5. State three factors that might influence the insurer’s retention on a facultative
placement.
Chapter 3
6. In what way is the relationship between the insurer’s deductible and that part of the
total original premium required by the reinsurer ‘inverse’?

Features and operation
4
of proportional
Chapter 4
outcomes
Learning objectives
Introduction
Key terms
A Main features and operation of proportional reinsurance 4.1
treaties
B Main accounting methods 4.2
C Commissions and deductions 4.3
D Premiums and claims reserves 4.4
E Calculation of reinsurance premiums and claims recoveries 4.5
F Cession and event limits 4.6
G Case studies 4.1
Key points
Question answers
Self-test questions
Learning objectives
• explain the operation of the main types of proportional treaties;
• discuss alternative bases of cover;
• calculate earned and unearned premiums and claims recoveries;
• explain the main methods of accounting;
• describe the various types of commission arrangements including loss participation
clauses;
• distinguish between premium and claims reserves; and
• explain the use of cession and event limits.
Introduction
Non-proportional A reinsurance treaty is a method of reinsurance whereby the insurer and reinsurer enter into
treaties will be
examined in an agreement for the former to cede, and the latter to accept, all insurances offered within
chapter 5 the limits of the treaty. This means that automatic acceptance is secured and there is an
obligation for the reinsurer to accept all risks within the scope of the treaty. The insurer can,
therefore, grant cover immediately for any proposal accepted within the limits of the treaty.
In this chapter we look at the characteristics of proportional treaties and the ways in which
they operate. Again, at the end of this chapter we have provided case studies to illustrate
the practical application of proportional reinsurance treaties.
Key terms
Capacity Cession limit Claims reserve Clean cut accounting

Chapter 4
Commission Event limit Exposure Facultative carve-out
Loss participation Net retention Portfolio transfer Premium reserve
Proportional Quota share treaty Sliding scale Surplus treaty

reinsurance treaty
Underwriting year
accounting
A Main features and operation of

proportional reinsurance treaties
Two main types of
There are two main types of proportional reinsurance treaty
treaty:
proportional
reinsurance treaty • the first results in the sharing of all risks between the insurer and the reinsurers and is
known as a quota share treaty
treaty; and
• the second enables the insurer to retain the smaller risks while sharing proportionately the
larger risks and is known as a surplus treaty
treaty.
We will also make some reference to facultative obligatory treaties in this chapter.
Learning point
Make sure you are clear on this key difference between a quota share treaty and a surplus
treaty.
A1 Quota share treaties

A quota share treaty is an obligatory treaty where the insurer has to cede a fixed percentage
of all its risks within agreed parameters. The reinsurer is then obliged to accept all the
cessions made, usually subject to a maximum amount in any one cession.
A1A Operation of quota share treaties

To help us understand how quota share treaties operation, we are going to use the example
of an insurer’s taxicab account. The details of the reinsurance in this example are that the:
• insurer retains 40% of all business written for its own account under its taxicab account;
• reinsurer agrees to accept a 60% share of all business written under the insurer’s taxicab
account; and
• reinsurer agrees that the insurer should have the benefit of a 12% ceding commission to
cover the costs of acquiring and managing the original business
The detail is shown in table 4.1.
Chapter 4 Features and operation of proportional reinsurance treaties 4/3
Table 4.1: Quota share treaty

Name of risk Amount of Reinsurer
Reinsurer’’s share Ceding Insurer’’s share†
Insurer
premium (net premium*) commission
Dodgy Cabs £1,000,000 £528,000 £72,000 £472,000
Ace Minicabs £500,000 £264,000 £36,000 £236,000
Pick-em-up £2,500,000 £1,320,000 £180,000 £1,180,000
Pubshut Cabs £1,500,000 £792,000 £108,000 £708,000

*
net premium = gross premium ceded less ceding commission. †retained net premium plus ceding
commission.
The ceding commission of 12% is deducted by the reinsurers and given back to the insurance
company. So, for Ace Minicabs, for example, reinsurers would originally get £300,000 (60%
of the premium) and they would then return 12% (£36,000) of this to the insurers as ceding
Chapter 4
commission.
Figure 4.1: Amount of premium

Amount of £2,500,000
premium
Insurers’s share
£2,000,000 Reinsurer’s share
Ceding commission
£1,500,000
£1,000,000
£500,000
£0
Dodgy Ace Pick-em-up Pubshut
Taxicab firms
If the losses shown in table 4.2 occurred, the reinsurer would pay its share of each loss.
Table 4.2: Share of each loss

Cab firm Date of loss Amount of Insurer
Insurer’’s share, £ Reinsurer
Reinsurer’’s
claim, £ share, £
Dodgy Cabs 12/02/2018 20,000 8,000 12,000
17/02/2018 120,000 48,000 72,000
26/06/2018 10,000 4,000 6,000
24/10/2018 2,500,000 1,000,000 1,500,000
Pick-em-up 27/07/2018 3,000,000 1,200,000 1,800,000
Pubshut Cabs 18/06/2018 150,000 60,000 90,000
24/12/2018 70,000 28,000 42,000
Total 5,870,000 2,348,000 3,522,000

Reinsurer takes its

As we can see in table 4.2, the reinsurer takes its share of the total amount of each loss, i.e.
share of the total 60%. The ceding commission is not considered when looking at the claims, merely the
amount of
each loss
respective shares, or proportion, as agreed by the insurer and reinsurer at the beginning of
the contract.
The treaty limit would usually be expressed as:
Maximum limit any one risk £3m for 100%. Reinsured’s retention 40%.
The £3m is an underwriting limit, and the scope of the treaty is for all risks written by the
reinsured for the agreed class with original sums insured of up to £3m. If the reinsured writes
a risk with a sum insured above £3m, that risk would be outside the scope of the treaty and
would be excluded. The exception would be if there is an agreement with the reinsurer for
the 100% treaty limit to apply after any proportional facultative reinsurance.
When written by the reinsurance company, this contract might be expressed as a 60% quota
share of all business written in the motor department under its taxicab account, subject to a
maximum cession any one risk of £3m.
Chapter 4
Be aware
It is important to realise that reference to 60%, or any other percentage when describing a
quota share treaty, refers to the percentage ceded, and not the percentage retained by
the insurer.
This would allow both the insurance company and reinsurance company to understand the
parameters within which the reinsurance was written. The risks reinsured would be written
under the taxicab account, so that all risks written under that account would be ceded
through to the reinsurance. Risks written in the general motor account would not be
included and the maximum risk accepted under the account would be £3m, limiting the size
of risk that could be ceded (to 60% of £3m). Any risks in excess of this size would have to be
reinsured by some other method, most likely a facultative arrangement.
States the
This type of treaty states the maximum that can be ceded in relation to any one risk. In the
maximum which case of incidents involving a recognisable and identifiable event, such as a hurricane, the
can be ceded
in relation to any
reinsurer will have to pay the stated proportion of claims for every risk, the total cost of
one risk which could be enormous. Therefore, it is common for quota share reinsurers to incorporate
an event limit in the contract. This puts a cap on the liability of the reinsurer for such single
incidents, irrespective of the total number of losses that would otherwise fall to the treaty.
Refer to section F A cession limit may also be incorporated instead of, or in addition to, an event limit. This
for cession and
event limits imposes a maximum limit that can be ceded in respect of specified types of risk. It is
intended to restrict the reinsurer’s liabilities, as opposed to its losses, in respect of a
particular geographical location.
A1B Use of quota share treaties

The use of quota share treaties is particularly appropriate in the following circumstances:
• A newly formed company needs a sufficiently large per risk capacity to enable it to attract
business, particularly in a market that has an excess of existing capacity. However, it may
not have the capital base to support the size of acceptances required, nor the experience
or reputation to develop a presence in an established market. A quota share treaty will
provide operating capacity while enabling the insurer to fix its net retention at a level that
matches its capital base. The reinsurer would prefer a quota share arrangement with
greater opportunity to participate in the underwriting of each policy and to obtain an
understanding of how the new business would be handled. The reinsurer can also benefit
from diversification in its own inward portfolio by accepting business in a class in which it
does not have expertise: it can be more cost-effective for the reinsurer to avail itself of the
other insurer’s expertise than to buy in or set up its own underwriting team. As the
company grows, the percentage of the insurer’s retention can be increased, which allows
a certain amount of expansion within existing arrangements. This also provides continuity
in its reinsurance security, which is important, particularly in the first few years of a
company’s development.
• Where the risks are homogeneous, or similar, and have relatively uniform sums insured (as
might be found in a household account), quota share treaties are useful where volumes
are high, as the administration of the reinsurance is relatively simple and cost-effective
when compared to other types. This is especially true if the type of business is written via
a number of small branch offices or agents. The ease of operation of this type of
reinsurance, again, may make quota share arrangements attractive to new or small
companies with staff of limited experience administering their reinsurance programmes.
Question 4.1
An insurer wishes to cede a large number of bloodstock and home contents risks, all
having a sum insured of £50,000. Are these risks collectively homogeneous?
• In general, quota share treaties carry the highest percentages of ceding commission
compared with other types of proportional reinsurance arrangements. This can provide a
welcome addition to the cash flow of an insurer and may be a factor that influences their
Chapter 4
choice of reinsurance method.
• A company may wish to expand its portfolio of inwards reinsurance business, but this may
only be achievable by giving some of its own business away through reciprocal
exchanges. Quota share treaties provide an efficient method of arranging such transfers.
Example 4.1
A Dutch reinsurer agrees a reciprocal 15% quota share exchange with a reinsurer writing
similar private motor risks in Indonesia. While matching profitability is more important
than duplicating lines of business, the arrangement described is deemed to be a suitable
basis for each insurer to develop its book of inwards reinsurance business.
• An established insurer, together with its reinsurers, may have experienced a period or
series of poor results under other less all-embracing reinsurance arrangements. As a
temporary expedient, a sign of good faith and to seek to maintain its reinsurance capacity,
a quota share treaty may be arranged to restore the balance. With this type of reinsurance
there can be no selection of the risks ceded to reinsurers. Therefore, if the original account
is profitable this may be a preferred method of retaining the support of reinsurers.
• With a large insurance group operating on a worldwide basis, the ‘sharing’ of business by
subsidiary companies within the group organisation can be a way of diluting the effects of
losses in any one part of the organisation, without losing the overall benefits of the
premium income from the business concerned.
• It is often overlooked that the sharing of each and every risk on a proportional basis
provides an insurer with a certain amount of natural perils or catastrophe reinsurance
capacity.
Be aware
For a property account, a quota share treaty may be used to provide specific protection,
such as earthquake, particularly in areas where the incidence of such losses is potentially
high. Such arrangements may be placed with reinsurers as a package in conjunction with
other pure fire treaties. This provides a better spread of risk for both the insurer and
reinsurer, and reduces the amount of pure catastrophe protection required.
• Where the company is in need of financial assistance to cover the costs associated with
an increase in volumes of business written. Such costs would include boosting reserves
for unexpired risks. Consider the case of an insurer that has launched a new insurance
offering directors’ and officers’ cover. It is proving extremely successful and the capital
backing allocated for it is quickly becoming exhausted. The insurer could allocate more
capital, but that would take capital away from other areas of the company. However, if
they added, say, a 40% quota share, this would allow them to write an equivalent amount
of additional business using the same existing capital base.
• Insurers are encouraged to create small quota share reinsurance treaties in which the
reinsurer can participate, particularly if it writes the insurer’s surplus reinsurance treaties.
In this way, reinsurers receive a more balanced book of business, but this dilutes the net
retention of the insurer. Usually, this approach is used when an insurer has had a bad set
of accounts in a particular area, which cannot be corrected immediately without affecting
its ongoing client relationships.
• To reduce net retained income in order to improve or protect solvency requirements.
• Quota share could be used to protect accounts with moderate sums insured that are
subject to abrupt variations in the loss ratio from one year to the next, such as agricultural
crops damaged by hail, to even out the occasional adverse result.
• There may be elements within the account to be reinsured that have a greater level of risk
than the remaining lines and do not appeal to the risk appetite of the quota share
reinsurer. In this case a facultative carve-out may be appropriate. A loose definition of
such an arrangement is that there is an exception to a general rule, leading to severance
of one part of a unit leading to a parallel or secondary agreement based upon a primary
Chapter 4
agreement.
Example 4.2
Reinsurer M is keen to participate in the quota share arrangement proposed by insurer L.
However, reinsurer M is concerned that specific parts of the account to be reinsured
contains heavy catastrophe exposed risks. As this part of the account requires separate
consideration, rating it is carved-out of the main account and facultative terms applied.
Question 4.2
We have stated that quota share treaties carry the highest percentages of ceding
commission. Why is this?
A1C Advantages and disadvantages of quota share treaties

Advantages
The advantages of quota share treaties are:
• The relationship between insurer and reinsurer is absolute – in such a context the reinsurer
follows the fortunes of the insurer almost identically.
• The accounting and reporting of business is simple.
• No up-front costs: deposit premiums are not payable, as they are on non-proportional
treaties. Balances are settled after submission of quarterly accounts, usually within 60 or
90 days of the close of each quarter.
• Flexibility exists in increasing or decreasing the amount of quota share ceded at each
anniversary.
• There is no limit to the number of individual loss recoveries.
• Unlimited cover is generally provided for aggregation of risk losses in a single loss event.
Disadvantages
The disadvantages of quota share treaties are:
• Since a quota share involves the cession of all business within the retention pattern, large
amounts of income are ceded away. If the class of business is a profitable one for the
insurer, this could be to its detriment.
• A quota share treaty is inflexible. The insurer cannot choose to vary its retention risk by
risk and select an amount below which it would retain the risk.
• If the risk does not fall entirely within the scope or capacity of the treaty arrangements,
the insurer must resort to the facultative method of reinsurance or retain the risk net.
• Where a risk falls within the scope of the treaty arrangements, the company is bound by
the treaty terms. The insurer cannot alter the retention or its underwriting practice where
these details form an integral part of the treaty. It cannot deal with the risk in any other
fashion; for example, it cannot make a new relationship with a different reinsurer unless
there is an agreement in the treaty that further reinsurance can be sought and used for the
benefit of the insured.
• The reinsurer has limited or no input into the underwriting practices of the insurer, yet is
still required to share in the outcome of the underwriting result.
• A quota share treaty protection by itself still leaves an insurer vulnerable to natural
catastrophe losses.
Example 4.3
Take for example a windstorm loss: an insurance company with a 40% quota share will
reduce its overall loss exposure by 40% but if 1,000 houses suffer an average of £10,000
damage the company will still face a net loss in the region of £6m.
Learning point
Before you move on to surplus treaties, make sure you are clear about the operation and
use of quota share treaties.
Chapter 4
A2 Surplus treaties
As we have seen, one disadvantage of a quota share reinsurance arrangement is that the
insurer has to cede a proportion of all risks to the reinsurer, no matter how small. For
example, an insurer might want to retain all risks under £70,000 in its household account,
believing that the cumulative risk is not so substantial compared to the premium cost. Since
a quota share does not allow an insurer this option, it would be interested in a type of
reinsurance where it would be allowed to cede only those risks that are surplus to its
retention. This is possible under a surplus treaty.
The insurer would agree to retain for its own account those amounts indicated in a table of
limits which attaches to and forms an integral part of the treaty. To help us understand how
surplus treaties work we will follow the example of insurer XYZ which reinsures its
commercial property account under a surplus treaty. Under the surplus treaty XYZ retains
the following amounts:
Factories £150,000
Warehouses £200,000
Retail Outlets £350,000
Offices £500,000
Miscellaneous £400,000
This means that, until a sum insured exceeds the retention in a category, no risk is ceded to Capacity of a
the reinsurance. The capacity of a surplus treaty is always a multiple of the insurer’s surplus treaty is a
multiple of the
retention and is referred to as a line
line. A line describes the monetary amount of the insurance insurer’s retention
company’s gross retention taken on an original risk.
Surplus treaties are usually a specified multiple of that gross retention, resulting in surplus
capacity being described as:
x lines of y maximum gross retention
Take, for example, a ten-line first surplus treaty, subject to a maximum cession of £5m on
any one risk. One line is a maximum of £500,000, thereby giving the insurer a maximum
gross capacity of £5.5m on the best risks (i.e. retention £0.5m plus cession to surplus
of £5m).
There are also cases where surplus capacity is constructed on the insurer’s net retention, or
gross retention after quota share cession, but we shall concentrate on surplus capacity
geared to a gross retention. If the reinsurance treaty in our commercial property example
were a ten-line surplus treaty, the maximum coverage under the reinsurance would be as
shown in table 4.3.
Table 4.3: Maximum coverage under the treaty

Retention Ten-line surplus limit
Factories £150,000 £1,500,000
Warehouses £200,000 £2,000,000
Retail outlets £350,000 £3,500,000
Offices £500,000 £5,000,000
Miscellaneous £400,000 £4,000,000
Be aware
Further lines could be added beyond the ‘first’ surplus treaty to become a ‘second’
surplus.
Chapter 4
A2A Operation of surplus treaties

The mechanics of ceding a risk under a surplus treaty do not differ from those of an
individual facultative proportional cession. However, there are substantial differences in the
creation of any surplus treaty. Again, let us use an example to illustrate this. Here we
consider EFG insurer, which has a four-line surplus treaty, giving the insurer an automatic
underwriting capacity of £5m (£1m own gross retention plus £4m, comprising four surplus
lines each of £1m).
The insurer has accepted five risks, all of first-class construction. If the insurer decided to
retain its maximum gross retention then the risks would be apportioned to the surplus treaty
as shown in table 4.4.
Table 4.4: Risks apportioned to treaty

Risk Original sum insured Company retains Cedes to surplus %
1 1,000,000 1,000,000 (100%) Nil
2 2,500,000 1,000,000 (40%) 1,500,000 (60%)
3 3,200,000 1,000,000 (31.25%) 2,200,000 (68.75%)
4 4,000,000 1,000,000 (25%) 3,000,000 (75%)
5 5,000,000 1,000,000 (20%) 4,000,000 (80%)
The information in table 4.4 is expressed graphically in figure 4.2.

Figure 4.2: Surplus reinsurance risk allocation
Original 6,000,000 Reinsurer’s share

sum insured
Insurer retention
5,000,000
4,000,000
3,000,000
2,000,000
Chapter 4
1,000,000
0
1 2 3 4 5
Risk
If a claim of £500,000 occurred, the insurer and reinsurers would share the loss
proportionately to the risk they undertook, as illustrated in table 4.5.
Table 4.5: Share of loss

Claim Original sum Company Cedes to surplus % Claim recovery from
insured retains % surplus reinsurers
500,000 1,000,000 (100%) Nil Nil
500,000 2,500,000 (40%) (60%) 300,000 (60%)
500,000 3,200,000 (31.25%) (68.75%) 343,750 (68.75%)
500,000 4,000,000 (25%) (75%) 375,000 (75%)
500,000 5,000,000 (20%) (80%) 400,000 (80%)

Figure 4.3: Allocation of claims under surplus

Company retains
Claim to surplus
Amount £500,000
of claim
£400,000
£300,000
£200,000
Chapter 4
£100,000
£0
1 2 3 4 5
Risk
Insurer is obliged
Once the terms and conditions of a surplus treaty have been finalised, the insurer is obliged
to cede all risks to cede all risks greater than its chosen retention and falling within the scope of the treaty
greater than its
chosen retention
agreement. The reinsurer is obliged to accept all such cessions. Both contracting parties, the
insurer and reinsurer, have identified obligations under the treaty and are automatically
bound in advance to transact business in the manner specified, with no freedom of choice
available to either party.
Be aware
Unlike individual facultative cessions, which have to be specifically agreed between the
parties, a cession to a proportional treaty takes immediate effect.
When this surplus treaty is written by a reinsurance company, it might be expressed in the
wording as:
a four-line surplus treaty of all business written by the property department, subject
to a maximum cession of £4m and a retention of £1m.
This shows both the insurer and reinsurer that all risks written by the property department
exceeding £1m are automatically ceded to the surplus treaty up to the limit (£4 m). Any
amount of risk exceeding £5m in total would have to be reinsured elsewhere or retained by
the insurer.
A2B Second, third and fourth surplus treaties

In addition to a first surplus treaty, there may be second, third, fourth or more surplus
treaties rising in ascending order. The fundamental point to remember is that a risk must be
ceded through each treaty in turn; namely that the capacity of the first surplus must be
exhausted in priority to the second surplus, then the second surplus in priority to the third
surplus and so on.
Example 4.4
Let us assume a four-line first surplus treaty, giving the insurance company automatic
underwriting capacity of £5m (£1m own gross retention plus £4m, comprising four surplus
lines each of £1m) plus a five-line second surplus treaty, increasing the overall automatic
underwriting capacity to £10m.
The insurer has accepted five larger risks, all of first-class construction. If the insurance
company decides to retain its maximum gross retention and cede its maximum capacity
to the first surplus and any balance to the second surplus, the risks would be apportioned
as follows.
Risk Original sum Company retains – Cedes to first Cedes to second

insured first surplus surplus surplus
1 5,000,000 1,000,000 4,000,000 Nil
2 5,500,000 1,000,000 4,000,000 500,000
Chapter 4
3 7,500,000 1,000,000 4,000,000 2,500,000
4 9,600,000 1,000,000 4,000,000 4,600,000
5 10,000,000 1,000,000 4,000,000 5,000,000
As can be seen from this example, the reinsurer receives an amount of premium
proportionate to the risk that it runs, and pays any losses that occur in the same proportion.
The second surplus treaty in this example would be written as:
a five-line second surplus treaty of all business written in the property department
subject to a maximum cession any risk of £5m.
It will be apparent that the whole of the insurer’s retention falls under the first surplus treaty
and that there is no further retention for the insurer under the second surplus.
A2C Use of surplus treaties

Where the portfolio of risks written by an insurer consists of risks of similar size and quality,
the concept of ‘giving away’ the same fixed proportion of each and every sum insured and
premium may be perfectly acceptable to the insurer and its reinsurers. This is particularly
true when considering any of the other financial or business reasons that promote the use of
quota share arrangements.
A portfolio of risks often contains a mixture of large, medium and small risks. In addition, the A portfolio often
quality of the risks varies from the very good to poor, all of which need insuring. This is contains large,
medium and
particularly relevant with a property book of business, but also applies in varying degrees to small risks
other accounts providing physical damage coverage to original insureds. For example, a
second surplus will accept the larger, target risks and as such will have fewer cessions made
to it. This means that there will be fewer premiums available to build a common pool from
which to pay claims. Consequently, such treaties may be vulnerable to considerable
fluctuations in results.
When arranging and ceding business to these arrangements, care should be taken to ensure
that there is a balance between the available premium income and the assumed liability. This
avoids exposing the reinsurer to unacceptable levels of risk, which could affect the future
availability of reinsurance cover when it’s needed the most.
When an insurer looks to create the required capacity to promote and expand its business, a
first and perhaps a second surplus is generally deemed sufficient. However, it may be that in
a certain territory there is limited development of insurance, but a significant number of
large or target risks. In such instances, third and possibly fourth surplus treaties may be
found. The allocation of liability, premiums and claims would follow the same principles.
The use of surplus treaties can provide an insurer with the capacity to write larger risks Surplus treaties
without having to increase its retained liability beyond an acceptable level. They also give enable an insurer
to establish a
the insurer the ability to retain more of its premium income for the smaller, and possibly consistent retained
better, risks that fall within its acceptable financial parameters. Surplus treaties enable an portfolio
insurer to establish and maintain a more consistent retained portfolio of business.
However, surplus treaties are significantly more complicated to administer than quota share
treaties because the proportion ceded varies from risk to risk. Additionally, there is always
the possibility that they will attract a higher than usual proportion of the larger or more
hazardous risks. This makes them difficult to arrange if the balance between the premium
income available and the maximum liability to be assumed is not adequate or reasonable.
In obligatory surplus treaties the insurer, having exhausted its retention, is obliged to feed
the different covers successively. Nevertheless, the insurer retains the right to proceed
selectively by the terms of the treaty wording in order to protect the treaties. For example,
in the case of particularly large risks, the insurer would only use a part of its surplus capacity
or would reinsure all of the risk facultatively.
Example 4.5
Let us consider a simple reinsurance programme which combines a proportional surplus
treaty where facultative proportional reinsurance is required.
The insurer has fixed its retention at £10m and has placed a proportional surplus treaty
Chapter 4
with five lines. It writes a risk with an exposure of £100m and requires facultative capacity
of £40m.
Purely proportional reinsurance allocates the premium and the claims generated by the
risk as follows:
Retention: £10m = 10%
Surplus treaty: £50m = 50%
Facultative reinsurance: £40m = 40%
The effect of facultative proportional reinsurance in the event of a loss is as follows.
100% loss Surplus (w/o Treaty retention Facultative Overall retention

retention) proportional
10.000 5.000 1.000 4.000 1.000
20.000 10.000 2.000 8.000 2.000
30.000 15.000 3.000 12.000 3.000
40.000 20.000 4.000 16.000 4.000
50.000 25.000 5.000 20.000 5.000
60.000 30.000 6.000 24.000 6.000
70.000 35.000 7.000 28.000 7.000
80.000 40.000 8.000 32.000 8.000
90.000 45.000 9.000 36.000 9.000
100.000 50.000 10.000 40.000 10.000
Amount of loss
(1000)
We can express the information in example 4.5 graphically, as shown in figure 4.4.
Figure 4.4: Loss distribution with surplus treaty and facultative

proportional reinsurance
Surplus treaty
Retention 10m
Five lines 50m
Exposure 100m
Distribution of Fac.surplus
liability (1000)
reinsured proportionally 40m =40%
100.000
90.000
80.000
Chapter 4
70.000
60.000 Facultative reinsurance

Treaty retention
50.000
40.000
30.000
20.000
Surplus
10.000
10.000 20.000 30.000 40.000 50.000 60.000 70.000 80.000 90.000 100.000
Amount of loss (1000)
A2D Advantages and disadvantages of surplus treaties

Advantages
The advantages of surplus treaties are:
• A surplus treaty allows the insurer to vary its retention depending on the type of risk and
level of hazard.
• There is automatic capacity available upon a particular class and size of risk providing that
such cession falls within the treaty conditions.
• The insurer is allowed to retain a greater proportion of its overall premium income. This
aspect would be diluted if the insurer chose to take out quota share reinsurance on all, or
selected parts, of its account.
• No up-front costs or deposit premiums payable. Balances are settled after submitting the
treaty accounts.
• The insurer receives a ceding commission, usually sufficient to pay the acquisition costs
and expenses, together with an additional contribution to reward underwriting profit.
• There is no limit to the number of individual loss recoveries that can be made from the
treaty.
• Unlimited cover is generally provided for aggregation of risk losses in a single loss event.
Disadvantages
The disadvantages of surplus treaties are:
• The insurer stands or falls by its chosen retention, so this is a fundamentally important
calculation for the insurer.
• Retained premium, whilst higher than it would be with a quota share treaty, would still be
lower than what the insurer would retain if the same account was covered by a
non-proportional programme.
• Administration work and supporting IT systems are needed. The apportionment on each
risk has to be calculated then all compiled for the treaty accounts.
• Comparison of results between the insurer’s net results and those of its surplus reinsurers
might be different. Imagine a situation where in years when the insurer’s gross loss ratio is
low, the net loss ratio after surplus cessions is high. Whichever way the results fall might
influence the original construction between the insurer’s net and gross accounts and the
benefit which the insurer should obtain from such arrangements.
Chapter 4
Consider this
this…
…
By selecting which risks it is reinsuring to its surplus treaty according to a pre-agreed
table of limits the insurer could, unwittingly or otherwise, only reinsure those risks most
vulnerable to losses. Think how this would exacerbate the difference between its
experience and that of its reinsurer(s).
If the risk does not fall within the scope or capacity of the treaty arrangements, the insurer
must still resort to the facultative method of reinsurance or retain the risk net.
• As with a quota share, where a risk falls within the scope of the treaty arrangements, the
company is bound by the treaty terms. The insurer has to fix its retention in accordance
with its table of limits or its underwriting practice and cede the risk to the reinsurer. It
cannot deal with the risk in any other way, for example, by making a new relationship with
a different reinsurer, unless there is an agreement in the treaty that further reinsurance
can be sought and used for the benefit of the reinsured.
• From the reinsurer’s point of view, the surplus treaty can result both in a widely
fluctuating loss experience and less desirable business, particularly in periods of intense
competition. On the other hand, lower rated or more hazardous business may be available
in larger quantities and passed on to the surplus treaty.
• The ceding commission is usually lower than if the treaty were a quota share. Also,
second, third and fourth surplus treaties have lower ceding commissions than first surplus.
• Surplus treaties generally provide useful protection in the event of natural catastrophes,
but still leave the insurer with aggregate exposures in its net account.
Learning point
Before you move on, make a note of some of the key differences between quota share
treaties and surplus treaties.
A3 Facultative obligatory treaties

Refer to Facultative obligatory reinsurance is a form of treaty for the placing of a number of
chapter 3,
section A2 individual cessions. You may recognise the commonly used abbreviation of ‘fac/oblig’. This
type of treaty combines some of the principles of both facultative and treaty methods of
Facultative
obligatory
proportional reinsurance.
reinsurance is for
placing a number As with all treaties, the contract is made in advance but once the treaty is in place the insurer
of individual has the option whether or not to cede a risk to it. The obligatory element falls upon the
cessions
reinsurer, which must accept such cessions once the insurer has decided to cede a risk. In
summary, the insurer may cede risks of a specified agreed class, which the reinsurer must
accept if ceded.
The reinsuring clause in a facultative obligatory contract wording can look like this:
The Company has the option to cede to the Reinsurer and the Reinsurer hereby
agrees to accept obligatorily by way of reinsurance, up to the limit of lines and the
maximum amount set out in the Schedule, a share of insurances underwritten direct
by the Company, or accepted in coinsurance or by way of facultative reinsurance
from local companies, in the lines of business covered at the terms and conditions
and within the territorial scope set out in the Schedule.
Such arrangements provide considerable flexibility to the insurer and you can see that a high
degree of trust must exist between the parties, so that the reinsurer receives a reasonable
spread of risks.
A3A Operation of facultative obligatory treaties

The capacity provided by a facultative obligatory treaty can, like a surplus treaty, be
expressed as a multiple of the reinsured’s gross retention, that is, its line, or the part it retains
Chapter 4
for its own account. Often, however, it is simply a monetary limit, so this type of treaty can
be described as lined or unlined.
As with other types of proportional treaties, once a risk has been ceded, premiums and
claims are allocated in the same proportion that the original liability was apportioned. We
have already seen that there is no obligation to cede business on the part of the reinsured,
and so risks attaching to such an agreement are likely to be fewer and larger than those
ceded to the surplus treaty. Consequently, they are more likely to produce an unbalanced
portfolio for reinsurers.
Consider this
this…
…
Why do you think reinsurers are likely to allow lower rates of commission for facultative
obligatory than surplus business?
A3B Use of facultative obligatory treaties

A facultative obligatory treaty may be needed purely to provide additional capacity to allow May be needed to
for the expansion and development of an existing account. It may also be used to allow an provide additional
capacity
insurer to maintain sufficiently high acceptance limits on large or target risks, or where it is
perceived that an accumulation of risk problems may arise. Alternatively, it may be used to
protect certain specific types, or categories, of risks where the insurer deems it prudent to
limit its own retention, due to the degree of hazard associated with the original business. For
example, an insurer has automatic capacity to accept risks up to £100m. This is sufficient to
enable it to write the risks that it is usually offered. In favourable market conditions, the
insurer sees opportunities to write more business on a selected number of larger risks, but it
needs more gross capacity if it is to be able to take them on. In order to offer its clients the
capacity they seek, the insurer may choose to establish a facultative obligatory treaty.
A3C Advantages and disadvantages of facultative obligatory

treaties
Advantages
These arrangements are useful for risks that have already been allocated to existing quota
share and surplus treaties, but where additional capacity is needed without the expense and
uncertainty of the single risk facultative method being used. They represent a further source
of additional cover for the insurer, once other options have been exhausted.
Disadvantages
The obligatory element falls upon the reinsurer, which must accept such cessions once the
insurer has decided to cede a risk. These treaties tend to generate small income for large
capacity, and so are not always popular with reinsurers. This is not simply because results
can often be poor, but also because small premiums relative to high exposures mean that a
single claim may have a significant impact upon profitability.
It follows that in market conditions that favour reinsurers, these arrangements tend to be in
short supply and, where provided at all, offer commission rates and associated terms which
are of no great advantage to insurers. They present a less attractive rate of commission to
the reinsured due to the level of anti-selection present.
Activity
Obtain placing slips or contract documents for two or three fac/oblig treaties, either
for an actual placement or a specimen text. Note whether the treaty limit is expressed on
a lined or an unlined basis and compare it with the underlying surplus treaty or treaties.
B Main accounting methods

This section looks at common ways in which the transactions under a proportional treaty are
accounted by the reinsured to the reinsurer.
Reinsured provides
In this type of business the reinsured provides an account at stated intervals, generally
an account at quarterly but sometimes half-yearly. This sets out the remittance due to, and by, the
stated intervals
reinsurer for the activity during each period. In essence, the reinsurer is credited with the
premiums ceded and is debited with the commission allowed under the treaty, any taxes and
charges for which it is liable, together with the losses paid. Other items, such as premium and
Chapter 4
loss reserve deposit movements, and any portfolio transfers are also credited or debited,
and a balance is struck for the period. After the statement of account has been rendered and
agreed, payment is made by the debtor, who could be the reinsured or the reinsurer, to
settle the balance.
B1 Underwriting year accounting

When a proportional treaty is put in place by a ceding insurer, the treaty takes cessions of
policies incepting during the period of the reinsurance. The inception date of each policy
issued by an insurer determines to which treaty year that policy is ceded. The reinsurer
shares liability with the insurer for the duration of the original policy through the reinsurer
receiving its ceded portion of the policy premium and paying its ceded portion of all losses
from that policy. Irrespective of when a claim occurs and is settled, the reinsurer that
receives the written premium on the underwriting year basis is the one that pays the claim.
With this ceding and accounting method, the year of origin of the cession of the policy has
particular importance.
Underwriting year accounting ensures that the reinsurer shares the liability of the insurer
under any given policy ceded to the treaty by booking all accounting transactions to the
year of policy inception. It gives the true result of the business ceded, but it can prove an
administrative burden since accounting information has to be produced and rendered to the
reinsurer for settlement on a regular basis, each quarter or half-year, until there are no
outstanding liabilities.
Example 4.6
Surplus reinsurance treaty incepts 1 July 2017 and runs for twelve months. This is
underwriting year 2017.
Underlying construction all risk policy incepting 31 January 2018 and running for 18
months.
Claim occurs 3 April 2019.
Even though the policy incepts in 2018 and the claim occurs in 2019, the premium for this
policy and the claim will be accounted into the treaty accounts for the underwriting
year 2017.
B2 Clean cut accounting

The clean cut method is when premium and loss portfolios are transferred into and out of a
year. Clean cut accounting shortens the lengthy underwriting year accounting process to, in
effect, a single year. It does this by transferring the portfolio between the reinsurer of one
year and the reinsurer of the next. The insurer can operate the treaty by accounting the
earned premium to the reinsurer for a given year and recovering the incurred losses for the
same period.
In example 4.8, with clean cut accounting
accounting, the surplus treaty for the 2017 year would accept
the written premium for the risk incepting 31 January 2018. However, with portfolio transfers
any payment for the claim occurring on 3 April 2019 would fall into a later treaty year, and be
recovered from the treaty incepting in 2018 or a later year depending on how long it takes
for the claim to be settled.
B2A Premium and loss portfolio transfer
Chapter 4
The main reason for using premium portfolio transfers is to transfer unexpired liability under Transfer unexpired
a treaty from one reinsurer to another. The portfolio transfer usually takes place on the liability under a
treaty from one
anniversary date of the treaty. reinsurer to
another
Therefore, if one reinsurer is to be relieved of its liability under the treaty for policies still in
force at the end of a treaty period, in the last account of the year it will be debited with a
portion of the premium it received in that year. It can also be relieved of its share of the
liabilities for the outstanding claims at the end of the treaty period by being debited with an
amount usually set between 90% and 100% of the ceding insurer’s reserve. These premium
and loss portfolio amounts will then be credited to the incoming reinsurer.
The effect is to relieve the old reinsurer of any further liability in respect of the unexpired
portion of the risks accepted under that treaty in the preceding years, as well as the
outstanding losses at the end of the treaty year. The new reinsurer accepts the future
liabilities from the unexpired policies at the date of transfer and the liability for settlement of
outstanding claims from the previous and all preceding years.
Consider this
this…
…
Why might a reinsurance company prefer to accept a reinsurance treaty accounted on a
portfolio transfer basis?
The premium portfolio represents the share of the unexpired premium of the old reinsurer,
subject to deduction of commission. Therefore, it is necessary to determine the amount of
unearned premium that also needs to be factored into the portfolio transfer.
Example 4.7 will clarify the distinction between earned and unearned premium. It relates
only to one risk and has been calculated on a ‘proportionate to time’ basis.
Example 4.7
Let us assume the following facts:
• Original policy period: 1 April 2018 to 31 March 2019.
• Reinsurance treaty period: 1 January 2018 to 31 December 2018.
• Original premium: £730.
• Reinsurer’s share of the original risk premium for the full annual period: £365.
On a daily basis, the premium would be earned over two reinsurance treaty years. In the
example below, the treaty years are 2018 and 2019.
It can be seen from the following table, that in April 2018, for example, £60 of the
premium was earned: i.e. as at the last day of April 2018, £60 of the £730 insurance
premium had been earned and the rest (£670) remained unearned. It was earned in the
sense that the reinsured had carried out a service in return for receiving that premium
because it was liable for any claims under the original policy in that period.
Chapter 4
Month Insurer
Insurer’’s Insurer
Insurer’’s Insurer
Insurer’’s Reinsurer
Reinsurer’’s Reinsurer
Reinsurer’’s
gross cumulative decreasing 50% quota 50% quota
premium, £ earned unearned share earned share
premium, £ premium, £ premium, £ decreasing
unearned
premium, £
April 2018 60 60 670 30 335
May 2018 62 122 608 31 304
June 2018 60 182 548 30 274
July 2018 62 244 486 31 243
August 2018 62 306 434 31 217
September 2018 60 366 364 30 182
October 2018 62 428 302 31 151
November 2018 60 488 242 30 121
December 2018 62 550 180 31 90
January 2019 62 612 118 31 59
February 2019 56 668 62 28 31
March 2019 62 730 0 31 0
Total 730 730 0 365 0
Original gross premium: £730. Risk subject to 50% quota share (QS) cession. Earned premium/
expired risk and unearned premium/unexpired risk are calculated on daily basis (days in month will
therefore differ).
Note: reinsured’s net retained share after 50% QS cession would be same as reinsurer’s 50% QS
cession.
Assumes that
Although it is possible to undertake such a calculation in respect of each risk reinsured, there
original risks may be hundreds or thousands of risks written by the reinsured each year, which makes such
attach more or less
uniformly during
a system difficult to operate and verify. As an alternative, the reinsurance market has
the year devised some comparatively simple methods to calculate an equitable premium to be
transferred from one set of reinsurers to another.
The most common methods are as follows and each assumes that original risks attach more
or less uniformly during the year:
• Fixed percentage
percentage. Under this method a simple percentage (usually 35%) is applied to the
premium accounted to reinsurers in the outgoing year, and is paid to reinsurers in the
incoming year as a premium portfolio.
• Eighths basis
basis. Under this method, each of the four calendar quarters is divided equally
into two, making eight blocks of premium. Each block has an earned and unearned
element and a fraction of eight is applied on a progressive earned/unearned basis.
• Twenty-fourths basis
basis. Under this method, which provides greater precision than the
eighths basis, each calendar moth is divided equally into two, making 24 blocks of earned
and unearned premium. A fraction of 24 is applied on a progressive earned/
unearned basis.
Question 4.3
Chapter 4
A treaty has an anniversary date of 1 January and runs for a calendar year. What
percentage of a twelve-month original policy premium is earned when the policy is ceded
to the treaty on 1 April of the same year?
Transfer of portfolio can arise in the following circumstances:

• Where the reinsured wants a new treaty to assume the portfolio of business in force at the
inception of the treaty, or a new reinsurer to assume the portfolio from a retiring reinsurer.
A portfolio premium, expressed as a percentage of the preceding twelve months’ written
premium, is transferred to the assuming reinsurer. The loss portfolio can similarly be
assumed and the amount, expressed as a percentage of estimated outstanding losses at
the assumption date, is likewise transferred.
• Withdrawal of portfolio arises where there is an option, usually open to the reinsured only,
to withdraw premiums and outstanding losses upon termination. This can either be of the
entire treaty or of a retiring reinsurer’s participation where the replacing reinsurer
assumes the portfolio. The withdrawal of portfolio by the reinsured from a retiring
reinsurer operates on exactly the same basis as for the assumption of portfolio, amounts
being debited to the reinsurer instead of credited.
• A treaty on an underwriting year basis may provide for the closing of each year after a
specified period, say three or five accounting years, and the transfer of any subsisting
liability into the next open underwriting year. In these cases, provision is made for the
transfer of a portfolio amount into the next open year representing both unexpired
liability and outstanding losses.
Be aware
Where the loss portfolio is transferred, it is usual to include the provision that, if an
individual loss is settled for an amount materially different from its reserved amount, the
account can be reopened and a suitable adjustment made, making the settlement
equitable to all parties.
B2B Worked example

At the end of the year when transferring the business from one accounting year to the next, Must be
it must be determined what has been earned and what remains unearned from a book of determined what
has been earned
business. Remember, the unearned premium is for that part of the risks that has not as yet and what remains
expired at the end of the accounting year and so there must also be some premium reserve unearned
set up against the potential liabilities arising from these exposures.
This reserve, less the reinsurance commission for the accounting year, is deducted from the
original premium written. The reserve less reinsurance commission from the end of the
previous year is then added, as that exposure has ended in the meantime. In the following
example, the premium reserve is based on the twenty-fourths method.
Example 4.8
Calculation of premium reserve
Premium reserve for prior 200.25
year
Direct Reinsurance Retained
Premium written 1,986.47 564.26 1,422.21
Premium earned 1,931.43 548.63 1,382.80
Claims 1,165.39 312.36 853.03
Month Monthly Earned premium Premium reserve

premium
Fraction Amount Fraction Amount
January 70.77 23/24 67.82 1/24 2.95

Chapter 4
February 74.83 21/24 65.48 3/24 9.35
March 68.58 19/24 54.29 5/24 14.29
April 58.69 17/24 41.57 7/24 17.12
May 55.37 15/24 34.61 9/24 20.76
June 45.25 13/24 24.51 11/24 20.74
July 43.54 11/24 19.96 13/24 23.58
August 32.15 9/24 12.06 15/24 20.09
September 31.42 7/24 9.16 17/24 22.26
October 28.26 5/24 5.89 19/24 22.37
November 27.84 3/24 3.48 21/24 24.36
December 27.56 1/24 1.15 23/24 26.41
Total 564.26 339.98 224.28
Ceded premium written in accounting year 564.26
Premium reserve for previous year after deduction of 35% + 130.16

commission (35% of 200.25)
Premium reserve for current year after deduction of 35% – 145.79

commission (35% of 224.28)
Ceded reinsurance premium earned in the current = 548.63

accounting year
Insurer must set up

The claims occurring in an accounting year will not necessarily be completely paid in that
a claims reserve same accounting year. For those that have not yet been settled, the insurer must set up a
reserve. However, the insurer will pay claims from previous accounting years for
claims reserve
which reserves have been previously set up. The claims payments made during the
accounting year are, therefore, made up of payments in respect of claims arising during the
accounting year and also claims from the previous accounting years.
At the end of the previous year there would be a reserve for outstanding claims. This reserve
for the previous year is reduced, providing the reserve was sufficient, to the extent that
these claims were paid during the course of the accounting year. The previous year’s reserve
is subtracted from the paid claims. The reserve for claims outstanding at the end of the
accounting year, that is from that and the previous accounting years, is added to the paid
claims.
Let us return to our example.
Example 4.9
Paid claims for the accounting year 261.86
Reserve for outstanding claims at the end of the accounting year + 188.95
Reserve for outstanding claims at the end of the previous year – 138.45
Claims incurred for the accounting year = 312.36
It should be now possible to determine the overall status of the current portfolio.
Premium 564.26
Commission (35%) 197.41
Premium portfolio in 130.16
Premium portfolio out 145.79
Claims portfolio in 138.45
Chapter 4
Claims portfolio out 188.95
Claims paid during current year 261.86
Balance 38.86
Learning point
Before you move on, make sure that you can distinguish between the ways in which the
transactions under a proportional treaty are accounted by the reinsured to the reinsurer.
C Commissions and deductions

The cost of reinsurance to an insurer is determined by the amount of premium that it must Cost of
pay to its reinsurers. With non-proportional treaties, such as excess of loss, the premium is reinsurance is
determined by the
set by reinsurers. It is not a direct sharing of the premium for any original risks, as is the case amount of
with proportional treaties and most facultative reinsurances. The reinsured has not sustained premium
any acquisition or administration costs directly attributable to the reinsurance risk being
offered to the non-proportional reinsurers. The risk is frequently the reinsured’s own net
retained liability in respect of all of the business it underwrites in a particular class or
account. Consequently, reinsurers are usually unwilling to allow the reinsured any reduction
in the reinsurance premium by way of commission.
However, with proportional reinsurances where reinsurers are participating in and sharing
the fortunes of an original book of business obtained by the reinsured, it can be seen that
they potentially benefit from being offered a share in the original risks directly. They would
not otherwise have been able to obtain this share without considerable expense on their part
and without a contribution to the costs of running the account.
Therefore, in these circumstances it is reasonable for the reinsured to seek the recovery of
some of the administration and acquisition costs incurred in the production of the original
portfolio of business. This recovery is achieved by the application of ceding commissions to
the reinsurance premium, thereby reducing the ‘cost’ of the reinsurance to the reinsured.
For a proportional treaty to be successful, it would be assumed from the start that it ought An insurer is in the
to be profitable in the long run. An insurer is in the business of trying to make an business of trying
to make an
underwriting profit from the risks it writes and any reinsurer sharing that same business underwriting profit
would expect to share in the benefits while committing themselves to a share of any overall
loss. Original ceding commissions would be negotiated with this in mind.
The size and manner in which any commission is calculated depends upon the:
• type of reinsurance arrangement concerned;
• past history of profitability for the risk or account concerned;
• state of the reinsurance market, which influences how much reinsurers will be prepared or
have to allow in order to underwrite the reinsurance;
• original commission paid by the insurer to intermediaries; and
• ceding insurer’s administration costs.
The most common forms of commission in use in such reinsurances are outlined in the
following sections.
C1 Flat-rate commission
The application of a flat-rate commission is commonly applied where a portfolio of
business is:
Chapter 4
• expected to have very stable results, with the results in any one year not subject to
significant fluctuations; and
• not to any great extent exposed to variations in profitability that can be influenced by the
way business is ceded to the treaty, as in the case of surplus or facultative obligatory
treaties.
The commission is shown in the reinsurance terms and conditions as a percentage of the
gross premiums that will be ceded to the reinsurance. The percentage will differ on each
reinsurance arrangement, depending upon the type of reinsurance, the class of business,
previous results, geographical scope, market conditions and so on, but it should be sufficient
to cover the ceding insurer’s own acquisition costs and make a contribution to its
administrative expenses.
Reinsurers must
However, reinsurers have their own expenses to bear in mind. Thus we find that flat-rate
also bear their own commissions are lower for facultative business than for treaties, and surplus treaty
expenses in mind
commissions are lower than for quota share arrangements. This is mainly due to the
additional administration involved in the reinsurers’ offices and the greater scope for
increased variability of results in surplus treaties.
Another factor influencing the size of the flat-rate commission is whether the premiums are
ceded to the reinsurers on an original gross basis, or are subject to deductions. It is not
uncommon for some reinsurances to be ceded net of any original commissions. In such
circumstances, it can be expected that the reinsurance commission will be reduced
accordingly.
Question 4.4
What do we mean when we refer to cessions being made net of original commissions?
The reinsured may seek an overriding commission from reinsurers as an additional benefit
for ceding business. Whether reinsurers are prepared to allow any such further deduction
from the premium depends on the potential profitability of the business. Paying a higher
total commission based on a flat-rate basis may be a way of rewarding the reinsured for
good underwriting results, but it further limits the reinsurer’s potential for profit.
Additionally, the reinsurer has no protection against any deterioration in the loss experience
of the business subject to the reinsurance.
If the reinsurance is also subject to provisions for the establishment of premium and/or loss
reserves, that is funds retained by the insurer, then this too limits the reinsurer’s potential for
investment income on the ceded premiums. Under these circumstances, it can be expected
that percentages only at the lower end of any range would be allowed by reinsurers.
Not possible to
In practice it is not possible to guarantee the perfect stability of any treaty results. Therefore,
guarantee the it may be that the reinsured would look to its reinsurers to provide an extra incentive for
perfect stability of
any treaty results
good underwriting results. They might allow an additional commission based on the
profitability of the business, such as a profit commission on a flat-rate basis; alternatively
they would grant a commission that directly relates to the results of the business concerned,
that is, a profit commission linked to a sliding scale
scale.
C2 Profit commission (flat-rate basis)

If a treaty is profitable, then both the reinsured and reinsurers benefit from the agreement. If
it is very profitable, the reinsured may seek an extra commission from reinsurers for giving
them a share in such a good account. This payment would be called a profit commission and
would most commonly be allowed on stable quota share and surplus treaties. The existence
of a profit commission in the treaty would be seen as an incentive to the reinsured to
underwrite a sound, profitable account.
It can be difficult to determine a reasonable basis for calculating a level of profit commission Several methods
that is fair to both the reinsured and its reinsurers. There are several methods of establishing of establishing a
profit commission
a profit commission formula, but there are no hard and fast rules for determining the formula
percentage of commission to be allowed on any resulting profit. This may be affected by
many different factors:
• How much will the market stand and what phase of the underwriting cycle is the market
presently at?
Chapter 4
• Is the treaty part of a reciprocal exchange?
• Is it a new treaty for the insurer?
• Is the treaty being offered to a new reinsurer?
• What part of the world does it come from?
• What will be allowed for reinsurers’ expenses?
• What will be the effect of any deficits in previous accounts?
• Will the profit be averaged over a number of years of account?
• What is the past profitability of the treaty?
There are many variations in the formulae used for calculating a profit commission, but in
each treaty the terms and conditions should show clearly the basis that is to apply.
Two principal methods used to deal with the problem of fluctuations from year to year are:
Average system Each year, the profit commission is based on the average of the aggregate treaty
results for the current and preceding years, typically between three and five years
in total.
Deficit carried A deficit in any one treaty year is carried forward and set against profits in an
forward ensuing year or years. It may be agreed that any deficit should be carried forward
for no more than a specified number of years, e.g. three years. Sometimes it is
carried forward to extinction. Whichever feature is used, it will be clearly
identified in the ‘outgoings’ section of the profit commission statement.
Question 4.5
What is the principal advantage of the ‘deficit to extinction’ method from the reinsurer’s
point of view?
The profit commission can be collected either by the reinsured rendering a specific account
after the close of the accounting year or by including it in the last periodic account for the
year in question.
To ascertain whether an account has made a profit or not, all the component parts relating
to the profitability of the treaty need to be identified. All the relevant income from whatever
source needs to be compared with all the relevant expenditure from whatever source. In the
event of income exceeding expenditure, a ‘profit’ has been made and a profit commission
could be calculated.
The relevant details that may form part of the profit commission calculation can be
summarised as follows:
• Income:
– premiums credited for the underwriting year;
– premium reserves from the previous year, if applicable;
– incoming premium portfolio and/or loss reserves from the previous year, if applicable;
– incoming loss portfolio, if applicable.
• Expenditure:
– losses and loss expenses paid during the underwriting year and outstanding loss
reserves at the year end, if applicable;
– outgoing loss portfolio, if applicable;
– premium reserve at the year end, if applicable;
– outgoing premium portfolio;
Chapter 4
– ceding commissions on premiums for the current year, taxes, fire brigade charges or
similar levies paid by insurers;
– an allowance for reinsurer’s expenses (usually a percentage of the ceded premiums),
– deficit, if any, carried forward from previous years.
Net profit is the amount by which the credit items exceed the total of the debit items. The
precise manner in which a profit commission is calculated varies from contract to contract
and is agreed in the profit commission clause of the treaty wording.
Activity
Can you recall the factors that might affect the percentage of profit commission? List as
many as you can.
C3 Sliding scale commission

Reward the
Profit commissions on a flat-rate basis reward the reinsured for a good result on a particular
reinsured for a treaty, but are an inflexible mechanism. The incentive to do better has a limited appeal, and
good result
certainly does nothing for either party should the results be less profitable than expected.
An alternative is to have commissions calculated on a sliding scale basis, which not only
automatically rewards the reinsured for producing a good result but also takes into account
the possibility of imposing a ‘penalty’ in the event of a poorer than expected performance.
The reinsured debits the reinsurer with a provisional commission on premiums paid during
the year. This commission would be adjusted at the end of the year. The adjustment is
determined in accordance with an agreed variable table of commissions, linked directly to
the loss ratio achieved by the treaty.
The loss ratio is calculated according to the following standard formula:
Incurred loss for the year 100

× = loss ratio percentage
Earned premium for the year 1
In this instance, the figures to be used would be arrived at as follows:

loss: losses and loss expenses paid by the reinsurer during the year plus
Incurred loss
outstanding loss reserve at the end of the year less outstanding loss reserve at the end of
the preceding year.
premium: premiums paid for the current year plus unearned premium reserve at the
Earned premium
end of the preceding year less unearned premium reserve at the end of the current year.
There will invariably be a negotiated minimum and maximum rate of commission and the
precise terms of the sliding scale must be clearly set out in the wording of the treaty
agreement.
Example 4.10
Such a wording might be: ‘A 1% increase in the commission rate will be payable for every
1% reduction in the loss ratio within the limits shown below. A commission of 30% will
apply if the loss ratio is 60% or more and a maximum 41% commission will apply if the loss
ratio is less than 50% .’
Rate of commission 30% if loss ratio is 60% or more
d 31% d 59% but less than 60%
d 32% d 58% d 59%
d 33% d 57% d 58%
d 34% d 56% d 57%
d 35% d 55% d 56%
d 36% d 54% d 55%
Chapter 4
d 37% d 53% d 54%
d 38% d 52% d 53%
d 39% d 51% d 52%
d 40% d 50% d 51%
d 41% d less than 50%
C4 Loss participation or reverse profit commission

While it can be seen that the sliding scale basis goes some way towards rewarding the
reinsured for good results and protecting the reinsurers against worse than expected results,
it does little in the event that the results of the treaty are exceptionally poor. A flat-rate
profit commission achieves even less to address this possibility, being purely an extra
reward for good performance.
Proportional reinsurance has its foundations in ‘sharing’ arrangements – the reinsured and
the reinsurer sharing in the fortunes of the original business. Therefore, if there is an
expectation that heavy losses may be incurred, some form of loss participation clause may
be adopted to ensure a more equitable distribution of the net loss between the reinsured
and its reinsurers. This can be explained as a reverse profit commission situation, whereby
the loss above an agreed loss ratio is redistributed so that the reinsured bears some portion
of a very heavy loss rather than the reinsurers bearing the whole burden. An example of such
a wording is:
In the event that the loss ratio for the treaty exceeds 100%, the reinsured bears 25%
of all losses in excess of this figure.
In order to operate equitably between the reinsured and the reinsurer, any such clause
should take a number of issues into account and seek to establish the obligations of both
parties to the contract as unambiguously as possible. The key points to be addressed and
included in any wording are:
• definition of the extent of the reinsured’s liability, for example, ‘If the loss ratio of any
treaty year exceeds X% the reinsured shall bear Y% of the amount by which the loss ratio
exceeds X%’;
• provision for how the loss ratio shall be calculated;
• definition of incurred losses and earned premiums;
• the limit of the percentage borne by the reinsured of earned premiums for each treaty
year; and
• when any such calculation shall be made.
Such a clause would appear to penalise a reinsured, but it should be remembered that the
intention is to redress any unusually heavy loss situation.
Be aware
Should the results improve and the loss ratio fall below the trigger point then the loss
participation clause would not operate.
D Premium and claims reserves

Premium reserves and claims (or loss) reserves are a means by which the reinsured may hold
monies during the term of the treaty for later release to the reinsurer.
The premium reserve deposit is a proportion of the ceded premium, whereas the claims or
loss reserve deposit represents the estimated amount of losses outstanding at a given date.
The retention by the reinsured of such deposits is a legal requirement in some countries.
Mainly held in cash

Premium reserves and claims or loss reserves are mainly held in cash or established by a
or established by a letter of credit issued to the reinsured by the reinsurer on funds in a mutually acceptable
letter of credit
bank. The letter of credit facility should clearly define the terms on which it is held by the
reinsured and the drawing rights it has on it.
D1 Premium reserve deposits

Chapter 4
The premium reserve deposit was developed as a safeguard enabling a reinsured to meet
justified claims in cases where the reinsurer, for whatever reason, could not meet its
obligations.
Consider this
this…
…
Think about the impact of the reinsured and the reinsurer being situated in different
hemispheres, continents or time zones. The transfer of monies may be delayed at a time
when the reinsured urgently requires funds.
The clause is a legal requirement in some countries, including a number of states in the
USA. However, many reinsurers strongly resist its inclusion.
The clause in the treaty must make provision for the following:
• The proportion of the ceded written premium which is to be retained by the reinsured.
Usually, this is considered as representing the unearned proportion of premiums ceded.
• How the reserve is to be taken (for example, 40% of each quarter’s premiums) and when
this amount is to be released (for example, in the corresponding quarter of the
following year).
• Disposal of the reserve in the event of termination of the treaty. It is usually applied to pay
the reinsurer’s proportion of loss settlements accruing after termination and the balance
released on expiry of all liability.
• The interest payable to the reinsurer on the amount of the reserve held.
D2 Claims or loss reserve deposits

As with the premium reserve deposit, the outstanding claims or loss reserve deposit was
developed to protect a reinsured in case a reinsurer could not meet its obligations.
The deposit comprises the amount estimated to be the known outstanding losses to the
treaty that have been advised but not yet settled. Usually, the deposit is established and
retained by the reinsured at the anniversary date of the treaty with an annual adjustment,
but sometimes it is adjusted at the close of each quarterly or half-yearly account.
The reserve may be drawn down every time there is a settlement. Theoretically this means
the reserve should be amended every time there is a movement in the reinsured’s reserve or
there is a claim settlement. This is administratively time-consuming and costly. Therefore, in
reality, this reserve is generally withheld and released at the end of a specified accounting
period, and is based on the losses outstanding at that date.
Claims reserves affect the experience of individual treaties from the reinsurer’s perspective,
because the more funds are retained by the reinsured, the less are available to the reinsurer
for investment purposes.
Be aware
Interest on the amount of the reserve is usually paid to the reinsurer when the reserve is
adjusted.
E Calculation of reinsurance premiums and

claims recoveries
The reinsurance premium is the price of the cover charged by the reinsurer in consideration
for offering to underwrite the risk. In all contracts of reinsurance, the premium is a reflection
of the insurer’s risk passed to the reinsurer. The basis for calculating the reinsurance
premium varies according to the type of reinsurance contract. There are, however, a number
of different definitions of the insurer’s premium income on which the reinsurance premium
is based.
In the case of proportional reinsurance, the premium income means the total of all the The premiums are
original premiums received by the ceding insurer which are passed, i.e. ceded, to the usually gross
reinsurer. The premiums are usually gross, as written by the insurer, but occasionally they
can be the original net premiums. We have seen that premiums are calculated in proportion
to the amount of risk transferred, so for example, if 50% of the sum insured is to be ceded
then the reinsurer will receive 50% of the premium. From this – in most cases – an allowance
Chapter 4
is made in the form of commission to cover the ceding insurer’s business acquisition costs.
F Cession and event limits

Consider this
this…
…
Can you think which type of treaty is particularly exposed to natural and other
catastrophe perils?
Reinsurers are particularly concerned if proportional treaties are exposed to natural perils
that could give rise to a catastrophic event. We must not forget that many proportional
treaties are designed to protect single risks and not to provide free or under-priced
catastrophe exposure on an unlimited basis.
Under all proportional reinsurance treaties, the exposure of the reinsurer on an ‘any one risk’
basis is defined and limited. In certain countries, there is a substantial risk of an accumulation
of losses arising out of a single loss event. Typical examples of this exposure are losses due
to natural perils such as earthquake, windstorm and flood.
Quota share treaties are particularly exposed to natural perils as an agreed percentage Quota share
cession must be made on all business falling within the reinsured’s retention. This could treaties are
particularly
involve many private dwellings, so any quota share thus exposed could provide substantial exposed to natural
catastrophe coverage. Both reinsured and reinsurer recognise this exposure and impose perils
special conditions to accommodate it.
It is important, both for the reinsured and the reinsurer, that adequate records are
maintained on the total exposure to such natural or other perils in the portfolio. This enables
them to arrange adequate catastrophe excess of loss protection and, at the same time, to
control the total amount of business that they accept.
F1 Cession limits
To help the reinsured keep and maintain accurate records of total exposures to the portfolio,
procedures need to be in place to monitor the total amount of business accepted. This, in
turn, will allow adequate levels of reinsurance to be put in place. The actual amount of the
cession limit is negotiated between reinsured and reinsurer.
Be aware
This is important because there is a special reporting clause known as a cession limit. This
requires the reinsured to tell reinsurers, on a periodic basis, the total of all business
exposed to natural perils and ceded to the proportional treaty, be it surplus or quota
share. The actual amount of the cession limit is negotiated between reinsured and
reinsurer, and market conditions will dictate the limit that is finally agreed. A lower limit
would restrict the reinsurer’s exposure while also limiting the premium ceded to the
treaty.
F2 Event limits
If the reinsurer believes that a natural perils event could seriously affect the treaty, then it
might impose another special clause, known as an event limit. The calculation of a
proportional treaty event limit is also the subject of negotiation between reinsured and
reinsurer, but its operation is often far from transparent.
The treaty event

The treaty event limit acts as a ‘first loss’ limit and treaty reinsurers would not be liable if this
limit acts as a ‘first event limit was exceeded following a natural perils loss affecting a proportional treaty. Some
loss’ limit
reinsurers allow the ‘fallback’, or amount greater than the event limit, to be added to the
reinsured’s net retained loss for the purposes of any recovery from its catastrophe excess of
loss programme. Other reinsurers state that any ‘fallback’ is not allowed to increase a net
retained loss, as liabilities could not be quantified at the negotiation stage of the original
catastrophe excess of loss protection, nor any premium calculated in advance for such
additional and unknown liabilities.
The situation is further complicated if both cession and event limits are imposed on a
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proportional treaty and the cession limit is exceeded at the date of a natural perils loss, but
the stated treaty event limit is not. This raises the question of whether the event limit should
be reduced by the proportion that the cession limit has been exceeded at the date of loss.
The reinsured has also paid reinsurers in good faith for their share of ceded premiums for the
amounts that exceed the cession limit. There are many other combinations, and these
examples are deliberately contentious.
Be aware
Cession limits and event limits can be applied separately or in tandem.
G Case studies
Structuring and evaluating quota share and surplus treaty solutions
In this section we will look at some worked examples showing how a certain type of
proportional treaty could be a workable solution for an insurance company seeking
reinsurance capacity and protection for a specific class of business. The advantages and
disadvantages of each type of treaty needs to be assessed. First, various other factors have
to be taken into consideration, including:
• The size of the company, capital and level of financial strength.
• Automatic capacity required. This is the maximum sum insured that the company wishes
to be able to write for any one policy or risk without the need to obtain additional
capacity for that risk by means of facultative reinsurance.
• The premium income for the class.
• Expected loss activity and projected loss ratios.
• Risk factors, both single loss, accumulation and catastrophe type loss scenarios.
• The reinsurance market and available capacity for both the class of business and the type
of treaty required.
• The corporate view of risk.
• Legislation and any regulatory matters.
G1 Quota share solution

Alba Insurance company is a medium sized insurer which currently only writes motor and
general liability. These classes are protected by a quota share and excess of loss
programme.
The company now wishes to expand and to start writing commercial property insurance.
Sources of business have been researched and identified and estimated gross premium
incomes are €1,500,000 in year one rising to €2,500,000 in year two. In order to achieve
these levels of business, the company has ascertained that it needs a maximum line size of
€3,000,000 any one risk.
Average losses in this sector, within the desired capacity level, are in the €100,000 to
€200,000 range. Losses in the €2,000,000 to €3,000,000 range are relatively rare. The
main catastrophe exposure is windstorm. Excluding major catastrophes, average loss ratios
are 55% to 60% total losses in any one year as a percentage of the gross premium income.
The directors and senior managers decide to follow a cautious strategy. The more hazardous
risks will be avoided, aggregate exposures will be carefully monitored and the priority in
choosing a reinsurance treaty will be to minimise net losses and any impact these may have
on the company’s balance sheet. The company’s paid up capital plus free reserves currently
adds up to €15,000,000 and the directors wish to set a retention of no more than €500,000
any one risk.
After discussions with brokers and potential reinsurers, Alba decided to proceed with a
quota share treaty with the following structure.
Reinsured: Alba Insurance Company Limited
Chapter 4
Type: Fire quota share - 85%
Territory: XXX
Period: Continuous treaty commencing on 1 January 2019 subject to three months’ notice
of cancellation prior to 31 December of each year.
Class: Fire and allied perils, including business interruption, for commercial property
risks.
Limits: 100% original maximum any one risk:

€3,000,000 sum insured
Reinsured to retain 15%, subject to XL protection.
Event limit: €30,000,000 for 100% any one event, applicable to natural perils.
Commission: 30% on original gross premiums.
Profit commission: 25% on the net profit after allowing 7.50% for reinsurer’s expenses.
Cash loss: €300,000
Accounts: Quarterly, within 60 days of the close of each quarter.
Estimated €1,500,000, gross written premium, for 100%, 2019 underwriting year.
premium income:
G1A Assessment of the costs and benefits of this treaty and its
structure
• Provides €3,000,000 of automatic capacity. Alba can write a €3m line on any one risk
without having to obtain prior agreement from the reinsurer and without the need to
obtain facultative reinsurance.
• Alba’s retention of 15% applies to each risk irrespective of the sum insured. The maximum
amount that Alba will retain is €450,000 any one risk.
• The percentage apportionment between Alba and the reinsurer for both the premium and
the sum insured on any one risk is 15% retained and 85% ceded to the reinsurer. This is
fixed and applies to every risk irrespective of the size.
• The event limit provides for €25,500,000 catastrophe reinsurance (€30m × 85%).
Exposures would be monitored as the account develops and windstorm loss scenarios
would be assessed or modelled to ensure the event limit is adequate.
• At €1,500,000 estimated gross premium income on an 85% quota share, Alba will be
ceding €1,275,000 to the reinsurer. However, with the 30% commission, €382,500 (for
85%) will be deducted in the accounts for the full underwriting year and that would
reduce the ceded premium, net of commissions, to €892,500.
• Loss recoveries from the reinsurer based on the 60% estimated loss ratio will be
60% × 85% of €1,500,000, which equals €765,000.
• The estimated profit to the reinsurer would be : the €892,500 net ceded premiums less
€765,000 losses which equals €127,500. That equates to a 10% profit to the reinsurer. A
profit margin of about 10% would be required to interest potential reinsurers.
Be aware
The fixed retained and ceded percentages are applied to both the original premiums and
all losses. For example, the 100% sum insured for a factory is €2m and the original gross
premium is €5,000. The premium apportionment is:
• retained 15% /€750;
• ceded 85% /€4,250.
Any loss on this risk will be shared 15% retained, 85% recoverable from the treaty.
In maintaining this specific quota share, Alba will be giving away a profit of €127,00 to
reinsurers in the first underwriting year. Some of that would be returned to Alba under the
agreed profit commission.
That would be a reasonable price considering that in return Alba will have reinsurance
capacity of €2,550,000 for any one risk (85% of €3,000,000) and catastrophe reinsurance
of €25,500,000 (85% of €30,000,000).
Chapter 4
Alba’s estimated retained earnings and profit would be the difference between retained
premiums plus incoming treaty commissions and retained claims plus outgoing commissions
to agents and producing brokers.
Retained earnings
€225,000 retained gross premiums (15% of €1,500,000)
plus
€382,500 retained commission (30% × 85% of €1,500,000)
Total Income €607,500.
Retained losses and outgoing commission
At the estimated 60% loss ratio and the estimated €1,500,000 premium income, the
retained losses for 2019 underwriting year would be €135,000 (15% × 60% × 1,500,000).
Assuming that Alba give 20% commission on average to agents and producing brokers, the
outgoing commission would be €300,000.
Total Outgoing €435,000.
This would give Alba an underwriting profit of €172,500, assuming that there are no major
catastrophe losses from a severe windstorm. Alba would need catastrophe excess of loss to
cover all the retained risks and they would need to budget for the cost of that. That would
still leave a satisfactory first year profit margin in relation to the benefits of the quota share.
In future years, if sufficient growth is achieved, Alba could consider other reinsurance
arrangements that could increase their retained income, such as a Surplus Treaty or Excess
of Loss programme.
G2 Surplus treaty solution

Brizo Insurance Company currently has a hull and cargo quota share treaty, which has been
in place for several years. A new general manager was appointed a few months ago and he
implemented a full review of the reinsurance arrangements for the hull and cargo accounts.
The hull and cargo quota share has a 100% limit of US$5,000,000 any one vessel or
shipment. This is an 80% quota share, with Brizo retaining 20% on each risk and ceding 80%
to the quota share.
The maximum amounts retained and ceded on any one risk are US$1,000,000 and
US$4,000,000 (20% and 80% respectively of US$5m). As the quota share percentages are
fixed, there are no minimum monetary amounts retained. If a vessel is insured for US$1m, for
example, the retention would be US$200,000 even if Brizo would now be comfortable
carrying a higher retention.
Gross premium incomes for the current year are US$4.1m for cargo and US$12.5m for hull.
The hull premium income figure includes US$3.5m in reinsurance premiums ceded for
proportional facultative reinsurances. The amount ceded for cargo facultative reinsurance is
much lower at US$100,000.
The gross ceded and retained premiums are therefore:
Currency Retained Ceded to QS Ceded to Fac Total

reinsurers
US$
Hull 1.8m 7.2m 3.5m 12.5m
Cargo 800,000 3.2m 100,000 4.1m
Total 2.6m 10.4m 3.6m 16.6m
The premium income for marine business has increased significantly over the last three
years, especially for hull. During the same period, Brizo has diversified into other classes and
the company’s capital has increased to US$50m.
The new general manager wanted to address the following key issues for the marine
account:
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• increase the retained premium income;
• increase the automatic capacity for hull to US$10m any one vessel; and
• greatly reduce the number of facultative placements.
The initial plan to solve these matters, was to discontinue the quota share and have separate
surplus treaties for hull and cargo placed with the same reinsurers as far possible.
Following discussions with brokers and reinsurers, it transpired that the reinsurers were
unwilling to write a cargo surplus treaty. Loss frequencies on cargo business are generally
quite high and for this reason proportional treaty reinsurers are often reluctant to provide
cargo surplus treaty capacity. Their preference is for a quota share with a fixed
proportionate sharing across the whole account.
Brizo then had to consider a Plan B. This involved maintaining the quota share but for cargo
business only, with the same US$5m limit.
The next stage was establishing a nine-line hull surplus treaty that provided Brizo with the
desired automatic capacity.
In order to evaluate this route and persuade reinsurers to accept the hull surplus, a number
of internal reports needed to be programmed and statistics supporting the proposal had to
be provided to reinsurers. The information needed included risk profiles that clearly show
the pattern of risks that would have been retained and ceded to the treaty at various limits
on the basis of the proposed surplus treaty being in place. In additionally, the ’as if’ results to
the surplus treaty over the last five years were required, showing what the results would
have been if the surplus treaty had been in place over that period.
The risk profiles demonstrated that a far higher number of risks would have been retained
100%, whilst a sufficient number of risks would have been ceded to the surplus, thus
providing sufficient premium income to the reinsurers to make the proposition viable for
both parties.
The ‘as if’ treaty statistics (as a simulated example) for a nine-line surplus treaty with a
maximum retention of US$1m produced the following results:
Year Gross ceded Commission Net ceded Incurred Result to treaty

premium to at 25% premium to losses
treaty treaty
2014 4,560,000 1,140,000 3,420,000 2,935,000 485,000
2015 4,900,000 1,225,000 3,675,000 4,280,000 –605,000
2016 5,200,000 1,300,000 3,900,000 3,271,500 628,500
2017 5,450,000 1,362,500 4,087,500 3,560,000 527,500
2018 at 30 4,550,500 1,137,500 3,412,500 2,940,000 472,500

September
(9 months)
Totals 24,660,000 6,165,000 18,495,000 16,986,500 1,508,500
Estimated premium income to the treaty for 2018 underwriting year: US$6,500,000
Based on a total annual gross premium of US$12.5m, the gross ceded and retained premium
with a nine-line, US$1m retention hull surplus treaty would be:
Currency US$ Retained Ceded to surplus Ceded to Fac Total

reinsurers
Hull 5.5m 6.5m 500,000 12.5m
In comparison with the previous quota share arrangement, under the new arrangement:
• the ceded income to facultative reinsurers has reduced by US$3m from US$3.5m to
US$500,000, because most of the facultative risks can now be covered by the new
surplus treaty;
• the ceded premium to the treaty has reduced by US$700,000 from US$7.2m to the quota
share to US$6.5m to the surplus,
– converting a quota share to a surplus usually results in a significant reduction in the
Chapter 4
ceded premium to the treaty. In this case the reduction is relatively modest because
US$3m of income that previously went to facultative reinsurers is now being absorbed
by the surplus treaty; and
• the retained premium income has jumped by US$3.7m from US$1.8m under the quota
share to US$5.5m under the surplus.
After discussions with brokers and potential reinsurers, Brizo decided to proceed with a
surplus treaty with the following structure.
Reinsured: Brizo Insurance Company Limited
Type: Marine hull surplus treaty
Territory: XXX
Period: Continuous treaty commencing on 1 January 2019 subject to three months’ notice
of cancellation prior to 31 December of each year.
Class: Marine hull and machinery, including war, strikes, riots, civil commotion and
malicious damage.
Treaty limits: Nine gross lines. Maximum retention any one vessel US$1m sum insured.
Maximum cession to the treaty US$9m any one vessel, sum insured.
Commission: 25% on original gross premiums.
Profit commission: 25% on the net profit after allowing 7.50% for reinsurer’s expenses.
Cash loss: US$600,000
Accounts: Quarterly, within 60 days of the close of each quarter.
Estimated US$6,500,000 gross written ceded premium income to the treaty 2019
premium income: underwriting year.
G2A Assessment of the costs and benefits of this treaty and its
structure
The costs and benefits of this treaty and structure are as follows:
• Provides Brizo with US$10m of automatic capacity for any one vessel; US$1m retention
plus a US$9m maximum cession to the treaty.
• Catastrophe protection is also provided, but only for the proportion of risks ceded to the
treaty. For example, a cyclone causes losses to seven vessels. Two vessels were retained
100% and the other five were ceded to the treaty using the full nine lines. 90% (9/10th) of
the losses on the five vessels is recoverable from the treaty.
• Brizo can now retain 100% of all vessels within the maximum US$1m retention and thereby
maximize the retained income and earnings at a sustainable retention level.
Surplus treaties can have a table of limits and retentions, giving a higher retention and
limit to the treaty for the low hazard risks and a lower retention and lower limit to the
treaty for high hazard risks. This feature is particularly relevant to a property account,
where different types of construction and occupancies result in a variety of hazard level,
e.g. a modern office block would be low hazard and an old timber warehouse would be
high hazard.
For the purposes of this case study we are assuming that Brizo are comfortable with
retaining up to US$1m on each vessel. The new treaty gives Brizo an increased retained
premium of US$5.5m and the retention could be protected by excess of loss for the net
account.
• Maintaining a fixed retention would still allow for flexibility on risks retained and ceded as
per the following examples.
Vessel Retained Ceded to surplus

value/ sum
Chapter 4
insured
US$
10m US$1m 1/10th = 10% 9 lines, 9 × 1m = 9m. 9/10th = 90%
7m US$1m 1/7th = 14.3% 6 lines, 6 × 1m = 6m. 6/7th = 85.7%
2m US$1m = 50% 1 line, 1m. 1/2 = 50%
1m US$1m Nil
Be aware
Premiums and losses are calculated by applying the same percentages to the original
premium and any losses.
In our US$10m example, if the original premium is US$150,000 then:
• 10% / US$15,000 is retained; and
• 90% / US$135,000 is ceded to the treaty (before treaty commission).
All losses on this vessel will be apportioned 10% retained, 90% recoverable from the
treaty.
The surplus treaty allows Brizo variable retentions and cessions from 100% retained /Nil
ceded to 10% retained and 90% ceded, with all the variables in between. This way the treaty
is used where it is needed most, on the larger risks, and less so on smaller risks.
Retained earnings
Forecasting retained results is more difficult for a surplus treaty than it is for a quota share
due to the variable retained/ceded percentages. Generally, though, with a surplus treaty
arrangement the retained result is more profitable than the result to the treaty. Situations do
in fact sometimes arise when the result to a surplus treaty is negative, but the retained result
is a profit. That could occur if, for example, the loss ratios on the larger risks ceded to the
treaty are higher than those on the retained risks. Additionally, the ceding company has the
benefit of treaty commissions. Brizo’s retained income would be:
US$5m retained premium income plus commission from the treaty of US$1.625m
(25% of the annual premium income to the treaty of USD 6.5m).
Brizo would also receive commissions on the remaining facultative reinsurances, which
would be about 20% of US$500,000, i.e. US$100,000.
If we assume that Brizo give 17.50% commissions their agents and producing brokers, the
outgo would be US$2.187m (17.50% of the 12.5m gross annual income).
Total net retained income would therefore be:
• Incoming
Incoming: Retained premium plus ceding commissions US$6.725m (US$5m, plus
US$1.625m, plus US$100,000.
• Outgoing
Outgoing: commissions to agents/producing brokers US$2.187m
The total net income would then be US$4.538m.
Based on the pattern of the ‘as if’ treaty results, the loss ratio in a good year would be
approximately 65% of the US$5.5m gross retained premium, i.e. US$3.575m. That would
leave Brizo with a profit US$963,000 before the cost of excess of loss for the retention.
Brizo would need catastrophe excess of loss and could also buy a single risk XL to take out
peak retained losses. The cost of the XL protections could be approximately US$250,000.
That would still leave a bottom line profit of over US$700,000.
Hull business is volatile though, and loss years can be expected to occur every three or four
years. Profits from the good years would need to be sufficient to cover losses from the bad
years and the excess of loss protections would limit the impact of retained losses.
Question 4.6
An event limit restricts the loss payments per event under a proportional reinsurance
treaty whereas a cession limit restricts the total sums insured ceded into a reinsurance
treaty for a whole country or a specified cession limit zone.
Chapter 4
A combination of the event limit with a cession limit and/or annual loss limit is possible
where natural perils are concerned, such as earthquake, windstorm or flood since the
reinsurer is looking to limit its catastrophe exposure.
This becomes yet another underwriting consideration as reinsurers seek to quantify, in
advance, their ultimate exposure to such a natural perils event from all their inwards
acceptances in that country, region or zone.
If a natural perils event affects a proportional treaty, then the reinsurer must ensure that
any treaty recoveries comply with the stipulations contained in such treaty event limit
clause, and also any treaty cession limit clause, if applicable.
One potential variation of this problem is explained below. It is impossible to be
prescriptive about how the problem is best addressed since this needs to be the subject
of separate negotiation between the parties to the reinsurance contract.
However, the following illustrates one hypothetical example of how event and cession
limits collide, although there are many other combinations and permutations.
• An insurer reinsures its North American property account against natural perils on a
50% quota share treaty subject to a maximum cession of US$2m any one risk. It passes
50% of its qualifying premiums, after deductions, to the reinsurer along with the same
percentage of its potential liability and expects to recover 50% of any qualifying loss.
• An event limit of three times the single risk limit applies.
• The insurer cedes ten individual risks up to the limit any one risk.
• A windstorm ‘event’ affects five of those risks creating losses up to the single risk limit
but exceeding the overall event limit.
• In the absence of the event limit the insurer will recover up to the maximum cession any
one risk limit in each case.
• However, the event limit effectively caps the insurer’s recovery even though it has
made a full proportional premium payment to the reinsurer in good faith.
Calculate:
1. the reinsurance recovery taking into account the application of both the event and
cession limits; and
2. the recovery that would have been possible had the event limit not been in place.
3. Would your calculation be different if the five risks had been affected by separate
losses rather than one ‘event’?
Key points
Main features and operation of proportional reinsurance treaties
• There are two main types of proportional reinsurance treaty.

• A quota share treaty is an obligatory ceding treaty where the insurer cedes a fixed percentage of all
its risks within agreed parameters. The reinsurer accepts all the cessions made, usually subject to a
maximum amount any one cession.
• Quota share treaties are used in the following situations:
– where a newly formed company needs a sufficiently large per risk capacity to enable it to attract
business;
– where the risks ceded are homogeneous, and have a relatively similar profile;
– where the highest level of ceding commission is required;
– where reciprocal exchanges are required;
– where reinsurers’ support is needed after a period of poor loss experience;
Chapter 4
– where it is desired to share risk within a network of subsidiary companies;
– where financial assistance is required from the reinsurer;
– to reduce net retained income in order to improve or protect solvency requirements; and
– to smooth abrupt variations in the loss ratio from one year to the next.
– •However, the effect of facultative carve-outs is to isolate, and treat separately heavy
catastrophe exposed risks.
• With surplus treaties, the insurer is obliged to cede all risks greater than its chosen retention within
the scope of the treaty and the reinsurer must accept all such cessions.
• The insurer can arrange second, third, fourth or more surplus treaties if additional capacity is
required.
• The insurer may have risks of dissimilar size and quality, and using a surplus treaty allows them to
avoid having to cede the same fixed proportion of each and every risk, as would be the case under a
quota share.
• Facultative obligatory (‘fac/oblig’) treaties accommodate the placing of numerous individual
cessions.
• With fac/oblig treaties, the insurer at its option chooses whether to cede a risk while the obligation
falls upon the reinsurer to accept all such cessions.
• A fac/oblig treaty operates like a surplus treaty where the available capacity is expressed as a
multiple of the reinsured’s gross retention.
• A fac/oblig treaty may be used to provide additional capacity or to allow a reinsured to maintain
sufficiently high acceptance limits on large or target risks.
Main accounting methods
• Under the underwriting year basis of cover the inception date of each policy issued by an insurer
determines the treaty year to which that policy is ceded.
• A method of accounting has evolved whereby the lengthy underwriting year accounting process
has been shortened in effect to a single year by the transfer of portfolio between the reinsurer of
one year and the reinsurer of the next. This is ‘clean cut’.
• Premium portfolio transfers are used to transfer unexpired liability under a treaty from one reinsurer
to another.
Commissions and deductions
• By applying ceding commission to the reinsurance premium the reinsured recovers some of the
administration and acquisition costs incurred in the production of the original portfolio of business.
• The way in which commission is calculated depends on:
– the type of reinsurance arrangement involved;
– the past history of profitability of the account;
– the current state of the reinsurance market; and
– the insurer’s administration and acquisition costs.
• The forms that commissions can take include:
– flat-rate commission;
– profit commission, but calculated on a flat-rate basis;
– sliding scale commission; and
– loss participation or reverse profit commission.
Premiums and claims reserves
• Premium reserves and claims reserves allow the reinsured to hold monies during the term of the
treaty for later release to the reinsurer.
• The premium reserve deposit is a proportion of the ceded premium while a claims reserve deposit is
the estimated amount of losses outstanding at a given date.
• Premium reserves are mainly held in cash or in letter of credit format issued on a mutually
acceptable bank.
• Claims reserves are established and retained by the reinsured at the anniversary date of the treaty
with an adjustment that takes place quarterly, half-yearly or annually.
• Claims reserves can impact the reinsurer’s ability to maximise investment opportunities.
Calculation of reinsurance premiums and claim recoveries
• The reinsurance premium is the price of the cover charged by the reinsurer in consideration for
underwriting the risk.
Chapter 4
• The basis for calculation of the reinsurance premium varies according to the type of reinsurance
contract.
• Premium income means the total of all the original premiums received by the insurer which are
passed, i.e. ceded to the reinsurer.
• The premiums are usually gross, as written by the insurer, but occasionally they can be the original
net premiums.
Cession and event limits
• Special conditions are imposed to control catastrophe exposure to natural perils. Common
measures include:
– cession limits, that require the reinsured to advise reinsurers periodically of the total of all
business exposed to natural perils and ceded to the treaty. (the actual amount of the cession
limit is negotiated between reinsured and reinsurer); and
– event limits, that act as a ‘first loss’ limit, beyond which reinsurers would not be liable if the event
limit were to be exceeded following a natural perils loss affecting the treaty.
• Cession and event limits can be applied independently or in tandem.
Question answers
4.1 No, to be homogeneous, risks need to be similar in type, as well as size. It is apparent
that there is no crossover between these two classes of risk.
4.2 Compared with other types of proportional reinsurance arrangements, there is
virtually a complete absence of anti-selection levelled against the reinsurer on the
part of the reinsured. Also, the reinsurer has less administration to perform compared
with, say, a surplus arrangement.
4.3 75%, because nine months of the twelve-month period fall during the calendar year.
4.4 An example would be where a fire and property insurer allows its own introductory
sources 15% commission on business received. Instead of ceding 100% of relevant
gross premiums to its reinsurers, it cedes only 85%.
4.5 ‘Deficit to extinction’ mitigates a situation where the reinsurer would pay out more
profit commission only a few years after the treaty has sustained a major loss year,
Chapter 4
which could happen if a deficit is only brought forward two or three years, and gives
the reinsurer the possibility of recouping profits in ensuing years. Such a situation
works to the reinsurer’s advantage.
4.6 1. US$6m as the event loss recovery is restricted up to the event limit which is
three times the single risk (or cession) limit.
2. US$10m.
3. No, the recovery amount would still be US$10m whether the five risks had been
affected by separate losses rather than one ‘event’ or not provided each loss
amount remains US$2m. If there was an event limit of US$6m in place but the
five risks had been affected by separate losses rather than one ‘event’, US$10m
could still be recovered provided each loss amount remains US$2m.
Self-test questions
1. What is a quota share treaty?
2. An 80% quota share has a Limit of £2m any one risk for 100% with the reinsured’s
retention being 20%. The reinsured has accepted a low hazard small risk with a sum
insured of £100,000. Can the reinsured retain 100% of this risk?
3. How can the use of proportional treaties improve an insurer’s solvency margin?
4. If an insurer converted a quota share into a surplus treaty for the same class of
business, what would be the likely effect on the retained premium income?
5. What is a facultative carve-out?
6. What problems might a reinsurer of a second surplus treaty face?
7. What is a facultative obligatory treaty?
8. What is the purpose of premium portfolio transfers?
Chapter 4
9. What happens in a reverse profit commission arrangement?

Features and operation
5
of non-proportional
outcomes
Learning objectives
Chapter 5
Introduction
Key terms
A Main features and operation of non-proportional 5.1
B Different bases of cover attachment 5.2
C Premium calculation for non-proportional reinsurance 5.3, 5.4
D Event limits 5.6
E Reinstatements 5.5
F Case studies 5.1
Key points
Question answers
Self-test questions
Learning objectives
• discuss the basic types of non-proportional reinsurance treaties and their uses;
• discuss the advantages and disadvantages of the different types of non-proportional
treaties;
• describe the information needed to rate non-proportional reinsurance treaties;
• outline the various definitions of premium income used under non-proportional treaties;
• describe the ways that premiums and claims recoveries are made under non-proportional
treaties;
• outline the different ways in which cover can attach under non-proportional treaties;
• describe the significance of ‘event’ in determining how losses are allocated under
non-proportional treaties;
• explain the importance of reinstatements; and
• discuss the use of event limits in non-proportional reinsurance treaties.
Introduction
When considering the disadvantages of proportional insurance, we noted that although it
provides useful protection for a natural catastrophe loss, such as a hurricane from which the
reinsured sustains losses from a number of different risks in its portfolio, the reinsured still
retains aggregate exposures for the retained portions of each risk in its net account. To
protect against these types of losses and substantial single large losses, a different type of
treaty was developed: non-proportional reinsurance.
Key terms
Accumulation of loss Aggregate excess of Buffer excess of loss Catastrophic loss event
loss
Cession bordereaux Clash excess of loss Common account Deductible
Event limits Excess First loss Gross net retained

premium income
(GNRPI)
Gross written Limit of cover Losses occurring during Per risk cover
premium (GWP) (LOD) basis
Reinstatement Retention Risk excess Risks attaching during

Chapter 5
(RAD) basis
Stop loss treaty Umbrella excess of loss Working excess of

loss cover
A Main features and operation of

non-proportional reinsurance treaties
Balance of any loss
With non-proportional reinsurance the balance of any loss which exceeds an agreed limit will
exceeding an be met by the reinsurer, usually up to a contractual maximum. The amount assumed per loss
agreed limit is met
by the reinsurer
by the reinsured is variously known as the deductible retention, the excess or sometimes
deductible, retention
the first loss
loss. The reinsurer’s part of the loss is known as the limit of cover
cover, this being the
defined amount it will pay in excess of the amount of loss borne by the reinsured. The
contract is for a fixed period. The best way of demonstrating how such a reinsurance is
constructed is to consider an example.
Chapter 5 Features and operation of non-proportional reinsurance treaties 5/3
Example 5.1
Insurance company B is writing a portfolio of homeowners’ property business. The
company decides that it is willing to meet any claim up to £250,000 from its own funds
and purchases reinsurance protection for any claims in excess of this amount.
The maximum perceived exposure from a single dwelling is £1,000,000, and the company
decides that it needs a treaty to meet the balance of this potential exposure of £750,000
(i.e. £1,000,000 less £250,000). It follows that:
• the deductible, or that part of a loss the insurer has to pay before it is possible to
involve the reinsurance, will be £250,000; and
• the limit, or that part payable by reinsurers, is £750,000.
This reinsurance can be referred to as covering £750,000 in excess of £250,000 per risk.
The table shows the distribution of loss payments between the company and the reinsurer
for three separate claims of £150,000, £400,000 and £1,275,000, respectively.
Claim Payment to insured Reinsured

Reinsured’’s Reinsurance Reinsured
Reinsured’’s
retention recovery additional
unreinsured
retention
1 £150,000 £150,000 Nil –
Chapter 5
2 £400,000 £250,000 £150,000 –
3 £1,275,000 £250,000 £750,000 £275,000
We can see that insufficient cover was purchased by the company to be able to recover
fully the large, unforeseen third loss. This suggests that the company miscalculated its
maximum exposure to any one risk. An additional layer of cover could have been
purchased in excess of £1m, that is, above the limit of the layer £750,000 excess of
£250,000. Alternatively, the treaty limit could be increased to automatically
accommodate the large loss although this might not be cost effective if losses of this
magnitude are seldom encountered.
From the way that the cover is applied, non-proportional reinsurance is also referred to as
loss. In non-proportional reinsurance, a series of ascending layers may protect an
excess of loss
account on a vertical basis and this is called an excess of loss programme
programme.
A1 Excess of loss treaties

Consider this
this…
…
What do you think is meant by ‘excess of loss treaties’?
Non-proportional reinsurance treaties are characterised by a distribution of liability between Distribution of

the reinsured and the reinsurer on the basis of losses rather than sums insured, as is the case liability between
the reinsured and
in proportional reinsurance. In consideration of the cover granted, the reinsurer receives part the reinsurer
of the original premiums but this is not that part of the premium corresponding to the sum
reinsured, which would be the case in proportional reinsurance. Several types of non-
proportional cover exist and we will look at these later.
Unlike a proportional treaty, the size of cession is not determined case by case. This allows
the reinsured to dispense with cession bordereaux (which is a list of risks ceded by the
reinsured to the reinsurance policy) and reinsurance registers, while losses are shown on a
loss bordereau or, more generally, on an individual basis.
A1A Use of excess of loss treaties

Before deciding which method of reinsurance to use for the protection of an individual risk
or class of business, an insurer has to take a number of different factors into account. It must
decide which is the most appropriate in the light of its business objectives. Traditionally,
proportional reinsurance has been used by an insurer to either increase its capacity to
underwrite more and bigger risks, or to expand its portfolio by the reciprocal exchange of
business.
However, an insurer must always be conscious of the potential effect on its account of
situations that its proportional reinsurance arrangements either cannot respond to or will
leave it with higher net retained losses than the insured is prepared, or able, to accept.
Consider this
this…
…
What defining terminology under insurer A’s quota share treaty might prevent it ceding a
portion of a £10m multi-tenure timber-built converted mill?
Examples of such situations include:

• losses on single risks that by their nature or size fall partially or totally outside the scope of
any existing proportional arrangements;
• losses arising on a number of original risks at the same time, all as the result of one
particular occurrence or event; and
• the general deterioration of the performance of an account or class of business due to an
abnormal or unpredictable increase in the incidence of losses.
In these circumstances, the various options provided by excess of loss reinsurance should be
considered.
Nature of business to be protected
Particular attention
When considering the choice of reinsurance protection, particular attention must be paid to
must be paid to the nature of the original business to be protected. While all original risks could probably be
Chapter 5
the nature of the

original business
reinsured individually on a facultative basis, this would prove inconvenient and
administratively expensive for an insurer with any sizeable portfolio of business. If the
portfolio is made up of a number of small risks for which there is little exposure, the insurer
may not wish to pass on the substantial volume of premium to its reinsurer on a largely
profitable account but merely protect against an ‘unforeseen’ event, which may accumulate
the exposure of the insurance company to a degree which substantially affects its
profitability.
Exposure to large losses
Excess of loss can be used specifically to protect the insurer against an exposure to a
specific large loss event, such as a windstorm, where the portfolio is exposed to large
individual losses and to the effects of the accumulation of loss as a result of that particular
event. While protection for large specific cases can be catered for by surplus treaty
arrangements, full protection for classes of business without known sums insured cannot.
Provision should be made for the effects of any possible catastrophe situation that may
arise; this can be achieved by arranging excess of loss reinsurance protection on a per
event basis.
Example 5.2
An insurer has a portfolio of 1,000 houses each insured for £400,000. Each house
suffered losses of £100,000 in a windstorm. If the insurer had purchased a 50% quota
share treaty it would have reinsured out £50m of the loss but retained £50m. However, if
it had purchased excess of loss cover in a series of layers excess of £10m, up to £100m it
would only retain £10m of the losses. This would make a significant difference to the
overall profit account of the company. Therefore, excess of loss reinsurance minimises the
influence of large losses on the insurer’s profits.
Other factors
Other factors also influence the decision as to which form of treaty reinsurance an insurer
will select:
• What will be the administrative costs and how easy will it be to operate?
• What is the effect on the company’s net retained premium income and does this support
its overall business strategy?
• Is reinsurance required solely to control exposures to losses or is it required to assist with
other financial considerations, such as increasing capacity or easing or meeting solvency
requirements?
• Does the company want to use reinsurance as a means of expanding its book of business
by use of reciprocal exchanges?
Ease of use
A major attraction of the excess of loss treaty is its simplicity of operation, particularly where A major attraction
the need for reinsurance is more important for the control of exposure to loss, rather than of the excess of
loss treaty is its
other financial considerations. The insurer must ensure that its retention, and the amount of simplicity of
cover it purchases, are sufficient to meet its foreseeable needs, but after that it need no operation
longer be concerned about the reinsurance of individual risks. The insurer will be liable for all
losses that fall below the limit of the deductible (the excess point) and the reinsurers will be
liable for all losses above this amount, up to the limit specified.
Question 5.1
What special consideration exists, when purchasing reinsurance, for a motor insurer
issuing original policies providing third-party personal injury and property damage
insurance?
Level of protection and retention

Assessing the amount of protection required, and the level at which the protection starts,
needs great care on the part of the insurer.
If the excess point is set at too high a level in relation to the anticipated normal losses of the
class of business being protected, the insurer may find that, in a typical year, it ends up
paying not only the cost of the reinsurance premiums, but also the full cost of all claims. Any
recovery from reinsurers will only be available for the exceptionally large claims to the
Chapter 5
account, which may be infrequent and few.
The operation of the principle that a deductible is retained by the reinsured, means that
excess of loss reinsurers do not expect to be involved in every claim, nor, in fact, in the
majority of claims. Therefore, if the retention is set at a level so low that reinsurers are
exposed to a disproportionate number of claims, it may be argued that the insurer is seeking
the benefits of quota share-type protection at a discounted price. In such circumstances, it
would be reasonable to expect either an increase in the cost of the protection or an
adjustment upwards of the company’s deductible under the covers concerned.
Consider this
this…
…
Consider the position of a reinsurer providing cover above an artificially low excess point.
Not only will they be exposed to the majority of the insurer’s losses, but they will also incur
additional administration costs in considering lengthy loss bordereaux.
A1B Advantages and disadvantages of excess of loss treaties

Advantages
Compared to proportional treaties, non-proportional business has the following advantages:
• Accounting procedures are simplified compared to proportional business, which is usually
accounted for on a quarterly basis. In addition, proportional treaties may provide for
entries for claims that occur above the cash call limit.
Regardless of significant movement in the account, proportional treaties require quarterly Proportional
statements while ever the treaty remains open. Only when all movements on the account treaties require
quarterly
have ceased, or the treaty has become ‘clean cut’, can the production of quarterly statements
statements be discontinued. This can be an administrative burden for all concerned.
• Administration costs are substantially reduced because there is less movement within the
account. Generally there is only a major reconciliation at the end of the contract period,
and when claims have to be settled.
• The reinsurance premium is all inclusive and not calculated on each cession but on the
whole of the ceding insurer’s portfolio in one or more branches, in order to cover losses
occurring during a calendar or treaty year.
• The reinsurance premium is predetermined.
• Usually, there is no profit commission.
• The reinsurer does not deposit technical reserves.
Be aware
A cash call limit allows the insurer to ask the reinsurer to pay its share of any large loss
over a predetermined figure immediately, rather than having to wait for the cost to be
included in the next quarterly loss account.
Disadvantages
Non-proportional business has the following disadvantages for the reinsurer:
• Calculation of excess of loss business is more complex and requires greater checking,
including the use of actuarial or rating models.
• The cost of reinsurance can vary considerably from one accounting period to the next,
depending on the development of the premium income, of the loss ratio and of the
reinsurance market.
• Lower premiums are received when compared to proportional business. This is due to the
elimination of a proportional recovery of all the smaller claims.
• The treaty can be unprofitable for the reinsurer whilst simultaneously being profitable for
the reinsured.
Reinforce
Before you move on, ensure that you are clear about both the advantages and
disadvantages of excess of loss treaties.
Chapter 5
A1C Use of excess of loss with other types of reinsurance

Treaty excess of loss reinsurance may be used by an insurer as the sole means of protecting
an account or class of business by purchasing protection both at a per risk level and for
catastrophe situations. It is also widely used in conjunction with proportional reinsurances
where the insurer does not want the restrictions in the amount of risk cover that may be
available from excess of loss reinsurers.
There might also be concerns over the effect that an accumulation of losses arising out of
one event may have on the insurer’s overall net retained liability. In this case, the individual
risk protection would be provided by quota share and/or surplus treaties, and/or facultative
policies, with the excess of loss treaty being in place to respond when the accumulated
losses to the reinsured on individual risks arising out of one event reach an unacceptable
level. This point will vary depending on the financial strength of the company concerned, but
would be deemed to be the point at which true catastrophe protection would commence.
Example 5.3
An insurer has a nine-line first surplus treaty protecting agricultural buildings up to £1m
any one building. The insurer’s maximum retention for any one building is £100,000.
It wishes to limit its net retention any one event to £1.5m and buys excess of loss cover in
layers providing cover of £28.5m in excess of £1.5m any one event. Should the same
windstorm cause total loss damage to 25 buildings its recovery potential would be:
From surplus reinsurer(s) 25 × £900,000 = £22.5m.
From excess of loss reinsurer(s) £2.5m – £1.5m = £1m.
Total recovery £23.5m.
A1D Types of excess of loss treaty

Treaty excess of loss protection is generally available in a variety of forms. Each is intended
to respond to different situations that may affect an insurer. We will consider the main types
of treaty excess of loss and examine the ways in which they operate.
Risk excess or per risk
The purpose of a per risk excess of loss is to provide protection for the reinsured should a
loss occur on an individual original policy, which is greater than a monetary amount that the
reinsured is prepared to retain itself. Each and every loss that is less than this amount, which
is the retention or deductible, will be borne by the reinsured. Reinsurers will be called upon
to respond to their share of each and every loss amount in excess of this retention.
Since there will be a number of policies in the reinsured’s portfolio that have an exposure in
excess of the agreed deductible, the reinsurer participating in such covers may expect to be
involved with losses from different original policies in any one year. The exposure to a per
risk excess cover can be within the policy sum insured or estimated maximum loss (EML), as
well as being greater than the reinsured’s EML where this has been incorrectly calculated.
Consequently, such treaties are often referred to as working covers
covers.
Consider this
this…
…
Why do you think the term ‘working covers’ is an appropriate way to describe such
arrangements?
Chapter 5
An important factor to be considered with such protections is the level of the deductible. We
already know that the deductible is the point at which reinsurers become liable to pay
claims. If the deductible is too high, the reinsured will end up paying both for the cost of the
reinsurance as well as a disproportionate amount of the claims. If the deductible is set at a
level reinsurers perceive to be too low, there will be a corresponding increase in the
premium charged for the protection. The cover should be arranged so that a balance is
maintained between the amount of cover required and its cost, which, if it is too high, will
erode the premium income it is seeking to protect.
Where insurers seek to limit the loss on any one risk by way of excess of loss, the reinsurance Reinsurance cover
cover must be designed on a per risk basis, which means that each loss is regarded must be designed
on a per risk basis
separately per risk. Where an event affects several risks, this will also result in several losses
for the excess of loss reinsurance. What we then have is a working excess of loss cover per
event (WXL/E
WXL/E). A working cover is where the deductible is effectively less than the retained
sum insured on a single risk. This means that claims can occur from an event that only
damages one risk. It is described as a ‘working cover’ because is triggered by a loss on a
single risk and is, therefore, exposed per risk. Example 5.4 illustrates how it can also be used
in combination with proportional reinsurance.
Example 5.4
The direct insurer cedes to reinsurance, via a surplus, risks on which the liability exceeds
£50m. It has a surplus reinsurance of 13 lines with a retention of £50m, i.e. a maximum of
£700m (13 × £50m + £50m retention).
Based on its maximum exposure to any one loss event, it is prepared to pay all losses on
any one risk up to £5m itself and goes to the reinsurer for the following per risk excess of
loss cover:
£45m in excess of £5m on its retained liability of the surplus treaty of £50m.
We can see in this example that the insurer wishes to protect its gross retained liability per
risk of £50m by means of a working excess of loss reinsurance of £45m in excess of £5m per
risk. Therefore, for all risks that the insurer writes under £50m, which would theoretically go
to its net account (as the surplus reinsurance would not operate on risks under £50m) the
insurer would retain the first £5m of any loss from each risk and the further £45m of any loss
from each risk would be covered by the working excess of loss reinsurance.
Risks greater than £50m would have to be ceded to the surplus in proportion to the size of
the risk and the loss would have to be recovered in accordance with the ceded proportion.
Example 5.5 takes this premise a stage further.
Example 5.5
Risk X: sum insured £120m; gross loss £20m
Loss to surplus treaty: £20m × (£70m/£120m) = £11.66m
Loss within retention (before excess of loss): £20m × (£50m/£120m) = £8.34m
Excess of loss: £8.34m – £5m = £3.34m
The insurer pays £5m of the loss, which is its retention under the excess of loss.t
The excess of loss reinsurer pays £3.34m and the surplus reinsurer £11.66m, equalling the
gross loss of £20m.
Risk Y: sum insured £40m; gross loss £12m
Loss to surplus treaty: £12m × (0/40) = 0
Excess of loss: £12m – £5m = £7m
The insurer would pay £5m of the loss, which is its retention under the excess of loss.
The excess of loss reinsurer pays £7m and the surplus reinsurer pays nothing, as the
original risk was not ceded to the surplus reinsurance as it is within the insurer’s risk
Chapter 5
retention.
If both the losses affecting Risk X and Risk Y can be attributed to the same event, the
direct insurer must itself bear the deductible of £5m per risk twice. On the other hand, the
reinsurer also grants the per risk excess of loss cover twice where two or more covers
have been agreed.
Common account protection

Refer to While accepting that excess of loss reinsurance was designed to protect an insurer’s net
chapter 3,
section A3A for account, either in conjunction with proportional treaty arrangements or as the only form of
common account reinsurance purchased, it might be necessary to arrange protection for the account of both
reinsurance
the reinsured and its proportional reinsurers. This is known as common account reinsurance.
It may be because the treaty reinsurer’s own retrocessions do not provide the necessary
protection or because the treaty is unduly exposed by certain risks falling within its scope.
The provision of such protection could also make the treaty more attractive to prospective
treaty reinsurers.
Occur most
Common account arrangements occur most frequently with quota share treaties as there is
frequently with a consistent, direct involvement between the parties participating in the reinsurance and the
quota share
treaties
original insurances. Both parties to the proportional treaty share the benefits brought by
excess of loss protection for the common account. The cost of the common account cover is
also shared, although, occasionally, the reinsured pays for this in its entirety.
Example 5.6
An original insurer has a quota share proportional treaty to which it cedes 40% of its
business. The total liability to both parties can still be very high, especially where a
number of claims all arise from the same ‘event’ or accumulation of circumstances. The
insurer may decide that it wants to limit its liability, irrespective of the existence of the
quota share treaty, and buy extra non-proportional cover. On the other hand, the insurer
and the quota share reinsurer may agree to purchase the cover to protect both their
interests (for the ‘common account’). The protection for them would be on a non-
proportional treaty basis, noting the interests of the insurer and its interested reinsurer.
Figure 5.1 shows how this arrangement looks when expressed diagrammatically.
Figure 5.1 shows how the arrangement in example 5.6 looks when expressed
diagrammatically.
Figure 5.1: Common account protection
Common account protection
Insurer retains Insurer cedes
0% 60% 100%
A similar arrangement may apply where the insurer has an existing facultative reinsurance
for a specific risk. The premiums for the common account cover would most likely be shared
between the insurer and its reinsurer, in accordance with their respective interests in the
treaty. In example 5.6, the quota share treaty reinsurer receives 40% of all original premiums
ceded to the treaty and pays for 40% of the common account cover. Recovery of losses
exceeding the common account deductible would usually be paid to the original insurer, i.e.
the reinsured arranging the cover for itself and its quota share reinsurer, which would then
reimburse the quota share reinsurer with its 40% of the recovery.
Be aware
Chapter 5
The excess of loss protection may be an option or compulsory feature of the treaty
arrangements. In either case, the reinsurance would be placed in a similar manner to net
account protections and would, in effect, reinsure the company’s gross account.
Catastrophe or per event

Where the insurer tries to limit the loss per event by means of excess of loss, it is then
interested in an actual ‘per event cover’. This provides it with claims settlement irrespective
of the number of possible risks affected by the loss.
Alternatively, a catastrophe excess of loss treaty provides protection for the reinsured
where one catastrophic event causes losses on various original insurance policies which, in
total, exceed the amount the reinsured is prepared to retain on each and every catastrophic
event. This protects the reinsured from an accumulation of its retentions on original risks
after the application of any prior per risk reinsurance on a proportional or non-proportional
basis.
Whether the insurer arranges a per risk or a per event excess of loss makes a considerable
difference, especially for classes of business with a significant accumulation potential.
Question 5.2
Refer back to example 5.5 and assume instead that the cover had been placed as per
event cover rather than on a per risk basis. If the losses had arisen from one event, how
many deductibles would the insurer have borne?
It would be wrong, however, to assume that the insurer always receives a greater
contribution from the reinsurer with a per event cover than with a per risk cover on
comparable losses. Example 5.7, which is based on the example referred to in question 5.2,
shows that a per risk cover can also lead to higher contributions to losses from the reinsurer.
This is because, where a sufficient number of large risks are affected by sufficiently large
losses from one and the same event, the insurer with a WXL/E cover in fact runs the risk of
having bought insufficient reinsurance cover. To illustrate this point we have added a third
loss to those already considered in that example.
Example 5.7
Assuming that:
Risk X: insurer’s net loss before excess of loss = £8.34m.
Risk Y: insurer’s net loss before excess of loss = £12m.
A third loss arises from the same loss event.
Risk Z: insurer’s net loss before excess of loss = £50m.
On a per risk excess of loss insurers could claim:
Risk X: £8.34m – £5m = £3.34m.
Risk Y: £12m – £5m = £7m.
Risk Z: £50m – £5m = £45m.
Making a total of £55.34m, with the insurer retaining three retentions of £5m = £15m.
Under the event based cover
Risk X: £8.34m
Risk Y: £12m
Risk Z: £50m
Chapter 5
Total £70.34m
Less deductible £5m
£65.34m
However, if maximum limit of reinsurance purchased is £45m.

Insurer retains further £20.34m.
Therefore, the insurer will retain £25.34m (£20.34m plus £5m retention) under the per
event and £15m under the per risk covers.
Recoveries may be
Whatever method of protecting each of its risks an insurer chooses, it must also consider the
restricted by event likelihood, and possible effects, of a major or catastrophic event that leads to a number of
limits
original policyholders making claims against the insurer at the same time. The insurer will
recover a proportion of such losses on individual policies from any proportional reinsurance
arrangements that it has in place and also, possibly, from any risk excess of loss cover it has
purchased. However, the amount of any such recoveries may be restricted by the inclusion
of event limits in the reinsurance protections. What constitutes one event is an essential
point for agreement between the reinsurer and the reinsured.
Accumulation of loss
It is the known, and possibly unknown, accumulations of losses to an insurer’s net retained
account that may present an unacceptably high risk to the ultimate profitability of any
particular account, or even of the company itself. The insurer should seek to purchase
catastrophe excess of loss protection to reduce the effect of such situations.
In a property account, such losses are usually associated with natural perils or
conflagrations, and the purpose of catastrophe excess of loss protection is to provide cover
for the occasional, infrequent but major loss event.
For our purposes, the definition of a catastrophic loss event is that it should be caused by a
specific, sudden, fortuitous, shocking and external happening that can be located in time
and place. Moreover, any such event must be the proximate cause of each and every loss to
the original insureds that the insurer is accumulating to calculate its catastrophe claim and
be a peril covered by the catastrophe treaty. It is accepted that a catastrophe claim can
include losses from any other peril covered by the treaty that directly arise from the
initial peril.
Deductible
The deductible is the point at which the excess of loss reinsurance will start to pay claims Deductible is the
and setting it at a suitable level is the first decision that must be made. In monetary terms, point at which the
excess of loss
this will vary greatly from company to company depending on its financial strength and the reinsurance will
extent to which it is exposed to catastrophe perils. It is assumed that a catastrophe start to pay claims
protection would not usually be called upon to respond to a claim situation unless the
company had lost the equivalent of a minimum of one risk retention, and that two or more
original risks had been affected by the same event.
If the deductible is too high, the reinsured finds it is paying a larger proportion of its net
accumulated losses than intended. If it is set too low, catastrophe reinsurers may find
themselves being called upon to pay a proportion of the normal losses that are expected to
attach to an account, which is not the intention behind catastrophe reinsurance protection.
Quantifying the exposure to an accumulation of loss from any particular cause or event –
and therefore the amount of protection that may be required – has always been an exercise
that is prone to error.
Example 5.8
An insurer believes it has a maximum of 1,000 insured properties situated on a flood-
prone stretch of coastline in eastern England with each property having a loss potential of
£300,000, giving an overall risk accumulation of £300m. It arranges catastrophe excess
of loss cover in layers of £250m excess of £50m.
Chapter 5
Its management information is incomplete: it actually has 1,500 insured properties giving
an overall risk accumulation of £450m. It is apparent that the catastrophe cover it has
bought is inadequate.
This miscalculation could be for a variety of reasons, including a failure to properly
account for additional exposures resulting from acceptances on inwards reinsurances.
Although modern methods of recording, indexing and collating risks provide the reinsurer
with much more and better information than in the past, the possibility of catastrophic
losses from natural perils, riots and conflagrations is always increasing. This can be as a
result of an increasing concentration of risks subject to such perils due to the development
of previously underdeveloped countries or regions.
Question 5.3
What other factors contribute to the increasing prospect of catastrophic losses
occurring?
It may be argued that a company should buy all the protection it can afford, bearing in mind
that any loss exceeding the total amount of cover available from the excess of loss
programme will otherwise have to be retained by the company in addition to its original
deductible, thus increasing its overall net retained loss.
However, if the company is operating in accordance with sound underwriting principles, There is a danger
there is a danger of being over-reinsured and paying for cover that is, in real terms, unlikely of paying for cover
that is unlikely to
to be used. Although the company’s total exposure on a sum insured basis may be quite be used
high, the probability of all the policies involved being total losses as the result of any one
particular event will be much smaller. Therefore, the amount of cover needed should be
assessed as carefully as possible.
In the past, subjective judgments have been used to identify the amount of cover to
purchase, such as a simple multiple of the premium income generated by the exposed
region or risks. Today, reinsurers require more detailed information regarding earthquake,
windstorm and other natural peril exposure by region, so that the potential liability can be
assessed more accurately. While such procedures may be costly (in terms of both time and
money), they benefit both reinsured and reinsurers in the long run by eliminating, or greatly
reducing, the incidence of buying excessive or inadequate levels of reinsurance and inexact
means of rating.
Determining the amount of catastrophe protection is not the end of the potential problems
for the insurer, or for its reinsurers. The protection will respond to claims arising out of a
catastrophic event, but deciding whether or not a particular set of circumstances constitutes
a catastrophe can be difficult and can frequently lead to disputes between the reinsured and
its reinsurers.
Consider this
this…
…
We mentioned earlier that a catastrophic loss event should be located in time and place.
Supposing we have an earthquake that occurs on 1 January and an aftershock takes place
six hours later but 100km away from the earthquake’s epicentre. Do you think that
insurers would always treat these as the same or separate events, or would it depend on
the definition of ‘event’?
A2 Stop loss treaties

A stop loss treaty reinsures aggregate losses arising in respect of a specific class or classes
of business, rather than individual losses or aggregations caused by an event or occurrence.
These types of protection are long-stop protections and, as such, apply after the benefit of
all other prior reinsurance. You may sometimes see stop loss referred to as ‘excess of
loss ratio’.
Expressed in
Stop loss contract limits are expressed in percentage amounts of the reinsured’s gross net
Chapter 5
percentage retained premium income (GNRPIGNRPI) (for example, 50% GNRPI excess of 105% GNRPI). The
amounts of the
reinsured’s GNRPI
GNRPI is the company’s premium income for the duration of the cover, generally one year,
less cancellations and returns only, and less the premium outlay for all other reinsurances, as
these are to the benefit of the stop loss reinsurance.
The premiums of the GNRPI are gross; no commission or costs are deducted for contribution
to the reinsured’s costs. They are subject to minimum and maximum criteria (to protect both
parties) and any resultant recovery converted into monetary terms based upon the ultimate
GNRPI for the annual period in question.
Table 5.1 illustrates three examples of where a reinsurer’s potential liability could attach
based on the reinsuring company’s GNRPI of £1m and the extent of the reinsurer’s liability
represented by the cover range.
Table 5.1
(i) Attachment point as (ii) Cover as a (iii) Cover (iv) Cover range
a percentage of GNRPI percentage of (i)
100% 20% £1m × 20% £1m to £1.2m
110% 30% £1m × 30% £1.1m to £1.4m
120% 40% £1m × 40% £1.2m to £1.6m
A2A Use of stop loss treaties

The following example illustrates how an insurer could use stop loss protection.
Example 5.9
A property insurer has a fire insurance portfolio protected as follows:
• 60% quota share with maximum gross acceptance of £100,000;
• catastrophe cover for common account of £1m excess of £300,000 at 5% of gross
premium income (GPI).
If GPI is £10m, the reinsured has a retained income arrived at as follows:
40% retained quota share £4m
Less 40% of 5% GPI (being its share of the £200,000 for catastrophe cover
premium for the catastrophe cover)
GNRPI = £3.8m
The insurance company decides to purchase stop loss protection of 50% of retained
premium in excess of 100% of retained premium.
If its retained losses after all prior reinsurance recoveries amount to £4.75m (or 125% of
retained income) the stop loss reinsurer would pay £950,000. However, if retained losses
reached £6.65m based on a retained premium income of £3.8m (or 175% of retained
income) the stop loss reinsurer would only pay the maximum cover of 50% of £3.8m.
This leaves the insurance company with the balance of £950,000, calculated as follows:
Retained losses £6.65m
Chapter 5
Less insurance company’s deductible £3.8m
£2.85m
Reinsurer’s liability 50% of £3.8m £1.9m
Balance not recoverable under stop loss £950,000

reinsurance
Therefore, insurance company’s total retained loss £3.8m
Plus £950,000
= £4.75m
A2B Advantages and disadvantages of stop loss treaties

Advantages
As we saw in example 5.9, stop loss reinsurance guarantees to meet retained losses that Gives the insurer a
exceed a pre-agreed percentage or amount of the insurer’s net retained income, up to a degree of certainty
that its overall
further predetermined percentage or amount. It, therefore, gives the insurer a degree of claims experience
certainty that its overall claims experience will be capped at a pre-selected loss ratio, will be capped
assuming, of course, that it has purchased sufficient reinsurance protection.
Disadvantages
Stop loss is unlikely to be available for motor and liability types. This is because the long-tail
nature of claims in these classes makes it difficult to take a view on how the account
protected has actually performed in the short- to medium-term. Furthermore, the insurer’s
options are limited, because cover is usually only applied to losses in excess of 100% of
premium income and so a substantial loss has to be sustained before reinsurance protection
becomes effective. Cover is also applied with an upper limit and sometimes with co-
insurance. There is a limited market for stop loss and it may only be available for certain
types of risk, such as crop hail insurance.
Co-insurance
Where cover is applied with co-insurance, the insurer participates in the loss, which would
otherwise have been wholly passed to the reinsurer. The use of co-insurance is expressed,
for example, as follows:
90% of 50% of GNRPI excess of 105% GNRPI
Here, the insurer contributes 10% to the reinsurer’s exposure in the range of 0-50% of
losses greater than 105% of the insurer’s GNRPI.
A3 Aggregate excess of loss treaty

A form of excess of
While stop loss operates based on pre-agreed percentages, aggregate excess of loss cover
loss reinsurance has limits that are expressed only as fixed amounts. The similarity is that both set out to limit,
or reduce, the aggregation of claims within predetermined boundaries over a period of time,
usually annually. Aggregate excess of loss reinsurance covers the aggregate of losses, above
an excess point and subject to an upper limit, sustained from a single event or defined peril
or perils, over a defined period, usually one year. In essence, it is an excess of loss treaty
reinsurance, under which the reinsurer responds when a reinsured incurs losses on a
particular line of business during a specified period, in excess of a stated amount.
Aggregate excess of loss contract limits are expressed in monetary terms, say, ‘$2.5m in the
aggregate excess of $5.25m in the aggregate’, and all losses affecting the account are
aggregated to ascertain any potential excess of loss recovery against those contract limits.
Example 5.10
The reinsurer indemnifies a US insurance company for an aggregate, or cumulative,
amount of losses in excess of a specified aggregate amount. This can be written ‘excess of
US$1m in the aggregate excess of US$1m in the aggregate’.
There might also be an inner deductible to apply only to losses excess of a stated dollar
amount. This would be expressed as ‘US$1m in the aggregate excess of US$1m in the
aggregate applying only to losses greater than US$100,000 per loss’.
Chapter 5
Use of aggregate excess of loss treaties

Aggregate excess of loss treaties are used to protect the insurer’s net absolute retained
account against attritional losses, which are relatively small in size but have a potentially
substantial impact on overall loss ratios.
A3A Advantages and disadvantages of aggregate excess of loss

treaties
Advantages
Provides a corridor
Aggregate excess of loss treaties provide a corridor of protection over the insurer’s
of protection expected results in exchange for a fixed premium. In addition, they may incorporate refunds
in premium if the insurer delivers good results to the reinsurer. They provide aggregate
protection of underwriting results. Finally, they ‘take the sting out of’ an above-average net
loss ratio.
Disadvantages
No claims can be made unless, and until, the insurer has first incurred an ultimate net loss on
business covered during the accident year that is in excess of a chosen figure. In addition to
its initial retention, the insurer may be required to retain a further percentage of the ultimate
net loss in the form of co-insurance.
Reinforce
Here we can see a parallel with stop loss, covered in section A2, where both variants
require the insurer to bear the effects of part of the overall loss.
A4 Other forms of excess of loss covers

Clash excess of loss
A single event can impact on two or more classes of business, for example a storm could
generate claims on both the insurer’s marine cargo and property business. This is significant
when the insurer has bought protection for each separate class of business.
The insurer might not want to risk having to retain losses from this event in both classes of
business, as this could unfavourably affect its overall profitability.
Clash excess of loss cover responds to the aggregation of identified classes of insurance
when two or more of its insureds suffer a loss from the same loss event. The insurer can
aggregate its individual programme retentions and set them against the clash excess of loss
protection.
Another scenario is that the insurer may have purchased separate excess of loss protections
for motor, general public liability, employers’ liability and personal accident, together with a
property excess of loss programme, including the motor own damage, or marine hull,
account. In addition, there may be separate programmes in force for the insurer’s
engineering and marine, aviation and transport accounts. In essence, clash cover provides
the insurer with protection against an accumulation of net losses across a number of
accounts once all of its more specific reinsurances have been used in the separate accounts.
Here is another example to help our understanding of how clash covers work.
Example 5.11
An insurer has provided cover for:
• cargo awaiting shipping at a dock, which belongs to one company; and
• goods stored at the nearby warehouse belonging to another company.
Both are destroyed by the same fire and the insurer has to pay both firms and seek to
recover from its excess of loss protections.
One claim is made against its marine account with a deductible of £100,000.
The other claim is under the property account with a deductible of £200,000.
The insurer is left with a combined net retention of £300,000.
However, if there was a clash protection for £400,000 excess of £100,000, then it could
Chapter 5
claim £200,000 from this excess of loss protection.
Question 5.4
If losses were to occur involving more than one of these separate programmes, how
would a clash excess of loss protection benefit the insurer?
Umbrella excess of loss

While the clash excess of loss protects the insurer’s aggregation of programme retentions, Protects the
an umbrella excess of loss protects the insurer against the exhaustion of all its excess of loss insurer against the
exhaustion of all its
programmes. In other words, against that fateful loss event that utilises all of the insurer’s excess of loss
programmes. It is a single composite excess of loss cover that protects the insurer against an programmes
accumulation of losses in excess of its specific underlying policy limits. Therefore, the cover
responds after a loss has gone through all the layers of a particular programme. It is called an
umbrella as it is designed to sit above the covers put in place for a number of classes. The
reinsurers would have to consider the loss potential arising from the programmes for any of
those classes of business, all of which are most likely to be exhausted at different monetary
levels. Figure 5.2 shows how this arrangement looks when expressed diagrammatically.
Figure 5.2: Umbrella excess of loss
Umbrella excess of loss protection
Motor Property Liability
Buffer excess of loss

A buffer excess of loss could be effected at a level as low as £250,000 within an account. It Could be effected
would respond to identified loss causes only, for example, all motor hull own damage losses at a low level
within an account
forming part of a combined property and motor hull own damage programme.
The buffer excess of loss may be effected on a stop loss basis, but it is more usual to be
effected as excess of loss within the main layer. Losses attributable to the identified source
pay in priority to the main layer.
Back-up covers
If the original reinsurance has two reinstatements
reinstatements, thus producing a gross limit of three
losses, an insurer might require further cover to protect the account. This cover would be
arranged to only come into operation if the original cover was exhausted. Therefore, the
price for this back-up cover should be substantially lower than the original cover.
Reinstatement premium protections
Reinstatements These covers indemnify the insurer for the payment of reinstatement premiums following a
covered in
section E loss that has affected a particular programme.
Consider this
this…
…
It is debatable whether the insurer has an insurable interest in reinsuring a contractual
obligation, namely the payment of additional reinstatement premiums following a loss, or
whether the promise to reimburse the insurer for the payment of such premiums could be
considered to be a financial guarantee – often a specific exclusion under many excess of
loss programmes. What is your view?
‘Top and drop

drop’’ and ‘cascade
cascade’’ protections
These specialist covers can form part of an excess of loss programme. They are often used in
Chapter 5
Often used in
connection with connection with retrocession business and provide cover at more than one level. The
retrocession
business
primary purpose is to provide top layer coverage. They can also act as a separate cover
where losses exceed the lower layers and reinstatements have been exhausted, and so ‘drop
down’ to provide additional protection. This protection makes good use of unexhausted
cover within higher upper layers.
B Different bases of cover attachment

In this section we seek to establish the basis of cover provided by the reinsurance contract
by defining the relationship between a feature of the original insurance policy or claim and
the period of the reinsurance contract. What follows is a description of the most common
bases. We will look at each type in more detail in chapter 7, section D1.
B1 Risks attaching during (RAD) (or policies issued and

renewed) basis
On this basis, reinsurers agree to assume liability for claims on risks attaching, and/or
original policies issued or renewed, during the period of the reinsurance.
A risk or policy is considered to attach if:
• it incepts; or
• is re-signed (in respect of multi-year contracts); or
• is treated as having been re-signed at the date when such risks, or part of such risks, have
reached any maximum period on any preceding period of reinsurance, during the period
of reinsurance.
Provided the inception date of a policy falls within the period of the reinsurance contract in
question, the reinsurers on that contract will be liable for all claims arising from that policy.
B2 Losses occurring during (LOD) basis

On this basis, reinsurers agree to assume liability for claims occurring during the period of Reinsurers assume
the reinsurance, irrespective of the inception dates of the original policies giving rise to the liability for claims
occurring during
claims. period of
reinsurance
The date the loss occurs must fall within the reinsurance policy period. The simplicity of this
approach has great attraction for the parties, making it easy to understand and to
administer.
Importantly, the clause should also state how time (or dates) are to be defined (for example,
‘Local Standard Time at the place where the loss occurs’) because the time in one place (or
zone) will be different in another part of the world. Greenwich Mean Time remains in
common use.
B3 ‘Claims made
made’’ and ‘losses discovered
discovered’’
On this basis, reinsurers agree to assume liability for claims made or losses discovered
during the period of the reinsurance. The reinsurer’s exposure to loss is not, therefore,
determined by the inception date of the original policy or the date on which the loss
occurred.
The reinsurance contract seeks to replicate the basis of the original insurance contract and Refer to
chapter 11 for
tends to be used for certain types of liability or casualty treaties.
Chapter 5
casualty
reinsurance
C Premium calculation for non-proportional

reinsurance
In this section we provide a general guide to the calculation of premium under a non-
proportional treaty account. However, it should be noted that these are general principles
only, and different reinsurers use different methods and apply different values to the rating
factors considered.
In the case of proportional reinsurance, the premium income means the original premiums
received by the ceding insurer, a proportion of which are passed, i.e. ceded to the reinsurer.
The premiums are usually gross, as written by the insurer, but occasionally they can be the
original net premiums. We have seen in chapters 3 and 4 that the premiums for proportional
reinsurance are calculated in proportion to the amount of risk transferred, so for example, if
50% of the sum insured is to be ceded then the reinsurer will receive 50% of the premium,
from which – in most cases – an allowance is made to cover the ceding insurer’s business
acquisition costs.
Premium is usually expressed as a rate per cent or per mille applied to the reinsured’s
premium income base
In the case of non-proportional reinsurance, the reinsurers are seeking an appropriate
premium for the risk that is being transferred to them. The premium is usually expressed as a
rate per cent or per mille applied to the reinsured’s premium income base for the account
being protected. Flat or in full premiums are also used.
Question 5.5
Why is the proportional method of allocating premium to reinsurers inappropriate for
non-proportional business?
The premium base can be defined in a number of ways. Table 5.1 shows a few of the most
common types.
Table 5.2: Premium bases

Gross written The total premium on insurance underwritten by an insurer during a period
premium (GWP) before deduction of any outwards reinsurance premium deductions for
retrocession cover.
Net written Written premiums net of outwards reinsurance premium deductions for
premium (NWP) retrocession/reinsurance cover.
Gross net written Gross written premium net of policy cancellations and outwards reinsurance
premium (GNWP) premiums but gross of commissions and expenses.
Gross net earned Represents the earned premiums of the reinsured company during the
premium period for the lines of business covered net, meaning after cancellations,
income (GNEPI) refunds and premiums paid for any reinsurance protecting the cover
being rated.
Gross net earned Gross earned premium less any policy cancellations and outward
premium (GNEP) reinsurance premiums but inclusive of commissions and expenses.
Gross net retained Gross premium income less policy cancellations and returns less the
premium income premium outlay for all other reinsurances with no deductions allowed for the
(GNRPI) reinsured’s costs.
C1 Adjustable premiums
Chapter 5
The final premium

Adjustable premiums are used in non-proportional reinsurance where the premium base on
can only be which the premium is calculated can only be estimated at the start of the contract. The final
calculated once
the contract
premium can only be calculated once the contract period has come to an end. In the case of
period has come to an excess of loss treaty, the reinsured’s actual premium income for the period of risk will only
an end
become known after the expiry date of the contract. At this point, any necessary adjustment
to the premium for the risk run during the period will take place, resulting in either an
additional or return premium due to or by the reinsurer.
Deposit premium is the amount of premium the reinsurer requires as an initial payment,
either in full at inception or by instalments during the period. Instalments are typically
payable on the first day of each quarter or half-year. A deposit premium is generally set at
about 80% or 90% of the expected final excess of loss premium, but it can be set at 100%. It
will be adjusted after expiry of the contract.
Excess of loss reinsurance contracts frequently contain a provision that the final adjusted
premium may not be less than a stated amount. This minimum premium is the least the
reinsurer will charge.
Consider this
this…
…
What is the benefit of a minimum premium provision for the reinsurer when the insurer’s
declared actual premium is much less than anticipated?
The custom in insurance transactions is that the insurer pays consideration to the reinsurer
at the start of the year of cover. In practice, the reinsurer usually makes provision for a
minimum and deposit premium as a fixed amount.
The amounts of both premiums are generally set at about 80–90% of the estimated excess
of loss premiums and are usually the same. At the end of the year of occurrence, the
minimum premium is adjusted. The adjustment is done by multiplying the agreed excess of
loss premium rate by the underlying premium actually written, or accounted. If the amount
obtained from this adjustment at the end of the year of occurrence is less than the minimum
premium, the insurer does not pay any more, but obviously does not obtain a refund.
Payment is considered completed if the same fixed amount has been arranged for deposit or
advance premiums and minimum premiums. If the effective premium is higher than the
minimum, the insurer pays the difference to the reinsurer.
C2 Basic information required for rating

non-proportional reinsurance
Insurers requiring excess of loss cover need to provide certain key (or basic) information to Insurers need to
the reinsurer, sometimes in the form of answers to a detailed questionnaire. The reinsurer provide certain key
information to the
then begins its rating process, giving attention to the following main points: reinsurer
• Annual premium income over the past few years and estimated income for the coming
year for the business to be protected.
• Structure of the proportional and non-proportional reinsurance programme and, in
particular, retention limits.
• Historical loss experience of the insurance company.
• Structure of the portfolio to be protected (risk or loss profile).
Two different rating methods exist which are often combined to work out a quotation:
• experience basis
basis: in accordance with the experience, with projection into the future; and
• risk exposure basis
basis: in accordance with the risk exposure.
C3 Detailed information required for rating non-

proportional reinsurance
Chapter 5
In addition to this basic information, reinsurers require more detailed information significant
to the rating process from insurers seeking excess of loss cover. This information is as
follows.
Original underwriting limits
The reinsurer will require detailed information on the original underwriting limits of the
reinsured.
The basis of these limits
The reinsurer will wish to know the basis of the reinsured’s original underwriting limits,
whether they are on a sum insured or EML basis. If it is on an EML basis, the minimum factor
that is applicable must be provided.
Reinforce
Do you recall what is meant by EML? You should note that interestingly, the figure may
well be less than either the market value or the replacement value of the insured property.
Claims experience
The number of years for which claims history is available depends upon the length of time
that the reinsured has been writing the particular class of business in question. For risk and
working covers, at least five years’ experience figures would usually be expected, and this
would be considerably longer for catastrophe protections. The detail required consists of
both the premium income for each year, as well as a profile of the amount and frequency of
losses that would have affected the cover. Any loss amounts should be defined as to
whether they are before (‘from ground up’), or after, the application of the proposed
deductible. The pure burning cost can be calculated from this information by expressing the
losses that reinsurers would have been liable for as a percentage of the premium income
being protected. Although this provides a basic factor for assessing the potential rate for the
excess of loss cover, especially for low level and working covers, other considerations need
to be applied:
• Do the loss figures represent the anticipated final cost of the claims? This may not be such
an issue for property claims, but will be an important factor in liability classes of business,
where the cost of the claim can increase over a period of years before its eventual
settlement.
• Are there significant or noticeable fluctuations in the cost of claims from one year to
another? This may indicate an unbalanced portfolio as a result of the underwriting policy
of the reinsured. The reinsurer should try to understand the reasons for such fluctuations,
possibly by comparing the loss experience with that of similar treaties from the same area.
• What level of loading factor would be appropriate to allow a margin for expenses and
profit? These loading factors vary from risk to risk and class to class and are customarily
expressed as ‘improper’ or ‘top heavy’ fractions, as follows:
Example 5.12
100
= 25% loading
a. 80th
100
= 33.33% loading
b. 75th
In a., the reinsurer believes that a loading factor of 25% is needed over and above the
burning cost of claims. This would have the effect of increasing, say, a burning cost
premium of £800,000 to £1m.
In b., a 33.33% loading factor would have the effect of increasing the same burning cost
premium from £800,000 to £1,066,640.
The loading factor should also be sufficient to include claims arising before the reinsurer has
been able to build a fund to meet them and for the fact that the reinsurer is supporting the
reinsured with its capital and security.
Nature of the account
The reinsurer
The reinsurer will expect that the insurer’s underwriting policy will not materially alter during
will expect that the period of the reinsurance cover, unless agreed to by both parties. However, it may be
insurer’s
underwriting
that the current portfolio is changing in comparison to previous years owing to amendments
policy will not to the insurer’s management policy and, or perhaps because of, the needs of the original
Chapter 5
materially alter
insureds. Any such changes should be allowed for in the calculation of the current price to
be applied.
Risk profiles
An analysis of the risks within a portfolio of business that groups the policies, aggregate
sums insured and applicable premiums into specified bands should be made available. Such
a profile of the risks to be protected should reveal the number and nature of the risks (i.e.
domestic, commercial or industrial), which may be expected to produce the normal size and
frequency of loss to risk or working excess of loss covers. The risk profile is used to help
decide an appropriate retention for the reinsurer in the context of its attitude to risk and the
cost of reinsurance. It also helps in determining how much cover should be bought.
Catastrophe perils
The extent to which a portfolio of business is exposed to natural catastrophe perils must be
considered. Any significant exposure should be reflected in the final rate calculated and
particular attention paid to the geographical spread of the business. Aggregate sums
insured should be available for every identified geographical or seismic zone, again split by
the nature of the original policies, for example, domestic, commercial and industrial.
Underlying protections
With catastrophe protections, the existence and extent of any underlying proportional or
risk excess of loss should be considered. Any such covers reduce the insurer’s net retained
losses arising out of any one event and consequently reduce a catastrophe reinsurer’s
potential exposure to loss.
Refer to Number of reinstatements
section E for
reinstatements The amount of reinsurance provided by each cover may be limited or restricted, particularly
in the case of ‘catastrophe’ types of protection. The contract of reinsurance may provide a
number of reinstatements.
Be aware
Put simply, this means that a reinsurance contract offering earthquake cover of £4m with
two reinstatements, provides the insurer with cover up to £12m, subject to the terms and
conditions of the contract.
In the event of a valid claim, additional premiums may be due to replace the amount of cover
‘used up’ in the claim, unless the reinstatements are free.
Amount of cover requested

This has an effect on the final rate to be quoted. As a consideration this varies depending on
the relationship between the size of the deductible and the level of anticipated exposure
that reinsurers have assumed. If the total amount of cover required is being layered, the
extent to which a reinsurer is, or wishes to be, involved in more than one layer can be
considered in the calculation of the premium. There may be occasions when a reinsurer
thinks that the top layer of a programme is insufficient to cover the reinsured’s exposures. If
the reinsured decides to buy more vertical cover there is an implication that its exposures
have increased and the reinsurer is potentially more exposed to loss: the reinsurer may wish
to protect its rating position by the imposition of a warranty that no higher layer is carried by
the reinsured.
C4 Extraneous factors for rating non-proportional

reinsurance
In this section we consider the extraneous factors that will affect how any given non-
proportional reinsurance is rated.
Table 5.3: Extraneous factors for rating non-proportional

reinsurance
Chapter 5
Effect of inflation The existence of inflation in an economy results in increases in property
values and the cost of repairs, which in turn, results in an increase in the
average size of claims. Loss details should be made available, not only of the
losses that have actually exceeded the deductible, but also of those claims in
previous years that are within, say, 75% of breaching the deductible. Similar
losses in future years may result in losses affecting the proposed
reinsurance.
Currency fluctuations Where the limits and deductibles of a proposed cover are expressed in one Refer to
currency and significant amounts of the original business to be protected chapter 7,
section B2A for
are in different currencies, as in the case of a worldwide portfolio, variations currency clauses
in rates of exchange may seriously affect the size and number of losses
affecting the reinsurance. Excess of loss reinsurances are rated generally at
the beginning of the reinsurance period. Therefore, any upward or
downward movement in exchange rates would alter burning cost
calculations and these movements cannot be satisfactorily predicted in
advance. In such circumstances, the use of a currency conversion clause will
limit any adverse effects on the cover.
Relationship with the The majority of excess of loss covers are arranged on an annual basis. This
insurer gives the reinsurer an automatic opportunity every year to review the basis
of cover and the contractual terms and conditions. However, contracts may
be arranged on a continuous basis, with tacit renewal at anniversary date,
giving the insurer and reinsurer the opportunity to build and maintain a long-
term working relationship.
Quality of the business It may be that because of the quality of the business being offered, the final
rate quoted reflects a reluctance to participate on the cover except at terms
that are specifically advantageous to the reinsurer.
Gross net retained Gross premium income less policy cancellations and returns less the
premium income premium outlay for all other reinsurances with no deductions allowed for the
(GNRPI) reinsured’s costs.
Consider this
this…
…
What would be the implications of a reinsurance contract that has limits expressed in
sterling and losses reported in euros at a time when the value of sterling is falling against
the value of the euro.
C5 Components of a non-proportional reinsurance

premium
The excess of loss premium consists of five main parts:
• the risk premium, which must cover the expected average loss cost to the cover;
• the fluctuation premium to cover random deviations of the claims experience, such as the
occurrence of catastrophes;
• a provision for the catastrophe loss that will occur sooner or later. These losses would be
met from a fund created for that purpose and consideration for such events built into the
rating process;
• a provision for the acquisition costs, intermediaries commission, management expense
etc.; and
• a margin of premium that could be considered in the future as the reinsurer’s profit – in a
soft market, this factor might not be possible to build in and reinsurers may have to rely
on investment income from the premium to guarantee profitability. The figure obtained is
converted, for the sake of practicality, into a rate that is then applied to the premium
volume of the underlying business covered.
Excess of loss
Excess of loss premiums can be fixed or variable. In both cases they are applied to the
premiums can be premium volume of the business protected, commonly called the gross net premium income
fixed or variable
(GNPI). The GNPI is the insurer’s premium income for the duration of the cover, usually a
Chapter 5
period of one year, less cancellations and returns only, and less the premium outlay for prior
reinsurances that are to the benefit of the excess of loss cover. This would be premiums for
facultative business, prior proportional reinsurance, and so on. The premiums of the GNPI
are gross; no commission or costs are deducted for contribution to the insurer’s costs.
A fixed or flat premium is a set amount decided at the beginning of a reinsurance treaty
period. It is not dependent on the amount of business written or the original premium
developed.
Example 5.13
A newly established personal accident insurer buys reinsurance protection to protect its
account along the following lines: Sum insured retained for risk of death £50,000; per
event cover obtained for £800,000 XS £200,000.
As the insurer is new, it may not be possible to estimate the predicted premium income at
the outset. Reinsurers might then ask for a flat premium of £25,000 and seek an additional
adjustment at the end, dependent on the business written.
Variable premiums are characterised by the fact that, by definition, they vary according to
the loss experience of the portfolio protected by the excess of loss.
Reinforce
Before you move on to the next section, make sure that you know the five components of
a non-proportional reinsurance premium.
C6 Pricing models for excess of loss reinsurance

Reinsurers develop and maintain their own computerised pricing models for each class of
business underwritten. The pricing model for any one reinsurer is slightly different from the
models other reinsurers maintain, although the fundamental mechanisms and application of
data is similar for all. The effect of the variances in models is that different reinsurers quote
different prices for the same excess of loss programme using exactly the same data. In
practice, reinsurers often apply a degree of flexibility. If a quote provided by one reinsurer
was more expensive than the quote accepted by the reinsured, then that reinsurer could still
agree to the terms presented unless the difference is significant.
A model for each class of business would need to assess the actual loss data, exposure levels
and loss probabilities for the specific class. There are, however, some core computation
functions that apply to all.
C6A Single risk exposed excess of loss layers

Claims analysis
The claims analysis involves evaluating trends and assessing what impact past losses would
have on the current excess of loss layer, taking into account changes to underwriting and
current values. Let us look at an example.
Example 5.14
An insurer wrote a 50% line on a risk with a sum insured of £5m three years ago. The
insurer’s maximum line was £2.5m at the time. There was a £5m loss and the insurer
paid £2.5m.
The insurer’s current maximum line is now £3.5m and the insurer could now write 70% on
the same risk. A £5m loss would now result in a £3.5m loss to the insurer.
Burning cost
The burning cost is the average annual losses to the layer, adjusted to current values, as a
percentage of the gross net premium income. Again, an example helps to explain how this
looks in practice.
Example 5.15
A property excess of loss layer for 500,000 excess of 500,000 has had average losses to
the layer of 120,000.
Chapter 5
Current GNPI is 4,000,000 therefore the ‘burn’ is 120,000 / 4,000,000 × 100 = 3%.
Exposure rating
The burning cost is based on historic data and the current exposures could be very different
from how they were during the years in which the losses occurred. Exposure rating
calculates loss probabilities to the excess of loss layer, based on the number of risks or
policies that are exposed to the layer. It also calculates the percentage of premium for the
exposed risks that should be charged to cover the loss probability. Risk hazard levels for the
categories included in the portfolio are also included in the calculations, for example, a
property owners account would have lower loss probabilities than an account comprised of
heavy industrial risks.
C6B Catastrophe excess of loss layers and aggregate and

accumulation exposures
Catastrophe layers are usually subject to a two risk or two person warranty and single risk
losses would not be recoverable. The reinsured needs to provide aggregate or accumulation
information relevant to the type of business. For example:
• Personal accident business – the maximum number of persons in any one location, or on
any one aircraft, vessel or vehicle. For earthquake exposed programmes, the number of
persons in each zone or region.
• Property business – sum insured aggregates per zone, region or postal area. These would
be the total aggregated sum insureds for all risks located in each zone or area.
The aggregate information is then input into the model and losses based on simulated loss
scenarios are calculated.
Example 5.16
A magnitude seven earthquake affecting zone two, in a country exposed to such
earthquakes, could result in 900 deaths and an insured loss to the reinsured of
$18,000,000, at an average loss per person of $20,000.
A tidal surge on the east coast of England caused by a combination of strong winds and
high tide causes flooding to a number of flood prone areas. The model will calculate the
total number properties affected and the average loss per property in each postal area
and calculate the loss for each area. It would then add the losses for each area to produce
the total loss to the reinsured for the event.
For example, Peterborough: 470 properties damaged with an average loss of £9,000 =
£4.23m loss to the reinsured for Peterborough. The total loss to the reinsured would be
the combination of the estimated loss for each of the 24 areas that could be affected by
the same flood, i.e. £85m.
The model would then calculate the premium for each excess of loss layer that the reinsurer
would require in relation to the disaster scenarios simulated and the loss probabilities.
D Event limits
An ‘event’ influences how losses paid by insurers after storms or other major catastrophes
Chapter 5
An event triggers
coverage under are aggregated for reinsurance coverage purposes. An event triggers coverage under the
the contract
contract. Events are made up of one or more occurrences. An occurrence is often equated
with ‘accident’; however, some policies define occurrence to include continuous or repeated
exposure, which results in bodily injury or property damage neither expected nor intended
by the insured.
D1 Significance of and importance in defining an event

One problem that reinsurers experienced with risk excess of loss reinsurance programmes
was the possibility that insurers could claim more than once for the same loss event, which
could seriously affect the profitability of the treaty. For example, a hurricane could hit the
outlying islands of the USA mainland, such as Puerto Rico, and then proceed to the mainland
states.
D2 Effect of ‘event
event’’ on aggregations
The reinsurance market has learnt from this and includes either limitation clauses, such as
hours clauses, or event limits. These act as ‘first loss’ limits. They prevent the reinsurer from
being called upon to pay an aggregate loss amounting to several times the reinsurance
cover because of a series of individual risks have had losses caused by one event. Some
reinsurers allow the ‘fallback’ or amount greater than the event limit to be added to the
reinsured’s net retained loss for the purposes of any recovery from its catastrophe excess of
loss programme.
D3 Effect of ‘event
event’’ on reinsurance recoveries
Example 5.17 illustrates the effect that events and event limits have on reinsurance
recoveries.
Example 5.17
In a property account risk excess treaty for £200,000 XS £50,000, an event limit of
£600,000 (i.e. three total losses) might be imposed. If four houses were hit by a storm,
each loss being over the £250,000 total insured limit, the claim would be apportioned as
follows:
Total gross claims 4 × £250,000 = £1m
Deductible retained by insurer 4 × £50,000 = £200,000
Risk excess of loss cover 4 × £200,000 = £800,000
As this exceeds the event limit:
Reinsurers only pay £600,000
with the insurer paying the remaining £200,000
This increases the insurer’s overall liability to £400,000

(£200,000 retention + £200,000 in excess of the
event limit)
E Reinstatements
Chapter 5
A reinstatement clause defines the number of times that a contract can incur losses. It allows Defines the
the cover under the contract to be automatically ‘reinstated’ in the event that the limit or any number of times
that a contract can
portion of it is exhausted by a loss. Reinstatements are most frequently used on property incur losses
covers. The purpose of the reinstatement condition is to limit the number of times the treaty
cover may be utilised. Without a reinstatement condition, there is no limit or, in other words,
there are unlimited reinstatements.
Example 5.18 shows how a reinstatement clause might work:
Example 5.18
Catastrophe cover is purchased to protect the insurer’s retentions in its property account,
of £2m XS £2m with one reinstatement.
Three losses occur: an earthquake costing £2.35m, a hurricane causing losses of £3m and
a fire causing a loss of £4m.
For the first event, the reinsurer pays £350,000, reducing the cover from £2m to £1.65m.
However, the cover is then automatically reinstated.
For the second loss, the reinsurers pay £1m. The cover is reduced to £1m but again
automatically reinstated to £2m as the insurer has not yet used up its automatic
reinstatement cover (having used £1m and £350,000 of the £2m available).
When the fire loss is recovered, reinsurers pay £2m, exhausting the reinstatement and
leaving £650,000 of cover under the contract.
If a further loss of £3m occurred, the cover could only pay £650,000 before being totally
exhausted and the insurer would either have to retain the loss itself or seek cover from
other reinsurances.
A reinstatement clause ‘reinstates’ the existing cover. Therefore, a reinsurance contract with
five reinstatements can cover up to six total losses.
Reinstatements may either be ‘paid’, ‘free’ or a combination of both:
• If reinstatements are paid for, the reinstatement premiums are charged as an additional
premium that is based on a proportion of the original premium paid.
• Some reinsurance contracts allow the insurer to obtain additional cover without the
payment of any further premium. Liability contracts often include unlimited reinstatement
at no additional premium.
• A treaty may combine the above by providing an initial reinstatement at no cost with later
reinstatement(s) subject to additional premium, but this is unusual.
If a reinstatement is subject to an additional premium, the reinstatement premium will be

charged as follows:
Cost of claim to cover

× premium = reinstatement premium
Limit of reinsurance cover available
Some reinstatements are also made pro rata to time. However, reinstatement premiums are
commonly charged 100% to time.
Consider this
this…
…
Apart from keeping the calculation process as simple as possible, why do you think
reinsurers prefer to charge 100% to time, rather than pro rata to time?
Reinsurers prefer to charge 100% to time as, if a loss happened towards the end of a policy
period, it would collect relatively little premium for the reinstatement.
Nevertheless, if ‘time’ is to be a charging factor this adds an additional factor into the
formula as follows:
Number of days from loss date to end of policy

Number of days in policy
Finally, we can look at an example of a reinstatement premium calculation.

Chapter 5
Example 5.19
Cover is £100,000 XS of £100,000 any one loss.
Minimum deposit premium £10,000 adjustable at a rate of 1% of gross net premium
income, subject to one reinstatement of 100% additional premium as to time and pro rata
as to amount. This would be referred to on the slip or cover note as ‘one full reinstatement
at 100% a.p.’.
Gross income declared on expiry: £1.2m.
The cover was for the period 1 January 2018 to 31 December 2018.
Date of loss: 15 March 2018.
Amount of loss: £150,000 net from the ground.
Therefore, loss to cover £50,000 or 50% of limit of indemnity.
Initial reinstatement premium will be:
£50,000
× £10,000 = £5,000 (50% of deposit premium)
£100,000
However, when the deposit premium has been adjusted, the actual premium for the
year is:
£1.2m × 1% = £12,000
Consequently reinstatement premiums should be:
£50,000
× £12,000 = £6,000
£100,000
An additional payment of reinstatement premium of £1,000 is required when the premium

adjustment is calculated.
F Case studies
As in previous chapters, to help us understand how all the principles learned really apply in
practice we are going to look at some case studies.
F1 Motor excess of loss – restructuring caused by new

legislation
The Egnatria Insurance Company wrote personal lines motor and small commercial vehicles.
Gross net premium income for the current year was €26m and the estimate for the following
year was €30m. The company’s capital at the time was €8m.
Minimum policy limits for motor, as set by legislation in the country, were €500,000 per
accident for bodily injury and €100,000 for third party property damage. The limits applied
to any one accident irrespective of how many people were involved. If four people were
killed in the same motor accident, the insurance policy for the driver held liable still only had
to pay a maximum of €500,000 in total, even if the court awarded a higher figure.
A new EU motor directive sets a new minimum of cover for motor policies in all EU member
states as follows:
• for personal injury, the minimum amount of cover is €1,000,000 per victim or €5,000,000
per claim, whatever the number of victims; and
Chapter 5
• for material damage, the minimum amount is €1,000 000 per claim, again whatever the
number of victims.
The country that Egnatria was located in therefore had two options for its bodily injury limits
to comply with the EU directive:
• a policy limit of €1,000,000 per person for third party personal injury liability, without a
limit for any one accident or event; or
• a policy limit of €5,000,000 any one claim or accident for third party personal injury
liability injury, irrespective of how many persons are killed or injured in the same accident.
The country concerned chose option 1, even though that meant a dramatic increase in motor
policy limits. The decision was very much influenced by the outcome of a major accident. A
truck hit a coach that was carrying 40 passengers and caused the coach to crash into a wall.
A number of passengers were either killed or left permanently disabled. The court awarded a
total of £30m to all the victims combined and the owner of the truck was liable to pay this.
The insurance policy had a limit of Euros 500,000 any one accident and that was the
maximum that the insurer was liable to pay, irrespective of the court award and the truck
owner’s liability. The company that owned the truck was unable to pay the amount awarded
and went into liquidation. This left the victims with virtually no compensation.
The reinsurance arrangement that Egnatria had at the time was just one layer for:
€250,000 excess of €350,000 with an annual aggregate limit of €4m The premium
was adjustable on the burning cost to the layer subject to a minimum rate of 2% and
a maximum rate of 6% of the GNPI.
This was sufficient at the time as the limits were €500,000 any one accident for bodily injury
and €100,000 for property damage.
This layer mainly gave Egnatria ‘frequency cover’ and the key value of the protection was
the €4m annual aggregate cover. Vertical loss amounts were limited by statute, but Egnatria
had a frequency exposure as an increasing number of individual claims were falling in the
€300,000 to €500,000 range. The €4m annual aggregate limit provided cover for up to 16
losses to the layer of €250,000.
The key issue that Egnatria had to address following the new legislation was how much
vertical reinsurance protection should be purchased. The courts will inevitably increase
award levels to victims of motor accidents knowing that insurance policies now provide
cover for €1m any one person. A number of individuals could be injured in the same accident,
and the court could award up to €1m to each victim.
Egnatria decided on €35m of vertical ground up cover to allow for a catastrophe situation
like the truck and coach accident. Egnatria only wrote private cars and small commercial
vehicles. Insurers that also wrote buses and coaches opted for even higher limits.
Egnatria finally decided on the following motor excess of loss programme structure:
First layer €500,000 excess of €500,000.

Three free reinstatements; annual aggregate limit €2m.
Second layer €4m excess of €1m.

Two free reinstatements.
Third layer €5m excess of €5m.

Two free reinstatements.
Fourth layer €15m excess of €10m.

One free reinstatement.
A layer beneath €500,000 would have been too expensive and the €500,000 retention
level was affordable. Egnatria opted to pay the premium for the first layer on a fixed rate
basis rather than adjust on a burning cost.
F1A Reinsurance pricing considerations

Historically all losses have been under €500,000 and the first question the reinsurer needed
to address was what losses to the first layer could be expected following the new legislation.
Chapter 5
If some of the past losses occurred after the new legislation came into effect, what awards
will be given by the courts?
These were unknown factors and neither computer models or manual calculations could
have foretold the future and provided the answer. In these situations it is important for
reasonableness from both parties. The reinsurer would have quoted the programme on the
understanding that the cost would need to be reviewed in future years, once a clear pattern
of claims levels can be ascertained.
In pricing the first layer, the reinsurer could have allowed for two losses of €700,000 from
the ground up resulting in two losses to the layer of €200,000 giving a total of €400,000.
Allowing for expenses, the reinsurer would have charged, say, a premium of €450,000 for
the €500,00 excess of €500,000 layer. The premium is almost the same as the limit for any
one loss. However, the reinsured purchased €2m of aggregate cover.
In this case, Egnatria had the benefit of the €30m estimated premium income and were able
to afford the cost of the new reinsurance programme. The total cost for all layers combined
would have been set at about 7% of the GNPI or slightly less. That left Egnatria with 93% of
the GNPI to cover losses within the 500,000 retention and acquisition costs.
A smaller company in this situation, with a much smaller premium income, may not have
been able to afford the reinsurance cost and the only alternatives would have been to stop
writing motor business, merge with another insurer or sell either the motor book or the
whole company to a larger insurer.
F2 Converting from a property surplus treaty to an

excess of loss programme
Dragon Insurance Company write commercial property business in the UK, covering risks
classified as commercial and as industrial. For the last five years, the reinsurance capacity
has been provided by a nine line surplus treaty with a maximum retention of £1m. A new
general manager was recently appointed and they initiated a feasibility study into
converting from a surplus treaty to an excess of loss programme. The main considerations
and key issues they wanted to assess and address were as follows.
Main considerations
• Dragon’s capital was recently increased to £50m.
• The gross premium income for the commercial account has grown from £12m in 2014 to
£25m in 2018. The estimated gross premium income for 2019 is £30m.
• The surplus treaty provides for a maximum gross automatic capacity of £10m. In addition,
there are 60 facultative placements for risks that have sum insureds of between £10m
and £15m.
• The estimated premium income to the surplus treaty for 2019 would be £12m out of a total
gross estimated premium income of £30m.
• The administration work and supporting IT programmes needed to manage the surplus
treaty and the numerous facultative placements.
• The surplus treaty has worked well in past years and particularly proved its value in 2015.
The result to the surplus treaty in that year was a loss to the treaty of £3.7m. This was due
to a combination of one large loss of £5.5m, where 80% of the risk was ceded to the
surplus, and an unusually high frequency of smaller losses.
Following that year, there was a major overall of Dragon’s underwriting criteria and
procedures. This included improved risk management, changes in the sources of business
and improved risk selection. The results to the surplus treaty for the years following were
profits of between £750,000 and £1.1m.
Key issues
Chapter 5
• Automatic capacity should be increased from £10m to £15m any one risk without the need
of facultative reinsurance.
• The aim is to reduce the net cost of reinsurance or the net amount ceded to 10% or less of
the gross net premium income. Based on the estimated figures for 2019, the £12m
estimated premium income to the surplus treaty, plus £600,000 for facultative
placements less 30% ceding commission, would give a total net ceded premium of
£8.82m. That equates to 29% of the £30m estimated gross premium income.
• Discontinuing the surplus treaty will greatly increase the net catastrophe exposures.
The surplus treaty has an event limit of £30m. Based on recent catastrophe modelling this is
considered sufficient to cover aggregated losses to the treaty from major windstorms or
floods.
Dragon currently has a Catastrophe Excess of Loss Layer of £4m excess £1m. The above
indicates that in total Dragon would need £35m of catastrophe ground up cover.
Information requirements
In order to obtain quotes for a Risk Excess of Loss and an expanded Catastrophe Excess of
Loss Programme, Dragon needed to provide the following.
Gross net premium 2014 to 2019
Year GNPI
£
2014 12m
2015 15m
2016 16m
2017 19m
2018 estimated 25m
2019 estimated 30m

Current table of retentions and limits to the surplus treaty is as follows:
Risk category Max retention Max cession to surplus Total gross capacity
treaty
A (best risk, lowest £1,000,000 £9,000,000 £10,000,000

hazard)
B £ 800,000 £7,200,000 £ 8,000,000
C £ 600,000 £5,400,000 £ 6,000,000
D £ 400,000 £3,600,000 £ 4,000,000
E (high hazard) £ 200,000 £1,800,000 £ 2,000,000
Gross losses from the ground up above £500,000
Year Loss 1 Loss 2 Loss 3
2014 none
2015 £5.5m – fire, brewery £850,000 – fire, furniture £520,000 – fire, carpet
warehouse manufacturer
2016 £650,000 – fire, car £850,000 – fire, department

Chapter 5
showroom store
2017 £680,000 – explosion, £540,000 – theft,

research laboratory computers from office.
2018 £610,000 – storm and flood

damage, paper
manufacturer
Gross risk profiles including risks that required facultative reinsurance
Sum insured band Number of risks Total sum insured Premium per band
£ £ £
up to 749,999 1,300 520,000,000 1,300,000
750,000 to 1,499,000 700 700,000,000 1,750,000
1,500,000 to 2,999,000 550 1,100,000,000 2,750,000
3,000,000 to 4,999,000 480 1,920,000,000 5.760,000
5,000,000 to 7,499,000 280 1,680,000,000 5,880,000
7,500,000 to 9,999,000 140 1,260,000,000 4,410,000
10,000,000 to 15,000,000 60 780,000,000 2,340,000
3,510 24,190,000
Aggregate exposures by area post code
This would run into several pages as the number of risks and the total sum insured for all risks
combined in each postal area would be captured.
Dragon eventually decided to cancel the surplus treaty and proceed with the following
programme structure.
Risk excess of loss programme, based on a maximum line of £15m sum insured any one risk
Underlying layer £750,000 excess of £750,000 after an aggregate deductible of losses

otherwise recoverable from the layer of £750,000.
Two reinstatements at 100% AP, pro rata to amount only.
First layer £1.5m excess of £1.5m.

Two reinstatements at 100% AP.
Second layer £4.5m excess of 3m.

Two reinstatements at 100% AP.
Third layer £7.5m excess of £7.5m.

One reinstatement at 100% AP.
TOTAL £13.5m/ £14.25 excess of £1.5m / £750,000.
Catastrophe excess of loss programme
First layer £2.5m excess of £2.5m.

One reinstatement at 100% AP, pro rata to amount only.
Second layer £5m excess of £5m.
Chapter 5
Third layer £10m excess of £10m.

Fourth layer £15m excess of £20m.

TOTAL £32.5m excess of £2.5m.
All layers are subject to two risk warranties; two or more risks to be involved in the same loss
occurrence. Hours clauses for windstorm, flood and other events also apply.
F2A Reinsurance pricing considerations

Risk XL
The reinsured opted for a first loss retention of £1.5m. Historically, there has only ever been
one loss above £1.5m, the £5.5m loss in 2015.
The underlying layer provides frequency cover. One loss of £1.5m would not result in a
recovery from the layer, but that would exhaust the aggregate deductible. Historically there
has only been one year during which there has been more than one loss above 750,000. In
2015 the 5.5m loss would have exhausted the aggregate deductible. The second loss of
850,000 would have resulted in a recovery from the layer of £100,000.
The reinsurer applied the gross risk profile for exposure rating. Additionally, Dragon
provided risk profiles by risk category and a breakdown of risk numbers and premium
income by trade category. That enabled the reinsurer to apply specific exposures curves to
the different types of risk.
Catastrophe excess of loss
Various catastrophe loss simulations could be calculated from the aggregate information.
The Risk XL is to the benefit of the Cat XL programme. Large single losses caused by a storm
or flood would be recoverable from the Risk XL and reduce the amount recoverable from the
Cat programme.
Example 5.20
Windstorm Alfred causes total losses to Dragon of £25m within a 72hour period. The total
loss figure included two individual losses which impacted the Risk XL:
one: £4m
Loss one
Underlying layer pays nil, but aggregate deductible is exhausted. £2.5m is recoverable
from first and second layer.
two: £1.5m
Loss two
Underlying layer pay £750,000
Ultimate net Loss to the Cat XL is:
• £25m – £3.25m recoverable from the Risk XL = £21.75m.
• £21.75m – £2.5m retention = £19.25m recoverable from the Cat layers.
F2B Final cost and affordability of the new excess of loss

programme
This is a sizeable programme and converting from a surplus involves incurring up front
deposit premiums payable in quarterly or half yearly instalments. The final cost would
depend on the precise information modelled by the reinsurer concerned, but taking into
account the retention levels chosen, the cost of the Risk XL could probably be just under
Chapter 5
£1m and the cost of the Cat programme could be just under £2m.
If we take £3m to be the total cost of the entire programme, that would equate to 10% of the
£30m GNPI and thereby would achieve the general manager’s expenditure target.
Acquisition costs and losses within the retention levels would be covered by the remaining
90%, which equates to £27m.
Key points
Main features and operation of non-proportional reinsurance
• Non-proportional reinsurance was developed to deal with the protection of retained aggregate
exposures on the account of the ceding insurer after the operation of proportional reinsurance.
• The balance of any loss which exceeds an agreed limit will be met by the reinsurer, usually up to a
contractual maximum.
• Non-proportional reinsurance distributes liability between the reinsured and the reinsurer on the
basis of losses rather than sums insured.
• Excess of loss exposures to reinsurers are not determined risk by risk unlike in proportional
reinsurance.
• Excess of loss contracts are used to deal with:
– losses on large single risks that fall outside the scope of existing proportional arrangements; and
– losses arising on a number of original risks at the same time, all resulting from one occurrence
or event.
• Proportional reinsurances may be used if the reinsured does not want restrictions to the amount of
risk cover that may be applied; excess of loss reinsurance can be used as an adjunct.
• The reinsured may have concerns over accumulation of losses arising out of one event and excess
of loss reinsurance can be used to protect the overall net retained liability under the proportional
treaty.
Chapter 5
• A ‘per risk’ excess of loss treaty protects against a loss occurring on an individual original policy
which exceeds a monetary amount which the reinsured is prepared to retain.
• Common account protection benefits both the reinsured and its proportional reinsurers.
• A catastrophe or ‘per event’ contract sets out to provide cover for the reinsured irrespective of the
number of possible risks affected by an accumulation of losses arising out of one event or
occurrence. Alternatively, it may protect the reinsured where one catastrophic event causes losses
on various original insurance policies which, in total, exceed the amount the reinsured is prepared to
retain on any catastrophic event.
• Otherwise known as ‘excess of loss ratio’, stop loss treaties reinsure aggregate losses from a
specific class of business rather than individual losses or aggregations caused by an event or
occurrence, and apply after all other prior reinsurances have been taken into account.
• Cover is described as a percentage of losses exceeding the ceding insurer’s GNRPI, where GNRPI is
the reinsured’s premium income for the duration of the cover.
• Stop loss treaties may require the insurer to contribute to the reinsurer’s losses by imposing a co-
insurance clause.
• Unlike stop loss which operates on pre-agreed percentages, aggregate excess of loss treaties have
limits expressed as fixed amounts.
• An aggregate of losses is covered beyond an excess point to an upper limit, resulting from a single
event or defined peril, over a specified period.
• Clash excess of loss provides protection in situations where a single event impacts on two or more
classes of business and covers the aggregation resulting from one identifiable loss event. It
provides protection against an accumulation of net losses across a number of accounts once all of
its more specific reinsurances have been used in the separate accounts.
• Umbrella excess of loss protects the reinsured in the event of the exhaustion of some or all of its
excess of loss contracts, and sits above the covers put in place for a number of classes. It is a single
composite excess of loss cover that protects the insurer against an accumulation of losses in excess
of its specific underlying policy limits.
• Buffer excess of loss is effected at a low level within an account, and responds to identified loss
causes only, for example, all marine hull own damage losses forming part of a combined marine and
aviation hull own damage programme.
• Back-up covers, where cover would operate in the event that the original reinsurance exhausts the
defined number of reinstatements and the reinsured requires further cover to protect the account.
• Reinstatement premium protections indemnify the reinsured for payment of reinstatement
premiums as a result of a loss (or losses) which has affected a particular programme
• Top and drop and cascade protections, act as additional cover that ‘drops down’ to provide further
protection on lower layers if those limits and their reinstatements have been exhausted by claims;
this protection makes good use of unexhausted cover within higher upper layers.
Different bases of cover attachment
• RAD (or policies issued and renewed) basis where reinsurers agree to assume liability for claims on
risks or original policies attaching during the period of the reinsurance.
• LOD basis where reinsurers agree to assume liability for losses occurring during the period of the
reinsurance, irrespective of the inception dates of the original policies giving rise to the claims.
• ‘Claims made’ or ‘losses discovered’ bases where reinsurers agree to assume liability for claims
made or losses discovered during the period of the reinsurance, irrespective of the inception dates
of the original policies or the date on which the loss occurred.
Premium calculation and claims recoveries in non-proportional reinsurance
• The rating process starts by gathering the following essential information:

– annual premium income;
– retention limits;
– historical loss experience;
– risk profile;
– original underwriting limits and the basis of those limits;
– claims experience;
– nature of the account;
– catastrophe perils;
– underlying protections;
– number of reinstatements; and
Chapter 5
– amount of cover required.

• Other factors include:
– the effect of inflation;
– currency fluctuations;
– the relationship with the insurer; and
– the quality of the business.
• The premium must be sufficient to cover:
– the risk premium;
– random deviations in the claims experience;
– provision for catastrophe losses;
– provision for acquisition costs; and
– a profit margin.
• The resulting figure is converted into a rate per cent or per mille which is applied to the GNPI of the
underlying business covered, to produce a fixed or variable reinsurance premium.
• A pricing model needs to assess the actual loss data, exposure levels and loss probabilities for the
specific class of business.
• The model for single risk exposed excess of loss layers needs to also take account of claims analysis,
the burning cost and the exposure rating.
• Catastrophe excess of loss layers and aggregate and accumulation exposures are usually subject to
a two risk or two person warranty and single risk losses would not be recoverable. The reinsured
needs to provide aggregate or accumulation information relevant to the type of business.
Event limits
• Events are made up of one or more occurrences and influence how losses paid by insurers after
storms or other major catastrophes are aggregated for reinsurance coverage purposes.
• ‘Hours clauses’ or event limits act as ‘first loss’ limits and prevent the reinsurer having to pay an
aggregate loss amounting to several times the reinsurance cover following a series of individual
risks being involved in losses caused by one event.
• Some reinsurers allow the ‘fallback’ or amount greater than the event limit to be added to the
reinsured’s net retained loss for the purposes of any recovery from its catastrophe excess of loss
programme.
Reinstatements
• A reinstatement clause states how often a contract can incur losses by allowing the cover under the
contract to be automatically ‘reinstated’ should any portion of the cover be exhausted by a loss.
• There would be unlimited reinstatements of cover in the absence of any such restriction.
• If reinstatements are paid for, the reinstatement premiums are charged as an additional premium
which is based on a proportion of the original premium paid. Some reinsurance contracts allow the
insurer additional cover without any further premium, while others may allow a combination of free
reinstatements and those that attract additional premium.
• Premiums can be calculated pro rata to the amount of the reinstatement needed with or without
recognition of the time left before the contract comes to an end.
Chapter 5
Question answers
5.1 It must ensure that its last layer of protection is unlimited if this is required by local
compulsory third party insurance requirements or it may find itself having to retain,
in addition to its agreed retention, any loss amounts that are greater than the total
amount of reinsurance purchased.
5.2 Only one deductible of £5m leaving the reinsurer to pay £15.34m made up of £8.34m
plus £12m less one deductible of £5m.
5.3 Concentration and accumulation of risk arising from general urbanisation, increasing
insurance penetration, increasing insured values with inflation, and the apparent
effect of changes in climate giving rise to an increased incidence of weather-related
claims.
5.4 The insurer would be entitled to aggregate its individual programme retentions and
set them against the clash excess of loss protection, but bear in mind that this cover
would only respond if an insurer sustained loss to more than one of its programme
retentions; in other words it would not pay if there was only a single large loss to one
programme.
5.5 For non-proportional business, when a loss occurs the reinsurer’s cover is not
exposed until the insurer’s retained amount is exhausted so for low level losses the
reinsurer escapes having to make any payment. The reinsurer cannot expect to
Chapter 5
receive a proportion of all the original premium when it will only have to pay the
larger losses.
Self-test questions
1. Why are accounting procedures simpler under an excess of loss treaty, compared
to a proportional treaty?
2. What is the principal difference between a ‘per risk’ and a ‘per event’ treaty?
3. What is the deductible?
4. What is an aggregate excess of loss treaty?
5. Why would an insurer buy umbrella excess of loss reinsurance?
6. In what circumstances would a reinsurer adjust a non-proportional reinsurance
premium at year end?
7. How are burning costs calculated?
8. What is gross net earned premium income?
9. Why is it important to describe ‘event’ accurately?
10. Why do reinsurers impose event limits?
Chapter 5
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Reinsurance programmes
6
outcomes
Learning objectives
Introduction
Key terms
A Designing programmes 6.1, 6.2, 6.5
B Pricing programmes 6.1
C Placing programmes 6.3, 6.5
D Reciprocity 6.4
Key points
Question answers
Chapter 6
Self-test questions
Learning objectives
• explain the insurer’s objectives when considering the reinsurance programme;
• describe how the price of the reinsurance programme is determined;
• describe the factors that influence the extent of cover required;
• discuss how the reinsurance programme is designed to meet the requirements of the
insurer;
• outline the material information required and the key features of the documentation used
in the placement of the reinsurance contract;
• explain the aims and goals of insurers wishing to enter into reciprocal arrangements; and
• discuss how solvency and security considerations affect reinsurance programmes.
Introduction
In order to understand the rationale for the design and construction of reinsurance
programmes, we need to consider the strategic and financial issues faced by the reinsurance
purchaser: the insurance company.
Essentially, the insurer wants protection in the form of one or more reinsurance contracts
which meets its objectives and incorporates cover, limits and retentions to safeguard its
existence and prosperity. This premise is a useful starting point to consider the design and
construction of a reinsurance programme – that is, a combination of reinsurance treaties –
which meets the aforementioned strategic objectives of the insurer together with the
operational needs of individual classes of business.
Be aware
We referred to an insurer’s strategy and objectives in earlier chapters. Clearly an insurer
must have a clear vision of its strategic objectives if it wants to achieve them. A key
objective for an insurer might be to make the best possible return on capital invested by
shareholders. Tactics and specific activities may have to be adjusted quickly to meet
changing circumstances if this goal is to be achieved, but this should be done with a clear
sense of purpose. An insurer’s reinsurance programme would be a central part of such a
dynamic approach.
In this chapter, we look, in turn, at the design, the pricing and the placement of reinsurance
programmes.
Key terms
Chapter 6
Adequate capacity Automatic reinsurance Catastrophe model Collateral

cover
Contract certainty Experience rating Exposure rating Frequency and severity

rating
Grading reinsurers Increased limit Insolvency Loading

factor (ILF)
Market Reform Material information Probabilistic risk Reciprocity

Contract (MRC) analysis
Risk premium Security
A Designing programmes
Number of
The main considerations to be taken into account in the design and formulation of a
considerations to reinsurance programme are:
be taken into
account • the primary objectives of the company when considering the reinsurance placement,
which could include:
– shareholder profit (in which case the company may well be aiming to minimise the
reinsurance premium outlay),
– ensuring that its overall portfolio is not unbalanced by single large losses, or by
accumulation or catastrophe losses where more than one risk or person is involved in
the same event,
– developing new business (which could lead to seeking more reinsurance protection),
and
– protecting against large fluctuations in the underwriting result, thus reducing the
amount of capital required and protecting capital;
• the company’s current balance sheet, paid up capital and free reserves, profit or loss
made in the last financial year;
• the company’s premium income for the class to be protected and for the whole company
(financial strength, company size and premium incomes are important factors in deciding
on retention levels);
Chapter 6 Reinsurance programmes 6/3
• legislation and statutory limits (most countries establish minimum legal limits for classes
such as motor, employer’s liability and workers’ compensation);
• what forms of reinsurance contract are appropriate, i.e. treaty, facultative, proportional,
non-proportional;
• the availability of sufficient information to enable realistic decisions to be made over the
cover and retention levels required;
• the availability of reinsurance capacity and the use of brokers;
• the availability of reciprocity
reciprocity, if appropriate; and
• what alternatives to conventional reinsurance products could be used.
In arranging its reinsurance programme, an insurer may seek to achieve a number of An insurer may
objectives, including: seek to achieve a
number of
objectives
automatic
reinsurance
cover
security and adequate

continuity capacity
Insurer’s
objectives
economic appropriate
advantage retention
Chapter 6
sufficient
scope
Let us examine each of these objectives in turn.

Automatic reinsurance cover
Whether the insurer requires proportional cover depends on if it considers its benefits to
outweigh the cost. A broad automatic cover would help with underwriting capacity and
ensure that the insurer could provide cover for risks without having to seek its reinsurer’s
approval first. However, such a cover would take a proportion of the insurance premium and
may not prove as cost-effective as alternative products.
Facultative reinsurance will usually remain an important part of an insurer’s protections, for
example, to provide extra capacity above treaty limits or for risks excluded by the
programme. They are, however, arranged on an individual ad hoc basis and form no part of
the programme.
Adequate capacity
The insurer will seek reinsurance product that provides a gross automatic capacity, which is
sufficiently large to enable it to accept most of the business offered, without needing to seek
the prior agreement of the reinsurers. However, the amount of automatic capacity
obtainable will typically be influenced by the size of the insurer.
Be aware
It would be unusual for an insurer with capital of £50and annual premiums of £100to have
the same automatic capacity as that of another insurer 20 times larger.
Capacity of the
The capacity of the cover will also reflect the size and nature of the risks which the insurer
cover will also transacts, as differences may exist between property and liability risks. In addition, the basis
reflect the size and
nature of the risks
of estimating the risk, such as the insurer’s sum insured or estimated maximum loss (EML) is
important, since this will determine the maximum loss he insurer is likely to suffer and,
accordingly, the amount of reinsurance required. The EML may be considerably less than the
sum insured, but calculation of this figure for any risk is difficult since so many
imponderables need to be taken into account.
In relation to capacity, the insurer also needs to consider the possibility of aggregations or
accumulations of risks exposed in a particular area to a natural peril, such as earthquake, and
the associated possible maximum loss.
Appropriate retention
The insurer will set its retentions on a per risk, per occurrence and aggregate basis in
accordance with its retention strategy, i.e. its willingness to retain risk. The main factors
considered are usually its level of capital and reserves, the cost of reinsurance and the
smoothing of earnings fluctuations. Regard will also be had to market norms and to various
experience based judgments, which suggest that the amount of the retention should be
within a particular range of percentages of capital or of premium income or some other
measure.
Choice of retention
In many instances, the choice of retention level will be made by the underwriter of the
level is usually account under consideration. The underwriter will use their skill and judgment, based on
made by the
underwriter
their knowledge and experience of the account, to balance the relationship between profits
and stability rather than to reduce the risk that the capital is exhausted, subject always to
market conditions and to what is available at what cost. If reinsurance is plentiful in a soft
market, the insurer may be inclined to reduce the amount it retains, and/or to buy more
reinsurance.
Sufficient scope
Chapter 6
The insurer requires a reinsurance programme that covers the business currently being
written.
classes of
business covered
by the treaty
the need for the

treaty to give cover
exclusions
for policies issued
proposed by the
prior to its inception
reinsurers
but still in force at
that date The insurer needs to
give consideration to:
provisions of the
treaty regarding the territorial
business written in scope of the treaty
foreign currencies
Economic advantage
Insurers are seeking an economic advantage when placing their reinsurance treaties. Insurers are
However, reinsurers will refuse to agree to terms that are unlikely to result in a profit for seeking an
economic
themselves over a period of time. advantage
If an insurer can obtain a rate of reinsurance commission on its proportional treaties that
more than covers the acquisition and administration expenses of the business ceded, the
value to its net account increases in proportion to the percentage of original premiums
ceded in reinsurance.
Security and continuity
Insurers and reinsurers alike are interested in continuity. Insurers will prefer reinsurers that
maintain relationships with them even after a run of bad results. Reinsurers identify clients
with which they can maintain a long-term relationship, to the benefit of both parties.
However, in the current climate, where financial returns have become increasingly
important, this desire for continuity has reduced in favour of price issues.
Insurers prefer to use reinsurers that have good security (this is usually indicated by a high Insurers prefer to
rating, e.g. AA, by a ratings agency such as Standard & Poor’s). This is because these use reinsurers that
have good security
reinsurers can be expected to remain solvent, even in times of financial crisis and to have the
ability to indemnify insurers when required, even years after the currency of the reinsurance
contract. Such a reinsurer must be convinced that the insurer is worthy of its support and
that the terms of the treaty or treaties are fair to both parties.
Good security is seldom the least expensive when considering excess of loss quotations, the
most generous in offering reinsurance commissions or the most liberal in deciding how many
lines a new surplus treaty should have. A prudent insurer will take these facts into
consideration before deciding which offers to accept.
The degree of security considered acceptable, balanced against the cost of the cover, may
be influenced by the type of business being reinsured. For short-tail business, where the final
Chapter 6
result will be known and all losses settled within a short time, the quality of security provided
by the reinsurer may be of less concern to some buyers than when reinsurance for long-tail
business is required.
Question 6.1
Why might long-tail business be viewed differently?
In considering the design of a reinsurance programme, the reinsurer, of course, has its own Reinsurer will want
objectives. While the reinsurer will want to accede to the wishes of the reinsured whenever to accede to the
wishes of the
possible and reasonable, the interests of the parties do not entirely coincide and the reinsured
reinsurer will consider the following points: whenever possible
and reasonable
• moral hazard;
• administration expenses; and
• accumulation.
Moral hazard
If the reinsured cedes virtually all of its exposure to particular risks to the reinsurer, there is a
danger that the reinsured loses interest in the performance of the original policies. The
reinsurer will want to ensure that the size of the reinsured’s retention avoids this.
Administration expenses
The reinsurer may tend towards programme structures that minimise the cost of
administering the premium and claims under the contract.
Accumulation
A reinsurer will naturally prefer business without accumulation potential, as each such
additional treaty will yield diversification benefits. Catastrophe perils are quite the reverse
and the reinsurer will look to limit its exposure to such losses.
A1 Factors determining the choice of treaty

The factors determining the choice of treaty or treaties are as follows:
• Does the portfolio consist of individual risks
risks, such as property with varying sums insured
that can be allocated separately to a surplus treaty; or liability risks with varying limits of
indemnity where the allocation is more difficult?
• Is the portfolio exposed to an accumulation of losses from many policies arising out of
one occurrence?
• Does the portfolio consist of policies with unlimited liability
liability, such as third-party bodily
injury under a motor policy?
• Is the portfolio subject to wide fluctuations in its annual results
results, such as crop hail
insurance?
• Does the insurer seek reinsurance as a means of providing growth or capacity?
Consider this
this…
…
Do you think that quota share and surplus treaties are best suited to these objectives?
• How much premium will be ceded? If the aim of the insurer is to maximise its retained
premium, it will choose a surplus treaty over a quota share treaty. Under the surplus
treaty, only that part of the policy which is above the insurer’s retention is reinsured;
under the quota share treaty, a fixed share of every policy, regardless of its size, is ceded.
An excess of loss per risk treaty can replace proportional treaties. It usually involves a
much smaller reinsurance premium than a proportional treaty. Therefore, a much greater
volume is retained but there are reduced loss-recovery expectations.
Alternatively, an insurer may have limited financial resources, which places its solvency
margin under pressure, so it may seek a quota share treaty to relieve this pressure by
passing a substantial volume of premiums to the reinsurers.
Chapter 6
• Is commission a factor? Proportional treaties provide for commission to be paid back to

the insurer, whereas non-proportional treaties do not.
• How are the claims to be shared? Does the insurer want a contribution towards each
claim or is it content to pay all or a fixed amount of each, and possibly all of a partial loss?
• Is the portfolio mixed evenly between property and casualty
casualty, or is there a bias towards
one type?
• How quickly will claims be settled? Most proportional claims are settled periodically in
arrears; whereas, in non-proportional treaties, all claims are recovered from the reinsurer
once the insurer has paid them to the original insured. Cash loss provisions in proportional
treaties will result in quicker payment by the reinsurer.
• To what extent can the cover be ‘reinstated
reinstated’’? Proportional treaties usually cover all risks
reinsured in respect of each and every claim during the original policy or treaty period.
This equates to the provision of unlimited reinstatements without additional premium.
However, reinsurers are increasingly applying some form of restriction on the amount that
they will pay in respect of specific incidents or high loss ratios.
Question 6.2
How are reinsurers doing this?
Excess of loss treaties are restricted ‘horizontally’, in so far as the number of reinstatements
is almost always limited and usually subject to the payment of additional premium. These
treaties are restricted ‘vertically’ because the cover of each layer is limited in amount, except
when unlimited cover is given to match the original policy, as in the case of motor third party
liability for bodily injury in many territories.
Be aware
Most excess of loss treaties are also subject to limited reinstatements. This aspect is part
of the overall costing of an excess of loss treaty.
• Does the insurer envisage a long-term relationship with the reinsurer which will ‘follow
the fortunes’ of the insurer –the type of relationship to which proportional treaties lend
themselves? Of does the insurer only require protection against losses over a specified
amount, with both parties prepared to review the arrangements on a yearly basis.
• Should reciprocity be pursued? Proportional treaties are suitable here, while non-
proportional treaties are less suitable.
• What is the cost of operation? Clearly, a quota share treaty is simpler to operate than a
surplus treaty. Under the former, all policies are subject to the same percentage of
reinsurance for premiums and claims; whereas under the latter, separate calculations are
necessary for each policy. An excess of loss treaty is even simpler to operate. The
reinsurance cost is calculated as a percentage of the insurer’s annual premium income,
and the number of claims under the treaty is limited since only those in excess of the
deductible fall under the treaty. As we know, most excess of loss treaties are also subject
to limited reinstatements. This aspect is part of the overall costing of an excess of loss
treaty.
A2 Combinations of treaties
When the insurer has decided which type of cover is suitable for its particular circumstances,
a treaty or a combination of treaties may be arranged to provide a programme of effective
cover. In the following examples we consider how a number of different combinations would
work in practice.
Example 6.1
Retention, quota share and surplus treaties
Here we have a combination of retention, a quota share and surplus treaties.
4 gross line 5 gross line
Chapter 6
Retention 50% quota share 1st surplus 2nd surplus
£100,000 £100,000 £800,000 £1,000,000
In this illustration, the insurer wishes to accept property risks with a maximum sum
insured of £2 The insurer’s net retention is £100,000.
A 50% quota share provides capacity for a further £100,000, giving a gross retention of
£200,000.
A four gross line first surplus treaty provides capacity for £800,000, while a five gross line
second surplus treaty provides a further £1m.
This arrangement allows the insurer to accept risks of up to £2m. Losses will be shared in
the same ratio of exposure and premiums ceded. Commission will be negotiated
according to the profitability of the account. The arrangements lend themselves to
reciprocity if the insurer wishes to pursue it.
Example 6.2
Retention and excess of loss ‘per risk
risk’’ treaties
Here we have a combination of retention of £100,000 and an excess of loss ‘per risk’
treaty for £400,000 in excess of £100,000, which will protect all risks with a sum insured
of £500,000.
£400,000 (limit) XS
£100,000 (deductible)
£100,000 retention/deductible
The insurer is content to pay all losses up to and including £100,000. However, if an
individual loss exceeds this amount, the insurer will seek a maximum recovery from the
reinsurer of £400,000.
The figure in example 6.2 represents the cover on a vertical plane. This is to demonstrate
that the claim must pass through the ‘floor’ of the excess of loss cover or, in other words,
exceed the deductible. The insurer will retain more premium than under a proportional
arrangement, but will not receive any commission. After the occurrence of a loss, the cover
may be reinstated on the payment of an additional premium. The number of reinstatements
is influenced by the expected frequency of loss at that level.
Example 6.3
Retention, quota share and excess of loss per risk treaties
£1,000,000 XS £200,000 any one risk
Retention 50% quota share

£100,000 £100,000
The figure here represents a combination of retention, quota share and excess of loss per
risk. This arrangement would permit a gross retention (net plus 50% quota share) of
£200,000.
The excess of loss treaty would operate if the loss exceeded £200,000, and would give
protection of £1m. The same considerations relating to premium retention and
reinstatement, associated with non-proportional treaties, would apply.
The insurer knows that it has capacity to accept risks up to £1.2but (probably) the
majority will be shared between itself and the quota share reinsurer.
As the diagram shows, the excess of loss treaty exists for the benefit of the insurer and the
quota share reinsurer, but this need not be the case (see example 6.4). They will share the
Chapter 6
premiums for the cover and the recoveries from it in proportion.
Example 6.4
Retention, quota share and excess of loss per risk treaties
£1,000,000 XS
£200,000 any one risk
50% quota share
Retention
£100,000
This figure also represents a combination of retention, quota share and excess of loss per
risk, but this time the per risk treaty protects only the insurer and not the quota share
reinsurer.
The arrangement would enable the insurer to accept risks up to £2.4m.
All risks and losses are shared equally, in the first instance, between the insurer and its
quota share reinsurer. However, the excess of loss contract operates to protect only the
insurer excess of £200,000 up to a limit of £1m.
Example 6.5
Excess of loss arrangement
£3,000,000 (limit) XS
£3,000,000 (deductible)
£2,000,000 (limit) XS
This figure represents an excess of loss arrangement showing a combination of excess of

loss ‘layers’ placed on a ‘loss occurrence’ basis to cover the possibility of accumulation of
risks. This arrangement would envisage a large loss arising out of, say, a hurricane, that
damages hundreds of small risks which individually would not be recoverable under a per
risk treaty. There would be a severe restriction on the number of reinstatements available,
usually one in each annual period.
Similar types of diagrams can be used to represent cover on a stop loss or aggregate
deductible basis, or where umbrella or clash arrangements cover losses arising in more
than one account from the same cause, for example, in property, casualty and marine
accounts.
A3 Class of business considerations

The type of reinsurance contracts required should reflect the market and type of business in Capacity of a
which the insurer operates, the type of risk written and the size and nature of the risks
Chapter 6
treaty should be
adequate for the
accepted. Therefore, the capacity of a treaty should be adequate for the majority of the risks majority of the
accepted or offered, and size of sum insured or limit of liability. If the insurer wishes to risks accepted or
offered
accept risks outside the definition or of a greater sum insured, it needs to resort to
facultative cover.
Original policies with unlimited liability for third-party personal injury, such as private motor
insurance in the UK, do not lend themselves easily to surplus treaties. Therefore, they require
a combination of, maybe, quota share and a number of layers of excess of loss contracts
providing the level of cover required by the insurer. This would need to be sufficient to take
into account the likely cost of claims arising out of multiple injuries that are settled in court.
In the case of marine risks, the insurer will be concerned to arrange cover that reflects its
liability in respect of one ship and the cargo on it, as well as other associated liability and
collision risks. Again, a combination of contracts to provide for unknown or unexpected
accumulations, in addition to those which relate to one voyage or hull or shipment, may be
necessary.
Question 6.3
When considering aviation risks, what potential liabilities will an insurer want to cover?
Sometimes, separate treaties are taken out for individual classes of business. On the other In liability business,
hand, in liability business, classes are often combined for reinsurance purposes, especially classes are often
combined for
for smaller clients whose book is most likely to be dominated by motor – as their other reinsurance
liability accounts tend not to be large enough to warrant separate excess of loss treaties. purposes
Combining classes under quota share treaties is relatively straightforward and different
levels of ceding commission can be accommodated.
The advantages of combining several classes of liability business in one treaty are as follows:
• In many cases, the reinsurance requirements are similar across the classes, thus one treaty
for all classes seems sensible.
• Ease of administration: calculation and payment of instalments, adjustments etc.
• It allows small companies in particular to include, within their main treaty, classes too
small to warrant separate reinsurance treaties.
• The insurer maintains flexibility by purchasing different limits under excess of loss treaties
for different classes.
The disadvantages of combining several classes of liability business in one treaty are as
follows:
• The insurer is often unable to split reinsurance costs accurately between different
departments or classes. Many reinsurers are now required to justify their exposures by
identifying premiums that correspond to such exposures. In the absence of actual
premiums, notional amounts are sometimes used.
• A common retention level applies to all classes for excess of loss cover.
• It is more difficult for the reinsurer to exercise underwriting judgment since the results of
different classes are obscured.
• Different classes of business may end up subsidising one another.
Example 6.6
Consider an insurer whose combined account is mainly motor business. The motor
account is suited to the highest reinsurance retention, yet its smaller public liability or
employers’ liability components would still have to carry the same retention under a
combined protection.
Chapter 6
Learning point
Before you move on, make sure you know the factors determining the choice of treaty
and the way in which combinations of contracts are used.
A4 Comparing the net experience of different

programmes
In general, both proportional and non-proportional solutions are used when putting a
reinsurance programme together.
Proportional
Proportional reinsurance is used to reduce the gross exposure; excess of loss reinsurance,
reinsurance is used including catastrophe excess of loss, and other non-proportional types are used to reduce
to reduce the
gross exposure
the net exposure. However, it should be noted that different types of reinsurance cover give
different results. An insurer obtains greater coverage under a quota share, but would expect
to pay more premiums. In certain situations only one type of cover would be suitable.
Be aware
If a property account is in a geographical area frequently hit by hurricanes, a proportional
cover will not adequately protect the insurer as it still has to pay a proportion of every risk.
It would seek an excess of loss reinsurance protection to ensure that it was not severely
affected by the aggregation of a number of small losses.
The reinsured would have to consider the historical development of its account and assess
what type of reinsurance programme might provide the best possible cover and what the
price of that cover might be.
Example 6.7
A company that accepts fire business up to a maximum sum insured of £500,000
considers the following two possible reinsurance programmes, each designed to limit its
maximum liability per risk to £100,000.
Programme 1
80% quota share with 40% ceding commission (reinsurance commission) subject to
maximum gross acceptance of £500,000.
Programme 2
Risk excess cover of £400,000 XS £100,000 premium adjustable at 20% of original gross
premium (OGP).
Assume that:
• the company’s OGP is £10m and that its commission and expense ratios relative to the
OGP are 15% and 20%, respectively;
• during the first year, total claims amount to £5m but only ten claims exceed the
£100,000 priority under the proposed risk excess of loss cover. The total recoveries
that would be made thereunder amount to £1.5m.
Ceding company
company’’s net of reinsurance experience
With a quota share With a risk excess of loss

£ £
Original gross premium income 10,000,000 10,000,000
Commission 1,500,000 1,500,000
Expenses 2,000,000 2,000,000
Chapter 6
Reinsurance premium 8,000,000 2,000,000
Less reinsurance commission (3,200,000) (Nil)
Net premium 1,700,000 4,500,000
Gross claims 5,000,000 5,000,000
Less reinsurance (4,000,000) (1,500,000)
Net claims 1,000,000 3,500,000
Net profit 700,000 1,000,000
In this example, risk excess of loss would prove more beneficial. However, different claim
payout patterns lead to different results. To help formulate a structured programme, brokers
have developed a number of programmes to assess the impact of different results arising
from the different branches of a reinsurance company.
A5 Using facultative reinsurance

It is unusual for an insurer to choose facultative reinsurance to use as its only method of Insurer should take
protection it is most commonly used for the risks or part of risks not protected by some form note of the normal
pattern of losses
of automatic or treaty reinsurance. Consequently, when choosing whether to purchase
proportional or excess of loss facultative reinsurance, the insurer should take note of the
normal pattern of losses that may be expected on the business concerned as this will affect
the amount of reinsurance recoveries.
In other words, care must be exercised to ensure that the selected programme of
reinsurance meets the needs and expectations of the reinsured company. This may best be
demonstrated by comparing the result of the same loss in different reinsurance situations for
a ceding company.
A5A Comparison - same loss in different reinsurance situations

Company A’s maximum fire retention is £500,000 sum insured per risk and has in place a
gross twelve-line surplus treaty giving it an overall capacity of £6.5m per risk. The retention
is protected by treaty per risk excess of loss for £400,000 XS £100,000.
Proportional facultative reinsurance

The company underwrites a risk with a sum insured of £8m, retains £400,000 and buys
additional proportional facultative reinsurance for the proportion of the risk that cannot be
ceded to the treaty. The allocation of this liability is as follows:
Amount
Retention £400,000 5%
Surplus treaty £4.8m (12 × ret.) 60%
Facultative R/I £2.8m 35%
£8m 100%
If a loss of £4m occurs it must be allocated in the same proportions:

Retained loss £200,000 5%
Surplus treaty loss £2.4 m 60%
Facultative loss £1.4m 35%
£4m 100%
As the insurer had protected its retention, the treaty per risk reinsurance would pay
£100,000, which is the amount in excess of the £100,000 deductible and this would be the
insurer’s net liability on this claim.
Non-proportional facultative reinsurance excess of the total treaty liability
Let us now, instead, assume that the facultative reinsurance cover in excess of the surplus
treaty capacity had been purchased on an excess of loss basis. The outcome of this claim to
the reinsurers involved would have been quite different:
Original sum insured £8m
Retention £400,000
Chapter 6
Surplus treaty £4.8m
Total treaty liability £5.2m
Facultative reinsurance for the amount in excess of the treaty capacity for this risk would
need to be:
£2.8m XS £5.2m
In this example, the total treaty capacity retention plus amount ceded to the surplus, will
respond on a first loss basis up to the first £5.2m. Such arrangements would need to be
specifically agreed by the surplus treaty reinsurers. In practice, most surplus reinsurers
refuse to have risks ceded on a first loss basis as this would be against the principles of
proportional reinsurance. With a first loss cession, the proportion of a claim paid by the
surplus treaty reinsurer could be higher than the proportion of premium it received.
The loss amount of £4m is below the deductible of the facultative reinsurance and no
recovery can be made from this cover. The loss would be allocated to the insurer and treaty
reinsurers in the same proportions as the original treaty capacity, i.e. 1/13th to the insurer and
12/13ths to treaty reinsurers.
This would leave the insurer with a gross retained loss of £307,692 of which £207,692 would
be recoverable from the treaty per risk excess of loss cover. This leaves it, again, with a net
liability of £100,000, while surplus treaty reinsurers would pay £3,692,308.
Brokers have developed a number of programmes that assess the impact of the losses
arising from the different underwriting areas of a company in order to formulate a structured
programme to reflect its overall needs when purchasing reinsurance.
Non-proportional facultative reinsurance for the reinsured
reinsured’’s retention
These are theoretical possibilities and explain how loss allocation actually works. It is unlikely
that the programme would be placed in this format; if it were it would require substantial
agreement from all participating reinsurers.
The usual method of facultative arrangement for this example is with a retention of
£400,000 and a cession of £4.8m to surplus. The remaining exposure of £2.8m comes back
to the cedant, giving them a net exposure of £3.2m. This exposure could be protected by a
facultative excess of loss reinsurance for £2.7m excess of £500,000, with the cedant’s first
retention still being protected by their risk excess of loss treaty of £400,000 excess of
£100,000. This is illustrated diagrammatically in figure 6.1.
On this basis, only the agreement of the risk excess of loss treaty reinsurers would be
required for the inclusion of the risk under the excess of loss cover, otherwise all the
reinsurers would be required to signify their agreement.
Figure 6.1: Facultative reinsurance

Supplementary
retention £2.8m
Maximum cession to
surplus £4.8m
Total cedant retention
£2.8m + £0.4m
Retention £400,000
£3.2m protected by
Facultative excess of
loss £2.7m XS £500,000
Risk excess of loss
Chapter 6
£400,000 XS £100,000
Cedant retention £100,000
Again, if a loss of £4m occurs:
Retained loss £200,000 5%
Surplus treaty loss £2.4m 60%
Additional retained loss £1.4m 35%
£4m 100%
This time the net exposure would be £1.6m, resulting in an ultimate cedant retention of
£100,000, a total loss to the layer of risk excess of loss reinsurance and a claim of £1.1m to
the facultative excess of loss reinsurance.
Activity
Using the figures provided, show that the largest loss which will not result in a claim on the
latter contract is £1.25m.
A5B Case study: loss recovery – motor quota share and excess
of loss
Rantiki Insurance Company writes motor business with a limit for any one event or accident
of €6m for third party bodily injury. The motor account was protected by a combination of a
50% quota share and an excess of loss layer for the net retention.
In order to protect the net account, based on the €6m policy limit for 100% and a 50% quota
share, the reinsured only needs €3m ground up cover plus an allowance for property
damage and legal costs to be protected by an excess of loss layer. The net was protected by
two layers:
• €500,000 excess of €500,000.
• €2.5m excess of €1m.
A motor accident occurred in which two persons were killed and one was left permanently
disabled. The driver, who had a motor policy with Rantiki, was held liable and the court
awarded €4m in compensation for all four victims combined. Legal and other costs
amounted to €200,000, which took the total loss amount to €4.2m. €2.1m was recovered
from the quota share: 4.2m loss × 50% QS.
Out of the remaining €2.1m:
• €500,000 was retained by Rantiki;
• €500,000 was collected from the first layer; and
• €1.1m was collected from the second layer.
A5C Case study: loss recovery – property, whole account quota

share, property risk and catastrophe XLs
Albion Insurance writes several classes, which are protected by a 40% whole account quota
share with a treaty limit of £10m any one risk for 100%, and by specific excess of loss
programmes for each main class.
The main exposures are from the property account, and Albion has a maximum line limit of
£10m sum insured for any one risk. Albion’s maximum retention for property risks, after the
40% QS, is £6m - 60% of 10m.
The net property account is protected by the following programmes:
Risk XL £500,000 excess of £500,000
£1m excess of £1m
£4m excess of £2m
Cat XL £2m excess of £2m

Chapter 6
£6m excess of £4m
£10m excess of £10m
Windstorm Boris caused total losses to Albion of £12m. All but one of the individual gross
losses were under £800,000. The exception was the loss to an engine manufacturer where
the roof was blown off during heavy rain. This caused a combined gross loss of £4m for
buildings and contents combined.
Loss recovery
£1.6m, being 40% of £4m, was recovered from the whole account QS for this single loss. The
net loss for purposes of recoveries from the Risk XL was:
£4m less £1.6m recovered from the whole account quota share
This left a net loss before XL recoveries of £2.4m.
Albion retained the first £500,000 net loss and recovered:
• £500,000 from the 500,000 excess of 500,000 layer;
• £1m from the £1m excess of £1m layer; and
• £400,000 from the £4m excess of £2m layer.
Total recoveries from Risk XL layers were £1.9m.
Total recoveries from the quota share for all windstorm Boris losses, including the £4m
single loss, were:
£12m × 40% QS = £4.8m
(The recovery from the risk XL was for the reinsured’s benefit only.)
The total net loss to Albion, before recoveries from the Cat XL programme, was:
£12m gross loss less £4.8m recovered from the QS and less £1.9m recovered from the
Risk XL.
That left a net loss from Windstorm Boris of £5.3m, i.e. £12m less £6.7m recoveries. Of this:
• £2m was retained by Albion;
• £2m was recovered from the £2m excess of £2m first cat layer; and
• £1.3m was recovered from the £6m excess of £4m layer.
Total recoveries from the Cat Programme were £3.3m.
Summary
Total ground up loss to Albion £12.0m
from Windstorm Boris:
Recoveries from QS: £ 4.8m
Recovery from Risk XL: £ 1.9m
Recovery from Cat XLs: £ 3.3m
Total Recoveries £10.0m
Net Retained Loss to Albion £ 2.0m

after all recoveries:
B Pricing programmes
Once designed, a reinsurance programme must be priced. So far as non-proportional is
concerned, the price of each treaty is derived from the following factors:
• risk premium
premium, which is the cost of claims including a loading for fluctuations;
• external costs, which include acquisition expenses and agents’ commission;
• internal costs, such as administration and staff costs; and
Chapter 6
• desired profit or return.
In basic terms, for each treaty, the risk premium – that is, the expected losses to the
particular contract for the prospective treaty year – is estimated using a variety of, largely,
actuarial techniques. Typically, the premium is modelled by a reinsurer’s pricing actuary and
we take a brief look at the main techniques used to do this in section B1. Next, the loss cost is
adjusted for any policy features that vary with losses (for example, aggregate retentions,
reinstatements and profit commissions).
To complete the process, the premium is then loaded for expenses and profit and any other
factors considered appropriate in the light of the particular circumstances.
B1 Pricing techniques
There are three

main approaches
to reinsurance
pricing:
(3)
(1)
frequency and
experience rating
severity rating
(2)
exposure rating
B1A Experience rating

Experience rating is the use of experience (losses and exposure) to project or estimate Use of experience
average future loss costs. This approach takes contract-specific historical loss and exposure to project or
estimate average
data (for instance, premium) and develops and/or adjusts it to reflect current exposures. It future loss costs
uses this as a basis for selecting the specific expected losses and hence the required
premium rate, or risk premium, for the reinsurance contract.
Depending on what data are available, historical premium may be projected to reflect rate
changes up to the prospective period. Similarly, incurred losses are developed to ultimate,
using one or more reserving methods, such as the loss development (or Chain Ladder)
method, or the expected loss ratio method, or a combination of the two (Bornhuetter-
Ferguson method), and a measure of claims inflation is applied. This technique may be used
for proportional and non-proportional treaties.
As regards proportional treaties, the only pricing decision is the overriding commission. This
is because the price of proportional reinsurance is the reinsurer’s percentage of the original
premium, less any reinsurance commission, profit commission and overriding commission.
From the reinsurer’s point of view, that commission should, however, take account of,
amongst other things, uncertain premium and claims volumes and associated administration
costs, the extent of any natural perils exposures and any event limitation and loss
participation clauses.
B1B Exposure rating

Exposure rating is the practice of using reinsurance exposures, together with general
industry data about loss ratios and severity patterns, as a basis for estimating the expected
losses to the layer, and hence the required premium rate. This method has no application to
proportional reinsurance and does not rely on the availability of historical loss data.
Typically, the exposures will be quantified in the policy limit/attachment (or risk) profile of
the portfolio. The industry data will usually take the form of exposure curves or increased
limit factors (ILFs
ILFs) or something similar, to allocate losses between layers of exposure,
together with a loss ratio expectation for the underlying book as a whole. Exposure curves
detail the relationship between the accumulation of insured values and the accumulation of
estimated loss.
Example 6.8
Chapter 6
A portfolio has a historical loss ratio of 75%. The original insurance policy has a limit of
£400,000 and a premium of £2,000. It is possible with an appropriate ILF curve to
estimate the expected cost of losses to a reinsurance layer of £300,000 excess of
£300,000 and hence to calculate the unloaded risk premium.
The exposure to the reinsurance layer from that part of the original policy which exceeds
the reinsurance retention of £300,000 is £100,000. Applying the ILFs, the exposure
attributable to that amount as a percentage of the exposure attributable to the entire
original policy, is 1-1.80/2.00, or 10%. So, on the basis of the historical loss ratio, the
estimated loss cost to the reinsurance layer is £150 (that is, 10% of 75% of £2,000).
Figure 6.2: Exposure rating

600,000
Limit ILF
400,000 100,000 1.0
300,000 300,000 1.8
400,000 2.0
Used to estimate
Catastrophe models are also used to estimate the expected loss costs to a layer and we look
the expected loss at these in section B2. The low-frequency nature of catastrophes and their complex
costs to a layer
dynamics render experience rating a scarcely credible predictor of future losses. Instead, the
emphasis is on exposure and experience serves mainly as an adjustment factor.
B1C Frequency and severity rating

Frequency and severity rating is the practice of developing a stochastic model of the risk
where you simulate the potential loss experience based on estimates of the number and size
of reinsured losses together with the reinsurance treaty terms. This gives you a distribution
for the recoveries and thus leads to a price. Such a model may be very simple or very
complex.
B2 Catastrophe models
Although introduced in the mid-1980s, catastrophe models were not widely accepted until
after the unprecedented losses caused when Hurricane Andrew hit Florida in August 1992.
Nine insurers became insolvent and it soon became clear that a simple actuarial approach
based on exposure curves was insufficient, and a more sophisticated probabilistic approach
to the measurement and management of natural catastrophe risk was required.
Today, the models are prevalent and assist (re)insurers with valuable insights into the
potential frequency and severity of catastrophic losses. By quantifying those losses, the
models enable (re)insurers to make decisions around pricing and portfolio management,
individual risk assessment and the extent of reinsurance cover. They are also used by
regulators and rating agencies to assess the financial strength of (re)insurers.
Useful website
www.air-worldwide.com/models/about-catastrophe-modeling/
B2A Components
Catastrophe models identify and quantify the likelihood of specific natural disasters Four basic
occurring in a region and estimate the extent of incurred losses. We will now consider the components to the
catastrophe model
four basic components to the catastrophe model.
Hazard
This component defines the hazards, that is, a set of stochastic (simulated hypothetical)
events. Each event is defined by a specific strength or size, location or path and probability
of occurrence. In the case of hurricanes, the model looks at storm tracks and wind speeds for
a given landfall and route. In the case of earthquakes, the model estimates the level of
ground motion across the region.
Chapter 6
Inventory
This component defines the inventory or portfolio of properties at risk as accurately as
possible. Key information includes the precise location of structures and their construction
type, use or occupancy, height/number of stories and age. The quality of this data is
paramount.
Vulnerability
The next step is the quantification of the expected damage to the inventory caused by the
hazard phenomena, in other words, the vulnerability of those risks.
Together, these first three components or modules are traditionally known as a probabilistic
risk analysis.
Loss (or financial)
This component translates the physical damage into total monetary loss. Loss is Translates the
characterised as either direct – e.g. the costs of repair or reinstatement – or indirect – e.g. physical damage
into total
business interruption or relocation costs. Once total losses have been calculated, estimates monetary loss
of insured losses are computed by applying policy conditions, e.g. deductibles and limits.
B2B Output
The main output of a catastrophe model is an exceedance probability (EP) curve. This gives
the annual probability that a certain level of loss will be exceeded.
In figure 6.3, there is a 1% probability of a loss exceeding US$4m in the year. Alternatively, a
US$4m loss (or more) is expected to occur once in a 100-year period. The event is said to
have a return period of 100 years.
Figure 6.3: EP curve

Annual probability
of exceedance
5.0%
4.0%
EP Return Loss amount

3.0% period (£m)
0.02% 5,000 40
2.0% 0.10% 1,000 30
0.20% 500 20
0.40% 250 15
1.0% 1.00% 100 5
0.0%
0 10 20 30 40 50 60 70 80
Loss amount
Reproduced with permission from Allianz Global Corporate & Specialty
Curve also yields

The curve also yields the average annual loss (AAL) (also known as the ‘pure premium’ or
the AAL the ‘burning cost’). The area under the curve represents the amount of capital necessary to
cover all expected losses over the stated time. In other words, the area under the curve is the
sum of all of the average annual losses. There is also the coefficient of variation, which gives
an indication of the volatility around the AAL estimates.
Chapter 6
Consider this
this…
…
If there is a 0.4% chance of losses exceeding US$15m in the forthcoming year, how much
reinsurance cover do you buy?
B3 Loading
Continuing the modern actuarial approach to pricing, having established the model price by
one or more or a combination of the techniques just described, the risk is underwritten to
establish a technical price (or premium). During this step, the reinsurer may wish to load the
risk premium for any number of factors that depart from those inherent in the risk used to
calculate the model premium.
Following a detailed analysis of the insurer’s portfolio, reinsurers may wish to load the risk
premium for the potential for extraordinary losses that could have a significant impact on
the whole account.
Example 6.9
A reinsurer reviews a property book and pays special attention to ‘high end’ risks. These
might be expensive industrial risks, such as fibre board manufacturers or large retail
shopping malls. They will also consider the potential of the portfolio to be exposed to
catastrophe losses and factor that in. Extraordinary catastrophic losses may have to be
temporarily removed from the statistics to gauge the underlying basic loss history before
factoring them in again separately.
The reinsurer will consider the current terms and conditions under which the insurer is
writing business and determine the following:
• Whether there has been a change in the nature of the portfolio that could affect the basic
loss pattern. An insurer may have focused more on writing residential property instead of
commercial property, which could result in a better – or worse – loss ratio.
• Underwriting changes within the company concerned.
Example 6.10
An insurer has recently lost a senior underwriter (who was in charge of a department with
many years’ experience). Its reinsurer may have concerns over who is going to replace
them and what their underwriting philosophy will be compared to that of the previous
underwriter.
• Rating changes in the underlying business as a result of aggressive marketing tactics

leading to price reductions, which could have an adverse impact on the loss ratios.
• Change in deductibles.
Additionally, if the insurer requires assistance from the reinsurer in, say, the provision of
pricing tools for the underlying business, wordings or claims assistance, this could also be
reflected by a service requirement loading.
Question 6.4
Why might reinsurers want a loading if they are required to consider a high number of
special acceptances?
C Placing programmes
The successful negotiation of a reinsurance contract or programme depends on the quality Successful
and quantity of the information made available to the potential parties. In many cases, negotiation
depends on the
reinsurers have a limited amount of time available to review information and make a decision quality and
that may have far-reaching consequences for their company. Similarly, insurers must decide quantity of
information
who to contract with on the basis of imperfect information about them, with potentially and
equally significant consequences.
Chapter 6
C1 Material information for reinsurers
The distribution of information is unevenly spread between the insurer and the reinsurer. The
reinsurer cannot make a proper assessment of the risk without receiving a fair presentation
of the risk, that is, detailed and accurate information. It may be put in a prejudiced position
by quoting terms based on inadequate or erroneous data.
Essential or key data that will influence the outcome of a negotiation include both general
information about the insurer, its overall portfolio of business and the way the company is
managed, as well as specific data about the risk or particular account to be protected, as
follows.
C1A Details of the client

When the insurer offering its business to the reinsurer is previously unknown to it, the
reinsurer will want to identify the:
• date the company was established;
• its capital structure and ownership;
• its trading results – best identified by reviewing recent balance sheets;
• the knowledge and experience of the individual underwriters it employs; and
• the ability and competence of its management.
C1B Specific information concerning the proposed reinsurance

The key information that should be made available to the reinsurer will typically include all or
some of the following items:
• Class or classes of business to be covered
covered. There should be a clear indication to the
reinsurance underwriter of the precise risks to be protected by the reinsurance. If
possible, the nature and extent of the original coverage should be outlined and, with a
new client, examples of original policy wordings would be advantageous.
• A breakdown by premium income and aggregate exposure in the territories for which
cover is being sought.
• Original policy sums insured
insured. Details of the sums insured or EML limits of liability being
issued by the reinsured, including any deductibles that are applied to the original policies.
• Risk profile
profile. Details of the different sums insured underwritten by the reinsured and an
indication of the composition of the portfolio.
Be aware
In the case of a property account, the risk profiling exercise would show whether it
consists of simple, commercial or industrial risks or a combination of them all. Risks would
also be allocated to bands into which sums insured fall.
The risk profile should indicate whether the portfolio consists entirely of direct insurances
or whether there is an element of inwards reinsurance business, as this may present the
potential reinsurer with significant additional unknown accumulation exposures. Finally,
the relationship between any hazardous and non-hazardous risks in the portfolio should
be made clear and what, if any, special perils or risks may be covered. If the proportion of
inward reinsurance business written is significant, potential reinsurers may require
separate profiles for this class of business. This would certainly be the case if the reinsured
purchased an excess of loss cover that was to include protection for its inward excess of
Chapter 6
loss writings.
• General experience
experience. There may be concerns about the insurer’s experience in the
particular class or classes of business that it is proposed the protection will cover. Positive
information confirming the overall experience of the company to manage its accounts
and its claims, as well as the individual experience and competence of the actual
underwriters can be beneficial in negotiating the required reinsurance.
• Premium income
income. The development of the insurer’s premium income is a measure of its
business activity and exposure. This information should be provided for the account to be
protected over the past five to ten years, together with an estimate for the current and
next year.
• Claims experience
experience. This information more than any other, forms the basis of the
negotiations on the price of the reinsurance. Claims experience influences the premium
required by non-proportional reinsurers and the commission that proportional reinsurers
will be prepared to allow. Any claims details must be sufficient to enable the reinsurer to
assess what its future liabilities may be. It would not be adequate to advise whether the
particular reinsurance being placed has had any losses or not. This could be misleading if
the insurer has recently increased its general underwriting policy, increased its original
policy limits or changed its underlying proportional arrangements, all of which would
require the reinsured to provide ‘as if’ loss figures. In the case of non-proportional
reinsurances, claims which previously were settled below the deductible may now be
considerably greater due to the effect of inflation or to changes in law and attitude of
courts in settling compensation claims.
Be aware
It may be necessary to obtain details of all claims that have affected the portfolio or at
least all claims larger than, say, 50% of any proposed reinsurance deductible.
With a liability account comprising long-tail business, there is a need for reinsurers to
project the anticipated eventual loss experience for each underwriting year. This is
because of the length of time it can take for claims to be reported and settled. Therefore,
statistics that predict the possible outcome are required. Such loss details are called
‘development’ or ‘triangulation’ statistics and will give paid and outstanding loss figures at
annual review dates on an individual claims basis. This information not only proves
invaluable for rating the risk, but also gives a significant insight to the insurer’s
claims-reserving philosophy and expertise.
• Exclusions
Exclusions. In addition to any standard exclusions that will be applied, such as nuclear or
war risks, the reinsured should provide, wherever possible, details of the business or perils
that it does not underwrite or for which it does not require reinsurance. Even if such a list
is available, it will not be unusual for reinsurers to impose their own exclusions.
Question 6.5
Why is a reinsurer interested in the pace at which an insurer’s account had developed?
C1C Reinsurance preference

The price and, in some instances, the availability of reinsurance, will influence the method Price influences
of reinsurance chosen. The differences between proportional and non-proportional methods the method of
reinsurance
will be considered when determining a programme structure. chosen
Proportional reinsurances
The cost of proportional reinsurance for the insurer is usually a pro rata share of the premium
charged for the original insurance; however, it will seek to retain a percentage of this
premium as a commission for ceding business.
Consider this
this…
…
Chapter 6
In effect, the reinsurers will be accepting a full share of any liability but receiving a
discounted premium. Think about what the discount represents.
Negotiating the size of any commission is a key factor with such reinsurances. The insurer
seeks a commission to cover its acquisition costs, such as agent’s and broker’s commission,
as well as any taxes for which it may be liable. In addition, it would look to recover a
contribution towards its own general and administration costs and, possibly, some form of
overriding commission from its reinsurers. For a reinsurer, the size of the total commissions
being taken on its premium limits its potential for profit on the business being ceded, and it
is essential for the reinsurer to get an agreement that is fair to both parties.
Non-proportional reinsurances
As reinsurers are not participating in each and every loss that arises on the business being
protected, the price for the non-proportional reinsurance cannot be a simple pro rata share
of the original premiums. This applies whether the reinsurance is a facultative single risk case
or an excess of loss treaty protecting an entire account or class of business. The methods
used to arrive at the price of the reinsurance must take into account the likelihood of loss
that is being transferred to reinsurers. In addition, the price needs to make allowance for the
reinsurers’ expenses, potential profit and any brokerage involved, as well as the degree or
possibility of fluctuations in the loss experience.
For each type or class of business the nature of the material information and statistics
required to negotiate reinsurance protection will largely follow a similar pattern or set of
categories. However, there will be differences of emphasis from one account to another, or
from one type of reinsurance to another. Additional or special factors may need to be
considered when reviewing particular accounts.
C2 Security considerations for reinsureds

Following the demise of a number of leading reinsurers, their long-term financial viability has
become a high priority. These insolvencies have focused insurers’ minds on the need to
analyse comprehensively the security of their outwards reinsurances.
C2A Security Committee

Insurers wish to
When purchasing outwards reinsurance, insurers will wish to reinsure with a company or
reinsure with a syndicate that is recognised as financially sound and which meets the insurer’s own security
company or
syndicate
requirements. Typically, those security requirements are managed by a Security Committee
recognised as whose membership will encompass personnel from the underwriting, accounting, actuarial
financially sound
and internal audit disciplines. The level of seniority of the personnel involved will depend on
the priority given internally to the Committee’s work.
Its duties will usually include:
• Grading all current and proposed reinsurance security. Each reinsured will have its own
review and monitoring processes and criteria for evaluating and grading reinsurers
reinsurers. Often
a report is prepared and a recommendation put to the Committee for a decision.
• Setting its maximum exposure to each approved reinsurer by class of business and in
aggregate.
• Monitoring market news and developments generally for information with potential
security implications, for example, writing unusual business, raising fresh capital, suffering
particular claims or catastrophes, ratings downgrades or corporate activity.
• Verifying that its gradings and recommendations are being followed internally. Within
some reinsurers, the approved security list may be no more than an indication or
recommendation to underwriters. In others, it may be mandatory with disciplinary
procedures following if breached.
• Monitoring its aggregate exposure to each reinsurer, that is, all classes of business over all
years, and to all reinsurers within the same group of companies. If the reinsured also
reinsures the reinsurer, the net exposure between the two companies will also be
monitored.
C2B Grading reinsurers

Chapter 6
When grading reinsurers, the factors to be taken into account by reinsureds are many and
varied.
First and foremost is the company’s financial characteristics, and a thorough analysis is
conducted of the company’s present and recent past for the purpose of obtaining an
indication of its future ability to pay claims. Key indicators include its solvency margin,
available shareholders’ funds, technical reserves and gross premium, all viewed in the
context of its wider business.
Size is paramount
Looking at it simplistically, size is paramount on the basis that insolvency is generally
restricted to the smaller reinsurers rather than the larger reinsurers. This is because the
business of the larger reinsurers is more diversified, both geographically and across classes
and is, therefore, better able to weather significant losses. That said, AIG would not have
survived the losses within its Treasury department without the assistance of the US
Government in the financial crisis of 2008.
Other factors include the quality of its management and key underwriting personnel, its
capital structure and the identity of its ultimate owner. A reinsurer may be subsidiary of a
large group and it may be appropriate to consider to what extent, if any, that parent would
assist a subsidiary in difficulty. Reinsurance pools may require special consideration. On the
one hand, they are usually graded according to their weakest member. However, on the
other, they may have been created for special purposes (e.g. terrorism risks) and be backed
by a government.
On the subject of capital structure, Lloyd’s is particularly attractive to some reinsureds
because of its unique capital structure. This, and in particular its Central Fund, is discussed in
chapter 9, section B1A.
Rating agencies A reinsurer’s rating by one of the rating agencies is another key piece of information, being
are covered in
more detail in the result of a rigorous, objective and independent analysis by experts. Care must be taken,
chapter 9, however, to understand the criteria underlying the rating and to cross-check these with the
section E
reinsured’s own views and situation. Another potential limitation on the usefulness of ratings
is the time lag in issuing reports following developments.
Regard should also be had to a reinsurer’s domicile as it may, for example, be politically
unstable or subject to minimal regulation or to low accounting standards.
Other, more qualitative considerations, may include historical speed of claims payment and
levels of related service. The reinsured may also reinsure the reinsurer, or compete in similar
markets, and claim particular knowledge of the soundness and quality of the reinsurer. The
reinsured should also have regard to the reinsurer’s retrocession arrangements, if known. If
they are unresponsive, the reinsurer may fail.
Insurers often modify security criteria for some kinds of reinsurance, especially long-tail Insurers often
lines, where a more cautious approach is demanded as reserves may stay on the books for a modify security
criteria for some
considerable time before settlement. Another reason is to maintain continuity of kinds of
relationships with existing reinsurers. If a reinsurer has served the reinsured well in the past, reinsurance
possibly in difficult circumstances when coverage was scarce and expensive, the reinsured
may be inclined to accommodate the reinsurer as it may assure similar treatment in the
future, should the need arise.
C2C Brokers
The intermediary can also have a significant role to play in the reinsured’s choice of
reinsurer. While the responsibility for the selection of the reinsurer is ultimately that of the
reinsured, the broker may also rate reinsurers and, in law, will usually have an obligation to
place business with reinsurers that are not solvency or credit risks. Typically, they are also
excellent sources for intelligence about the ability or willingness of a reinsurer to pay its
losses.
C2D Collateral
If a reinsurer would otherwise not meet the reinsured’s strict security requirements –
whether to write the business in the first place or perhaps to exceed internal limits on the
amount of that business, the reinsured may accept back-up security or collateral
collateral.
This may be achieved by including a loss reserves clause (or similar) in the contract. This Refer to
chapter 7,
Chapter 6
requires, in effect, that the reinsurer capitalise incurred (not paid) claims upon notification. section B2C for
This may be done, for example, by establishing a Letter of Credit, a cash advance into a trust loss reserves
clause
fund or by withholding funds. So, in the event of solvency problems, the monies are readily
available to the reinsured when those claims become due.
In some jurisdictions, the requirement to provide collateral may be a regulatory one, rather
than a voluntary one, if the reinsured is to be allowed a statutory credit against its claims
reserves for the reinsurance it has purchased. Taking the USA as an example, if the particular
reinsurer is authorised in the reinsured’s state, there may be no regulatory requirement to
post collateral, but it may still be required by the reinsured for reasons of common prudence.
You will appreciate that providing collateral can significantly add to a reinsurer’s cost of
doing business with a particular counterparty in a particular jurisdiction. It should also be
understood that the credit risk is merely being transferred elsewhere – to a bank, to a broker
or to a trust company.
C2E Insolvency
To reiterate, the process of monitoring current reinsurers should continue throughout the
life of the particular agreement(s) and for as long as obligations remain outstanding under
it(them).
Should a reinsurer’s financial condition deteriorate mid-term, the reinsured may wish to Reinsured may
change carrier and it is common, in the event of a downgrade, for such a right to have been wish to change
carrier
reserved in the contract. If there is no express right of termination, the parties may agree to
terminate in any event and, even if not, the reinsured may be prudent to treat its
participation as having been terminated and replace it.
Should a reinsurer’s financial condition deteriorate after expiry and while there are
outstanding balances, the reinsured may seek to commute those balances (that is, receive a
reduced sum and end the contract). Another way to reduce the credit risk is an offset clause
in the reinsurance contract. To the extent that amounts are recoverable from insolvent
reinsurers, the reinsured can reduce any payment to be made, on this or other contracts, to
the reinsurer.
C2F Other considerations

In placing a reinsurance programme, reinsureds may choose to use a number of different
reinsurers to improve the overall security of the programme. Diversification by the reinsured
reduces the impact of reinsurer credit risk or of the withdrawal of capacity on, typically,
annual renewal in hard markets. Clearly, the fewer reinsurers used, the more important the
security of those reinsurers to the financial wellbeing of the reinsured.
Question 6.6
Name two common treaty terms and conditions which could reduce the impact of
reinsurer insolvency on the reinsured’s reinsurance recoveries.
C3 Contractual placing documentation

By way of introduction to the next chapter, we complete our consideration of the placement
of the programme by describing the process and by introducing the Market Reform
Contract (MRC
MRC) and the Contract Certainty Code of Practice
Practice.
C3A Acceptance of the risk

Having received a fair presentation of the risk the reinsurer may choose to accept that risk. It
will then enter the amount or percentage of the risk that it is prepared to accept on the
contract document, usually described as the slip, and adds its stamp, initial and the date.
Its liability will generally only attach from that point. However, it is not uncommon for
reinsurers of certain classes of reinsurance to back-date the start of their liability, providing
that they are satisfied with the circumstances prevailing on that particular risk. Such a
willingness to back date cover requires a great deal of trust to exist between the reinsurer
Chapter 6
and reinsured.
Slip provides
Once the underwriter has committed itself to a participation in a reinsurance by ‘writing a
evidence of line’ on a slip, the slip provides evidence of a contract of reinsurance.
contract of
reinsurance The London Market uses of a standard form of contract document, incorporating the full
terms and conditions. This document, the market reform contract (MRC) (see section C3B),
has become the evidence of cover and, in effect, replaces the slip and any subsequent
contract wording. All London broker placements are made on this basis, unless the reinsured
requests otherwise.
In a subscription market, business is offered to and accepted by a number of separate, and
totally independent, risk-bearing organisations. This can be best seen in the way that the
London reinsurance market operates.
Learning point
While we are referring here to ‘subscription’ market business, markets can also be
‘vertical’. Be sure you can recognise the differences between the two.
Here, each entity, whether it is a Lloyd’s syndicate or a reinsurance company, decides either
to decline or accept proportions of risks offered by clients. Risk continues to be offered until
the total amount of insurance or reinsurance required by the client has been placed, or the
maximum amount of the risk that the market is prepared to accept has been achieved.
C3B Market Reform Contract (MRC)

According to the Open Market MRC standard, the MRC should be used for:
• all firm quote and firm order open market insurance and reinsurance business placed by
London Market brokers;
• all marine open cargo covers and declarations attaching to them. Marine open cargo
covers are defined as those risks where the insured has, or is expected to acquire, an
insurable interest in each declaration bound;
• declarations or off-slips attaching to line slips; and
• declarations off limited binding authority agreements, where appropriate.
Coverholders are firms that are authorised by Lloyd’s syndicates, and sometimes by
company underwriters, to enter into contracts of reinsurance and issue documentation on
their behalf. They can be established anywhere in the world.
The MRC is in six sections, as follows. The MRC is in six
sections
Table 6.1: Market Reform Contract (MRC)

Risk details Details of the risk/contract involved, such as the insured, type, interest,
coverage, conditions, subjectivities, jurisdiction and premium.
Information Free text additional information is used to detail or, more typically, reference
the information provided to (re)insurers to support the assessment of the
risk at the time of placement.
Security details Includes reinsurers’ liability (for reinsurances), order hereon, basis of written
lines, basis of signed lines, signing provisions, and insurers’ or reinsurers’
‘stamp’ details (which indicate each insurer’s share of the risk and their
references).
Subscription This section documents all of the inter- and intra-market arrangements to
agreement operate between the subscribers to the risk in relation to the agreement of
contract changes, claims, the collection of expert fees, the payment of
premium and the use of third-party service providers.
Fiscal and regulatory Includes details of fiscal and regulatory issues specific to the placement of
the risk.
Broker remuneration Information relating to brokerage, fees and deductions from the premium.
and deductions
There are also a number of guidelines so that its use is consistent with the principles of
contract certainty and the Contract Certainty Code of Practice. These guidelines are that:
Chapter 6
• any monetary amounts should be clear as to the applicable currency. To avoid doubt,
symbols such as £ or $ should not be used. Instead the relevant three-letter ISO currency
code should be used, such as GBP for British pounds sterling and USD for United States
dollars;
• the contract should not contain any acronyms or other terms which are ambiguous or
non-specific, in particular, terms such as ‘TBA’ – to be agreed or to be advised;
• all contract terms should be clearly stated. Any standard registered wordings or clauses
should be referenced or attached, and all bespoke and non-standard wordings and
clauses must be attached in full;
• any subjectivities stated in the contract must be expressed as unambiguous conditions;
• standard contract provisions must be relevant to the risk or the administration of that risk;
• signing provisions should be used where there is more than one participating reinsurer so
that certainty of the signed lines is achieved by inception or by the time the contract is
finalised; and
• all of the requirements specified in the Contract Certainty Code of Practice should be met.
Be aware
When we refer to a ‘bespoke’ wording, we mean a form of words that has been designed
to a one-off specification that is not in widespread use and, therefore, not universally
recognised.
C3C Contract certainty

The Contract Certainty Code of Practice – Principles and Guidance was introduced in 2005 Code represents a
(last updated in October 2012) to ensure that final agreement on all terms is achieved by all common approach
for the whole UK
parties prior to the inception of the contract. It represents a common approach for the whole insurance industry
UK insurance industry and applies to general insurance contracts either entered into by a
UK-regulated insurer, or arranged through a UK-regulated broker (that is, slip and non-slip
business). That said, its status is that of industry guidance, and it is not intended to be
binding on any party.
It starts with a definition of Contract Certainty as follows:

Contract Certainty is achieved by the complete and final agreement of all terms
between the insured and insurer by the time that they enter into the contract, with
contract documentation provided promptly thereafter.
Principles
The definition is supported by seven principles, as follows:
A. When entering into the contract:
The insurer and broker (where applicable) must ensure that all terms are clear and
unambiguous by the time the offer is made to enter into the contract or the offer is
accepted. All terms must be clearly expressed, including any conditions or
subjectivities.
B. After entering into the contract:
Contract documentation must be provided to the insured promptly.
C. Demonstration of performance:
The insurers and brokers (where applicable) must be able to demonstrate their
achievement of principles A and B.
D. In respect of contract changes:
Contract changes need to be certain and documented promptly.
Where there is more than one participating insurer:
E. When entering into the contract:
The contract must include an agreed basis on which each insurer’s final participation
will be determined. The practice of post-inception over-placing compromises Contract
Certainty and must be avoided.
F. After entering into the contract:
Chapter 6
The final participation must be provided to each insurer promptly.

G. Where the contract has not met the principles:
The insurer and broker (where applicable) have a responsibility to resolve exceptions
to any of the above principles as soon as practicable and without undue delay.
For each principle an explanation is provided, followed by detailed guidance on its
implementation. There are also three appendices containing guidance regarding
subjectivities and signing provisions, and a checklist. In this way, the Code seeks to
eradicate, insofar as possible, the uncertainties associated with the parties contracting on
the basis of a price and the principal terms now, but leaving the detail until later.
The reinsured is able to see immediately what protection it has bought, the reinsurer will
have a clearer view of its exposure and any broker involved in the transaction will reduce its
legal, fiduciary and operational risks. Of course, if agreed, that detail will not satisfy everyone
all of the time. There will always be differences of opinion and the potential for coverage
disputes.
C3D Confirming placement

Once the placement of reinsurance has been completed, evidence of coverage should be
given to the reinsured as soon as possible.
Full details of
Full details of the coverage and its terms and conditions will be set out to enable the
coverage and reinsured to check that the cover has been arranged in accordance with its instructions and
terms and
conditions are
for any discrepancies to be explained and resolved (if necessary). This is particularly
set out important if the cover had been arranged through a reinsurance broker. If it does not
provide a copy of the MRC (in whole or in part), the broker will issue its own document
evidencing the terms of the cover it has placed. Such a document is usually described as a
cover note. It should be signed by a director or senior executive of the company, as it is
confirmation of the contract of reinsurance that has been effected.
The MRC standard provides that, when providing a copy of the contract to the reinsured, the
risk details, information and security details sections should always be retained in full. A
schedule of signed lines may be added but, if there are any changes to those sections, the
document becomes a broker insurance document (BID).
Question 6.7
What specific information would the evidence of cover document contain in addition to
the contract terms and conditions?
Following the issuance of the evidence of cover document, the last process in the placing of
reinsurance is the issuance of closing instructions.
These take two forms:
• a debit note – to advise the reinsured what money is due to its reinsurer;
• a credit note – to confirm what money reinsurers can expect to receive, either as an
excess of loss premium or as a proportional treaty balance.
These documents enable both parties to establish the appropriate technical and financial
records in their accounts and set the accounting activity in motion.
D Reciprocity
Reciprocity is the exchange of comparable business on a proportional basis by one Mutual exchange
insurance company with another. In other words, it is the mutual exchange of reinsurance, of reinsurance
whereby each company reinsures the other. The objectives and advantages of such an
exchange should be considered in the context of negotiating the optimum manner in which
an insurer’s portfolio or account should be reinsured.
In proportional reinsurance an insurance company is ceding away a sizeable volume of
premium for what, in most cases, may be expected to be reasonably profitable business.
One way of reducing the effect of this outflow, while spreading risk and possibly influencing
the overall cost of the reinsurance programme, may be to consider trading business
Chapter 6
reciprocally.
Question 6.8
We discussed reciprocity briefly in chapter 1, section F5. What is the difference between
‘strict’ and ‘loose’ reciprocity?
D1 How reciprocity works to enable an insurer to retain

gross profit
The main goals of reciprocity are to enable insurers to retain their gross profit while
spreading their business. Let us examine them in turn.
Retain gross profit
If it is practical for an insurer to exchange its business with business of a comparable or
possibly better quality, the company would be able to retain its gross profit instead of giving
it away to reinsurers. By maintaining the volume of premium income it retains, the insurer
would also be able to achieve higher investment income on its net retained account and
keep its expense ratio lower. It is very rare that a 100% reciprocal exchange of premiums
could be arranged. Although substantial reciprocity may be obtained through proportional
treaties and facultative exchanges, professional reinsurers would not be able to offer full
reciprocity, and no direct exchange of business would be available for excess of loss treaties.
Spread business
With a few exceptions, companies in the UK no longer exchange treaties amongst
themselves.
Consider this
this…
…
Think about the likely consequences if they did exchange treaties amongst themselves.
They are often participating in the same original business and therefore, should a major
loss occur, they would simply find themselves being involved in both their direct and
inward reinsurance accounts. Their objective of achieving a spread of risk on their
retained account would be nullified.
An effective spread of business can be achieved by exchanging their business reciprocally

with companies overseas. The number of countries with which it would be possible to trade
is such that even the largest proportional treaties need not be placed with more than a
select few reinsurers in each country. The reciprocal exchange of business from each
reinsurer would give a wide geographical spread of risk to the original insurer, thereby
reducing the possible effect of any one major loss to its overall underwriting results.
While it is unlikely that professional reinsurers will provide 100% reciprocity, these major
international companies can provide a wide geographical spread on their own reinsurance
treaties. This may be in the form of the retrocession of a specific treaty or in a share of one of
its pools, which may be for a specific region or on a worldwide basis.
Profitability is not
Profitability is not synonymous with either premium volume or spread of risk. Usually, a wide
synonymous with geographical spread would be expected to improve the likelihood of a more stable profit by
either premium
volume or spread
the losses in one area being offset by the profits from another, but there is always the risk
of risk that a company may find itself exchanging its own profitable business for poor quality
inwards reinsurance business. Therefore, the emphasis with any reciprocal exchange should
be on matching results rather than premium volumes. As with the more common methods of
arranging reinsurance, the quality of the management of the company and its underwriting
records are of prime importance when negotiating to arrange reinsurance reciprocally.
Be aware
The essence of a successful reciprocal arrangement is that both parties believe they are
deriving real benefits from the relationship. If this is not the case, the partnership is
unlikely to survive in the long-term.
The success of any exchange of reinsurance business is affected by the care with which the
business to be exchanged is selected. This care in selection should apply to the choice of
company as well as to the choice of business.
Chapter 6
If it is considered essential that a direct underwriter has a good understanding of the nature
of the business it is writing to have a successful account, it is equally essential that a
company should have a good knowledge of the insurer from which it is proposing to accept
reinsurance.
Question 6.9
What type of reinsurance contracts and underlying business are best suited to reciprocal
exchanges?
As far as possible, the types of insurance covered and the terms and conditions of the
treaties should be matched in regard to commission rates, premium deductions and reserve
deposits. While it may be desirable to break the treaty down into a large number of small
shares to maximise the spread of risk, any one share must be large enough to support the
administration costs involved in servicing both the inwards and outwards reinsurance
accounts.
The premium size of each exchange should be kept to a level that removes the possibility of
excessive or unbalanced involvement in any one area. Liabilities accepted on inwards
reinsurance business should not be greater than those usually written on a direct basis.
The time spent in monitoring the trading results of the exchanged treaties and in negotiating
mutually acceptable terms adds to a ceding company’s administration costs, yet the careful
use of reciprocity can help it in managing the outflow and inflow of premium income and
profitability.
Example 6.11
Insurer Y places a first surplus treaty for the reinsurance of its commercial and industrial
property account. For strategic business reasons it wishes to keep this treaty in place. The
treaty has relatively light natural perils exposures so Y might seek to match the outflow of
premiums and profit by making a reciprocal exchange of similar business with insurer Z in
another territory.
In practice, specific reciprocity of similar treaties is now generally out of fashion and far
fewer companies engage in reciprocal exchanges in comparison with the level of reciprocity
activity that occurred some years ago. Specific regions, however, still maintain general
reciprocal agreements and aim to keep as much reinsurance within a group of countries and
minimize the need to seek reinsurance capacity from other markets or regions.
Learning point
Before continuing, are you aware of the main goals of reciprocity.
Chapter 6
Key points
Designing programmes
• When considering the reinsurance placement, the insurer sets out to achieve automatic cover,
adequate capacity, sufficient scope, economic advantage, and security and continuity.
• The type of treaty chosen will depend on:
– the composition of the business to be reinsured;
– exposure to accumulations of losses arising from one occurrence;
– the extent that unlimited liability is covered by the original policies;
– whether fluctuating profits and losses is a feature of the classes of business covered;
– the extent to which the ceding insurer requires growth or capacity; and
– the amount of premium that the ceding insurer wishes to cede.
• Other relevant considerations include:
– whether the insurer wants part of the reinsurance premium rebated in the form of commission;
– whether the insurer wants a contribution towards each claim;
– the class of business mix;
– whether speed of claims settlement is important; and
– whether reinstatements of cover are required.
• The capacity of a treaty should be adequate for the majority of the risks offered and accepted.
• Separate treaties are taken out for individual classes of business except in the case of liability
business where classes are often combined.
• The insurer considers the historical development of its account in order to assess the type of
reinsurance programme that provides the best cover and if it is obtainable at an acceptable price.
• The programme may comprise proportional and/or non-proportional treaty reinsurance:
– proportional reinsurance can be used to reduce the gross exposure; and
Chapter 6
– non-proportional reinsurance can be used to reduce the net exposure.

• Facultative reinsurance is commonly used for the risks or parts of risks not protected by the
treaty(ies).
Pricing programmes
• Price is derived from the following factors:

– risk premium, which is the cost of claims including a loading for fluctuations;
– external costs, which include acquisition expenses and agents’ commission;
– internal costs, such as administration and staff costs; and
– desired profit or return.
• There are three main approaches to reinsurance pricing:
– experience rating uses experience (losses and exposure) to estimate average future loss costs;
– exposure rating uses reinsurance exposures together with general industry data about loss ratios
and severity patterns as a basis for estimating your expected losses; and
– frequency and severity rating involves developing a stochastic (simulated hypothetical) model
to simulate loss experience.
• Catastrophe models identify and quantify the likelihood of the occurrence of specific natural
disasters in a region and estimate the extent of incurred losses. They comprise four basis
components (or modules):
– the hazard module defines the hazards, that is, a set of stochastic events;
– the inventory module defines the portfolio of properties at risk;
– the vulnerability module quantifies the expected damage to the portfolio caused by the hazards
(together, the probabilistic risk analysis); and
– loss (of financial) component translates the physical damage into total monetary loss.
• Having established the model price, the risk is underwritten to establish a technical price (or
premium) and reinsurers may wish to load the risk premium for any number of factors including:
– any change in the nature of the insurer’s portfolio;
– any change in its underwriting philosophy;
– rating changes designed to grow market share;
– the possibility of abnormal fluctuations in loss experience; and
– service requirement costs if the insurer wants to buy the reinsurer’s technical assistance.
Placing programmes
• The successful negotiation of a reinsurance programme depends on the quality and quantity of the
information provided to reinsurers.
• The reinsured has a duty to make a fair presentation of the risk to the reinsurer. Essential data
includes:
– details of the insurer seeking reinsurance;
– the classes of business to be covered;
– premium income and aggregate exposures;
– the profile of the business to be reinsured;
– general experience;
– claims experience; and
– the exclusions that are applied to the original business.
• For its part, the insurer needs to be satisfied that its reinsurer(s) offers satisfactory security.
• It is common practice for insurers to have a Security Committee tasked with grading all current and
proposed reinsurance security, monitoring aggregate exposure to each reinsurer, and being alert to
market news and information with potential security implications.
• Grading reinsurers involves analysing:
– financial characteristics, in particular, size;
– quality of management and key underwriting personnel;
– capital structure, and the ultimate owner(s);
– ratings;
– domicile, that is, the political, legal and regulatory environment within which each company
operates; and
– other qualitative characteristics such as historic speed of claims payment and service levels.
• In the London Market, a standard form of contract document, incorporating the full terms and
conditions, has been mandated (that is, the MRC) and has replaced the slip and any subsequent
contract wording as the evidence of contract.
Chapter 6
• The MRC is in six sections: (1) Risk details; (2) Information; (3) Security details; (4) Subscription
agreement; (5) Fiscal and regulatory; and (6) Broker remuneration and deductions.
• Business can be placed in subscription or vertical markets.
• A debit note confirms premiums that are due from the insurer while a credit note sets out what
premiums the reinsurer can expect to receive.
• Contract certainty is achieved by the complete and final agreement of all terms between the
(re)insured and (re)insurer by the time that they enter into the contract.
Reciprocity
• Reciprocity is the exchange of comparable business on a proportional basis.

• Participating insurers aim to retain gross profit while achieving a spread of business.
• The emphasis placed on reciprocal exchanges is to match profitability rather than premium
volumes.
Question answers
6.1 In the case of long-tail business, it may be many years before the liabilities of the
business have been discharged. Therefore, the durability and commitment of the
reinsurer are critical.
6.2 By applying event limits or cession limits to control catastrophe potential and loss
corridors or loss participation restrictions to make the insurer bear some of the
ceded losses.
6.3 Its liability in respect of any one hull; the risk of multi-aircraft collision; cargo;
passenger and other third-party liabilities; personal accident covers.
6.4 If there are a number of special acceptances, these would be risks outside the normal
ambit of the treaty and hence their acceptance may lead to an unbalancing of the
homogeneous product: this would have to be factored into the loading. Also,
constant consideration of risks outside the normal range of the treaty adds to
reinsurers’ administration costs.
6.5 It would offer a good indication whether the company’s attitude to growth is
aggressive or conservative, and point to the quality of the underlying risks and
adequacy of the rating.
6.6 Loss reserves clause, off-set clause and/or termination clause.
6.7 The evidence of cover document also sets out the names of the reinsurers that have
accepted the risk and the amount of their participation.
6.8 Strict reciprocity is the agreement to offer a specified volume of business in return
for the receipt of a comparable volume of premium from a similar portfolio. Loose
reciprocity applies where a general broad account of reinsurance business is offered
in a two-way flow of business between two insurers.
Chapter 6
6.9 Business of a relatively straightforward type capable of producing stable results such
as well-balanced quota share and first surplus treaties that show a high ratio of
premium income to possible maximum loss. No undue exposure to catastrophe risks.
Self-test questions
1. In what ways are excess of loss treaties limited ‘horizontally’ and ‘vertically’?
2. What type of proportional treaty is unsuitable where the original insurance
provides unlimited liability cover for third-party personal injury?
3. State two advantages of combining employers’ liability and public liability business
in one treaty.
4. A catastrophe excess of loss programme protects the net account after a 50%
quota share. What losses should be deducted from the gross loss following a
catastrophe loss before ascertaining the net loss for purposes of recovery from the
catastrophe XLs?
4. What four main considerations have to be factored into the price of reinsurance?
5. What is the significance of ‘development’ or ‘triangulation’ statistics?
6. Outline three uses of the MRC.
7. Outline three duties carried out by an insurer’s Security Committee.
Chapter 6
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Contract wordings
7
outcomes
Learning objectives
Introduction
Key terms
A Main features of facultative and treaty wordings 8.1
B Clauses common to proportional and non-proportional 8.2
wordings
C Clauses used in proportional wordings 8.2
D Clauses used in non-proportional wordings 8.2, 10.3
E Treaty exclusions 8.3
Key points
Question answers
Self-test questions
Learning objectives
Chapter 7
• describe the main features of facultative and treaty wordings;
• summarise the clauses common to proportional and non-proportional wordings;
• outline the clauses used in proportional wordings;
• outline the clauses used in non-proportional wordings; and
• identify both general and market-specific exclusion clauses.
Introduction
Reinsurance wordings are the signed agreements that evidence the contracts (or policies) of
reinsurance between the parties. In this chapter, we will review the main elements of those
wordings in current use in the London Market after some general comments about wordings
in that market. Other examples of wordings are included in the relevant chapters as the
clauses refer more specifically to the interests arising from those lines of business.
Contract clarity
Imperative that
It is imperative that wordings are clear in expression, avoid ambiguity and reflect the
wordings are clear intention of the parties. Some of the common problems that can arise in relation to the
in expression
drafting of wordings are as follows:
• An incomplete statement as to who the parties are. For example, if an excess of loss
reinsurance is also for the benefit of the quota share reinsurers of the reinsured, the
contract should say so.
– The slip headlines a clause (or attachment) but completely omits its wording, leaving
the parties to decide, for example, which of the many claims cooperation clauses
prevalent in the market should be applied.
• The careless use of definitions and defined terms. This could, for example, be the failure to
define terms properly or to identify them, when appropriate, in the main body of the
wording.
• Illegible annotations or attachments, for instance, in the latter case, poor photocopies of
original documents scheduling covered risks.
• Clauses added by ‘cutting and pasting’ from other documents that have not been
properly integrated into the new wording, adding meaningless words or phrases to the
wording.
• The inclusion of incompatible or contradictory clauses, for example, a ‘follow the
settlements’ clause and a claims control clause (see chapter 8, section C4). Is the
reinsurer’s approval required to settle the original claim?
• Misstatements in relation to which terms and conditions apply to different sections of
cover, for example, the application of sublimits or deductibles may be unclear.
The London Market continues to address these (and related issues) by various means
including, for example:
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• employing solicitors to draft (and validate or approve) wordings;

• using ‘base wordings’, meaning model or ‘as expiring’ wordings, whenever appropriate;
• continuing to develop standard wordings and clauses through the work of its various
market committees; and
• compiling wordings databases (or repositories).
Learning points
Before you move on, make sure you are aware of the common problems that can arise in
relation to the drafting of wordings.
Policy documentation
Wordings are used
Wordings are used to prepare formal policy documents as evidence of cover. Increasingly,
to prepare formal the parties agree that the MRC – in its entirety, with the terms and conditions, etc either
policy documents
as evidence
following the MRC provisions and being either referenced or set out in full in the risk details
of cover section – will constitute the sole evidence of cover. If this is agreed, then no additional formal
policy documentation will be prepared for, and produced to, the reinsured.
Signing
All wordings must
All wordings (and amendments) must be signed and dated by all the parties to the contract.
be signed and A reinsurer’s participation is shown next to its stamp, and is known as its written line. In
dated by all parties
certain circumstances (for example, where the total of the written lines exceeds 100%), this
line will be adjusted (or signed) and a schedule of all of the reinsurers’ participations
attached to the wording.
Chapter 7 Contract wordings 7/3
If a formal policy is prepared, it will need to undergo a separate signing process. This is
becoming rarer in the London Market now that the MRC is commonly the sole contract
document. Xchanging, the business process provider, continues to provide this service on
request.
Key terms
Arbitration Back-to-back Boiler plate clauses Cession clause
Commutation Continuous contract Hours clause Index clause
Interlocking clause Law and jurisdiction Letter of credit (LOC) Portfolio transfer
clause
RAD/LOD Reinstatement clause Treaty exclusions Ultimate net loss (UNL)
A Main features of facultative and treaty

wordings
All reinsurance wordings must record the answers to the following three questions:
1. Who are the parties?
2. What have they agreed to reinsure? In other words, what is the subject matter (or
business) of the reinsurance?
3. On what terms, conditions, limitations and exclusions have they agreed to reinsure that
business?
Further, the MRC standard, along with the requirements of contract certainty, applies
equally to reinsurance wordings. Accordingly, this chapter is concerned almost entirely with
discussing the content of the risk details section of the MRC.
The parties
The parties to the contract are the insurer (or insurers) on the one hand, and the reinsurer (or The parties to the
reinsurers) on the other hand. contract are the
insurer and the
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Description reinsurer
Each of the parties to the contract should be clearly described and, if not individually stated,
should be readily identifiable from the definition provided. Otherwise, the entity risks the
obvious consequences of being omitted from the contract.
Typically, an entity is described by its name and address, or by its relationship with another
entity. The name should be its full and official (or registered) name without abbreviation to
avoid ambiguity. The address should be its registered or head office or main place of
business. Strictly, a company is defined in law by its number not name, the latter being
readily amended by resolution. While the number is rarely (if ever) seen, it is common, e.g.
for US reinsurance companies, to provide their National Association of Insurance
Commissioners (NAIC) Code or other regulatory or reporting codes.
To be provided with a complete list of reinsureds is rare and it is usual for a wording to
contain a form of words intended to incorporate all relevant entities into the contract.
For example, in the context of facultative reinsurance:
Insurers being members of [ ] mining pool’ or ‘Insurers being subscribers to the [ ]
lineslip’ or ‘Insurers being subscribers to Policy Number [ ].
For example, in the context of treaty reinsurance:
The [ ] Insurance Company Limited and/or their quota share reinsurers
Here, the treaty reinsurance is purchased for the benefit of the insurance company and its
quota share reinsurers. If no reference is made to the quota share reinsurers, how can the
benefit of the treaty extend to them? In Kingscroft & Walbrook v. Nissan (1999)
(1999), the High
Court held that quota share reinsurances between members of an underwriting agency were
protected by the specific reinsurance, even though the reinsurance treaty wording did not
add the words ‘and or quota share reinsurers’ to the name of the reinsured. The judge
accepted extrinsic evidence as proof of the intention of the reinsurance. The case showed,
not only the value of extrinsic evidence, which in different circumstances could lead to a
different conclusion, but the importance of clearly defining who is reinsured.
It should not be forgotten that a description such as ‘the [ ] Insurance Company Limited and
its associated and subsidiary companies and branches’ is set in time (at placement).
Therefore, it cannot be effective to reinsure entities which, as the result of corporate activity
or otherwise, may subsequently be described as such.
Each contract is
Clarity as to the identity of reinsurers is equally important because legally there is a separate
for the particular contract between the reinsured(s) and each individual reinsurer. Each contract is for the
reinsurer’s
participating
particular reinsurer’s participating share only. In other words, the reinsurer does not agree to
share only pay for defaulting co-reinsurers, and the wording should include a several liability clause
(see section B5 – a reinsurer’s liability is several not joint). In practice, the reinsured is
defined in the risk details section, and subscribing reinsurers are listed at the end of the
security details section, of the MRC.
Subject matter of the reinsurance
What the parties have agreed to reinsure is the subject matter of the reinsurance. In other
words, the reinsured’s interest in a particular insurance contract in the case of facultative
reinsurance or, in the case of treaty reinsurance, a particular account or book of insurance
business.
Wording should
A facultative reinsurance wording should reference and incorporate the original insurance
include a detailed wording and, in the absence of a copy of that wording, give a thorough and detailed
description of all
key features
description of all of its key features (or reference the Unique Market Reference (UMR)).
These key features include:
• the name of the original insured;
• the original risk;
• the original period;
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• the policy limits;

• the deductibles;
• the standard (or model) wording, if applicable; and
• a list of any additional or unusual clauses.
name of the
original
insured
a list of any
additional or the original risk
unusual clauses
Key features
the standard
(or model) the original
wording (if period
applicable)
deductibles limits
In treaty reinsurance, the business reinsured (or covered) clause sets out what business the
reinsurance agreement covers. It is also known as the interest clause.
Typical descriptions include:
all business classified by the reinsured as professional liability business’ and ‘all fire
and allied perils business…and any other classes written in the reinsured’s fire
department’ and ‘all risks on interests of any description in their whole account (this
whole account including hull, cargo, liability, war (hull/cargo), energy (drilling rig)).
Alternatively, the description may reference the reinsured’s ‘participation in’ a particular
binder, contract or programme. In the context of a motor account, the description may
include liability of the reinsured as ‘Article 75 Insurer’ under the provisions of the domestic
regulations of the Motor Insurers’ Bureau or overseas equivalent.
The business description often ends with the phrase ‘or business which would otherwise
have been allocated to such accounts but for the fact that there is no separate allocation of
premium’. So, for example, exposures written as part of a package policy that would
naturally fall within the account (and therefore this reinsurance contract) but are, perhaps,
incidental to the main purpose of the package policy and not separately priced, are
protected, even though the reinsurance contract receives no allocation of premium for that
exposure.
By contrast, the clause may also extend coverage to include risks considered by the
reinsured to be incidental to the main business. In any event, ‘incidental’ is imprecise and to
be avoided where possible.
In the next section, we will look at facultative and treaty wordings in turn, answering the
remaining question for each form of reinsurance.
A1 Facultative wordings
A facultative wording must specify the:
• parties to the reinsurance contract;
• subject matter of the reinsurance contract (that is, the original insurance wording); and
• terms, conditions, limitations and exclusions of the reinsurance contract.
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Be aware
To be clear, the reinsurance contract is an entirely separate and distinct contract from the
underlying insurance contract. The reinsurance relationship that results from the
reinsurance contract is mutually exclusive from the relationship between the reinsured
and the insured. The liabilities and obligations of the reinsured and reinsurer are governed
by the reinsurance contract, not the insurance contract.
Given that the reinsurance contract is entirely separate and distinct from the underlying
insurance contract, it is important to distinguish between the terms, conditions etc. of the
original insurance contract and those of the reinsurance, and the following standard clauses
are often used for this purpose. In this regard, you should be aware that the underwriter may
or may not have an opportunity to review the original insurance wording (which is typically
referenced ‘as original’ in the facultative wording).
A1A Proportional facultative reinsurance

Here, the facultative reinsurer agrees to accept a specified proportion or share of the original Specified
risk. In quota share reinsurance, this share will usually be expressed as a percentage of the proportion or
share of the
original limit. In return, the reinsurer receives the same percentage of the original premium, original risk
unless otherwise stated.
An example of a proportional facultative reinsurance clause follows:
In consideration of the premium charged, and subject to the terms and conditions of
this Contract as set out in the slip and its attachments and/or endorsements
applicable thereto, this Contract reinsures the Reinsured’s interest in payments
made within the terms and conditions of the Original Policy
Unless otherwise stated in this Contract the Reinsured:

a. shall retain during the period of this Contract at least the retention(s), subject
to any proportional and/or excess of loss treaty reinsurance, on the identical
subject matter and perils and in identically the same proportion(s) as stated in
the Contract. In the event of the retention(s) and/or proportion(s) being less,
the Reinsurers’ liability will be correspondingly proportionately reduced.
b. warrants that the premium paid to the Reinsurer(s) for this Contract is
calculated at the same gross rate as the Original Policy for the identical subject
matter and perils and in the proportions reinsured, less only those deductions
stated.
A1B Non-proportional facultative reinsurance

The most common form of non-proportional facultative reinsurance is excess of loss
reinsurance. The reinsurers agree to accept a specified proportion or share of the premium
in return for paying that same share of the amount by which any loss exceeds the retention
up to the limit of cover.
An example of the operative part of a standard non-proportional facultative reinsurance
clause is as follows:
In consideration of the premium charged, and subject to the terms and conditions of
this Contract as set out in the slip and its attachments and/or endorsements
applicable thereto, this Contract reinsures the Reinsured’s interest in those payments
made within the terms and conditions of the Original Policy exceeding the Excess
amount as set out in the slip up to the Limit amount as set out in the slip.
Refer to The wording must specify the amount and currency of the retention – that is, the amount
section D3 for the
UNL clause retained by the reinsured – and of the limit of cover (or indemnity). What comprises the
amount is usually defined in the ultimate net loss (UNL) clause. At its simplest, the UNL is
the sum actually paid by the reinsured in settlement of a claim.
An alternative reinsuring clause referencing the UNL follows:
In consideration of the premium to be paid to the Reinsurer by or on behalf of the
Reinsured, subject to the terms and conditions of this Agreement the Reinsurer shall
reimburse the Reinsured to the extent that its Ultimate Net Loss (as defined in the
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Ultimate Net Loss Article of this Agreement) under business reinsured by this
Agreement exceeds the Reinsured’s retention but only up to the limit of
reimbursement.
The basis on which the limit and retention are to be applied must also be stated in the
wording, for example, any one claim, or any one accident, or any one loss. In each case, there
should be a definition.
Wording should
The reinsured will also have incurred costs and expenses in handling the original claim, and
state how those the wording should state how those costs and expenses are to be divided between the
costs and
expenses are to be
parties. In practice, the costs are shared on either a ‘costs in addition’ or ‘costs
divided between inclusive’ basis:
the parties
• on a costs inclusive basis: the allocated costs and expenses are merely added to the
indemnity claim for the purposes of applying the limit and deductible; and
• on a costs in addition basis: they are pro-rated across each party’s share of the indemnity
claim, and paid in addition to the limit
Example extracts from standard International Underwriting Association (IUA) clauses follow:
The IUA 01-024 (formerly NP82): ultimate net loss (costs inclusive) clause
clause:
The Reinsurer shall indemnify the Reinsured to the extent of the Reinsurer’s
participation hereunder in respect of any loss and interest which falls within the
terms and conditions of the original policy and Allocated Loss Expenses arising
therefrom. In calculating such amount of indemnity any salvages recoveries and
payments from third parties, including any recoveries from other reinsurers, whether
collected by the Reinsured or not, shall be taken into account.
The IUA 01-025 (formerly NP83): ultimate net loss (costs in addition) clause
clause:
The Reinsurer shall indemnify the Reinsured to the extent of the Reinsurer’s
participation hereunder in respect of any loss and interest which falls within the
terms and conditions of the original policy. In calculating any such amount, any
salvages recoveries and payments from third parties, including any recoveries from
other reinsurers, whether collected by the Reinsured or not, shall be taken into
account.
The Reinsurer shall pay its proportion of Allocated Loss Expenses arising in respect
of any such loss and interest. The amount to be allocated to this layer shall be in the
same proportion as the loss and interest payable by this layer bears to the total net
loss and interest payable by the Reinsured, subject to the Reinsurer’s total payment
not exceeding [percentage to be expressly agreed/provided]% of the layer limit.‘
In each instance, ‘Allocated Loss Expenses’ shall include reasonable adjustment
expenses and legal costs and expense of litigation incurred by the Reinsured when
settling claims covered under the original policy. Salaries of employees,
management expenses and other overhead expenses of the Reinsured shall not be
included.
Question 7.1
Three claims have been made under a facultative excess of loss reinsurance. The
reinsurance has a limit of £1,000,000 and a retention of £1,000,000. In each case,
£300,000 of costs and expenses has been incurred in defending the claim and the
reinsured has been found liable under the original policy in the amount of that claim. What
is recoverable by the reinsured on:
1. a ‘costs inclusive’; and
2. a ‘costs in addition’, basis?
Claim A: £1,000,000
Claim B: £1,500,000
Claim C: £2,000,000
Chapter 7
A1C Facultative premium
The wording should also set out the cost to the reinsured,. This is the facultative reinsurance Wording should
premium less commission, if applicable, and brokerage. The premium is a percentage of the set out the cost to
the reinsured
original premium, unless otherwise stated. I is usual for a proportional facultative reinsurer to
pay the reinsured a commission in order to share the reinsured’s original commission and
administration costs.
A1D Back-to-back
While the primary objective of an underwriter purchasing facultative reinsurance is to ensure Reinsurer may
that the reinsurance protection exists on the same terms and conditions (where relevant) as require additional
terms, conditions,
the direct placement, a facultative reinsurer may not wish for various reasons to give such limitations and
‘back-to-back
back-to-back’ cover. Instead, the reinsurer may require additional terms, conditions, exclusions
limitations and exclusions if it is to accept the particular risk. These additional terms,
conditions etc. may be considered to fall into two broad categories - those relating to the
requirements of the reinsurer pertaining to the:
• original policy or risk; and
• conduct between the parties.
Pertaining to the original policy or risk

Common examples of these include the following:
• The original insurance period may differ from the reinsurance period if a reinsurer is only
willing to reinsure an insurer’s exposure to a five year constructors’ all risks policy, on an
annual basis.
• The war or terrorism exclusion clause may be imposed by a reinsurer unwilling to accept
the full set of original perils.
• To reinsure a large industrial building, a reinsurer may require an operational sprinkler
system. This may mean a sprinkler warranty in the original policy or in the reinsurance
contract.
• From time to time, governments impose sanctions against various countries, entities and
individuals and not wishing to fall foul of, for example, a provision prohibiting it from
paying a claim to the reinsured, a reinsurer may insist on a sanctions and embargo clause
as follows:
Facultative Reinsurance Sanctions and Embargo Clause (IUA 09-049)
09-049):
Notwithstanding anything to the contrary in the Policy the following shall apply:
1. If, by virtue of any law or regulation which is applicable to a Reinsurer at the
inception of this Policy or becomes applicable at any time thereafter,
providing coverage to the Reinsured is or would be unlawful because it
breaches an embargo or sanction, that Reinsurer shall provide no coverage
or benefit and have no liability whatsoever nor provide any defence to the
Reinsured or make any payment of defence costs or provide any form of
security on behalf of the Reinsured, to the extent that it would be in breach of
such law or regulation.
2. In circumstances where it is lawful for a Reinsurer to provide coverage under
the Policy, but the payment of a valid and otherwise collectable claim may
breach an embargo or sanction, then the Reinsurer will take all reasonable
measures to obtain the necessary authorisation to make such payment.
3. In the event of any law or regulation becoming applicable during the Policy
period which will restrict the ability of a Reinsurer to provide coverage as
specified in paragraph 1, then both the Reinsured and the Reinsurer shall
have the right to cancel its participation on this Policy in accordance with the
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laws and regulations applicable to the Policy provided that in respect of

cancellation by the Reinsurer a minimum of 30 days notice in writing be
given. In the event of cancellation by either the Reinsured or the Reinsurer,
the Reinsurer shall retain the pro rata proportion of the premium for the
period that the Policy has been in force. However, in the event that the
incurred claims at the effective date of cancellation exceed the earned or pro
rata premium (as applicable) due to the Reinsurer, and in the absence of a
more specific provision in the Policy relating to the return of premium, any
return premium shall be subject to mutual agreement. Notice of cancellation
by the Reinsurer shall be effective even though the Reinsurer makes no
payment or tender of return premium.
Pertaining to the conduct between the parties
Common examples of the reinsurer’s requirements pertaining to the conduct between the
parties include the following:
• Clauses dealing with the notification and settlement of claims.
As facultative policies are on individual risks, the underwriting process and the claims
handling process are far more involved. It is common to incorporate a claims notification,
cooperation or control clause, imposing varying requirements on the reinsured and, in the
latter instance, reserving to the reinsurer the right to control settlements. These clauses
are discussed in greater detail in section D6.
• A premium payment condition or warranty to encourage prompt payment.
Imposed irrespective of the original premium payment terms, a warranty will typically Insurance Act
2015 covered in
provide that the reinsurance premium is paid, and received by the reinsurer, by a chapter 8,
particular date otherwise cover will cease ab initio (from inception). However, unless the section C1
warranty has been amended to exclude the application of the Insurance Act 2015 2015, the
impact of non-payment is likely to exclude any loss that occurred before the breach was
remedied, that is prior to the premium being paid. On the other hand, a premium payment
condition will usually provide cover up to the deadline date, and for its cancellation or
termination thereafter.
For example:
It is a condition of this contract of reinsurance that the premium due at inception
must be paid to and received by Reinsurers on or before midnight on [ ]. If this
condition is not complied with, then this contract of reinsurance shall terminate on
the above date with the Reinsured hereby agreeing to pay premium calculated at
not less than pro rata temporis [(by time)].
A1E Law and jurisdiction

To avoid unnecessary disputes, it is common practice for all facultative (and treaty) Common practice
wordings to include a choice of law and jurisdiction clause
clause, setting out which law governs to include a choice
of law and
the particular contract and where any disputes should be heard. As a distinct contract, it jurisdiction clause
cannot be assumed that, if omitted and necessarily implied by law into the reinsurance
contract, such terms will mirror those in the original policy and provide back-to-back cover.
The governing law may be specified as a legal system other than English law; a German
reinsured may insist on German law and a French reinsured may insist on French law. It is not
unusual for a US domiciled reinsured to insist upon the law of the state of its domicile in
the USA.
Where both the reinsurer and reinsured are permanently based in the UK and the contract is
effected in London, English law and its jurisdiction will usually apply. That cannot be taken
for granted where one or both of the contracting parties has significant contacts outside of
the UK, although the presumption is that if the contract is effected in London, e.g. the
reinsurance of an overseas reinsured placed in London, the jurisdiction of the English courts
will prevail. However, the law governing the subject matter of the reinsurance would usually
be that applicable to original claims.
Therefore, where an English court has jurisdiction over a dispute between the reinsured and
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reinsurer and the dispute concerns a claim on the original insurance governed by a foreign
law in a foreign jurisdiction, it would be the law of the foreign jurisdiction that would apply to
that claim. However, the House of Lords’ decision in WASA v. Lexington (2009) should be
noted in this context. This case dealt with the situation where the law governing the
reinsurance contract is English and the law governing the original insurance is a foreign
jurisdiction (in this case the State of Washington). Their Lordships found that where the
reinsurance contract does not explicitly bind the reinsurers to the law governing the original
policy, the reinsurance contract may not be held to follow the original settlement, where
such a settlement is, by English law, clearly outside the terms of the contract of reinsurance.
Extraordinarily, the parties may agree for courts of a particular jurisdiction to apply a foreign
law, adding an extra layer of complexity and expense to claims handling and to any legal
proceedings. The main reason would typically be that the existence (or absence) of
particular provisions – for example, avoidance for innocent non-disclosure – was
unacceptable to one of the parties.
Reinforce
Before you move on, make sure that you understand how the previous standard clauses
work to distinguish between the terms and conditions of the original insurance contract
and those of the reinsurance.
A2 Treaty wordings
On one view, there are two basic styles of treaty wording in common use. Firstly, there is Two basic styles of
what may be described as the full (or complete) wording that details within its body, within treaty wording in
common use
the text, all of the variables peculiar to the parties’ actual agreement. The variables will
include names, period, premium, limit, excess, geographical scope and so on.
Secondly, there is the schedule-based wording which relies on a core wording and a
statement of variables (or schedule). Here, those variables are incorporated into the core
wording by individual reference within the wording from a particular part, or section of the
schedule.
Refer to An example of a schedule-based wording in widespread use is the Joint Excess Loss
appendix 7.1 on
RevisionMate and Committee (JELC) Excess Loss Clauses. These clauses are often used in wordings
chapter 12, subscribed to by the marine market, although the subject matter is not always marine
section B
business.
A treaty wording is
In any event, a treaty wording is typically a long and complex document. In the next section,
typically a long we review the many clauses (usually termed articles) that are current in the London
and complex
document
reinsurance market.
B Clauses common to proportional and

non-proportional wordings
In this section, we review the different clauses that are common to proportional and
non-proportional reinsurances. In sections C and D, we shall review those clauses that are
specific to each type of reinsurance. For ease of reference, we consider the clauses common
to proportional and non-proportional treaty wordings under the headings given in table 7.1.
Table 7.1: Clauses common to proportional and non-proportional

wordings
Limitation clauses • Period.
• Territorial scope.
• Special termination (or cancellation).
• Special acceptances.
Premium clauses Referred to in section C5 for proportional contracts and in section D2 for
and commission non-proportional contracts.
clauses
Claims clauses Referred to in section C6 for proportional contracts and in section D6 for non-
proportional contracts.
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Payment clauses • Currency clauses.

• Late payments.
• Loss reserves.
Law and dispute • Law and jurisdiction.

resolution clauses • Dispute resolution.
Miscellaneous • Access to records (alternatively, inspection of records).

clauses • Underwriting policy.
• Errors and omissions.
• Extra contractual obligations (ECO) and excess of policy limits (XPL).
• Insolvency.
• Offset.
• Co-reinsurance.
• Net retained lines.
Boiler plate • Notice.

clauses • Intermediary.
• Termination of intermediary.
• Confidentiality.
• Amendments and alterations.
• Severability.
• Entire agreement.
• Non-waiver.
• Several liability.
The first part of the wording typically provides a brief description of the contract and a The statement of
statement of the parties to it. The contract description outlines the main subject matter and the parties must
enable all of the
type of reinsurance contract (for example, property quota share or marine cargo excess of parties to the
loss). As discussed in section A, the statement of the parties must enable all of the parties to contract to be
identified
the contract to be identified.
Preamble
There may also be a preamble which, traditionally, provides a more detailed introduction to,
and description of the purpose of, the contract.
For example:
WHEREAS the Company insure and assume liability in respect of risks on interests of
any description in their Whole Account (this Whole Account including Hull, Cargo,
Liability, War (Hull/Cargo), Energy (Drilling Rig)).
IT IS HEREBY AGREED AS FOLLOWS:
It may, however, contain operative language such as the reinsurance agreement itself.
Reinsurance clause
At the outset of the wording, you would also expect to see the actual reinsurance agreement
between the parties, such as:
In consideration for the premium to be paid to Reinsurers by or on behalf of the
Reinsured, the Reinsurers shall reimburse the Reinsured in relation to…
This Agreement is subject to all limits, terms, conditions and exclusions contained
herein.
There must also be a clear and comprehensive statement defining the business which is to
be the subject matter of the agreement.
B1 Limitation clauses
B1A Period
This clause sets out the period (or term) of the reinsurance contract, which can be either Clause sets out the
continuous or fixed. period of the
contract
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Continuous contract
A proportional treaty is usually a continuous contract
contract, meaning that it continues until
terminated on notice, by agreement or otherwise, as shown in the following clause:
This agreement shall commence at [ ] on [ ] and shall continue until terminated by
either party giving the other at least 3 months’ notice to terminate at the 31
December of any year.
It is unlikely that the parties will want to commit to an indefinite arrangement. So, the right is
reserved for each party to give notice under the contract and this is usually three months
prior to the anniversary date. Such termination will have no impact on any business that has
been, or will be, ceded to reinsurers prior to the date of termination – 31 December in our
example wording.
Fixed period contract
On the other hand, a fixed period is usual for a non-proportional treaty:
This Contract shall become effective on [ ] in respect of losses occurring on or after
that date, and shall remain in force until [ ], both days inclusive, Local Standard Time
at the place where the loss occurs.
The period is typically a year. Exceptionally, it may be extended to achieve a more
convenient renewal/expiry date if, for example, the accounting date is changed or it is
necessary to harmonise with other contracts.
B1B Territorial scope clause

Defines the
This clause defines the territorial or geographical scope of the reinsurance contract.
territorial or Typically, it limits the reinsurer’s liability under the contract by reference to, for example, the
geographical
scope of the
location of the insured property, the domicile of the insured person, or where the original
contract policies were issued or underwritten by the reinsured.
The following clause comes from a property catastrophe reinsurance contract:
The liability of the Reinsurer shall be limited to losses under policies covering
property located within the territorial limits of the United States of America, its
territories or possessions, Puerto Rico, the District of Columbia and Canada: but this
limitation shall not apply to moveable property if the Reinsured’s policies provide
coverage when said moveable property is outside [those] limits.
A different approach is required for accident and liability reinsurances:
The contract shall be limited in scope to business underwritten in the United
Kingdom and follow the territorial scope specified in the Reinsured’s policies.
There may be no
Alternatively, there may be no limit on the scope of the contract. The scope may be
limit on the scope described as ‘worldwide’ or be in respect of losses wherever they occur. In the light of the
of the contract
devastation caused by hurricanes in recent years, it has become commonplace to see scope
limited to ‘losses occurring in the Gulf of Mexico’. Quite what is meant by the Gulf of Mexico
should be defined precisely.
B1C Special termination (or cancellation) clause

The special termination (or cancellation) clause provides that one or both parties may
terminate (or cancel) the agreement immediately. This will be by serving written notice on
the other if, during the currency of the agreement, there is a significant change in the
character of that other party, or in the commercial and/or political background since
placement.
the introduction of law or

the insolvency of a party legislation restricting or
prohibiting the performance
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of the treaty
The termination
events of a typical
clause include:
war or occupation of a a material change in the

country or territory where a ownership, management
party is domiciled or has its or control of the other
head office party
The downgrading of a reinsurer by a leading rating agency during the currency of the policy
is another special termination event enabling a reinsured to terminate cover, and has been
incorporated into some treaties.
Activity
Check the ratings of the insurance or reinsurance entity you work for, or one with which
your firm does business.
Effect of termination
In a non-proportional context, the liability of the reinsurer ceases outright, apart from losses
that occurred before termination. In a proportional context, a reinsurance contract may be
terminated on a portfolio transfer or run-off basis:
• if the portfolio is transferred, which is usual for a continuous proportional contract, the Refer back to
chapter 4,
outstanding liabilities (claims and return premiums) and run-off premiums are calculated section B2 for
and transferred over to the new year of account; and more details
• if a run-off basis is elected, the reinsurer remains liable for all losses arising from policies
covered by the contract until their natural expiration or cancellation. The clause may also
reserve to the reinsurer the right to take over the handling and settlement of losses.
B1D Special acceptances clause

The special acceptances clause notes that a reinsured may submit business not covered by
the reinsurance contract to the reinsurer for special acceptance under the contract. It may
require the approval of all reinsurers but, more usually, only the leader and it will be
memorialised in an endorsement to the contract. Reinsurers may find that this clause deems
that the risk has been accepted if they fail to respond to the request within a certain period.
Usually, the clause provides that all previous special acceptances are carried forward
automatically from predecessor contracts (and their renewal), subject perhaps to no
material change. If so, they are commonly listed in a schedule to the renewal contract.
Special acceptance
B2 Payment clauses
Payment clauses are concerned with the payment of monies between the parties, and may
be divided into loss reserves, late payment and currency clauses.
Types of
payment
clause
currency loss reserves

clauses
Chapter 7
clause
late payment
clause
We will review each of these in turn.
B2A Currency clauses

These clauses set out the relationship between the currency of the original premium and/or
claim transactions, and the corresponding reinsurance (premium and/or claim) transactions.
At its simplest, the contract may require all reinsurance transactions to be made in a single
currency:
All transactions hereunder shall be payable in United States Dollars. All amounts
received by the reinsured or their agents or representatives in currency other than
United States Dollars shall be converted into United States Dollars at the rate of
exchange which such transactions have been entered in the reinsured’s books.
Claims payable in currencies other than United States Dollars shall be converted into
United States Dollars at the rate of exchange ruling in the reinsured’s books on the
date of settlement by the reinsured.
Therefore, if the original claim is paid in sterling, the US dollar equivalent – to be paid by
reinsurers – is calculated by reference to the rate of exchange used by the reinsured in its
books on the date that it paid the original claim. By contrast, the parties may agree to settle
premiums and claims in the original currencies.
In situations where claims payments are required in a combination of currencies, the clause
in a non-proportional treaty should require the deductible and limit to be apportioned in the
proportion that the amount each currency bears to the total amount of the reinsured’s loss.
To complete the calculation, it is necessary to reduce the separate currency amounts to a
common currency and the clause should stipulate the relationship (or rates of exchange)
between the various currencies.
Question 7.2
If a reinsured paid US$1m and £100,000 in original indemnity and surveyor’s costs,
respectively, what is payable by a reinsurer under an excess of loss reinsurance contract
with a deductible of $800,000 and in which the rate of exchange for these purposes is
£1 = $2?
B2B Late payments clause

The late payments clause requires the defaulting (or debtor) party to pay interest on any
amounts past due under the contract. In casualty reinsurances, it is also known as a
remittance clause.
Some contracts deem amounts owed to the reinsured and not ‘in dispute’ as overdue if not
paid within a period of, say, 45 days of the date of receipt of a satisfactory proof of loss or
payment demand, depending on the particular loss settlements clause. In this context, a loss
is usually considered ‘in dispute’ where there is a pending arbitration or litigation or where
the loss has been denied or coverage queried.
This provision must be specifically invoked in writing. If it is invoked, interest will accumulate
until payment of the original amount due, plus interest, is received by the innocent party (or
the intermediary). The clause should define the applicable rate of interest, for example, the
London Interbank Offered Rate (LIBOR) plus 1%, or the six-month US Treasury Bill rate, as
quoted by a particular newspaper or journal on a particular day, and set out how the interest
is to be calculated.
Refer to The Enterprise Act 2016 implies a term into the Insurance Act 2015 that affects any
chapter 8,
section D5 for (re)insurance contracts governed by the law in England and Wales entered into on or after
more on this term 4 May 2017. The term states that if a (re)insured makes a claim under the contract, the
(re)insurer must pay any sums due in respect of the claim within a reasonable time
time. If
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breached, the (re)insured may seek contractual damages from the (re)insurer.
It is yet to be seen what impact this law will have on existing late payments clauses. It is likely
that the clauses will exclude the Act in whole or in part, expressly or impliedly.
B2C Loss reserves clause

The loss reserves clause allows the reinsured to establish reserves for the reinsurer’s
proportion of amounts outstanding to the treaty. This clause is also known as a loss funding
or an unauthorised reinsurance clause
clause.
In some countries,
In some countries, such a reserve is a legal requirement where, for example, the reinsurer is
reserve is a legal considered ‘unauthorised’ or ‘unlicensed’ and does not qualify for credit with the regulatory
requirement
authority having jurisdiction over the reinsured and its reserves. In other words, potential
reinsurance recoveries from certain reinsurers are not deductible in reporting for regulatory
purposes.
Form of reserve clause
By this clause, the reinsurer agrees to fund these reserves in one of three main forms:
• funds withheld;
• cash advances (also known as OCAs, that is, outstanding cash or claims advances); or
• letter of credit (LOC)
(LOC), provided the chosen method is acceptable to the particular
regulatory authority. While funds withheld and cash advances are self-explanatory, LOCs
are not.
An LOC is a document (or letter) issued by a mutually acceptable bank at the request (and
expense) of the reinsurer to the reinsured. It will be issued for a limited period and be for an
amount equal to the reinsurer’s proportion of the outstanding reserves to the treaty.
B3 Law and dispute resolution clauses

B3A Law and jurisdiction clauses
The law and jurisdiction clauses record the parties’ choice of law and tribunal for the
The first part of the clause identifies the (proper) law(s) which governs the reinsurance
agreement. The parties should take care in describing the governing legal system as there is,
for example, no such thing as UK law. The UK is a political entity that encompasses more
than one body of law. Similarly, in a federal country such as the USA, the reference should be
to the law of the applicable state, not the country.
The second part of the clause identifies the courts that have the power and authority to
administer justice between the parties to the reinsurance agreement. A court has jurisdiction
in a dispute if it has the power to decide that dispute. Under an exclusive jurisdiction clause,
the parties agree that no other place than that stated shall determine disputes between the
parties.
A typical wording is:
This Contract shall be governed by and construed in accordance with the Laws of
England and Wales and shall be subject to the exclusive jurisdiction of the English
courts.
In the absence of express choice, it will be for any court to decide on the applicable law and
jurisdiction.
Clearly, if the parties and the risk in question are located in the same country, choice of law
and jurisdiction are unlikely to be a concern to the parties. However, if they are not, it is
important to have considered, at the outset, the likely consequences of choosing one system
of law and/or jurisdiction over another.
B3B Dispute resolution clauses

The dispute resolution clauses set out how the parties have agreed to go about resolving
any disputes that arise between them under the reinsurance contract.
Arbitration clause
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This clause is invariably found in brokered reinsurance contracts and sets out the terms and This clause is
conditions of the parties’ agreement to arbitrate certain disputes arising in relation to the invariably found in
brokered
contract. This procedure, a form of alternative dispute resolution (ADR), is concerned with reinsurance
the resolution of disputes outside courts of law. It is confidential and, subject to the right of contracts
appeal, any award is binding and remains private.
The important points to note about an arbitration clause are as follows:
• The parties agree to arbitrate before litigating any dispute between them. This
requirement is often expressed as a condition precedent to any right of (court) action
under the contract. In most common law territories it is mandatory to use arbitration if
there is an arbitration clause in the policy prior to commencing litigation.
• It should describe the number of arbitrators to be used, typically three but sometimes a
sole arbitrator is used, and any required qualifications or experience. This can either be
from an existing panel of qualified arbitrators or by listing the particular experience
required, for example, ten years insurance or reinsurance underwriting experience.
• It should address the issue of the procedure to be followed by the panel (or tribunal) once
constituted, either by outlining the procedure within the clause itself or by reference to a
tried and tested set of rules, for example, those of the reinsurance and insurance
arbitration society of the International Association for Insurance Law (ARIAS) (that is, the
ARIAS rules). Alternatively, and more usually, the procedure is left for the panel to decide
as they see fit in the circumstances.
An example of an extensive arbitration clause can be found in appendix 7.1, available on
RevisionMate, at paragraph 16 of the latest edition of JELC Excess Loss Clauses
(01/11/2003).
Mediation clause
Another way of resolving disputes is to mediate them. Here, a trusted third party attempts
by various means to broker a settlement between the parties. This approach places
particular emphasis on principled negotiation, and away from strict legal rules and
procedures. An example of such a clause is:
Where any dispute or difference between the parties arising out of or in connection
with this Reinsurance, including formation and validity and whether arising during or
after the period of this Reinsurance, has not been settled through negotiation, both
parties may agree to try in good faith to settle such dispute by non-binding
mediation. The commencement of mediation will not prevent or preclude the parties
from commencing, or continuing arbitration/court proceedings unless the parties
so agree.
In this clause, the parties may mediate at any time. Sometimes, the parties mandate
mediation before arbitration and agree to seek to resolve the dispute within a particular
period, say 30 days, before commencing arbitration proceedings. Also, to provide some
rubric to the mediation process, the parties may agree to apply a model procedure; one in
widespread use is the Centre for Effective Dispute Resolution (CEDR
CEDR) Model Mediation
Procedure
Procedure.
Activity
Visit the CEDR website (www.cedr.com) and review the 2016 edition of the CEDR Model
Mediation Procedure. Identify three main advantages of mediating over litigating. What
do you consider to be the main disadvantage?
Service of suit clause

Legal requirement
A service of suit clause is a legal requirement for certain reinsurance contracts where the
for certain reinsured is domiciled in certain states of the USA and the reinsurer is elsewhere. It names a
reinsurance
contracts
local organisation that the reinsurer has authorised to represent its interests and accept
service of suit on its behalf, should there be a dispute with the reinsured. Its main purpose is
to avoid the inevitable delay and expense otherwise associated with the reinsured suing, and
therefore having to serve papers on, an entity that could be located anywhere in the world.
B4 Miscellaneous clauses
Chapter 7
In this section, we will review some of the more important miscellaneous clauses that you
might encounter.
B4A Access to records clause

Right to examine
The access to records clause (also known as the right of inspection clause) gives the
or inspect the reinsurer the (express) right to examine or inspect the reinsured’s books and records that
reinsured’s books
and records
pertain to the reinsurance contract. The reinsurer may wish, at its own cost, to satisfy itself
that the treaty is being handled properly, e.g. premiums are being ceded correctly or that
the claims reserves are adequate.
Typically, the right to inspect is exercised by the reinsurer when it perceives a problem that
usual enquiries cannot resolve. It can be expensive, particularly if outside experts are
employed. The right to inspect lasts as long as either party has a claim against the other, and
may continue long after the original period of the agreement. It will also survive termination,
again provided that one party has a claim against the other.
An example of this clause is as follows:
For as long as either party remains under any liability hereunder the Reinsured shall,
upon request by the Reinsurer, make available at the Reinsured’s head office or
wherever the same may be located, for inspection at any reasonable time by such
representatives as may be authorised by the Reinsurer for that purpose, all
information relating to business reinsured hereunder in the Reinsured’s possession or
under its control and the said representatives may arrange for copies to be made at
the Reinsurer’s expense of any of the records containing such information as they
may require.
The clause may require reinsurers to enter into a confidentiality agreement prior to
inspecting the books and records.
B4B Underwriting policy clause

The underwriting policy clause requires the reinsured to seek the reinsurer’s approval to
significant change in its underwriting policy. The purpose of this clause is to prevent the
reinsured eroding or otherwise changing the nature of the original bargain struck between
the parties.
A typical clause is as follows:
It is a condition precedent to the reinsurer’s liability hereunder that the reinsured
shall not introduce at any time after the reinsured enters into this Agreement any
change in its established acceptance and underwriting policy which may increase or
extend the liability or exposure of the reinsurer hereunder in respect of the classes of
business to which this Agreement applies without the prior written approval of the
reinsurer.
B4C Errors and omissions clause

The errors and omissions clause seeks to ensure that any inadvertent errors, omissions or
delay in complying with the terms and conditions of the treaty are remedied immediately
upon discovery and without any impact to the treaty beyond that of ordinary rectification.
Originally, the clause was incorporated into proportional reinsurances to address mistakes
made in supplying information to reinsurers about the risks ceded to such treaties.
Later, the scope of the wording was extended to cover the keeping of records of cessions to Commonplace in
the treaty, and to the provision of periodic bordereaux. It is now commonplace in non-proportional
reinsurances
non-proportional reinsurances, where it is used to ensure that a claim is not declined
because of an inadvertent error on the part of the reinsured.
A simple example of this clause is as follows:
Such error or omission shall be rectified immediately upon discovery, and shall not
impose any greater liability on the Reinsurers than would have attached if the error
or omission had not occurred.
B4D Extra contractual obligations (ECO) and excess of policy limits

(XPL) clauses
Chapter 7
These clauses are typically found in wordings where the reinsured is domiciled in the USA.
ECO clause
An extra contractual obligations (ECO) clause extends the scope of the treaty to damages
arising from the reinsured’s bad faith or negligence in handling claims, under policies subject
to the treaty. In this case, the court has made an award against the insurer/reinsured outside
of the insurance relationship. Reinsurers often insist on a high degree of co-reinsurance in
this cover to encourage greater care in future, perhaps up to 25%.
An example from the US Brokers and Reinsurance Market Association (BRMA) follows:
This Contract shall protect the Company within the limits hereof, where the ultimate
net loss includes any Extra Contractual Obligations. The term ‘Extra Contractual
Obligations’ is defined as those liabilities not covered under any other provision of
this Contract and which arise from the handling of any claim on business covered
hereunder, such liabilities arising because of, but not limited to, the following: failure
by the Company to settle within the policy limit, or by reason of alleged or actual
negligence, fraud, or bad faith in rejecting an offer of settlement or in the preparation
of the defense or in the trial or any action against its insured or reinsured, or in the
preparation or prosecution of an appeal consequent upon such action.
The date on which any Extra Contractual Obligation is incurred by the Company shall
be deemed, in all circumstances, to be the date of the original disaster and/or
casualty.
However, this Article shall not apply where the loss has been incurred due to fraud
by a member of the Board of Directors or a corporate officer of the Company acting
individually or collectively or in collusion with any individual or corporation or any
other organization or party involved in the presentation, defense or settlement of
any claim covered hereunder.
XPL clause
Extends scope of
An excess of policy limits (XPL) clause extends the scope of the treaty to original loss in
treaty to original excess of the original policy limit, where this arises from the reinsured’s bad faith or
loss in excess of
original policy limit
negligence in handling claims under policies subject to the treaty. In this case, the court has
set aside the original policy limit, awarding a claim amount in excess of that limit.
It is similar to the ECO clause, as both exposures arise out of the same claims handling
conduct. However, the difference is that the loss or liability that is the subject of the XPL
clause, would be covered under the original policy but for the paucity of its limit, whereas
the loss or liability which is subject to the ECO clause falls outside the original policy and the
other provisions of the reinsurance agreement. As such, XPL is considered the excess
liability of the original insured, and ECO the liability of the insurer (or, in this context, the
reinsured).
B4E Insolvency clause

Sets out the
The insolvency clause sets out the effect the reinsured’s insolvency will have on the
impact of the reinsurance contract. As a reinsurance contract is an indemnity contract, the reinsured is
reinsured’s
insolvency on the
usually required to pay the original claim prior to seeking an indemnity or reimbursement
reinsurance from the reinsurer. Of course, in an insolvency situation, it is no longer possible for the
contract
reinsured to do so, either in full as the funds are generally not available, or within the usual
time scale. The original (non-protected) policyholder would expect to receive only a
proportion of its claim by the means of irregular payment of dividends.
See also However, in Charter Reinsurance Co Ltd v. Fagan (1996) it was held that, unless there is very
chapter 8,
section C1 clear wording to the contrary, a reinsurance contract must respond to a claim when the
reinsured’s liability to pay has been established and quantified, and not to an actual payment
by the reinsured. So, if the reinsured becomes insolvent before having paid claims, and its
liability to pay those claims is established before or during the insolvency proceedings, the
reinsurers are required to make payment. Therefore, reinsurance wordings must be clear on
this point.
Thus, under English law, in the absence of any specific provision to the contrary, reinsurers
are legally required to pay claims that have been established and are due for settlement by a
reinsured that has entered into insolvency procedures. The insolvency clause removes the
requirement for the reinsured to actually pay the original claim before collecting on its
reinsurance contract. It also allows the parties to set-off sums outstanding between the
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parties. In short, it states that, in the event of the insolvency of the reinsured, the liability of
the reinsurer shall be determined as if the reinsured had not gone into liquidation, subject to
any rights of set-off.
B4F Offset clause

The offset clause allows the parties to offset any balance or amount due from one party to
the other under a particular reinsurance contract or any others between the parties, whether
acting as reinsurer or reinsured.
B4G Co-reinsurance clause

The co-reinsurance clause states the proportion (or percentage) of the particular contract
that the reinsured agrees to retain ‘net and unreinsured’. The purpose of the clause is to
make certain that the reinsured remains interested in economic claim settlement.
In proportional reinsurance, it is more usually described as co-participation rather than
co-reinsurance. In non-proportional reinsurance, a reinsured assumes an amount or
percentage of the reinsurance cover (or layer), in addition to the deductible.
B4H Net retained lines

The net retained lines clause states that the contract applies only to the amount of loss
retained by the reinsured for its own account after relevant deductions. Typically, the clause
is in two parts.
The first part of the clause states that this reinsurance contract only applies to that part of an
underlying loss which the reinsured retains net for its own account. In other words, any other
reinsurances protecting the same loss must be taken into account before applying the terms
of this contract. This requirement is logical, otherwise the reinsured could potentially
recover the same loss from more than one reinsurance policy (although, any attempt to do
so would probably fall foul of local law).
The clause also recognises that the reinsured and reinsurer may specifically agree that the
reinsured may purchase additional reinsurance to reduce the amount it retains for its own
account after the application of this reinsurance contract. In other words, it may protect its
retention under this contract.
The second part of the clause bars a reinsured from seeking to collect under this particular
contract any amounts which had been reinsured elsewhere, but for whatever reason remain
unpaid by those reinsurers. In other words, if another reinsurer is unable or unwilling to pay
its share of a claim, the reinsured cannot increase its UNL by the uncollected amount in order
to recover from a contract with a net retained lines clause.
An example of a net retained lines clause is:
1. This Agreement applies only to that part of any insurance or reinsurance which
the Reinsured retains net for its own account and/or that portion of any
insurance or reinsurance which the Reinsured cedes to its Quota Share
Reinsurers and in calculating the amount of any loss hereunder and also in
computing the amount in excess of which this Agreement attaches only sums
payable in respect of that portion of any insurance or reinsurance which the
Reinsured retains net for its own account and/or that portion of any insurance
or reinsurance which the Reinsured cedes to its Quota Share Reinsurers shall be
included.
2. The amount of the Reinsurers’ liability hereunder in respect of any loss or losses
shall not be increased by reason of the inability of the Reinsured to collect from
any other reinsurers (whether specific or general) any amounts which may have
become due from them whether such inability arises from the insolvency of
such other reinsurers or otherwise.
B5 Boilerplate clauses
Chapter 7
Boilerplate clauses are standard clauses with little reinsurance content to them. They are, Standard clauses
however, essential to making the contract work and to providing the parties with the essential to making
the contract work
appropriate protections in the event of a dispute. More information is given in table 7.2.
Table 7.2: Boilerplate clauses

Notice clause Sets out how notice required by the agreement shall be given, i.e. in writing
either by fax or email, and to whom the notice should be sent.
Intermediary clause Identifies, and provides contact details for, any intermediary or broker on
the contract. Importantly, it requires all communications – which, on
occasion, is drafted to include payments – to be transmitted through that
broker.
The version used in US business typically provides that payments by the
reinsured to the broker shall be deemed to constitute payment to the
reinsurer, whereas payments by the reinsurer to the broker shall be deemed
to constitute payment to the reinsured only to the extent that such
payments are actually received by the reinsured.
Termination of Provides that the reinsured may terminate the role of the intermediary at
intermediary clause any time during the contract by giving written notice. If notice is given, it is
usually agreed that brokerage is deemed earned pro rata up to the date of
the notice after which its entitlement ends. The reinsurer agrees to
cooperate in the change of broker.
Table 7.2: Boilerplate clauses

Confidentiality clause Prohibits the reinsurer from disclosing confidential information to another
unless it falls within prescribed categories, or the parties otherwise agree.
Confidential information has been defined to include all documentation,
information and other data provided by the reinsured to the reinsurer in
connection with the placement, execution or performance of the
reinsurance contract. Excluded from this definition would be information in
the public domain or information otherwise known to the reinsurer before
the placement of the reinsurance.
Of course, in the ordinary course of its business, a reinsurer will be required
to make various regulatory and financial returns, and wish to claim in turn on
any retrocession. It is always open for the parties to extend the categories of
those to whom information may be disclosed.
Amendments and States the means by which the parties are entitled to make changes to the
alterations clause contract, for example by correspondence as well as addendum:
This Agreement may, at any time, be altered by mutual

consent of the parties, whether by addendum [that is,
Broker’s Slip endorsements] or by correspondence, and
such addendum or correspondence shall be deemed to
form an integral part of this Agreement.
This clause would not help a party that sought to argue that the contract
had been modified by subsequent verbal agreement.
Severability clause Attempts to ensure that a provision that is found to be invalid, illegal or
otherwise unenforceable does not imperil the entire contract.
Entire agreement Limits the parties’ rights and obligations to those set out in the contract and
clause specified documents alone. The clause helps to dissuade a party from later
arguing that the parties had agreed to other terms that are not explicit, such
as oral representations, emails, memoranda or other documentation.
Non-waiver clause Notes that the failure by one party to insist on the other’s compliance with a
particular provision of the contract does not constitute a waiver (or a giving
up) of that right or remedy.
Several liability clause Explains that a reinsurer’s liability is limited to the extent of its participation.
In other words, liability under the contract is several (or separate) and not
joint. So, a reinsurer has no obligation to pay the share of a defaulting
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co-reinsurer.
According to the MRC standard, this clause is mandatory for subscription
business and resides in the security details section of the MRC.
Reinforce
Before you move on to examine clauses used only in proportional wordings, make sure
that you can summarise the different clauses that are common to proportional and
non-proportional reinsurances.
C Clauses used in proportional wordings

C1 Cession clause
The cession clause sets out the nature and the main terms of the proportional reinsurance. It
is also known as the ‘reinsurance clause’ or the ‘treaty detail’.
The first part of the clause confirms the obligatory nature of the contract: that is, the
reinsured agrees to cede, and the reinsurer to accept, the amount of the cession – the
proportion ceded to reinsurance.
A quota share treaty will identify the fixed proportion or percentage of the applicable
business for the account of each party, whereas a surplus treaty will identify the number of
lines and the minimum retention of the reinsured. Here, the parties agree that the reinsurer
shall be subject to the same terms, warranties, clauses and conditions as are in the original
policies protected under the reinsurance; subject to the terms and conditions of the
reinsurance. This is, typically, followed by a statement of the overarching intention of the
agreement, namely that:
Reinsurers shall follow the fortunes of the Reinsured in all things coming within the
scope of this Agreement
This statement is considered fundamental to the operation of proportional reinsurances,
reflecting the true sharing of risks, premiums, commissions, expenses and losses between
the parties.
Further, it is usually agreed that the reinsurer’s liability commences simultaneously with that
of the reinsured. In practice this corresponds to when the reinsured accepts the original risk
under a quota share treaty, or as soon as the retention is exceeded on a surplus treaty.
Cession limit
The agreement to accept a fixed proportion of the business that falls within the terms and Agreement to
conditions of the reinsurance is subject to a cession limit. The cession limit is the maximum accept a fixed
proportion of the
monetary amount that may be ceded to the treaty in respect of each risk, interest, policy or business
on whatever basis the parties have agreed that the limit will apply.
Cession retention
The reinsured agrees to retain an amount for its own account. The clause may allow that
amount to be protected by other reinsurance or it may not. Typically, the reinsured will be
required to retain that amount net and unreinsured, subject only to the benefit of excess of
loss catastrophe reinsurance.
In 2012, the IUA published a model surplus cession clause as follows:
Cession Clause (IUA 09-001 (P12))
a. The Company binds itself to cede to the Reinsurer and the Reinsurer agrees to
accept the share, stated in the attached Schedule to this Agreement, of all
surplus amounts over the gross amounts retained by the Company for its own
account in respect of the business described in the Schedule. The gross amount
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retained by the Company shall not exceed the sum stated in the Schedule and
the amount accepted by the Reinsurer shall not exceed the treaty limits as
specified in the Schedule.
b. The Reinsurer shall only cover those risks accepted by the Reinsured which are
situated within the territorial limits as defined in the Schedule.
c. The Reinsurer shall not be liable for any losses caused by or arising from the
exclusions detailed in the Schedule.
d. i. The Reinsured shall decide what constitutes one risk hereunder and unless
otherwise hereinafter provided shall fix its net retention without reference
to the Reinsurer.
ii. Should a loss affect this Agreement prior either to the fixing or revision of
its net retention then the net retention of the Reinsured shall not be less
than that shown by its records and practices to be its usual net retention
for similar risks.
e. The Reinsured may in the interest of the Reinsurer reduce the amount to be
ceded in respect of any risk by effecting individual reinsurances. The Reinsured
may also effect reinsurance to protect its overall net retained portfolio.
f. An insurance granted by the Reinsured wherein the Reinsured is named as the
Insured either alone or jointly with another party or parties shall not be
excluded from this Agreement merely because no legal liability may arise in
respect thereof by reason of the fact that the Reinsured be the Insured or one
of the Insureds.
g. The liability of the Reinsurer in respect of each risk covered hereunder shall
commence and expire simultaneously and automatically with the liability of the
Reinsured in respect of the original acceptance subject to the provisions
relating to Commencement and Termination.
You should note that paragraph (e) of this clause permits the reinsured, in the interest of the
reinsurer, to reduce the amount of a risk ceded to the treaty by effecting specific
reinsurance. This exception to the obligation to cede to the line capacity of the treaty would
be used where the reinsured considers that a particular risk might unbalance, or adversely
affect, the treaty results if it incurs claims. The paragraph also allows the reinsured to effect
reinsurance to protect its overall net retained portfolio with, for example, a property per
catastrophe and/or per risk excess of loss treaty.
C2 Record of cessions clause

Maintain records of
As its name suggests, this clause requires the reinsured to maintain records of all cessions to
all cessions to the the contract, including renewals and amendments, and to provide a copy in bordereau form
contract
to reinsurers. Such a record is available for inspection by a reinsurer by reason of an ‘access
to records clause’ (or similar).
C3 Commencement and termination

This clause sets out when cover under the reinsurance contract commences and when it
terminates, and the basis of that cover.
C3A Commencement
Cover is typically arranged either on an underwriting year basis or on an accounting
year basis.
Underwriting year basis
On this basis, reinsurers agree to assume liability for claims on risks or original policies issued
or renewed during the period of the reinsurance.
This Agreement shall take effect on the date stated in the Schedule and continue in
force until terminated and shall be in respect of policies issued or renewed during the
period of this Agreement not to exceed 12 months plus odd time, not exceeding 18
months in all.
If the business to be ceded includes longer term policies such as contractors’ all risks, the
twelve-month limitation on the original policy period would have to be extended to
encompass. For example, 36 months plus twelve months maintenance period.
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Accounts year basis

Reinsurers assume
On this basis, reinsurers agree to assume liability for claims occurring during the period of
liability for claims the reinsurance. This is irrespective of the inception dates of the original policies giving rise
occurring during
period of
to the claims. The date the loss occurs is the date of loss, which must fall within the
reinsurance reinsurance policy (and original policy) period.
This agreement shall take effect in respect of all losses occurring on or after the
(date) under policies in force, issued or renewed.
C3B Termination
Clause will state
As illustrated in section B1A, a proportional reinsurance treaty is typically a continuous
the notice period contract without an automatic termination date. The parties, therefore, reserve the right to
terminate (or cancel) the contract on written notice. The clause states the notice period, the
effective date for the cancellation and confirms that cessions made during the notice period
continue to bind the parties. This right is in addition to any right of termination set out in the
special termination clause.
Often the reinsurer and/or the reinsured will give notice of cancellation for the purpose of
forcing a review and renegotiation of one or more of the terms and conditions of the treaty.
The reasons for this can include, the:
• treaty results are good and the reinsured wants to increase the ceding commission;
• treaty results are poor and the reinsurer wants to reduce the ceding commission and/or
impose restrictions to the cover; or
• reinsured wants to increase its retention because the premium income is increasing and
the results are good and, at the same time, may want to increase the amount of
reinsurance capacity.
Of course, the purpose may be to cancel the treaty outright because, for example, the
results are poor or it no longer fits a party’s business objectives or requirements.
A typical termination clause is as follows:
This Agreement may be terminated by either party giving notice of termination on
the basis set out in the Schedule (e.g. 3 months), such notice to expire on the date
stated in the Schedule (e.g. any 31st December). Notice of termination shall be given
in writing which shall be deemed to include cable, telex, facsimile or other means of
instantaneous communication. In the event of either party giving notice of
termination in accordance with the provisions set out in the Schedule then such
notice shall be automatically deemed to have been given by both parties. During the
period of notice the Reinsurer shall continue to participate in all cessions covered by
the terms of this Agreement.
Basis of termination
In this context, a reinsurance contract may be terminated on a portfolio transfer or
run-off basis.
If the portfolio is transferred, which is usual for a continuous proportional contract, the See section C7 for
portfolio transfer
outstanding liabilities (claims and return premiums) and run-off premiums are calculated clause
and transferred over to the new year of account.
If a run-off basis is elected, the reinsurer remains liable for all losses arising from policies
covered by the contract until their natural expiration or cancellation.
Question 7.3
A proportional treaty on an ‘accounts year’ basis covers all losses on policies issued or
renewed during a particular year. True or false?
C4 Accounting clause
The accounting clause requires the reinsured to prepare and despatch periodic accounts to States when
the reinsurer. It states when accounts have to be presented to the reinsurer, what details accounts have to
be presented to
have to be included in them and when money should be rendered to the reinsurer in respect the reinsurer
of those accounts, or vice versa. They include the following:
Chapter 7
• the accounting period, i.e. quarterly, monthly, half-yearly;
• how close to the end of the relevant period the account has to be rendered;
• how and when the account is to be confirmed and the balances settled, i.e. within 90 days;
• any special class of provisions, such as the rendering of separate accounts for specified
currencies.
C5 Premium clauses
C5A Premium clause
The premium clause states that cessions to the treaty are subject to the same terms and
conditions as those of the original business. It provides that the reinsured will pay the
reinsurer its proportionate share of the original gross (or net) premiums received by the
reinsured on that business. If the reinsurer agrees to receive its proportionate share of
original net premiums, the clause should set out the permissible deductions from the original
gross premiums.
C5B Commission clause

This clause sets out how much commission is to be paid by the reinsurer to the reinsured and
when it is to be paid. There are two basic types of commission: ceding commission and profit
commission.
Reinforce
Refer back to chapter 4, section C, and remind yourself of the types of commission.
C6 Claims clauses
These clauses deal with the notification and settlement of all losses to the treaty.
C6A Claims information

The treaty should set out, in the required level of detail, the extent of individual and/or
summary loss information to be provided to the reinsurer, and when it should be provided.
The level of detail required varies between reinsurers.
One reinsurer may require quarterly loss bordereaux plus full particulars of claims in excess
of a certain amount. For example, the reinsurer may have outwards reinsurance available for
such losses. On the other hand, another reinsurer may, perhaps where there is a high level of
trust between the parties, dispense with bordereaux entirely and rely on the access to
records clause should the need arise.
Treaty may contain

The level of loss information is often a function of the strength of the relationship between
a claims the parties. In any event, the reinsurer will usually require at least summary information on a
notification,
cooperation or
quarterly basis to maintain appropriate reserves in its own books. The treaty may contain a
control clause claims notification, cooperation or control clause; each such clause requiring the reinsured
to provide claims information.
C6B Claims (or loss) settlement clause

The treaty should also set out the basis on which the reinsurer is to settle claims.
An example clause where the overarching intention of the agreement is to ‘follow
follow the
fortunes’ is:
fortunes
The Reinsurers agree to be bound by the terms and conditions of the Policies
protected hereunder and the Reinsured has the sole right to settle losses and all
settlements including payments on account and compromise payments shall be
binding on the Reinsurer. The Reinsured shall consult the leading Reinsurer only prior
to any ex gratia settlement.
The Reinsured may institute any action they think fit in relation to any claim and the
Reinsurers shall be liable for their share of the claim including all expenses incurred in
connection therewith other than the salaries of employees and office expenses of the
Reinsured. The Reinsurers shall participate in all salvages and recoveries obtained by
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the Reinsured in respect of any losses in which the Reinsurers are interested.
Accordingly, a following reinsurer even agrees to make ex gratia (as a favour) settlements,
provided they are agreed by the leading reinsurer. There is also a clear statement that
reinsurers are to share in all salvages and recoveries.
C6C Payment of claims clause

Refer back to Typically, claims are paid (or remitted) either individually as cash losses or collectively as
section C4
part of the periodic rendering and settlement of accounts: ‘in relation to the former, the
parties will agree a cash loss limit. When this limit is exceeded, the reinsured may request
immediate payment, circumventing the periodic settlement process’.
Purpose of such a
The purpose of such a provision is to avoid cash flow problems inherent in the settlement of
provision is to large gross losses out of the net retained funds of the reinsured.
avoid cash flow
problems
C7 Portfolio transfer clause

The portfolio transfer clause is concerned with the transfer of liability for pre-existing
business, a portfolio, from one set of reinsurers to another. You may see similar clauses
entitled ‘portfolio acceptance and withdrawal’.
C7A Premium portfolio

The parties may agree that reinsurers assume liability (from prior year or outgoing
reinsurers) for all policies in force (that is, the premium portfolio) at a certain date. In return,
the reinsured agrees to pay reinsurers a sum of money, known as an incoming premium
portfolio (or similar). There is no contract between incoming and outgoing reinsurers.
In this way, (incoming) reinsurers assume liability for the unexpired risk of cessions made in Refer back to
chapter 4,
the immediately preceding treaty year in return for the unearned premium reserve for those section B2
risks. A premium portfolio may also be withdrawn, typically at the reinsured’s option, as well
as assumed. If withdrawn, (outgoing) reinsurers agree to transfer the unexpired risk of
cessions made in the current year, and pay over the unearned premium reserve for those
cessions.
C7B Loss portfolio

The parties may agree that (incoming) reinsurers assume liability (from outgoing reinsurers)
for all losses outstanding (that is, the loss portfolio) at a certain date. In return, the reinsured
agrees to pay reinsurers a sum of money known as an incoming loss portfolio (or similar),
which represents the reinsurer’s share of the estimated outstanding losses at that date.
So, incoming reinsurers accept responsibility for claims outstanding to the prior treaty and
receive the outstanding loss reserve for those outstanding claims, although the reserve is
often discounted (for example, from 100% to 90%). Similarly, at the end of the treaty period,
again typically at the reinsured’s option, responsibility for the outstanding claims is
transferred with the outstanding claims reserve. It is usual to include a provision that, if a loss
is settled for an amount materially different from its reserve, the account (or transfer) can be
reopened and an appropriate adjustment made.
C7C Portfolio transfer clause

The clause will specify whether there is a:
• premium portfolio assumption;
• premium portfolio withdrawal;
• loss portfolio assumption; and/or
• loss portfolio withdrawal.
It does not follow automatically that, because there is a premium portfolio assumption, there Each element must
is also a withdrawal, and the same apples to claims. Similarly, it should not be assumed that be agreed
between the
because there is premium assumption (or withdrawal), there is automatically a claims parties
assumption (or withdrawal). Each element must be agreed between the parties, as must the
method of calculation for the premium portfolio, for instance, on a twelfths or
twenty-fourths basis.
Chapter 7
Appendix 7.2, available on RevisionMate, contains a copy of the portfolio premium and loss
transfer clause (IUA 09-021 (P271)). This topic is discussed in detail in chapter 4.
C8 Premium and loss reserves (or deposits) clauses

The parties may agree to the retention by the reinsured of premium and/or loss reserves (or
deposits).
C8A Premium reserves (or deposits) clause

This clause allows a reinsured to retain additional premium by requiring the reinsurer to
deposit a fixed proportion of prior written premium.
The original purpose of the clause was to ensure that the reinsured suffered no financial Clause remains a
impairment if, for example, all of the original business was cancelled and it needed to return legal requirement
in some countries
the original premium, or it was necessary to make significant claim payments in a short
period of time and reinsurers could or would not, for whatever reason, meet their obligations
in the required time frame. The clause remains a legal requirement in some countries,
including a number of states in the USA. Otherwise, many reinsurers strongly resist its
inclusion.
As an alternative method to a cash deposit, reinsurers may provide another form of
collateral, for example, an LOC or a pledge or deposit of securities.
C8B Loss reserves (or deposits) clause

The loss reserves (or deposits) clause allows the reinsured to establish reserves for the
reinsurer’s proportion of amounts outstanding to the treaty.
In the event of cancellation of the treaty, the reinsurer may be required to pay the reinsured
its proportion of the outstanding losses (often 90%). In this situation, you would expect the
agreement to provide for the loss reserve to be adjusted periodically until all liability on the
part of the reinsurer was extinguished, or the parties otherwise agreed. The reinsurer should
also receive interest on the monies deposited with the reinsured.
Consider this
this…
…
Can you distinguish premium and loss portfolios from premium and loss reserves?
C9 Loss participation clause

The loss participation clause requires the reinsured to participate as co-reinsurer if a stated
loss ratio is exceeded.
For example:
In the event that the loss ratio for any contract period exceeds (%), the reinsured
shall retain each percentage increase in loss ratio up to a maximum of (%) loss ratio
for the contract period applicable.
Large losses for the sake of this calculation shall be capped at (£).
Loss Ratio: Shall be calculated by dividing the Total Losses by the Earned Premium
and expressed as a percentage.
Total Losses: Shall mean the losses paid in the current year plus the reserve for
outstanding losses at the end of the current year.
Earned Premium: Shall mean the premium income of the current year plus the
premium reserve from the preceding year less the premium reserve for the
current year.
The key elements of the clause are the:
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• definition and the amount of the loss ratio which, if exceeded, triggers the reinsured’s co-
reinsurance; and
• extent of that co-reinsurance.
In the example, the reinsured retains all of those claims that correspond to a particular range
of loss ratio. Alternatively, the parties may agree to share such claims at a fixed or variable
rate, or for the reinsured to retain all of those claims which exceed a particular loss ratio.
C10 Event limitation clause

Refer to The event limitation clause limits the amount of claims recoverable under the treaty for a
section D4
for limits defined event to a stated monetary amount. An aggregate limit may be imposed on cessions
for risks exposed to particular perils in particular locations (for example, earthquake risk in
high risk zones), either as an alternative, or in addition, to the event limitation clause.
Learning point
Before you move on, ensure that you have a note of the clauses used in proportional
wordings.
D Clauses used in non-proportional

wordings
D1 Basis of cover clause
The basis of cover clause sets out the basis of the cover provided by the reinsurance Describes the
contract. It describes the necessary relationship between the period of the reinsurance necessary
relationship
contract and a characteristic of the original insurance policy or claim, as appropriate.
• On a losses occurring during (LOD) basis something must have happened during the
reinsurance contract period; for example, a loss/claim must occur or be made or
discovered during that period.
• On a risks attaching during (RAD) basis, the inception date of the original policy need
only fall within that period.
Together, the period clause and the basis clause are known as the commencement clause
clause.
RAD (or policies issued) basis
On this basis, reinsurers agree to assume liability for claims on risks or original policies Refer to
chapter 5,
attaching during the period of the reinsurance. A risk or policy is considered to attach if: section B1 for
RAD basis
• it incepts;
• is re-signed (that is, multi-year contracts); or
• is treated as having been re-signed at the date when such risks, or part of such risks, have
reached any maximum period on any preceding period of reinsurance, during the period
of the reinsurance.
Provided the inception date of a policy falls within the period of the reinsurance contract in
question, the reinsurers on that treaty will be liable for all claims arising from that policy.
Figure 7.1: RAD (or policies issued) basis

Date of loss
01/05/2017 30/04/2018
Chapter 7
Original policy period
Reinsurance period
In figure 7.1, if the date of loss was 24 March 2018 then the claim would be recoverable from
the 2017 – calendar year – reinsurance period, being the period in which the policy which
gave rise to the loss incepted.
Accordingly, it is possible for loss dates to be outside the period of the reinsurance contract, Refer to
section D7 for
and for major events (e.g. hurricanes) to impact more than one reinsurance period. This is interlocking
because the applicable reinsurance contract period depends on the date of original policy clause
inception, not the date of loss. You will see this basis in action when you come to the
interlocking clause.
Another characteristic of contracting on this basis is that the tail on the assumed business
may be considerable if, for example, there is no limit on the period of the attaching policies.
Contractors’ all risks policies, for example, may run for many years, producing claims long
afterwards. To counter this, reinsurers often impose a warranty, limiting the period of the
underlying risk to twelve months plus odd time but, in any event, no longer than 18 months
(or similar). Also, the adjustment of premium, typically, takes place a year later than
contracts written on the LOD basis.
LOD basis
On this basis, reinsurers agree to assume liability for claims occurring during the period of
the reinsurance, irrespective of the inception dates of the original policies giving rise to the
claims.
The date the loss

The date the loss occurs is the date of loss and this must fall within the reinsurance policy
occurs is the date (and original policy) period. The simplicity of this approach has great attraction for the
of loss which must
fall within the
parties, as it is easy to understand and to administer. Importantly, the clause should also
reinsurance policy state how time (or dates) are to be defined (for example, ‘Local Standard Time at the place
where the loss occurs’) because the time in one place (or zone) will be different in another
part of the world. Greenwich Mean Time remains in common use.
Loss discovered/claims made basis
On this basis, reinsurers agree to assume liability for circumstances notified to the insurer
within the period of the reinsurance. Reinsurers’ exposure to loss is not, therefore,
determined by the inception date of the original policy, or when the loss occurred, but by
when the original claim was made or the loss discovered.
In this way, the reinsurance contract seeks to replicate the basis of the underlying insurance
contract. Accordingly, this basis tends to be reserved for liability (or casualty) treaties. As
with the other contract bases, this clause should also address the consequences of
non-renewal of the reinsurance contract.
If original policies written on a losses discovered or claims made basis are to be protected by
a LOD treaty, it is common to include a losses discovered or claims made clause as follows.
This is to avoid disagreements as to when a particular loss actually occurred.
1. It is understood and agreed that as regards losses arising under Policies and/or
Contracts covering on a ‘Losses Discovered’ or ‘Claims Made’ basis, that is to
say Policies and/or Contracts in which the date of discovery of the loss or the
date when the claim is made determines under which Policy or Contract the
loss is collectable, such losses are covered hereunder irrespective of the date
on which the loss occurs provided that the date of the discovery of the loss, in
respect of Policies and/or Contracts on a ‘Losses Discovered’ basis or the date
the claim is made, in respect of Policies and/or Contracts on a ‘Claims Made’
basis, falls within the period of this Reinsurance.
2. For the purpose of the foregoing the date of the first discovery of a loss
occurrence or the date a claim is first made, shall be the date applicable to the
entire loss and the Reinsurers shall be liable for their proportion of the entire
loss irrespective of the expiry date of this Reinsurance provided that such date
falls within the period of this Reinsurance.
Chapter 7
So, the date of first discovery (for losses discovered policies) or the date a claim is first made
(for claims made policies) is the date that must fall within the period of the treaty.
Question 7.4
If, in successive calendar years, the basis of cover clause changes from RAD to LOD, is
there a gap in reinsurance cover?
D2 Premium
Refer to The premium clause sets out how much reinsurance premium is to be paid and when it is to
chapter 5,
section C for be paid. The premium may be either fixed at the outset or adjustable in accordance with a
non-proportional specified rate or calculation.
premiums
D3 UNL clause
Sum actually paid
The UNL clause is central to excess of loss reinsurance, and describes the loss to which the
by the reinsured in treaty limits (and deductibles) are applied. In short, the UNL is the sum actually paid by the
settlement of
losses or liability
reinsured in settlement of losses or liability after agreed deductions.
after agreed
deductions
The important points to note about the UNL clause are as follows:
• The UNL comprises the sum actually paid (or, on occasion, payable or to be paid or liable
to be paid) by the reinsured in settlement of losses/claims. Accordingly, the reinsurance
contract is not a form of contingency cover, but a contract to indemnify loss, subject to
those exceptions.
• Unless specifically excluded, expenses attributable to the claim are included in the UNL
(for example, legal and loss adjustment expenses). Usual office expenses and salaries
payable by the reinsured cannot be included as a claims expense on the basis that they
are incurred whether or not a claim subject to recovery happened. Some contracts
reimburse reinsureds for extraordinary costs for staff when diverted from their normal
duties, for example, overtime to pursue recovery actions.
If expenses are not included in the UNL, they may be recoverable in addition to the limit of
indemnity in which case they will be pro-rated in proportion to reinsurers’ share of
the loss.
Question 7.5
With a £5m excess of £5m reinsurance, what is recoverable from the reinsurer in respect
of indemnity claims of i. £5m, ii. £8m; and iii. £10m, respectively, each with associated
costs and expenses of £1m, where those expenses:
A. form part of the UNL, or
B. are recoverable pro rata in addition to the limit?
• The UNL will not include ex gratia payments, literally, payments as a favour rather than The UNL will not
from an obligation. For the avoidance of doubt, ex gratia payments are usually defined as include ex gratia
payments
not including the settlement of losses arguably within the contemplation of coverage
under the policies reinsured, or made to avoid coverage dispute resolution costs under
those policies.
• The agreed deductions are typically all recoveries, salvages, subrogations and claims on
other reinsurances. The treaty will not, for whatever reason, cover the failure to recover
from a particular reinsurance.
• The clause enables recovery by the reinsured from the reinsurer in advance of the claim
being finally ascertained (see paragraph two in the example wording below). Otherwise,
Chapter 7
the reinsured would potentially be out of pocket for a significant period while, for
example, a recovery action was being pursued in the courts.
• Payments into court, or the overseas equivalent, are usually expressly recoverable from
liability reinsurers as a loss settlement of the reinsured, provided they fall within the terms
and conditions of the policies protected. The clause should also address how interest
earned on the monies deposited with the court is to be distributed.
For example:
‘Ultimate Net Loss’ shall mean the sum actually paid by the Reinsured in settlement
of losses or liability (including the amount of any appropriate Extra Contractual
Obligation awards and any appropriate Excess of Policy Limits awards as defined in
the relevant Articles of this Agreement) after making deductions for all recoveries,
all salvages and all claims upon other reinsurances, whether collected or not, and
shall include all legal costs and expenses of litigation and all costs and adjustment
expenses arising from the settlement of claims, other than the salaries of employees
and the office expenses of the Reinsured but including the fees of ‘in house’
assessors used in connection with the adjustment of any losses hereunder.
All salvages, recoveries or payments recovered or received subsequent to any loss
settlement under this Agreement shall be applied as if recovered or received prior to
the aforesaid settlement, and all necessary adjustments shall be made by the parties
hereto. Nothing in this clause shall be construed to mean that a recovery cannot be
made hereunder until the Reinsured’s Ultimate Net Loss has been ascertained.
Underlying recoveries under any other Excess of Loss Reinsurance Agreements (as
far as applicable) are for the sole benefit of the Reinsured and shall not be taken into
account in computing the Ultimate Net Loss or Losses in excess of which this
Agreement attaches, nor in any way prejudice the Reinsured’s right of recovery
hereunder.
D3A Other (or specified) reinsurances

The impact of other reinsurances on the UNL can be clearly seen in the last paragraph of our
example wording:
Underlying recoveries under any other Excess of Loss Reinsurance Agreements (as
far as applicable) are for the sole benefit of the Reinsured and shall not be taken into
account in computing the Ultimate Net Loss or Losses in excess of which this
Agreement attaches, nor in any way prejudice the Reinsured’s right of recovery
hereunder.
It is imperative in any wording to be clear how related reinsurances protecting the reinsured
in one way or another interact, if at all.
The last paragraph of our example may be read as qualifying that part of the first paragraph,
requiring the deduction of ‘all recoveries, all salvages and all claims upon other reinsurances’:
‘Ultimate Net Loss’ shall mean the sum actually paid by the Reinsured in settlement
of losses or liability (including the amount of any appropriate Extra Contractual
Obligation awards and any appropriate Excess of Policy Limits awards as defined in
the relevant Articles of this Agreement) after making deductions for all recoveries,
all salvages and all claims upon other reinsurances, whether collected or not, and
shall include all legal costs and expenses of litigation and all costs and adjustment
expenses arising from the settlement of claims, other than the salaries of employees
and the office expenses of the Reinsured but including the fees of ‘in house’
assessors used in connection with the adjustment of any losses hereunder.
Accordingly, in this particular instance, underlying recoveries are not agreed deductions
from the UNL. The reinsured is stated to be the sole beneficiary of any underlying recoveries.
If the underlying recoveries are for the benefit of both parties, then they are deducted from
the UNL and the reinsured’s retention is, in effect, increased by the extent of those
recoveries.
Chapter 7
Let us look at a further example. The following addition to the UNL clause would be required
if, for example, the reinsured wished to retain the sole benefit of a quota share reinsurance
purchased to protect its net retention.
Notwithstanding the foregoing, it is agreed that any Quota Share reinsurance
arranged by the Reinsured to protect their net account shall be for the sole benefit of
the Reinsured and shall be disregarded for the purpose of calculating the net
retention hereunder.
In this way, if the reinsured’s (excess of loss) retention of £100,000 was subject to a 50%
quota share reinsurance, the reinsured would be entitled to recover claims in excess of
£100,000 without having to deduct the 50% quota share reinsurance. Otherwise, without
the additional clause, the excess of loss reinsurance would not respond until a gross claim
exceeded £200,000 (that is, a net claim of 50% of £200,000 or £100,000). Contrary to the
reinsured’s intention, the reinsurer would have the benefit of the quota share reinsurance.
Consider this
this…
…
If an excess of loss reinsurance was silent as to whether the underlying recoveries were to
be taken into account in computing the UNL, what difference would it make to the
retention of the insurance company? This last paragraph of the UNL clause makes it clear
that the underlying recoveries do form part of the contract’s deductible. In other words,
they are not agreed deductions from the UNL.
To help us understand all of this, let us look at a working example of the UNL clause in action.
Example 7.1
The reinsured’s property account was protected by a risk and catastrophe excess of loss
programme with the following structure:
Risk excess of loss
US$1m XS US$1m – two reinstatements
US$3m XS US$2m – two reinstatements
Catastrophe excess of loss
US$18m (over three layers)
excess of:
US$2m – Reinstatements: one each layer.
An earthquake occurred and all losses caused by the earthquake within a 72 hour period
aggregated to US$15m.
Two single losses were recovered from the Risk XLs:
Loss 1 2m loss US$1m recovered from Risk XL first layer
Loss 2 5m loss US$4m recovered:

US$1m from the first layer
US$3m from the second layer
Total recovered from US$5m

Risk XLs
UNL was US$10m

US£15m total loss from the earthquake less US$5m recovered from the Risk XLs.
Recoveries from CAT XL
US$10m UNL less US$2m retention = US$8m recovered from Cat XLs.
D4 Limits and deductibles
Chapter 7
These clauses set out the limit(s) of liability and the excess(es) (or deductible(s)) on the Clauses set out the
contract, and how they are to be applied (alternatively, the basis of the cover). limit of liability and
the excess on the
The amount and currency of each limit(s) and deductible(s) should be stated. There may contract
also be sublimits, franchises, aggregate deductibles (see example) and ‘loss corridors’ to
watch out for.
Notwithstanding the foregoing, this reinsurance shall only pay in excess of the first
[ ] of losses in the aggregate settled by the reinsured which would otherwise be
recoverable hereunder.
When it comes to their application, the phraseology used in these clauses varies widely – for
example, ‘event’, ‘loss’, ‘risk’, ‘accident’ and ‘claim’. It is how such phrases are defined that is
of paramount importance to the agreement between the parties.
In proportional reinsurance, there is no need for a separate definition of the basis of cover as
all original losses are shared in the agreed proportion and there is no need to aggregate
losses for the purposes of making a reinsurance claim. However, in non-proportional
reinsurance, this is not the case. The limit and deductible are applied to losses arising from a
defined ‘event’ or ‘loss occurrence’ or similar, and there is necessarily an aggregation of
losses. How the ‘event’ or ‘loss occurrence’ is defined will determine which losses may or
may not be aggregated for the purposes of applying the limit and deductible.
Typically, subject to having purchased adequate vertical cover, it is in a reinsured’s interests
to aggregate losses, whereas it is in a reinsurer’s interests to split them up and so increase
the amount retained by the reinsured.
We look now at examples of the different bases on these contracts.
‘Each loss occurrence

occurrence’’ – catastrophe excess of loss
‘Loss occurrence’ is usually defined in the hours clause as the sum of all individual losses
directly occasioned by any one disaster, accident or loss or series of disasters, accidents or
losses arising out of one event. It is the event (or catastrophe) that is the proximate cause of
the individual losses. However, the losses that actually make up the occurrence are limited in
time and by geography.
Typically, the wording limits the loss occurrence to losses that occur during a period of 168
consecutive hours (or a week) within a state of the USA or province of Canada and adjoining
states or provinces. These limitations are further refined according to the particular peril or
cause of the losses. So, for example, hurricane losses occurring within a period of 72
consecutive hours may contribute to one ‘loss occurrence’ and they need not be within
contiguous states.
It is important to note that, under the hours clause, it is the reinsured that reserves the right
to decide when a particular ‘loss occurrence’ commences (alternatively, the loss period).
Further, if a catastrophe is greater in duration than the relevant period, the reinsured may
divide that catastrophe into two or more ‘loss occurrences’, provided that:
1. no two periods overlap; and
2. no period commences before the earliest recorded loss.
Reinsured may
Therefore, if the catastrophe lasts longer than the period for a single event, the reinsured
select the period in may select the period in which most damage occurred. You may have seen the operation of
which most
damage occurred
this clause in practice when Hurricane Katrina first made landfall in Florida and then a day or
so later in Louisiana. Insurers selected two separate 72-hour periods in order to maximise
their reinsurance collections. Let us look at an example wording defining ‘loss occurrence’.
Definition of ‘loss occurrence
occurrence’’
1. The words ‘loss occurrence’ shall mean all individual losses arising out of and
directly occasioned by one catastrophe. However, the duration and extent of
any ‘loss occurrence’ so defined shall be limited to:
a. 72 consecutive hours as regards a hurricane, a typhoon, windstorm,
rainstorm, hailstorm and/or tornado
b. 72 consecutive hours as regards earthquake, seaquake, tidal wave and/or
volcanic eruption
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c. 72 consecutive hours and within the limits of one City, Town or Village as
regards riots, civil commotions and malicious damage
d. 72 consecutive hours as regards any ‘loss occurrence’ which includes
individual loss or losses from any of the perils mentioned in (a), (b) and (c)
above
e. 168 consecutive hours for any ‘loss occurrence’ of whatsoever nature
which does not include individual loss or losses from any of the perils
mentioned in (a), (b) and (c) above
and no individual loss from whatever insured peril, which occurs outside these
periods or areas, shall be included in that ‘loss occurrence’.
2. The Reinsured may choose the date and time when any such period of
consecutive hours commences and if any catastrophe is of greater duration
than the above periods, the Reinsured may divide that catastrophe into two or
more ‘loss occurrences’, provided no two periods overlap and provided no
period commences earlier than the date and time of the happening of the first
recorded individual loss to the Reinsured in that catastrophe.’
It is common for UK property catastrophe excess of loss treaties to add a freeze extension to
the standard hours clause LPO98A. This extension gives the reinsured the option of
aggregating all claims, occurring during a period of 168 consecutive hours and which result
from collapse caused by the weight of snow, and water damage from burst pipes and/or
melted snow.
Freeze extension to LPO98A

Notwithstanding the above, as regards loss or losses from collapse caused by weight
of snow and water damage from the burst pipes and/or melted snow, the Reinsured
shall have the option to deem any one ‘loss occurrence’ to be the aggregate of all
such individual losses which occur during the period of 168 consecutive hours within
the United Kingdom. No period may commence earlier than the date and time of the
happening of the first recorded individual loss to the Reinsured in that ‘loss
occurrence’ and the periods of two or more ‘loss occurrences’ may not overlap.
You will notice that flood is not specified as one of the named perils within the hours clause.
Therefore flood losses fall under section (e): ‘168 consecutive hours for any loss occurrence
of whatsoever nature which does not include individual loss or losses from any of the perils
mentioned in (a), (b), and (c)’. Reinsureds exposed to flood losses argue that 168 hours is an
insufficient length of time for flood occurrences, as flood water can continue to flow and
cause damage beyond that time. Some reinsurance programmes now allow the standard
clause to be amended to allow periods greater than 168 hours for flood.
For contracts with US exposure to hurricanes the hours limitation is typically applied to
‘Named Storms’. These are any storm or storm system declared as such by the US National
Hurricane Center (NHC), a division of the US National Weather Service.
Activity
Visit the NHC website and find past track maps for hurricanes in the 2000s which
were the:
• deadliest;
• costliest; and
• most intense landfalling.
www.nhc.noaa.gov/data
‘Each loss occurrence

occurrence’’ – casualty excess of loss
‘Loss occurrence’ is often defined to mean any one disaster or casualty or accident or series
of disasters or casualties or accidents or losses arising out of or caused by one event.
However, this definition works less well for claims that do not arise from a sudden and
identifiable accident or event, for example, occupational disease and products liability
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claims, which may arise from gradually operating causes spread over many years.
In employers’ liability and workers’ compensation reinsurances, it is usual to incorporate one Refer to
section D10G for
of the standard accident circle occupational disease (ACOD) clauses, whose provisions are ACOD clauses
stated to override any other conflicting provisions. In this way, the original ‘loss occurrence’
definition is replaced with one tailored for claims resulting from occupational disease and
physical impairment.
Similarly, the claims series clause is used in relation to products’ liability business, enabling Refer to
section D10C for
all claims from a specific cause that involve one original insured to be aggregated for the claims series
purposes of recovery under a casualty excess of loss treaty. clause
‘Each and every loss each and every riskrisk’’ – property (per) risk excess of loss
Here, the reinsured is typically the sole judge of what constitutes ‘each and every risk’,
subject to certain constraints. Examples of these constraints are as follows:
• ‘In no event shall a building and its contents be considered more than one risk.’
• ‘Any one risk’ shall mean all insurance written under one or more policies covered hereon
for all insureds each and every four-wall area. A four-walled area means any:
– building or other structure, or
– series of interconnected buildings or other structures, or group of buildings or other
structures, and any associated property.
• ‘Risk’ shall be considered in accordance with the way the business is protected.
• Hereunder was written and accepted by the reinsured.
• ‘All values at any one location’. Location means a building or structure, or group of
buildings and/or structures, found on one site; a site being identified by its ‘complex’ or
‘site’ address.
In the extreme, each definition needs to be able to cope with the multitude of interests to
which an insurer may be exposed in, for example, blocks of flats, industrial estates, rows of
terraced houses and large office complexes, such as Minster Court in London.
Contain a two risk

A catastrophe excess of loss reinsurance contains a two risk warranty; that is, at least two
warranty risks must have been involved in the loss occurrence. Otherwise, the reinsurance is
potentially exposed to losses to large risks. You should also note that, for obvious reasons, a
contract usually limits its exposure to risks arising from a single catastrophe by imposing an
‘any one occurrence’ limit.
‘Each loss
loss’’ – marine excess of loss
The JELC Excess of Loss clauses define ‘loss’ as ‘loss, damage, liability or expense thereof
arising from one event’. Other examples include:
• ‘In the aggregate each annual period’ – stop loss (or aggregate excess of loss).
• ‘Each and every loss each policy and/or section and/or insured’ – casualty excess of loss.
• ‘Any one insured and/or policy and/or interest’ – (marine or aviation) cargo excess of loss.
• ‘Any one vessel’ – (marine) hull excess of loss.
D5 Reinstatement clause
Refer to The reinstatement clause limits the amount of cover available under the contract by
chapter 5,
section E for a specifying the number of times the limit of indemnity, or any portion of it, may be
detailed review of automatically reinstated after loss. In other words, it limits the number of reinstatements:
this clause
without such a condition, there is no limit.
The clause must also specify whether the reinstatements are free or must be paid for. If they
are to be paid for, it must describe how the reinstatement (or additional) premiums payable
by the reinsured are to be calculated. Such premiums are paid simultaneously with the claim.
It is not unusual for UK motor and liability treaties to have unlimited free reinstatements.
They are, however, strictly limited in the case of per risk (usually free) and per catastrophe
excess of loss treaties.
An example reinstatement clause for a scheduled contract is:
In the event of the whole or any portion of the indemnity given hereunder being
exhausted the amount so exhausted shall be automatically reinstated from the time
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of commencement of the appropriate loss period subject to payment of a pro rata as

to time and amount additional premium calculated on the premium due hereunder.
If the loss settlement is made prior to the adjustment of premium the reinstatement
premium shall be calculated provisionally on the deposit premium subject to
adjustment when the reinsurance premium hereon is finally established.
Nevertheless, the Reinsurer shall never be liable to pay more than the limit of
indemnity as set out in the schedule in respect of any loss occurrence nor more than
the amount set out in the schedule in all in respect of the period of this agreement
representing the number of reinstatement(s) of the limit of indemnity set out in the
schedule.
Basis of reinstatement
Amount and basis
If reinstatement is subject to the payment of additional premium, the amount and basis of
of that payment that payment must be set out. The basis of the premium payment is either pro rata to
must be set out
amount and 100% as to time or pro rata to amount and pro rata to time.
If the basis of reinstatement is pro rata to amount and 100% to time, the additional premium
is calculated on the amount of cover reinstated in proportion to the limit of cover, and
irrespective of the date of loss. If the basis is pro rata to amount and pro rata to time, the
premium is pro-rated both to the amount of cover reinstated and to the period of the
reinstatement, that is, from the date of loss until the expiry of the period of reinsurance.
D6 Claims clauses
These clauses address:
• the notification (or reporting or advice) of losses and the provision of related information
to reinsurers; and
• reinsurers’ rights and obligations in relation to those losses.
In this context, ‘claim’ is used interchangeably with ‘loss’, unless otherwise stated.
D6A Notification of claims (or loss)

As its name suggests, the notification of claims clause states when notice should be given to States when notice
the reinsurer by the reinsured in the event of a loss or losses. Typically, it sets out what is to be given by
the reinsured to
information about the loss(es) is to be provided. the reinsurer
As to when notice should be given, some clauses are drawn quite simply, requiring, for
example, no more than prompt notice. Other clauses may require notice when the reinsured
has reason to believe that a loss(es) may exceed the deductible or a high proportion of it. On
the other hand, some clauses are highly prescriptive, with draconian results if breached.
What follows is an example of a claims notification clause
clause:
Notwithstanding anything to the contrary contained in this Contract, it is a condition
precedent to reinsurer’s liability under this Contract that:
1. The Reinsured shall give to the Reinsurer written notice as soon as reasonably
practicable of any claim made against the Reinsured in respect of the business
reinsured hereby or of its being notified of any circumstances which could give
rise to such a claim.
2. The Reinsured shall furnish the Reinsurer with all information known to the
Reinsured in respect of claims or possible claims notified in accordance with (1)
above and shall thereafter keep the Reinsurer fully informed as regards all
developments relating thereto as soon as reasonably practicable.
Sub-paragraph 2 gives an example of what information reinsurers may require. This
information enables reinsurers to, amongst other things, reserve appropriately while a claim
is being adjusted and respond promptly in due course to the reinsured’s loss settlements.
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D6B Loss settlements clause
The loss settlements clause sets out reinsurers’ obligations in relation to the reinsured’s loss Sets out reinsurers’
settlements (that is, original loss payments). It states what the reinsured must demonstrate obligations in
relation to loss
to reinsurers in connection to its settlements to trigger those obligations: settlements
All loss settlements made by the Reinsured, including compromise settlements, shall
be binding upon the Reinsurers provided such settlements are within the terms and
conditions of the original policies and/or contracts and within the terms and
conditions of this Agreement, and amounts falling to the share of the Reinsurers shall
be payable by them upon reasonable evidence of the amount paid [or scheduled to
be paid] being given by the Reinsured.
In this example, a reinsurer’s obligation to pay depends on the reinsured’s loss settlements
being within the terms and conditions of both the:
• original policies; and
• reinsurance contract.
In which case, they become binding and are payable on receipt of reasonable evidence of
the loss settlement having been made by the reinsured. Additionally, clauses may
incorporate a period within which reinsurers should make payment. Unlike proportional
reinsurance treaties, where claims are recovered on a balance of account basis within the
periodical accounts, claims under non-proportional treaties are recovered individually.
Be aware
A simpler clause may also refer to ex gratia (as a favour) payments. By definition, such
payments are outside the terms of the original policies; however the parties may agree to
write them back in so take care.
D6C Claims handling clauses

The claims handling clauses reserve reinsurers’ rights of involvement in the management
and/or determination of the original claim. They may be imposed in circumstances where
the reinsurer’s exposure to the loss, and/or its experience in handling that particular type of
loss, is far greater than that of the reinsured. If a reinsured is not well known to the reinsurer,
the latter may wish to take control of a claim. The strength of the relationship between the
parties is a key determinant when negotiating these provisions even if, in practice, a claims
cooperation clause is inserted more often than not.
An example of a claims cooperation clause follows:
Notwithstanding anything to the contrary contained in this Contract it is a condition
precedent to reinsurer’s liability under this Contract that:
1. The Reinsured shall give to the Reinsurer written notice as soon as reasonably
practicable of any claim made against the Reinsured in respect of the business
reinsured hereby or of its being notified of any circumstances which could give
rise to such a claim.
2. The Reinsured shall furnish the Reinsurer with all information known to the
Reinsured in respect of claims or possible claims notified in accordance with (1)
above and shall thereafter keep the Reinsurer fully informed as regards all
developments relating thereto as soon as reasonably practicable.
3. The Reinsured shall cooperate with the Reinsurer and any other person or
persons designated by the Reinsurer in the investigation, adjustment and
settlement of such claim notified to the Reinsurer as aforesaid.
With the addition of the following paragraph, the clause becomes a claims control clause
clause:
4. The Reinsurer shall have the right at any time to appoint adjusters and/or
representatives to act on their behalf to control all investigations, adjustments
and settlements in connection with any claim notified to the Reinsurer as
aforesaid.
In practice, these provisions can be a source of frustration for the parties and give rise to a
number of problems. For example, the failure by the reinsured to provide timely notice of a
claim where the parties have agreed to cooperate may mean claim handling decisions are
being taken with which the reinsurer disagrees. On the other hand, delayed decision making
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by the reinsurer may adversely impact the key insurer–insured relationship, leading to
unnecessary friction between the two and a less than optimal experience for the insured at a
difficult time.
It is important to recognise the obvious conflict between loss settlement clauses on the one
hand, and claims cooperation (and control) clauses on the other. While the former trust
reinsureds to make settlements, the latter typically do not, providing for a certain level of
involvement by reinsurers in that settlement process.
D7 Interlocking clause
Clause appears in
The interlocking clause appears in RAD (policies issued) treaties. If an occurrence or event
RAD (policies impacts risks which attach to different treaties, the reinsured may have to run more than one
issued) treaties
retention and the reinsurer pay more than one limit of liability for the same occurrence or
event, depending on the total amount of the original losses. The purpose of this clause is to
distribute those losses between the involved (or interlocked) years.
The clause applies in circumstances where:
• the reinsured has losses under more than one policy and/or contract but from the same
occurrence or event; and
• such policies and/or contracts attach to different treaty periods.
The result is that the amount to be retained by the reinsured under a particular treaty is
reduced. It is reduced to that percentage of the retention which the reinsured’s losses on the
original policies (and/or contracts) incepting during the usual twelve-month treaty period,
bears to the reinsured’s total losses, arising out of all the policies and/or contracts
contributing to the loss. The amount to be paid by the reinsurer is arrived at in the same
manner.
In each case, it is important to be clear about the purpose of any interlocking calculation.
This is because the incurred and paid positions will invariably differ until all of the claim files
are closed.
Question 7.6
A catastrophe results in losses to a reinsurer of US$400,000 on contracts incepting in
underwriting year one, and US$1,200,000 on contracts incepting in underwriting year
two. Neglecting any reinstatement premium payable, how much can that reinsurer
recover under interlocked ‘risks attaching’ catastrophe excess of loss reinsurance
programmes for those years? Each programme has a limit and a deductible of US$1m.
D8 Salvage and subrogation clause

The salvage and subrogation clause sets out how recoveries from third parties are to be
distributed between the reinsured and the reinsurer. It may also be known as a ‘third-party
recoveries clause’.
An example of a typical clause where any recoveries are pro-rated across the reinsured’s
entire original loss (including relevant expenses) is:
The Reinsurer shall be credited with its proportionate share of salvage (that is,
reimbursement obtained or recovery made by the Reinsured, less the actual cost,
excluding salaries of officials and employees of the Reinsured and sums paid to
attorneys as retainer, of obtaining such reimbursement or making such recovery) on
account of claims and settlements involving reinsurance hereunder. The Reinsured
hereby agrees to enforce its rights to salvage or subrogation relating to any loss, a
part of which was sustained by the Reinsurer, and to prosecute all claims arising out
of such rights.
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Otherwise, any recoveries would typically be applied top down in accordance with the UNL
clause and, therefore, benefit reinsurers alone, at least until the deductible is reached. This
particular clause has the effect of incentivising reinsureds to pursue recoveries.
The clause also addresses the reinsured’s right and/or obligation to take steps to hold third
parties responsible for any loss. Any agreement to enforce those rights to salvage or
subrogation may be subject to the proviso that, in the reinsured’s opinion, it is economically
reasonable to do so.
Question 7.7
A reinsured makes a subrogation recovery of US$600,000 in relation to a loss on which it
has already collected US$250,000 from reinsurers. The limits and excess on the
reinsurance contract are both US$1m. Calculate the amount to be reimbursed to
reinsurers.
D9 Currency fluctuation clause

This currency fluctuation clause is used in treaties where the retention and limit of liability
are stated in the same currency, but where the original business may result in claims in
another, or more than one, currency. The purpose of the clause is to enable the parties to
share any fluctuation in the value of the currency of the original loss between the inception
date of the contract and the date of the settlement of that loss.
To calculate the amount of the loss to be paid in the contract currency (for example,
sterling), use this three-stage process:
Convert the retention and limit of liability into the

currency of loss at the rate of exchange existing at the
treaty inception date
Calculate the amount of the loss in excess of the

currency of loss retention but below the currency of loss
limit of liability
Convert that amount into the contract currency at the

rate of exchange existing at the date of settlement by
the reinsured
An example currency fluctuation clause is:

In the event that the Reinsured sustains losses in a currency other than the currency
stated in the Slip, the Reinsurers’ liability shall be calculated as follows:
The retention of the Reinsured and the liability of the reinsurers as expressed in the
currency stated in the Slip shall be converted into the currency concerned at the
rates of exchange utilised by the Reinsured in its books at the inception date of this
contract.
And
the balance of any loss payment in excess of the Reinsured’s retention shall be
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converted from the currency in which the loss was settled into the currency stated in
the Slip at the rate of exchange as used by the Reinsured and ruling on the date or
dates of settlement of the loss by the Reinsured.
In the event of losses being sustained by the Reinsured in respect of the same loss
occurrence in more than one currency, the retention of the Reinsured and the limit of
liability of the Reinsurers shall be apportioned between the various currencies, in the
proportion that each currency bears to the total loss calculated by converting each
currency into the currency stated in the Slip at the rates of exchange as indicated
above. The balance of any loss payment in each original currency in excess of the
Reinsured’s retention in each currency apportioned as above shall be converted into
the currency stated in the Slip at the rate of exchange used by the Reinsured and
ruling on the date or dates of settlement of the loss by the Reinsured.’
Question 7.8
How much can the reinsured recover from its reinsurers under a casualty excess of loss
treaty with a limit and deductible of £1m in respect of an original claim payment of
A$2.6m? The rate of exchange at inception was 2.5, and at payment 2.0 A$ to sterling.
The treaty contains a currency fluctuation clause.
D10 Liability clauses

This section looks at the following liability clauses:
index clause
aggregate
loss corridor extension
clause
change of law claims series

clause clause
Liability clauses
occupational commutation
disease clauses clause
extended claims
sunset clause
reporting clause
D10A Index clause

The index clause adjusts the limit and deductible by reference to an index, to take into
account inflation over a period of time.
Consider this
this…
…
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Why would such clauses be required in casualty classes of business impacted by bodily
injury claims?
The key elements of the clause that the:

• index is identified and is usually an earnings or wages or retail prices index;
• base date of the index, that is, the start date for the purposes of the claim(s) under the
policy (this date may predate the inception of the treaty); and
• agreed variation of the clause. A franchise may apply in which case no adjustment is made
until the index has increased by, for example, 15% over the relevant period. Alternatively,
an excess may apply and this type of clause is usually known as a severe inflation
clause (SIC).
All this is best explained by looking at an example.
Example 7.2
A liability excess of loss reinsurance contract has a limit and deductible of £5m.
Payments of £6m are made in settlement of a serious bodily injury claim
In this situation, the reinsured would ordinarily recover £1m.
However, the limit and deductible are indexed to take account of retail price inflation.
Therefore, the recovery must be adjusted for the rise in the index over the relevant period.
Assuming the index rose from 125 to 150 from the base date to the payment date and
applying the standard clause, the calculation of the adjusted payment value is as follows:
£6m × 125/150 = £5m
To adjust the deductible it must be multiplied by the actual payment divided by the
adjusted payment value:
£6m × £5m
= £6m
£5m
The amount recoverable is the actual payment less the adjusted deductible:
£6m – £6m = Nil
A related clause is the London Market severe inflation clause (CA2003/SIC03). This clause,
as the title suggests, only responds in the event of severe inflation. For the limit and
deductible to be adjusted, the index must have increased by a specified percentage of the
base index. This result is achieved by replacing ‘base index’ with ‘base index times 1.25’, so
that only increases in excess of 25% are taken into account. On the other hand, the clause
may operate as a franchise applying the full value of the increase in the index above a
specified figure.
A copy of the London Market Index Clause (IUA 02-014) can be found in appendix 7.3, which
is available on RevisionMate.
Question 7.9
In example 7.2, how much would be recoverable from reinsurers if the index had risen only
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to 140?
D10B Aggregate extension clause (AEC)

The aggregate extension clause (AEC) allows a reinsured to present as one loss, for the
purposes of the reinsurance contract, separate and unrelated losses, which it covered on an
aggregate basis under the terms of the original – usually products’ liability – policy.
The operative part of the clause provides:
If required by the Reinsured this Agreement shall be extended to cover on an
aggregate basis that liability which the Reinsured incurs from any one risk for any
one insured covering on an aggregate basis. The Reinsured shall combine all their
interests which emanate from the same original insured Policy to comprise an
original insured aggregate loss.
In short, the usual ‘each and every loss’ limit is deemed to apply ‘in the aggregate each
original insured aggregate loss’. The date of loss is taken to be the inception date of the
original policy.
Example 7.3
An insured provides UK product liability cover on an aggregate basis (i.e. the limit of
indemnity applies to all losses occurring in the period of insurance, irrespective of the
cause of loss or the number of products giving rise to a loss).
The AEC allows all of the losses to be aggregated as one for the purposes of the
reinsurance contract, thereby extending the aggregate basis of the original cover to the
reinsurance. In other words, the limit and retention of the reinsurance no longer apply to
each and every loss, but instead to all losses in the aggregate arising from the same
original insurance.
The clause also has the effect of changing the way in which losses attach to the reinsurance Clause has the
contract. As the date of loss is the inception date of the original contract, reinsurance effect of changing
the way in which
contracts agreed on a ‘claims made’ or ‘losses occurring during’ basis are, in effect, losses attach to
converted to a ‘policies incepting during’ basis. The original contract must incept during the the reinsurance
contract
reinsurance period in order to be covered. In the mid-1980s, following severe US liability
losses, the AEC was largely replaced by claims series clauses.
D10C Claims series clause

This clause extends the cover provided by a casualty treaty to a ‘claims series event’, Clause modifies
enabling all claims from a specific common cause that involve one original insured to be the ‘event’
aggregated for the purposes of recovery. In this way, the clause modifies the ‘event’ (or
similar) to cater for public and/or products liability and professional indemnity policies. The
standard clauses are known as TPX 1986 and TPX 1988 and the main elements of the latter
are as follows:
• ‘Claims series event’ definition – for example, a series of claims arising from one specific
common cause which is attributable to one design and/or specification and/or formula in
products and/or services supplied by one and only one original insured.
• The statement that a ‘claims series event’ is deemed, for the purposes of the reinsurance
contract, to be an event with a date of loss (as determined).
• ‘Date of loss’ definition applicable to ‘claims made’ and ‘losses occurring’ policies:
– in relation to ‘claims made’ policies, the date of loss is the date the original insured is
first advised, in writing, of the first claim of the ‘claim series event’;
– in relation to ‘losses occurring’ policies, or a combination of ‘claims made’ and ‘losses
occurring’ policies, the date of loss is the date on which the first loss of such a ‘claims
series event’ occurred. Be aware that the corresponding provision in the TPX 1986 is
very different, namely, the date of written notification by the reinsured to reinsurers of
the possibility of a ‘claims series event’.
• There are special reporting provisions requiring notification to reinsurers within 90 days
of the reinsured having knowledge of any claims series event involving five or more
claimants, or the reinsured establishing a reserve for a claims series event in excess of 25%
of the retention.
• A list of exclusions including all losses occurring before 1986, and claims part of a claims
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series event that arise from any policy issued or renewed after notification of such an
event.
D10D Commutation clause

In the commutation clause, the parties agree to close off (or commute) all claims under the
reinsurance contract, extinguishing a reinsurer’s known and unknown liabilities. In return for
a single payment, the reinsured grants the reinsurer a full and final release from all past,
present and future obligations under the contract.
Commutation may be optional or mandatory. If mandatory, the parties must come to an Commutation may
agreement on the terms and the amount of the payment necessary to discharge the be optional or
mandatory
reinsurer of its liability. Such a clause typically details the mechanism for valuing that liability
and, if the parties cannot agree, for settling the dispute (usually with the assistance of one or
more actuaries).
D10E Sunset clause

Th sunset clause requires the reinsured to notify claims within a certain period, beyond
which the contract ceases to respond. In other words, the sun sets on claims not reported to
reinsurers within, for example, five years of expiry of the reinsurance treaty. This type of
clause is usually found on old US non-proportional casualty treaties.
The clause requires the reinsured to notify reinsurers, within the requisite period, of all
outstanding occurrences that have not been settled and may give rise to a claim under the
reinsurance contract. If not listed (or reported), no liability attaches under the reinsurance
contract and they are lost to the contract. A commutation provision usually follows.
D10F Extended claims reporting clause

The extended claims reporting clause is an extended version of the previously discussed
claims notification and handling clauses. The clause serves to require the reporting of three
types of claims:
• claims valued in excess of a specified percentage of the retention irrespective of liability;
• certain types of serious bodily injuries irrespective of value or liability; and
• claims involving periodical payments under the Damages Act 1986 (as amended).
A copy of a claims cooperation and reporting clause (IUA 02-015) can be found in appendix
7.4 on RevisionMate.
D10G Occupational disease clauses

The occupational disease clauses set out the basis on which reinsurers are prepared to
provide cover for occupational disease and physical impairment arising under an employers’
liability and/or workers’ compensation policy.
It was recognised that, while the legal liability for occupational disease and physical
impairment may arise from a sudden and identifiable event, it may also arise from a
gradually operating occupational hazard spread over many years. The clauses, therefore,
apply in the latter situation. They define what constitutes an event and the date of the loss
occurrence for the purpose of determining the applicable treaty period. The standard
clauses are known as the accident circle occupational disease (ACOD) clauses. These are
shown in table 7.3.
Table 7.3: Accident circle occupational disease (ACOD) clauses

ACOD/A Any one claim by any one employee is considered one event.
ACOD/B Any one claim by any one employee is considered one event and,
• if original liability is established on an exposure basis, the claim paid by any
one period of reinsurance is reduced in proportion to total length of exposure,
and the retention and cover reduced in proportion to the reinsured’s period of
exposure to all years;
• if legal liability is not established on an exposure basis, the date of loss
occurrence is deemed to be the date the legal liability was established.
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ACOD/C In relation to covers on a ‘claims made’ basis, any one claim by any one employee
is considered one event (as ACOD/A), however the date of the loss occurrence is
deemed to be the date the original insured is advised of claim following diagnosis.
A copy of these clauses has been reproduced in appendix 7.5 on RevisionMate.
Example 7.4
Employee, John Smith was awarded £1m having developed an occupational disease
following exposure to a particular occupational hazard for the 45-month period between 1
July 2015 and 31 March 2019. For the first 18 months of that period, John Smith worked for
a single employer and the original insurer purchased reinsurance cover in excess of
£100,000 for each calendar year which incorporated ACOD/B. How much is recoverable
from reinsurers?
Treaty year Treaty year as Proportion of Pro-rated Amount of Amount

a proportion claim to each retention pro-rated recoverable
of total period treaty period retention
of exposure
2015 6/45 133,333 6/18 33,333 100,000
2016 12/45 266,667 12/18 66,667 200,000

D10H Change in law clause

The change in law clause is designed to protect the reinsurers’ agreement with the reinsured
from a change in the law after the commencement of the treaty. If the change is considered
to significantly increase reinsurers’ liability, the parties agree to work to revise the terms and
conditions of the treaty. However, if that process fails, cover continues as if the law had not
changed.
The clause is common in casualty excess of loss treaties where, for example, benefits to Clause is common
injured workers may be altered by legislation with retroactive effect. in casualty excess
of loss treaties
A typical example is:
In the event of any change in the law, whether arising from legislation, decisions of
the courts or otherwise, at any time after the Reinsurer has entered into this
Agreement by which the Reinsurer’s liability hereunder is materially increased or
extended the parties hereto agree to take up for immediate discussion at the request
of either party a suitable revision in the terms of this Agreement. Failing agreement
on such revision within thirty days after such a request it is agreed that the
Reinsurer’s liability hereunder whensoever arising shall be determined as if the said
change in law had not taken place.
Activity
See chapter 11, section B4A to find out about the changes to the personal injury discount
rate. Consider the immediate impact of the implementation of a change on a reinsurer’s
approach to reserving for personal injury claims in the context of a non-proportional
treaty containing the example clause set out above.
D10I Loss corridor clause

The loss corridor clause describes an additional amount retained by the reinsured, usually on
the working layer of a casualty treaty. Under the terms of this clause, the reinsured agrees to
retain an additional ‘corridor’ of losses with reinsurers providing cover outside (say, above
and below) that corridor.
Example 7.5
A reinsured may agree to retain an aggregate amount of paid losses equivalent to 10% of
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net earned premium income, otherwise recoverable under a particular layer of excess of
loss reinsurance. This amount (or percentage) may sit above 35% of net earned premium
income such that reinsurers pay losses recoverable under that layer of excess of loss
reinsurance up to an aggregate amount equivalent to 35% of net earned premium income
and above 45% of net earned premium income, subject to an upper limit.
Learning point
Before you move on, ensure you know how the liability clauses listed are used.
D11 Miscellaneous
D11A Simultaneous settlements clause
The simultaneous settlements clause requires reinsurers to pay the reinsurance claim at the
same time as the reinsured pays the insurance claim.
To facilitate this payment, the reinsured often agrees to give at least two weeks advance
notice of the proposed settlement dates for the original claims.
Consider this
this…
…
Why would an insurance company desire this?
D11B Projected payments

A related provision enables a reinsured to recover from the reinsurer on the basis of
anticipated or projected payments to its original policyholders over a particular period.
Whether in the reinsurance contract itself as, for example, the loss collection clause, or
articulated as a claims handling arrangement in the subscription agreement section of the
MRC, this provision is occasionally found in non-marine catastrophe excess of loss contracts.
Its purpose is to help a reinsured with its cash flow in the immediate aftermath of a major
catastrophe when significant sums are being paid out over a short period of time, and the
reinsured would prefer to avoid the usual time lag between submitting collection notes and
reimbursement.
A high degree of
Payments are made by reinsurers on the basis of the reinsured’s anticipated, or projected,
trust between the (insurance) payments and adjusted, if necessary, once the spike is over. Further, it is usually
parties is essential
agreed that all monies paid remain those of reinsurers until such time as the reinsured pays
its policyholders, and any interest earned in the meantime accrues to reinsurers. A high
degree of trust between the parties is essential.
Be aware
The catastrophe claims settlement clause was introduced in early 2017. Property
reinsurers now agree to advance monies on request up to a percentage of the reinsured’s
ultimate loss estimate, if considered reasonable.
A copy of the catastrophe claims settlement clause can be found in appendix 7.6 on
RevisionMate.
E Treaty exclusions
In this context, exclusions (or exceptions) are express terms of the treaty that reduce the
extent of the cover which, but for the exception, would be provided by the treaty. In other
words, exclusions state what a treaty does not cover. The reasons for the main treaty
exclusions include:
• Some risks are considered un(re)insurable (e.g. nuclear or terrorism risks). In other words,
the risks of loss are considered too great, in terms of frequency or severity or both, to be
commercially acceptable to the reinsurer.
• Other risks are, for whatever reason, considered outside the scope of the reinsurance (for
example, inwards reinsurance, assigned risks or market pools).
• Other risks are reinsured elsewhere, for instance, a non-marine property policy would be
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expected to exclude marine and aviation property losses.

• Alternatively, a reinsurer may exclude risks relating to specific territories or perils (e.g.
mould).
When reviewing exclusion clauses, it is important not to forget that:
• Ambiguity in the exclusion is usually construed against the drafting party.
• In the event of a claim, the reinsured has the burden of proving that the loss suffered is
within the scope of the treaty, whereas it is the reinsurer who has the burden of proving
that the loss falls within a particular exclusion.
• Local law may apply to restrict what may or may not be excluded from certain contracts.
In this section, we outline those exclusions that are common to all forms of proportional and
non-proportional treaty reinsurance:
information
insolvency fund reinsurance
technology hazards
exclusion clause assumed
clarification clause
Common treaty exclusions
pollution (or
nuclear exclusion environmental war and terrorism
other
clauses contamination) exclusion clauses
exclusion clauses
Exclusions that are specific to property, casualty, marine and aviation reinsurance are
discussed in chapters 10, 11 and 12.
E1 Nuclear exclusion clauses

The nuclear exclusion clauses exclude liability for nuclear risks. Such risks are not considered These clauses
insurable by conventional means, and are typically the subject of pooling arrangements. exclude liability for
nuclear risks
However, nuclear risks have the potential for catastrophic loss, so they remain of concern to
reinsurers following the break-up of the Soviet Union, general nuclear proliferation and,
more recently, the possibilities for nuclear terrorism.
Non-marine reinsurance
Here, it is usual to include the following suite of clauses (as appropriate):
• Nuclear Incident Exclusion Clause – Physical Damage – Reinsurance – USA (NMA 1119);
• Nuclear Incident Exclusion Clause – Physical Damage and Liability (Boiler and Machinery
Policies) – Reinsurance – USA (NMA 1166);
• Nuclear Incident Exclusion Clause – Physical Damage – Reinsurance – Canada (NMA
1980a);
• Nuclear Incident Exclusion Clause – Physical Damage and Liability (Boiler and Machinery
Policies) – Reinsurance – Canada (NMA 1251);
• Nuclear Incident Exclusion Clause – Liability – Reinsurance – USA (NMA 1590);
• Nuclear Incident Exclusion Clause – Liability – Reinsurance – Canada (NMA 1979a);
• Nuclear Energy Risks Exclusion Clause (Reinsurance) (1994) (Worldwide excluding USA
and Canada) (NMA 1975a).
In this way, the reinsurance contract seeks to exclude any loss or liability accruing to the
reinsured, directly or indirectly and whether as first or third party, insurer or reinsurer, from
any pool of insurers or reinsurers formed for the purposes of covering nuclear energy risks.
The NMA 1975a concerns cover for potential damage to nuclear power plants and other
nuclear installations, as well as to liability claims resulting from the operation of such nuclear
installations or from the utilisation, storage and transport of nuclear material
including waste.
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E2 Pollution (or environmental contamination) exclusion
clauses
The pollution (or environmental contamination) exclusion clauses exclude reinsurers’ liability
for environmental contamination claims.
Non-marine reinsurance
Following issues with coverage of pollution losses arising from the North American market, LMC drafted
which were spread over a number of policies over various years and led to costly litigation clauses which
covered pollution
for the London Market, the London Market Committee (LMC) drafted clauses LMC1 and losses
LMC2. They are designed to counteract this problem both in the North American market and
elsewhere:
• LMC1 is intended to remove liability for losses arising from gradual pollution from
reinsurance cover of public liability and general third-party policies covering operations
located outside North America.
• LMC2 is intended to specifically exclude from reinsurance cover any liability for losses
from pollution (both ‘sudden and accidental’ and ‘gradual’) for operations located in the
USA and Canada. The difference in wording is due to the fact that litigation in the USA
resulted in the definition of ‘sudden and accidental’ being no longer clear.
Marine reinsurance
The standard marine seepage and pollution exclusion can be found as exclusion 8 of
appendix 7.1, which is available on RevisionMate.
E3 War and terrorism exclusion clauses

Traditionally, war
Traditionally, war risks were uninsurable. In the light of recent events, and the increasingly
risks were destructive and widespread nature of warfare, it remains general practice in all non-marine
uninsurable
standard lines of business to exclude war and terrorism risks, although specific reinsurance
of terrorism has arisen. In practice, however, and with exceptions for the use of nuclear
weapons, cover is usually available for such risks, either by an extension to the basis cover or
by means of an entirely separate cover.
Activity
Look up the War and Civil War exclusions on the BRMA website (www.brma.org) and the
IUA clauses websites (www.iuaclauses.co.uk).
The Terrorism Act 2000

2000, stipulates how the term ‘terrorism’ is to be interpreted. To
summarise, terrorism must involve an ‘action’ that :
• involves serious violence against a person;
• involves serious damage to property;
• endangers a person (other than the offender’s) life ;
• poses a risk to the health or safety of the public; or
• is designed to seriously interfere with or disrupt an electronic system.
In addition to the perpetration of any of these ‘actions’, terrorism can also include the use or
threat of these defined ‘actions’ that are designed to:
• influence the Government;
• influence an international Governmental organisation;
• intimidate the public; or
• advance a political, religious, racial or ideological cause.
Useful website
You can access the Terrorism Act and its complete interpretation of terrorism at:
http://bit.ly/11Qowcv
The interpretation in the Act is used as the base for the standard London Market terrorism
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exclusions NMA 2930 a, b and c.

By contrast, in the USA, an act of terrorism is certified as such by the Secretary of Treasury
for the purposes of the Terrorism Risk Insurance Act (TRIATRIA) and related Acts. This Act
provides reinsurance coverage to insurance companies following a declared terrorism event
that results in damage within the USA.
In the context of general liability treaties in the UK, the standard war and terrorism clause is
usually caveated to the extent that it is necessary to comply with the Road Traffic Acts
and/or the law relating to the compulsory insurance of liability to employees. Here,
‘terrorism’ is invariably expressed to follow the interpretation given to it in the Terrorism Act
2000.
E4 Reinsurance assumed clause

The reinsurance assumed clause excludes liability arising out of any reinsurance business
written (or assumed) by the reinsured.
Consider this
this…
…
Why would reinsurers desire this?
The purpose of this clause is to reduce a reinsurer’s exposure to retrocession contracts, in

particular, their tendency to aggregate single event risk at low premium. The clause has
many forms and, of course, is absent in contracts intended to provide retrocessional cover.
At its simplest, the reinsurance contract may exclude ‘all treaty business’. Alternatively, it
may exclude ‘all reinsurance assumed other than facultative, intra-company reinsurance
among many of the companies controlled by or affiliated with the Company, or reinsurance
of policies underwritten by the Company’.
Be aware
In marine reinsurance, it is common for a whole account protection to write back business
written on a ‘facultative, reporting or named account basis’. Similar provisions appear in
aviation reinsurance contracts.
E5 Insolvency fund exclusion clause

The insolvency fund exclusion clause excludes liability arising from the reinsured’s Clause excludes
involvement in any insolvency fund. In the USA, an insolvency fund is often established by liability arising
from the
statute to handle the run-off of an insolvent insurer. Typically, it is a non-profit reinsured’s
unincorporated legal entity backed by all other insurers licensed to transact insurance involvement in any
insolvency fund
business in the particular state. The fund’s obligations and expenses are ‘assessed’ to those
insurers.
E6 Information technology hazards clarification clause

The information technology hazards clarification clause excludes losses flowing from
damage to, or failure of, a computer system unless arising from a specified peril. Similar
provisions are entitled ‘electronic date recognition’ exclusions or endorsements.
A per catastrophe/event reinsurance would bar aggregation of such losses, save where
caused by a specified peril and, in the marine market, the JELC information technology
hazards clause XL 2001/003 is in use for this purpose.
By contrast, in the aviation market, the ‘aviation date recognition (reinsurance) clause’ (LSW
1036) confirms coverage for an aircraft accident caused by the failure of any equipment to
function safely or correctly following any real or simulated change of date, without which no
aircraft would be able to fly.
E7 Other
Other general exclusion clauses include:
• pools, associations and syndicates exclusion clause;
• cyber attack exclusion clause/electronic data endorsement; and
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• a sanction exclusion clause provides that the reinsurer has no liability to provide
coverage, or to pay claims, to the extent that to do so would be in violation of any
political, economic or trading sanctions or penalties.
An example of a sanction exclusion clause (LMA 3100) is:
No Reinsurer shall be deemed to provide cover and no Reinsurer shall be liable to
pay any claim or provide any benefit hereunder to the extent that the provision of
such cover, payment of such claim or provision of such benefit would expose that
Reinsurer to any sanction, prohibition or restriction under United Nations resolutions
or the trade or economic sanctions, laws or regulations of the European Union,
United Kingdom or United States of America.
Key points
Main features of facultative and treaty wordings
• The parties to the contract are the insurer(s) and the reinsurer(s).
• The subject matter of the reinsurance contract is the reinsured’s interest in a particular insurance
contract in the case of facultative reinsurance or, a particular account or book of insurance business
in the case of treaty reinsurance.
• The reinsurance contract is a separate and distinct contract from the underlying insurance contract.
This reinsurance relationship is mutually exclusive from the relationship between the reinsured and
the insured.
Clauses common to proportional and non-proportional wordings
• A proportional treaty is usually a continuous contract, that is, it continues until terminated on
notice, by agreement or otherwise. A fixed period is usual for a non-proportional treaty.
• The territorial scope clause defines the territorial or geographical scope of the reinsurance contract.
• The cancellation clause provides that one or both parties may terminate (or cancel) the agreement
immediately if there is a significant change during the currency of the agreement in the character of
that other party, or in the commercial and/or political background, from that at placement.
• Currency clauses set out the relationship between the currency of the original premium and/or
claim transactions, and the corresponding reinsurance (premium and/or claim) transactions.
• Late payments clause requires the defaulting (or debtor) party to pay interest on any amounts past
due under the contract.
• Law and jurisdiction clauses record the law governing the treaty and the courts having power and
authority to administer justice between the parties to the treaty.
• Dispute resolution clauses set out how the parties go about resolving any disputes between them,
for example, arbitration and/or mediation failing which litigation.
• The underwriting policy clause requires a reinsured to seek a reinsurer’s approval to significant
change in its underwriting policy.
• The errors and omissions clause seeks to ensure that any inadvertent errors, omissions or delay in
complying with the terms and conditions of the treaty are remedied immediately upon discovery
and without any impact to the treaty beyond that of ordinary rectification.
• An ECO clause extends the scope of the treaty to damages, arising from the reinsured’s bad faith or
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negligence in handling claims under policies subject to the treaty. In this case, the court has made
an award against the insurer/reinsured outside of the insurance relationship.
• An XPL clause extends the scope of the treaty to original loss in excess of the original policy limit,
arising from the reinsured’s bad faith or negligence in handling claims under policies subject to the
treaty. In this case, the court has set aside the original policy limit, awarding a claim amount in
excess of that limit.
• The insolvency clause sets out the impact of the reinsured’s insolvency on the reinsurance contract.
• The offset clause allows the parties to offset any balance or amount due from one party to the other
under a particular reinsurance contract or any others between the parties, whether acting as
reinsurer or reinsured.
• The co-reinsurance clause states the proportion that the reinsured agrees to retain ‘net and
unreinsured’.
• ‘Boilerplate’ clauses are standard clauses with little reinsurance content and include the following
clauses: notice, intermediary, termination of intermediary, confidentiality, amendments and
alterations, severability, entire agreement, non-waiver and several liability.
Clauses used in proportional wordings
• The cession clause sets out the nature and the main terms of the proportional reinsurance, and
imposes a cession limit and a cession retention, which may or may not be protected by other
reinsurance.
• The accounting clause requires the reinsured to prepare and dispatch periodic accounts to the
reinsurer. It states when accounts have to be presented to the reinsurer, what details have to be
included in the accounts and when money should be rendered to the reinsured in respect of those
accounts, or vice versa.
• The premium clause provides that the reinsured will pay the reinsurer its proportionate share of the
original gross (or net) premiums received by the reinsured on business covered by the reinsurance
agreement.
• The commission clause sets out how much commission is to be paid by the reinsurer to the
reinsured and when it is to be paid. There are two basic types of commission: ceding commission
and profit commission.
• The claims clause deals with the notification and settlement of all losses to the treaty; claims are
paid either individually as cash losses, or collectively as part of the periodic rendering and
settlement of accounts.
• The portfolio transfer clause is concerned with the transfer of liability for pre-existing business, a
portfolio, from one set of reinsurers to another.
• The parties may agree to the retention by the reinsured of premium and/or loss reserves (or
deposits). The premium reserves (or deposits) clause allows a reinsured to retain additional
premium by requiring the reinsurer to deposit a fixed proportion of prior written premium. The loss
reserves (or deposits) clause allows the reinsured to establish reserves for the reinsurer’s
proportion of amounts outstanding to the treaty.
Clauses used in non-proportional wordings
• The basis of the reinsurance contract:

– on an RAD basis, reinsurers agree to assume liability for claims on risks or original policies
attaching during the reinsurance period;
– on an LOD basis, reinsurers agree to assume liability for claims occurring during the reinsurance
period, irrespective of the inception dates of the original policies giving rise to the claims;
– on a losses discovered or claims made basis, reinsurers agree to assume liability for losses that
were discovered by, or claims that were notified to, the insurer during the reinsurance period.
• The UNL clause describes the loss to which the treaty limits (and deductibles) are applied. The UNL
is the sum actually paid by the reinsured in settlement of losses or liability after agreed deductions.
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Those agreed deductions may or may not include recoveries from other reinsurances.
• The hours clause limits the individual losses arising from one event (or catastrophe) that may be
aggregated by reference to peril, time and, on occasion, geography.
• The reinstatement clause limits the amount of cover by specifying the number of times the limit
may be reinstated. Absent such a condition, there is no limit.
• The claims clauses address:
– the notification (or reporting or advice) of losses and the provision of related information to
reinsurers;
– reinsurers’ obligations in relation to the reinsured’s loss settlements (that is, original loss
payments), and what the reinsured must demonstrate to reinsurers in relation to its settlements
to trigger those obligations (loss settlements clauses); and
– reinsurers’ rights of involvement in the management and/or determination of the original claim.
• The salvage and subrogation clause sets out how recoveries from third parties are to be distributed
between the reinsured and the reinsurer.
• The currency fluctuation clause enables the parties to share any fluctuation in the value of the
currency of the original loss between the contract’s inception date and the loss settlement date.
• The index clause adjusts the limit and deductible by reference to an index to take into account
inflation over a period of time.
• The aggregate extension clause allows a reinsured to present as one loss, separate and unrelated
losses which it covered on an aggregate basis under the terms of the original policy.
• The claims series clause extends the cover provided by a casualty treaty to a ‘claims series event’,
enabling all claims from a specific common cause which involve one original insured to be
aggregated for the purposes of recovery.
• The sunset clause requires the reinsured to notify claims within a certain period beyond which the
contract ceases to respond.
Treaty exclusions
• An exclusion is an express term of a contract that limits or reduces the extent of cover provided by
that contract. Typically, they exclude un(re)insurable risks or risks reinsured elsewhere.
• A reinsurer has the burden of proving that a particular loss falls within an exclusion.
• Nuclear, pollution, war and terrorism exclusions are common to all forms of proportional and non-
proportional reinsurances.
Chapter 7
Question answers
7.1 1. £300,000, £800,000 and £1,000,000; and
2. Nil, £600,000, £1,150,000.
7.2 US$333,333 and £33,333. The sterling element of the claims forms 2/12ths (or 1/6th)
of the total claim and is, therefore, subject to 1/6th of the deductible, leaving £33,333
(£100,000 less £66,667).
7.3 False.
7.4 No, there is an overlap.
7.5 A. i. £1m; ((£5m + £1m) – excess of £5m).
ii. £4m; ((£8m + £1m) – excess of £5m).
iii. £5m; ((£10m + £1m) – excess of £5m) only limited to £5m limit of excess.
B. i. Nil; as indemnity did not exceed excess of £5m then no costs allocated to
reinsurance layer.
ii. £3,375,000; (£8m -– excess of £5m = £3m) costs = £3m/£8m = £375,000.
iii. £5.5m; (£10m -– excess of £5m = £5m) costs = £5m/£10m = £500,000. The
costs can be paid in addition to the policy limit.
7.6 Year 1 ((loss in year 1 US$400,000/total loss US$1,600,000) × Deductible
US$1,000,000 = New deductible US$250,000) US$400,000 – $250,000 =
US$150,000; and
Year 2 ((loss in year 2 $1,200,000/total loss $1,600,000) × Deductible $1,000,000 =
New deductible $750,000) $1,200,000 – $750,000 = US$450,000.
7.7 US$120,000.
7.8 £1,000,000 deductible converted at 2.5 (rate at inception) = A$2,500,000
Claim A$2,600,000 – deductible 2,500,000 = 100,000.
Converted to £ at rate at settlement 2:1 = £50,000.
7.9 £400,000.
Chapter 7
Self-test questions
1. What are the bases of cover under a non-proportional wording?
2. What is included and excluded from the UNL?
3. Which provision distinguishes a claims control clause from a claims cooperation
clause?
4. When would an interlocking clause apply?
5. What are the provisions of the loss settlements clause in an excess of loss treaty?
6. What should be specified in an index clause?

Chapter 7
Legal issues relating
8
to reinsurance
outcomes
Learning objectives
Introduction
Key terms
A The law applicable to reinsurance contracts 7.1
B Interpreting contractual documents – key issues and 7.2
case law
C Express terms 7.2
D Implied terms 7.2
E Limitation 7.2
F Measures to avoid disputes 7.2
Key points
Question answers
Self-test questions
Learning objectives
Chapter 8
• describe the general legal principles of reinsurance law;
• explain the rules of construction for interpreting reinsurance contracts;
• describe the hierarchy of terms in reinsurance contracts;
• describe the legal issues often associated with incorporation, aggregation and loss
settlement provisions in reinsurance contracts; and
• explain what a limitation period is and how it may relate to reinsurance contracts.
Introduction
A reinsurance transaction is the buying and selling of contractual promises. In this chapter,
we examine the reinsurance contract with particular reference to its formation, its
interpretation, and its express and implied terms. We also look at the issues of choice of law
and jurisdiction, and limitation. Please note: we look only at the law of England and Wales
and relevant case and statute law is included where appropriate.
Key terms
Aggregation clauses Condition precedent Consideration Contra proferentem
Fair presentation Follow clauses Implied terms Incorporation
Indemnity Innominate terms Insurable interest Limitation
Loss settlement clause Material circumstances Rules of construction Utmost good faith
Warranty
A The law applicable to reinsurance

contracts
In law, a reinsurance contract may be defined as an agreement in which one party, known as
the reinsurer, undertakes to indemnify the other party, known as the reinsured, either wholly
or partly, for liabilities it may incur under a contract (or contracts) of insurance. Reinsurance
has been described (in Reinsurance in Practice by Robert and Stephen Kiln) as ‘insurance
between consenting adults’ and, although perhaps more descriptive of the practical realities
of reinsurance, the quotation helps to illustrate a number of important legal points about
reinsurance contracts.
Contracts of
Firstly, a contract of reinsurance is an entirely distinct and separate contract from the
insurance and underlying contract of insurance. The contracts of insurance and reinsurance are mutually
reinsurance are
mutually exclusive
exclusive, ordinarily the original insured having no legal interest in the reinsurance contract
and the reinsurer having no legal interest in the insurance contract.
Typically, the original insured and the reinsurer have no rights or obligations against or to
each other.
Secondly, a contract of reinsurance is also a contract of insurance or, according to Lord
Mansfield in Delver v. Barnes (1807)
(1807):
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a new assurance, effected by a new policy, on the same risk which was before
insured in order to indemnify the underwriters from their previous subscriptions; and
both policies are in existence at the same time.
Furthermore, as a contract of insurance, the subject matter of the reinsurance contract is
considered to be identical to that of the original insurance (the risk in the goods or whatever
might be insured). In legal theory, it is not the liability of the insurer to the insured under that
WASA v. Lexington (2009)
original insurance; reinsurance is not liability insurance (WASA (2009)).
A reinsurance contract is, therefore, subject to the general rules governing contracts and the
special rules governing insurance contracts.
Be aware
To avoid doubt, it has been confirmed, in Re NRG Victory Reinsurance Limited (1995)
(1995),
that a retrocessional contract is also a contract of reinsurance and hence a contract of
insurance.
The law of reinsurance is primarily concerned with the contractual relationship between the
parties. However, it may also address their relationship with their agents, either brokers or
underwriting agents and, to a lesser extent, the way in which regulatory bodies control the
practice of reinsurance.
Chapter 8 Legal issues relating to reinsurance 8/3
This section concentrates on the contractual relationship between the parties, in particular,
the formation and the construction or interpretation of the contract, all with reference to
English law only.
A1 Principles of insurance
Reinsurance contracts are subject to the following principles governing insurance contracts:
Principles governing insurance contracts
utmost good faith indemnity insurable interest form
A1A Utmost good faith

Reinsurance contracts, as insurance contracts and most other contracts of a fiduciary Reinsurance
nature, are based on the principle of uberrima fides (the utmost good faith
faith). This remains contracts are
based on the
enshrined in section 17 of the Marine Insurance Act 1906
1906, as amended by the Insurance principle of utmost
Act 2015
2015. good faith
Under the Insurance Act, there is no express statutory remedy for a breach of that duty, the
former remedy of avoidance having been repealed. Nonetheless, the parties to reinsurance
contracts are obliged to be open, honest and fair in their dealings with each other.
A1B Fair presentation

For reinsurance contracts, the basic rule is that the reinsured has a statutory duty to make a
fair presentation of the risk to the reinsurer before the contract is entered into.
Obligation
Under the Insurance Act 2015:
3(3) A fair presentation of the risk is one:
a. which makes the disclosure required by subsection (4) of the Act (see
below);
b. which makes that disclosure in a manner which would be reasonably clear
and accessible to a prudent insurer; and
c. in which every material representation as to a matter of fact is substantially
correct, and every material representation as to a matter of expectation or
belief is made in good faith.
Disclosure
There are two aspects to this duty of disclosure as follows:
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3(4) The disclosure required is as follows, except as provided in subsection (5):
a. disclosure of every material circumstance which the insured knows or ought
to know; or
b. failing that, disclosure which gives the insurer sufficient information to put a
prudent insurer on notice that it needs to make further enquiries for the
purpose of revealing those material circumstances.
The first aspect (a.) requires the ‘disclosure of every material circumstance which the
(re)insured knows or ought to know’.
Section 7(3) states that ‘a circumstance or representation is material if it would influence the
judgment of a prudent insurer in determining whether to take the risk and, if so, on what
terms’. The section continues with examples of things which may be material circumstances,
that is, special or unusual facts relating to the risk, and any particular concerns which led the
insured to seek insurance cover for the risk.
Example 8.1
By way of general illustration, the following facts have been held to be material by the
courts in reinsurance cases:
• Nature of the risks underwritten.
– In WISE (Underwriting Agency) Limited v. Grupo Nacional Provincial (2004)(2004), the
high value watches used in a shipment to be reinsured were mistranslated as ‘clocks’
in the original Spanish policy. This was held to be a breach of the duty of disclosure.
– Similarly, in Aneco Reinsurance Underwriting v. Johnson & Higgins (2002) the
broker described the underlying risk as a proportional quota share contract, when it
was in fact a facultative obligatory treaty. This was judged as being a material
misrepresentation.
• Arbitrage underwriting.
– In Sphere Drake Insurance v. Euro International Underwriting Ltd (2003)
(2003),
reinsurance was sought for a US workers’ compensation ‘carve-out’ business in the
expectation that it would be loss making on a gross basis, but profitable on a net
basis. The court considered that, while this practice was disapproved of by many, it
was neither objectively nor subjectively dishonest but should have been disclosed.
The reinsured who is not an individual knows only what is known to one or more individuals
who are in senior management at the reinsured, or responsible for the reinsured’s
reinsurance (e.g. the risk manager or broker). As to what the reinsured ought to know, it is
that which ‘should reasonably have been revealed by a reasonable search of information
available to the (re)insured’. This includes information held within the reinsured’s
organisation or by any other person, for instance, the reinsured’s agent.
The second aspect to the duty of disclosure (b. in our quote from the Act) is a fallback
position in the event that the reinsured fails to fulfil the primary duty of disclosure. The
reinsured must give the reinsurer ‘sufficient information to put a prudent (re)insurer on
notice that it needs to make further enquiries for the purpose of revealing those material
circumstances’.
So, the duty of disclosure may be positively satisfied by the reinsured giving less than full
disclosure of all material information, provided what has been disclosed is enough to put the
reinsurer on notice that it needs to ask further questions. Being unduly cryptic in referring to
a material matter, for example, may not satisfy the duty on the basis that ‘sufficient
information’ had not been provided to put the reinsurer on notice to make further enquiries.
It remains to be seen how the courts will deal with any deliberate failures to disclose
information, even when sufficient ‘signposts’ have been left to put the reinsurer on notice. As
the reinsurance contract remains one of utmost good faith, it may be that such conduct will
be held to amount to deliberate breach of the over-arching duty to make a fair presentation.
Chapter 8
Excluded from the disclosure obligation are circumstances which diminish the risk, which are
known, ought to be known or presumed to be known by the reinsurer, and facts waived by
the reinsurer, all in the absence of enquiry.
Presentation
The manner of the presentation of the risk is also prescribed by the Insurance Act. Disclosure
must be made in a manner that is ‘reasonably clear and accessible to a prudent (re)insurer’. It
is not acceptable, for example, to ‘data-dump’ a vast amount of unordered, indigestible data
in an attempt to avoid inadvertent non-disclosures.
Under the Act, a material representation is fair if as to a matter of:
• fact, it is substantially correct; and
• expectation or belief, it is made in good faith.
For example, in Pan Atlantic v. Pine Top (1994)
(1994), a broker made available full loss information
to an underwriter but, at the same time, showed summary loss statistics which were
inaccurate. The House of Lords held that this was not a fair presentation.
Question 8.1
How may the disclosure of an inaccurate loss record not constitute a material
non-disclosure?
Remedy
The remedy for breach of the obligation to make a fair presentation depends on the
reinsurer being able to demonstrate that, but for the breach, it would not have entered into
the contract at all, or would have done so only on different terms.
Avoidance remains a remedy for a deliberate or reckless breach of the duty. Otherwise, the
remedy depends upon what the reinsurer would have done had the risk been fairly
presented (for example, varying the terms of the policy, increasing premium or avoiding the
policy).
Contracting out
In order to successfully contract out of the changes brought in by the Insurance Act, Reinsurers will
reinsurers will need to satisfy certain transparency requirements. They must ensure that any need to satisfy
certain
terms which would put the reinsured in a worse position than before the Act are clear and transparency
unambiguous as to their effect, and sufficiently drawn to the reinsured’s attention before the requirements
policy is entered into. In determining whether this requirement has been met, the reinsured’s
characteristics and the circumstances of the transaction will be taken into account.
At the time of writing, the main focus of contracting-out provisions appearing in the
marketplace is the duty of fair presentation and, in particular, the remedy for failures that are
neither deliberate nor reckless, as insurers reserve the right to pay additional premium rather
than have their claims reduced proportionately.
Activity
Search for a copy of the Consumer Insurance (Disclosure and Representations) Act 2012
and compare a consumer’s duties of disclosure on placement with those of a reinsured.
A1C Indemnity
All reinsurance contracts are contracts of indemnity
indemnity. Indeed, indemnity has been said to be All reinsurance
Castellain v. Preston (1883)
the ‘controlling principle in insurance law’ (Castellain (1883)) and will be implied if contracts are
contracts of
not expressly provided for in the reinsurance contract. Simply, the reinsured may recover indemnity
from reinsurers the amount of its actual loss, provided that the loss falls within the original
insurance contract and within the relevant reinsurance contract.
Reinforce
Before you move on, check your understanding of the way in which indemnity works in
practice – perhaps by revisiting the topic from your earlier studies.
A1D Insurable interest Chapter 8
Broadly, in this context, the rule is that the insurer must have a reinsurable interest in the Insurer must have
subject matter of the reinsurance contract. This interest depends on the original insured a reinsurable
interest in the
having an insurable interest in the original risk and the insurer being liable, under the terms subject matter of
of the original policy, to indemnify the original insured against loss arising out of that risk. the reinsurance
contract
Classically, the requirement is for the original insured to have an interest in the subject
matter of the (re)insurance contract, so ‘as to have a benefit from its existence, prejudice
Lucena v. Crawford (1806)
from its destruction’ (Lucena (1806)).
The rule has, however, been complicated by the Gambling Act 20052005. Before the Act, wagers
were unenforceable and what distinguished (re)insurance from a wager was insurable
interest. Now, the Act may not require an insurable interest but, as the indemnity principle
remains, its impact is rendered largely academic.
A1E Form
There is no general requirement that a reinsurance contract takes any particular form to be
valid, or even that it is in writing. There are, however, specific requirements in relation to life
and marine reinsurances, ensuring that these contracts are written, not oral. Section 2 of the
Life Assurance Act 1774 requires that the person with the insurable interest be named in the
policy, and s.22 of the Marine Insurance Act 1906 provides that a contract of marine
insurance shall be inadmissible in evidence unless embodied in a marine policy in
accordance with the Act. Certainly, according to the responses published by the Law
Commission to its 2011 consultation on proposals to repeal s.22, the requirement for a formal
marine policy is largely ignored in practice and is ripe for abolition.
Be aware
In practice, reinsurance contracts are without exception written, avoiding the likely and
significant evidential difficulties associated with reconstructing the terms of an oral
contract in the event of a dispute. As to their written form, in addition to the traditional
slip, contracts are also concluded via fax, email or other electronic means.
A2 Formation of the reinsurance contract

General rules of
For the formation of a valid reinsurance contract, the general rules of contract law require,
contract law apply among others, the following elements:
• offer and acceptance;
• consideration;
• legality; and
• intention to create legal relations.
Valid
reinsurance
(1) contract (4)
Offer and Intention to create
acceptance legal relations
(2) (3)
Consideration Legality
In this section, we look at a number of issues raised by the first three elements.
Chapter 8
A2A Offer and acceptance

For the formation of a valid reinsurance contract, there must be an offer and acceptance of
that offer.
Offer
Refer to The offer in reinsurance is invariably made in writing. In the London Market, a Market Reform
chapter 6,
section C3B Contract (MRC) is generally used. This can be done direct or via a broker.
for MRC
The offer having been made is open for acceptance by the reinsurer. Alternatively and more
usually, the reinsurer suggests amendment(s) to those terms and, in doing so, makes a
counter-offer. In this case, the original offer is implicitly rejected, and lapses; the original
offeree becoming the counter-offeror. The law requires an unreserved assent by the offeree
to the exact terms proposed by the offeror.
Consider this
this…
…
How else may an offer lapse?
Acceptance
Eventually, once the bargaining process has been successfully concluded and the slip has
been amended to express the various terms, conditions, limitations and exclusions of the
parties’ bargain, a reinsurer will stamp, initial and date the amended slip. At that moment,
subject to any outstanding conditions or other evidence to the contrary, the reinsurer’s
subscription to the slip is the acceptance of the offer and a binding contract comes into
Fennia Patria (1983)
effect (Fennia (1983)).
The Zephyr (1984) case illustrates the problems that have arisen in this area. The Court of
Appeal considered, in some depth, the practices of ‘signing down’ and giving ‘signing
indications’.
Example 8.2
General Accident Fire and Life Assurance Corporation v. Tanter (‘The Zephyr
Zephyr’’) (1984)
In this case, a broker placed a risk with a number of underwriters. During placement, the
broker advised, as was its usual practice, that it intended to place approximately twice the
order that it had been given and subsequently to write down each reinsurer’s line. In other
words, it intended to obtain twice the required amount of reinsurance and then reduce
each underwriter’s line to 50% of what they had promised.
Unfortunately, before it could complete the placing exercise, the insured vessel sank and
claims were made against the reinsurers who, at that time, had agreed to underwrite
the risk.
In court, one reinsurer claimed that it should only be obliged to pay an amount based
upon the line that it expected to have after signing down.
The court held that it was obliged to pay the amount that it had actually agreed to pay
and for which it had signed.
From the moment the slip is signed, a reinsurance contract is agreed and a reinsurer is
obliged to indemnify the reinsured according to its terms and in the amount specified in the
slip until such time as that slip is amended or otherwise modified.
In situations where reinsurance business is being concluded by fax, email or other non-
instantaneous means, a number of additional issues may arise, including the place and
communication of the acceptance.
Acceptance must be communicated to the other party or its representative and it may be It must be
necessary to distinguish between the fact of the acceptance, and the communication of the communicated to
the reinsured that
acceptance. In law, both elements are essential for agreement. In other words, it must be its offer has been
communicated to the reinsured that its offer has been accepted, otherwise there is no accepted
agreement. For example, a reinsurer in contact with the reinsured (or its broker) by email
alone, may have executed a document in order to accept a risk. But, until that fact has been
Chapter 8
communicated to the reinsured (or its broker), the agreement is not complete.
If the negotiating parties are located in different countries, the place in which the contract
was made may determine the appropriate jurisdiction for any dispute. A contract concluded
by fax or email is made at the place where the offeror receives the offeree’s acceptance of
Brinkibon v. Stahag Stahl (1982)
the offer (Brinkibon (1982)).
A2B Consideration
Consideration is that which is actually given or accepted in return for a promise. It need not Consideration is
be adequate. In this context, the reinsured pays a premium in return for a reinsurer’s promise that which is
actually given or
of indemnity in the event of a loss covered by the reinsurance contract. accepted in return
for a promise
A2C Legality
Contracts that are forbidden by statute or are contrary to common law or public policy are
illegal and, generally, without legal effect (or void).
The Financial Services and Markets Act 2000 provides that ‘no person may carry on a
regulated activity in the United Kingdom…unless he is an authorised person’. This is known
as the general prohibition. Further, at s.26(1): ‘an agreement made by a person in the course
of carrying on a regulated activity in contravention of the general prohibition is
unenforceable against the other party’.
Accordingly, where the regulated activity is the effecting and carrying out of contracts of
reinsurance, an unauthorised reinsurer may not enforce a reinsurance contract against a
reinsured. The reinsured may, however, at the discretion of the court, enforce the
reinsurance contract (see s.28(3)). It remains to be seen quite how the court will exercise its
discretion in practice. In any case, under s.26(2), the reinsured is entitled to recover the
premium paid and compensation for any loss sustained as a result of having parted with that
premium (presumably, interest in most cases).
Learning point
Before you move on, ensure that you know the elements required for the formation of a
valid reinsurance contract.
B Interpreting contractual documents – key

issues and case law
It is of vital importance for the effective and efficient operation of reinsurance contracts and
for the avoidance of disputes, that the rights and obligations of the parties under the
contract accurately reflect their intention. This will not always be the case and it is, therefore,
necessary to have an understanding of how the courts will interpret a wording, if asked
to do so.
Construction and interpretation are used interchangeably in this section.
B1 Rules of construction
By way of introduction to this section and to the rules of construction and how terms are
interpreted, consider the following quote from Lord Steyn in Sirius International Ins. v.
FAI (2004)
(2004):
The aim of the inquiry is not to probe the real intentions of the parties but to ascertain the
contextual meaning of the relevant contractual language. The inquiry is objective: the
question is what a reasonable person, circumstanced as the actual parties were, would
have understood the parties to have meant by the use of specific language. The answer to
that question is to be gathered from the text under consideration and its relevant
contextual scene.
Subject to the
As commercial contracts, reinsurance contracts are subject to the ordinary principles of
ordinary principles construction and we set these out, in brief, in this section.
of construction
The primary rule of construction of the contract is that the court must give effect to the
Chapter 8
intention of the parties. ‘Intention is determined by reference to expressed rather than actual
Deutsche Genossenschaftsbank v. Burnhope (1996)
intention’ (Deutsche (1996)).
The starting point is that words should be given their ordinary and natural meaning.
However, if the meaning of the word(s) has been settled by the court, or if a word has a
technical meaning, it is presumed that such meanings were intended. ‘The ordinary meaning
of words is the meaning when read, not in isolation, but in context’ (source: The Law of
Insurance Contracts by Malcolm Clarke et al). Context may come from either within, or
exceptionally, outside the terms and conditions of the reinsurance contract.
Extrinsic (or outside) evidence may be sought to elucidate technical meaning, to resolve
ambiguity or absurdity or, as envisaged by Lord Hoffmann in Investors Compensation
Scheme v. West Bromwich BS (1998) in which he summarised the modern principles for the
construction of contractual documents.
His principles included:

1. Interpretation is the ascertainment of the meaning which the document would
convey to a reasonable person having all the background knowledge which would
reasonably have been available to the parties in the situation in which they were in at
the time of the contract.
2. The background … referred to by Lord Wilberforce as the ‘matrix of fact’ …
includes absolutely anything which would have affected the way in which the
language of the document would have been understood by a reasonable man…
4. The meaning which a document (or any other utterance) would convey to a
reasonable man is not the same thing as the meaning of its words. The meaning of
words is a matter of dictionaries and grammars; the meaning of the document is
what the parties using those words against the relevant background would
reasonably have been understood to mean. The background may not merely enable
the reasonable man to choose between the possible meaning of words which are
ambiguous but even (as occasionally happens in ordinary life) to conclude that the
parties must, for whatever reason, have used the wrong words or syntax.
5. The ‘rule’ that words should be given their ‘natural and ordinary meaning’
reflects the common sense proposition that we do not easily accept that people
have made linguistic mistakes, particularly in formal documents. On the other hand, if
one would nevertheless conclude from the background that something must have
gone wrong with the language, the law does not require judges to attribute to the
parties and an intention which plainly could not have had.
Lord Hoffman’s principles signalled a move away from a literal non-contextual approach and
from ascertaining intention out of the natural and ordinary meaning of the language,
towards a more commercial and common sense (purposive) approach to interpretation.
Indeed, his summary has been read as enabling the courts to look at the surrounding
circumstances more often than was previously the case.
In Dornoch v. Royal and Sun Alliance Insurance (2005)
(2005), the Court of Appeal recognised the
‘dangers in judges deciding what the parties must have meant when they have not said what
they meant for themselves’, especially in a situation where the parties selected for
themselves an unsuitable standard clause. In other words, the difference appears to be that
the courts will now respond more readily to evidence that the parties intended something
different to what they had expressed. Further, if a reasonable person in the position of the
relevant party to a contract would be expected to understand a term in a particular way,
they will be bound by that understanding even if it does not quite correspond to the normal
or literal meaning.
In Rainy Sky v. Kookmin Bank (2011)
(2011), the Supreme Court held that where a term of a
contract is open to more than one interpretation, it is generally appropriate to adopt the
Chapter 8
interpretation which is most consistent with business common sense.
B2 Historical rules
Notwithstanding the entrenched purposive approach, the courts continue use the long Courts continue to
established rules of construction, but now as presumptions or guidelines. These include: use rules of
construction
• the parol evidence rule;
• contra proferentem;
• standard printed terms v. specifically agreed terms;
• ejusdem generis; and
• implied terms.
The parol evidence rule
The parol evidence rule, aimed primarily at promoting certainty, prevents evidence from
being admitted to add to, vary or contradict a document that is presumed to be the whole of
the parties’ contract. In practice, this presumption is reinforced by including an entire
agreement clause.
This rule operates to exclude oral evidence of the pre-contractual negotiations, draft
agreements or slips.
In New Hampshire Insurance v. MGN (1997)

(1997), Staughton, LJ, identified the Superhull case as
authority for the proposition that:
the policy will…be conclusive evidence of the contract unless and until it is rectified;
the slip cannot be used to add to, explain or contradict the meaning of the policy.
There are, however, numerous exceptions to the rule and it does not preclude extrinsic
evidence to clarify meaning, for example:
• factual background material to show the commercial purpose of the contract; or
• expert evidence to show, for example, what meaning would have been understood by a
reasonable professional in the market at the time and what, therefore, could reasonably
be presumed to have been intended by the parties when they entered into the contract.
In recent times, parties have sought to exploit these exceptions to make use of the change in
emphasis as to the construction of documents.
Contra proferentem
Rule used by the
The rule of contra proferentem is used by the courts to resolve ambiguity. It does this by
Courts to resolve construing an ambiguous clause against the party that drafted it. In a reinsurance context,
ambiguity
the draftsman is usually the broker who acts on behalf of the reinsured.
At other times, it may be the reinsurer who prepares the wording, which is then negotiated
with each party proposing amendments. It is the origin of the ambiguity that determines
which party the court may apply the rule against. It has been suggested that the rule should
Gan Insurance v. Tai Ping
not be applied to standard clauses in reinsurance contracts (Gan
Insurance (No.2) (2001)
(2001)).
Standard printed terms v. specifically agreed terms
Standard printed terms are overridden by terms specifically agreed by the parties. These
may, for example, have been written, stamped or typed.
Ejusdem generis
The rule of ejusdem generis provides that, in a string of words, general words that follow two
or more specific words are restricted to the same type as the preceding specific words.
However, in practice, the operation of this rule is often avoided by the use of phrases such as
‘whether or not similar to the foregoing’ or ‘without prejudice to the generality of the
foregoing’. The rule does not apply when specific words follow general words.
Implied terms
Another way in which the courts occasionally resolve issues of ambiguity is to imply certain
terms. We discuss implied terms in detail in section D.
C Express terms
Chapter 8
In this section, we look at express terms, in particular, how incorporation

incorporation, aggregation and
loss settlement clauses have each given rise to legal issues in reinsurance contracts.
C1 Hierarchy of terms
There is a hierarchy of express terms in insurance and reinsurance contracts, each with
different remedies on breach.
C1A Warranty
Contractual
A warranty is a contractual promise made by a reinsured as to past or existing facts (or
promise made by a ‘state of affairs’), or to its own future conduct. Under the Insurance Act 2015, a breach of
reinsured as to
past or existing
warranty causes the reinsurance cover to be suspended until the breach is remedied (if it
facts or to its own can be). The former rule that the reinsurer is automatically and permanently discharged from
future conduct
liability under the contract from the date of breach has been repealed.
Section 10(2) of the Insurance Act 2015 states:
An insurer has no liability under a contract of insurance in respect of any loss
occurring, or attributable to something happening, after a warranty (express or
implied) in the contract has been breached but before the breach has been
remedied.
The Act identifies two types of warranties:
Time warranty A time warranty is one that requires that by a particular ascertainable time,
something is or is not to be done, or a condition is to be fulfilled, or
something is or is not to be the case. The breach of such a warranty is
remedied if the risk to which the warranty relates later becomes essentially
the same as that originally contemplated by the parties.
For example, if there is a breach of a warranty in a facultative reinsurance
contract to have a new fire detection system installed by inception, this will
be remedied on the date on which it is installed. This is because on that date
the fire risk will essentially be as originally contemplated by the parties.
Any other case The breach of any other warranties are remedied ‘if the insured ceases to be
in breach of warranty’.
The use of the word ‘warranty’ has been said to be indicative, but by no means decisive. The use of the
Examples of warranties in common use in reinsurance contracts include retention and word ‘warranty’ is
indicative but by
premium payment warranties. However, unless amended to exclude the Act or address its no means decisive
impact, pure premium payment warranties may now only serve to exclude losses occurring
before payment is made rather than all losses.
C1B Condition precedent

A condition precedent is a contractual promise that must be performed to bring a valid
contract into force or, once in force, to make the reinsurer liable under that contract.
Examples of the latter type of condition precedent include claims notification, cooperation
and control clauses. In this context, on breach, the reinsurer is discharged from liability to
pay a particular claim. The breach has no impact on future claims under the contract.
Additionally, until Charter Re v. Fagan (1996)
(1996), it had been thought that ultimate net loss
(UNL) clauses, which referred to ‘the sum actually paid by the reinsured in settlement of
losses or liability’, imported a condition precedent into the reinsured’s right of recovery from
the reinsurer. This condition precedent was that it must have made payment of the inwards
claim to its original insured, i.e. to have actually transferred the funds. Here, the House of
Lords decided that the clause and policy worked perfectly well when understood as
requiring the satisfaction of only two pre-conditions:
• an insured event had occurred within the policy period; and
• the event had created a loss of sufficient amount to impact the particular layer/contract in
question.
The purpose of the words ‘actually paid’ was to emphasise that the ultimate outcome of the
net loss calculation was the final liability of the reinsurers under the policy, and not to impose
a condition precedent.
C1C Condition Chapter 8

A condition is a contractual promise under which the reinsured promises to perform some Reinsured
action. Importantly, a reinsured’s right of recovery does not depend on the act being promises to
perform some
completed. A reinsurer is entitled to claim damages for loss caused by the breach. For action
example, a failure to notify a claim in breach of an ordinary notification clause would entitle a
reinsurer to claim damages. In practice, the extent of those damages depends on the
reinsurer being able to show significant prejudice as a result of the non-compliance.
C1D Innominate terms

An innominate term is another contractual promise where the remedy for a breach depends
Phoenix General Ins. Co. v. Halvanon Ins. Co. (1985)
on its seriousness (Phoenix (1985)). Where the breach
is serious, a reinsurer may be entitled to repudiate the contract (that is, treat the contract as
terminated). Where it is minor, the remedy would be in damages only.
In Alfred McAlpine v. BAI (2000)

(2000), an insurer denied liability to its insured when the latter
failed to comply with a condition requiring written notification of a claim as soon as possible.
The Court of Appeal found that the notice clause was an innominate term, a breach of which
was unlikely to amount to repudiation of the contract as a whole, although according to
Waller, LJ in Friends Provident Life & Pensions Ltd v. Sirius International Insurance & Ors
(2005) ‘it is not impossible that it could in extreme circumstances of consistent breach over
a number of claims’. This view does not, however, represent the current state of the law as
agreed by the remaining Court of Appeal judges in Friends Provident, which renders any
remedy other than damages for breach of such a condition unlikely. It was considered
important that the parties could have agreed otherwise if they had so wished.
C2 Incorporation clauses
The parties may use incorporation clauses to import the terms of the original insurance
contract into the reinsurance contract. Such practice remains a common way of avoiding the
preparation of full wordings for facultative reinsurances where cover is agreed ‘back-to-
back’ with the original policy. Examples of these clauses include:
• ‘as original’;
• ‘subject to the same terms and conditions as the original policy’; and
• ‘being a reinsurance of and warranted same gross rate and terms and conditions’.
The words of
These clauses can, however, raise a number of issues. The words of incorporation may be
incorporation may ambiguous, for instance, what is meant by ‘as original’ in the context of multiple tiers of
be ambiguous
reinsurance? In addition, the underlying terms and conditions may be inconsistent with the
other terms of the reinsurance contract or inappropriate because they belong in a contract
of insurance rather than one of reinsurance. Do the words of incorporation bind reinsurers to
not only terms defining the risk, but also terms prescribing the formal and procedural basis
of the insurance contract, such as arbitration clauses, choice of law clauses and terms
relating to claims procedure? Further, is the effect of the clause to amend the reinsurance
cover to mirror all subsequent amendments to the contract of insurance? As a result, the
courts have been forced to rely on rules of construction and general common sense to give
commercial meaning to otherwise nonsensical situations.
In short, general words of incorporation are considered effective only to incorporate those
terms and conditions of the original insurance cover that do not contradict or conflict with
any express term of the reinsurance contract (e.g. an exclusion clause) and that are not
clearly inappropriate in the reinsurance context.
In Pine Top v. Unione Italiana Anglo-Saxon Re (1987)
(1987), it was held that the incorporation of
the ‘terms, clauses and conditions as original’ was ineffective to incorporate an arbitration
clause into a reinsurance contract. Gatehouse, J, decided that the purpose of the
incorporation clause was to ensure that the terms defining the risk underwritten matched in
Chapter 8
both the original cover and the reinsurance and, as this had been accomplished elsewhere,
the incorporation clause was unnecessary. Subsequent attempts by reinsurers to
incorporate arbitration agreements and also exclusive jurisdiction clauses in this way into
reinsurance contracts from an underlying policy have also failed.
In ARIG v. SASA (1998)

(1998), Tuckey, J, said in relation to a reinsurance contract containing the
words ‘policy wording as original’:
A degree of transposition is permissible where the terms from one contract are
expressly incorporated into another. But I find it difficult…to accept that reinsurers
writing a reinsurance on the London Market should be taken to have intended to
agree that the courts of the underlying insured’s domicile should have exclusive
jurisdiction over the contract of reinsurance.
Vesta v. Butcher (1989) concerned a facultative reinsurance of a Norwegian fish farm and
contained the words: ‘being a reinsurance of and warranted same gross rate and terms and
conditions and to follow the settlements of’ the insurer. A storm in the fjord resulted in
thousands of fish escaping into the open sea and, in breach of a 24-hour watch warranty,
there was no night watchman. The evidence was that, even if there had been, the watchman
could have done little to prevent the loss of the fish.
Under Norwegian law, a breach of warranty only operated to void the contract if it caused Refer to
section D4 for
the loss. Accordingly, the insurers were liable to the owners of the fish farm. Prior to the Insurance
Insurance Act 2015, English law (which governed the reinsurance contract) deemed it Act 2015
irrelevant that the breach was not causative of the loss and so the reinsurers denied the
claim on the basis of the breach of warranty.
The House of Lords treated the contracts as back-to-back, enabling the reinsured to recover
from the reinsurer. Lord Templeman said:
in the absence of any express declaration to the contrary in the reinsurance policy, a
warranty must produce the same effect in each policy. The effect of a warranty in the
reinsurance policy is governed by the effect of the warranty in the insurance policy
because the reinsurance policy is a contract by the underwriter to indemnify Vesta
against liability under the insurance policy.
Neither the insurance nor the reinsurance contract contained an express choice of law
clause. Thus this case may be considered authority for the proposition that general words of
incorporation need not bind reinsurers to the governing law of the underlying cover which,
in this case, had been implied.
The House of Lords also pointed out the absurdity of trying to construe and apply terms in
the reinsurance contract which served no useful purpose and were appropriate only to the
original policy of insurance. One provision, for example, allowed the insurer to re-stock the
fish farm with fish rather than pay money to the insured. If incorporated into the reinsurance
cover, it would have allowed the reinsurer to pay its claim in fish itself.
Question 8.2
The reinsurance contract was held to be governed by Norwegian law, disentitling the
reinsurer to deny the claim for breach of warranty. Is this statement true or false?
The presumption remains that certain insurance and reinsurance contracts should be
construed as being back-to-back so that their terms are interpreted consistently. However,
the House of Lords, in WASA v. Lexington (2009), were not prepared to ignore the proper –
English law – effect of a fundamental term of a reinsurance contract governed by English
law, which was construed in a radically different way in accordance with the proper law of
the underlying insurance contract.
In this case, Alcoa had been ordered by the US Environmental Protection Agency to clean up
pollution occurring between 1942 and 1986 at a number of its manufacturing sites in the
USA. Alcoa sought to recover its clean-up costs from its insurers, including Lexington, which
had insured Alcoa for a three-year period from 1 July 1977 to 1 July 1980 for physical loss and
damage to Alcoa’s property worldwide. Following a Washington Supreme Court ruling in
2000, Lexington was held to be jointly and severally liable under Pennsylvanian law for the
Chapter 8
whole of Alcoa’s clean-up costs notwithstanding that it was on risk for only the three-year
period of the insurance policy, as opposed to the 44 years during which pollution had taken
place. Lexington accordingly settled Alcoa’s claims and sought an indemnity from its
reinsurers.
The reinsurance was governed by English law and covered an identical period and subject
matter to the underlying insurance, as well as containing a ‘follow the settlements’ provision.
The House of Lords held that the period clause in the reinsurance contract had to be given
its ordinary meaning under English law, such that only loss and damage actually occurring
during the specified three-year period could be recovered. Accordingly, any claim paid on
the basis of loss or damage spanning a period of 44 years, could not be recovered under the
reinsurance.
C3 Aggregation clauses
A common issue for the parties to a reinsurance contract is whether original claims may be Refer back to
chapter 7,
aggregated for the purposes of a claim under that contract. The issue may be addressed section D4 for the
specifically by aggregation clauses
clauses, such as the hours clause, or alternatively, the parties hours clause
must look to the reinsuring clause and to the basis of the limit and retention (e.g. each and
every loss).
Occurrence is
Typically, that basis is defined by reference to event or occurrence and, in recent years, the
synonymous with courts have been granted many opportunities to decide quite what is meant by those
an event
particular terms. An occurrence is synonymous with an event, unless the context dictates
otherwise. You should be aware that the basis of aggregation may also be defined by
reference to a common cause rather than a common event.
In Caudle v. Sharp (1995)
(1995), the reinsured provided errors and omissions cover to various
Lloyd’s underwriting agents, including the managing agency for syndicates 317 and 661 and
the members’ agents which had placed Names on those syndicates. The syndicates
sustained terrible losses when the active underwriter wrote 32 run-off contracts attached to
a single (1982) year of account, aggregating significant long-tail asbestos-related liabilities.
The Names on that year sued the agents for the alleged negligence of the underwriter and,
when the matter settled, the reinsured sought recovery under various reinsurance contracts.
The retention under the reinsurance contract was expressed as ‘each and every loss’ which,
in turn, was defined as ‘each and every loss and/occurrence … or series of losses and/or
occurrences … arising out of one event’.
At first instance, the arbitration award was upheld on the basis that the underwriter’s
continuing failure to take the steps he should have in the circumstances (or ‘blind spot’) was
a state of affairs that amounted to one ‘event’, out of which the losses eventually arose. The
Court of Appeal disagreed. The ‘blind spot’ was not a single event. It was not limited in time
nor was it causative of a loss, save on each of the 32 occasions when the underwriter’s failure
manifested itself and his ignorance gave rise to an occurrence of negligence, leading to a
claim and a loss under the original policy.
Evan, LJ, proposed his three-prong test for determining an event:
• a common factor which could properly be described as an ‘event’;
• which satisfied the test of causation; and
• was not too remote for the purposes of the clause.
In Kuwait Airways v. Kuwait Insurance (1996) the loss of 15 aircraft belonging to Kuwait
Airways, following the invasion of Kuwait, was held to be a single event as there was unity of
time, location, cause and intent.
Rix, J, said that:

an ‘occurrence’ (which is not materially different from an event or happening,
unless perchance the contractual context requires some distinction to be made) is
not the same as a loss, for one occurrence may embrace a plurality of losses.
Nevertheless, the losses’ circumstances must be scrutinised to see whether they
involve a degree of unity to justify their being described as, or as arising out of,
one occurrence. The matter must be scrutinised from the point of view of an
informed observer placed in the position of the insured…In assessing the degree of
Chapter 8
unity regard may be had to such factors as cause, locality and time and the
intentions of the human agents.
Later, in Scott v. Copenhagen Re (2002)

(2002), attempts to aggregate that loss with a British
Airways aircraft, which was grounded on invasion but destroyed during allied bombing the
following year, failed on the basis of lack of unity of time and cause.
In Mann v. Lexington (2001)
(2001), rioting took place at a number of locations in Indonesia over
the course of a couple of days in May 1998, and it was held that damage to various stores
proceeded from separate occurrences and not from a single occurrence.
In American Centennial v. INSCO (1996)
(1996), the latter sought to aggregate losses arising from
claims against the auditors, and 14 directors and officers, of a failed US Savings and Loan
company (S&L). The collapse of S&L was held not to be a relevant ‘event’. It was not
causative of INSCO’s losses which arose out the acts or omissions of the auditors, directors
and officers, rather than the subsequent collapse of S&L.
In Axa Re v. Field (1996)
(1996), the main issue was whether ‘one originating cause’ in errors and
omissions policies should be construed as being synonymous with ‘one event’ in an excess of
loss reinsurance contract, which potentially responded to losses arising under the original
policies.
Lord Mustill observed that:

in ordinary speech, an event is something which happens at a particular time, at a
particular place, in a particular way… A cause to my mind is something altogether
less constricted. It can be a continuing state of affairs; it can be an absence of
something happening.
In summary, the meaning of event or occurrence is as follows:
• A unifying factor allowing a number of individual losses to be aggregated and treated as a
single happening.
• An event is what has happened as opposed to the reason for what has happened. It is
something that happens in a particular time, at a particular place and in a particular way.
• The individual losses must be sufficiently closely connected to the event by reference to
the unities of time, locality, cause and motive.
• The individual losses must have a causal connection to and must not be too remote from
the aggregating event.
• The assessment is objective, to be made from the perspective of the informed observer
and is a matter of intuition and common sense.
Before leaving this section, we should mention the ‘sole judge’ clause as another route to
aggregation. In this clause the reinsured reserves the right to decide, or is expressed as the
sole judge of what constitutes, e.g. each and every loss and/or one event.
In RE Brown v. GIO Insurance (1998) and at a time when the law equated ‘event’ with
‘originating cause’, the reinsured sought to aggregate claims arising from each (negligent)
underwriter for the purposes of claiming under its ‘event’-based reinsurance. It was held
open to the reinsured to decide mixed questions of fact and law and, as the reinsured had
directed itself to the correct question and the answer was neither perverse nor in bad faith
nor otherwise manifestly unreasonable, the decision was not open to question by reinsurers.
Consider this
this…
…
In your view, could a series of thefts over the period of a month by the same person in the
same manner constitute an ‘event’?
Learning point
Before you move on, make sure that you know the meaning of an event or occurrence in a
C4 Follow clauses
The follow clause (also known as loss settlement clause
clause) in a reinsurance contract binds
Chapter 8
reinsurers to pay in accordance with the payments of the reinsured under the original
insurance contract. Without it the reinsured ‘must prove the loss in the same manner as the
original assured must have proved it against them, and the reinsurers can raise all defences
Re London County
which were open to the reassured against the original assured’ (Re
Commercial Reinsurance Office (1922)
(1922)).
This latter approach is far from practical, hence the parties invariably agree – in facultative as
well as treaty reinsurances – some sort of loss settlement provision. In this section, we look
at three types: ‘follow the settlements’ clauses, ‘loss settlements binding’ clauses and, briefly,
‘follow the fortunes’ clauses.
It is important when interpreting such provisions to understand the inherent tension or
conflict in this clause. This was articulated by Lord Mustill in Hill & Others v. Mercantile and
General Reinsurance Co. (1996)
(1996). On the one hand, a reinsured wishes to avoid having to
investigate and agree a loss a second time, the first time when responding to a claim under
an insurance contract and the second time for the purpose of claiming under a reinsurance
contract. On the other hand, a reinsurer does not want to be bound to respond to all of the
reinsured’s original claim payments, of whatever nature. So, while payments relating to a
judgment or award are unlikely to be contentious, the same cannot necessarily be said of
settlements reached between an insured and its insurer. A loss settlement provision must
find a balance between these competing requirements of the parties.
Follow the settlements clause

A typical example of a follow the settlements clause is as follows:
‘Being a reinsurance of and warranted same gross terms and conditions as and to
follow the settlements of [the reinsured].’
In Insurance Company of Africa v. SCOR (1985)
(1985), a facultative reinsurance contract
contained both a ‘follow the settlements’ clause and a claims cooperation clause. Warehouse
premises in Monrovia, Liberia were insured against fire by the Insurance Company of Africa
(ICA) and, in turn, the ICA was reinsured facultatively by SCOR and other London Market
reinsurers. The warehouse caught fire. The adjusters – a local unqualified adjuster and a
second qualified adjuster from the head office – appointed by ICA found no suspicious
circumstances and, in due course, a claim was made against reinsurers. Reinsurers, however,
received anonymous letters claiming arson and fraud, and SCOR, after having instructed its
own adjusters, denied the claim. Later, it emerged that the anonymous letters had been sent
by business rivals of ICA. ICA was sued by the insured in Liberia and lost, and brought
proceedings against SCOR in London.
Both the court at first instance and of appeal, held that ICA was entitled to indemnity.
Importantly, Robert Goff, LJ, set out the effect of such a ‘follow the settlement’ clause,
namely that reinsurers agree to indemnify insurers if the:
• claim as recognised by the reinsured falls within the risks covered by the reinsurance
contract as a matter of law; and
• reinsured acted honestly and has taken all proper and businesslike steps in settling the
claim (the implied obligation).
So, in cases of absent dishonesty or breach of the implied obligation, reinsurers have no
basis to reinvestigate the original claim, and must rely on the honesty and professionalism of
the reinsured. The businesslike obligation will extend to include the appointment of the
adjuster, the adjuster adjusting the claim and the reinsured settling the claim. Further, it is
not relevant how the original claim was presented to the reinsured, only that it was settled.
Reinsurers may, however, argue that the claim falls outside the risks covered by the
reinsurance contract. On this point, it has been held in the Court of Appeal that a reinsured
does not have to show that the claim it settled, in fact, falls within the risks covered by the
reinsurance, but that the claim which [it] recognised ‘did or arguably did’ (Tuckey LJ in
Assicurazioni Generali v. CGU International Insurance (2004)
(2004)).
In ICA v. Scor, there was an added complication in that the reinsurance agreement also
contained a claim cooperation clause. This contradicted the follow the settlements clause by
requiring the reinsurer’s agreement before settling the claim. The court concluded that this
requirement took precedence over the follow the settlements clause. On the facts, this made
no difference, since the court concluded that the loss had been suffered and was covered by
the clause. Nevertheless, one can see that the claims cooperation clause can operate to
Chapter 8
emasculate a follow the settlements clause.

The courts have confirmed that, in most cases, once a reinsured has demonstrated that it has
settled a claim in the ordinary course of its business and its claim falls within the reinsurance
contract, it is for the reinsurer to prove that the original settlement was not in fact bona fide
or businesslike. In other words, there will be a presumption in favour of the reinsured that the
original claim is bona fide and businesslike.
Clear words must

Subsequently, the courts have considered the meaning of ‘liable or not liable’ and ‘without
be used if the question’ when added to loss settlements clauses. The first phrase was held to make no
parties intend to
exclude this
Charman v. GRE (1992)
difference to the relationship between the parties (Charman (1992)), and did not
implied obligation remove the obligation to settle inwards business in a businesslike fashion. Similarly, in
relation to the latter phrase, it was held only to emphasise that reinsurers were bound by the
settlement, even if it was subsequently proved that there was in fact no original liability, and
did not mean that the only limitation on the reinsurers obligation to follow the reinsured’s
Assicurazioni Generali v. CGU
settlement was that the reinsured had not acted in bad faith (Assicurazioni
International & Ors (2003)
(2003)). Clear words must be used if the parties intend to exclude this
implied obligation.
Loss settlements binding clause

An alternative loss settlements clause often found in excess of loss treaties and which was
considered by the House of Lords in Hill v. M&G Re (1996), is as follows:
All settlements by the reinsured shall be binding upon reinsurers provided that such
settlements are within the terms and conditions of the original policy and within the
terms and conditions of this policy.
Kuwait Airways Corporation (KAC) and British Airways (BA) lost a number of aircraft that
were on the ground at Kuwait Airport when Iraq invaded Kuwait on 2 August 1990. The
aircraft belonging to KAC were flown out of Kuwait at various times on dates in August and
September 1990. Some were later recovered and returned but seven were destroyed during
the course of the allied air offensive during 15 January and 28 February 1991. The BA plane
remained in Kuwait but was destroyed in an explosion on 22 February 1991.
The reinsured, a Lloyd’s syndicate underwriting as Hill & Others, had settled inwards claims
on the basis that such claims represented one loss that occurred on the date of the Iraqi
invasion. The reinsurer, M&G Re resisted the claim on many grounds, including that the
losses had occurred in 1991 when the reinsurance contracts on a losses occurring during
1990 basis had expired. M&G Re also argued that not all of the aircraft in respect of which an
indemnity was claimed had, in fact, been lost; some were subsequently recovered, and that,
if lost, there was no single loss encompassing all aircraft. In this context, the issue before the
court was whether the reinsurer could question the loss settlement of the reinsured. No
issues were raised in relation to the implied obligation.
The House of Lords distinguished the case from ICA v. SCOR on the grounds that the
relevant clause expressly required claims under the outward reinsurances to be within the
terms and conditions of both the original policies and the reinsurances. The reinsurer was,
accordingly, entitled to query whether it should be bound by the settlement of a loss that
occurred during a year in which it did not provide reinsurance to the reinsured, and that was
made up of distinct losses, each of which fell below the retention.
A similar wording was considered in Equitas v. R&Q (2009)
(2009). This case is particularly
interesting because the court approved the use of actuarial models to satisfy the first
proviso – namely that, on the balance of probabilities, the losses were within the terms and
conditions of the original, or in this case, the underlying, policies.
The London Market had wrongly aggregated certain losses and included irrecoverable
losses relating to, e.g. the Iraqi invasion of Kuwait. The issue was whether this precluded
Equitas from recovering losses that would otherwise be recoverable from particular
retrocessional excess of loss reinsurance contracts, the losses being tainted by its inability to
replicate the LMX spiral completely (and extract the irrecoverable losses).
It was held that while it was plainly necessary to proceed with caution, the models provided
an acceptable and soundly based route to establishing the properly recoverable minimum
Chapter 8
losses sustained by the syndicates. It was not necessary for Equitas to prove that the sums
claimed were properly due, on a contract by contract basis.
Following the grounding of the tanker, Exxon Valdez, and subsequent spillage, and clean-up,
of crude oil in Prince William Sound, Alaska, a reinsurer (NRG Victory Re) disputed its
liability to reimburse reinsureds (including Commercial Union (CU)) for amounts paid to
Exxon in respect of Exxon’s liability for clean-up costs. The reinsureds had settled with
Exxon during legal proceedings in Texas and, under the reinsurance contracts, it was a
condition precedent to the reinsurer’s liability that the reinsured’s underlying settlements
were in accordance with the terms and conditions of its original policies. In Commercial
Union v. NRG Victory Re (1998)
(1998),NRG argued that the original policies were governed by
English law and under that law the reinsureds were not liable to Exxon, so it was not bound
by the settlements. In turn, CU argued that it had demonstrated its legal liability to its
insured by taking all reasonable defences in the proceedings and making a sensible
settlement on the advice of its local lawyers.
At first instance, it was held that the reinsureds had proved their loss. On appeal, this was
overruled on the basis that the first instance judge should have made his own decision as to
whether or not it was arguable that the reinsureds were not liable to Exxon under the
applicable law, and not relied on the local lawyer’s opinion. The wider point is perhaps that, if
a reinsured’s liability to its insured is established by a court of competent jurisdiction, the
reinsurer will be liable under a reinsurance contract that is governed by English law.
Question 8.3
Does the reinsured have to prove that it acted honestly and took all proper and
businesslike steps in settling a claim, in order to recover from a reinsurer?
Further, in AstraZeneca Ins Co v. XL & Ace (2013)

(2013), a pharmaceutical’s captive sought
reimbursement from its reinsurers for settlements and costs incurred in the USA in relation
to a prescription drug, Seroquel. Unusually, the Bermuda Form was governed by English law
and conferred jurisdiction on the English Commercial Court. Reinsurers declined
reimbursement on the basis that the cases were settled in the absence of any legal liability to
do so. Accordingly, the main issue before the court was whether it was only necessary for
the claimant to demonstrate that it settled an arguable liability rather than an actual liability
(that is, in the sense that, on a balance of probabilities, ‘it would have been liable for the
claim in question, on the basis of the correct application of the system of law governing the
claim to the evidence properly analysed’. Justice Flaux held that the form responded only to
an actual liability.
Other settlements
Clauses make
On occasion, loss settlements clauses make reference to whether ex gratia and/or without
reference to ex prejudice settlements are included or excluded from the obligation to follow settlements.
gratia and/or
without prejudice
settlements
Be aware
Ex gratia settlements are payments made in the absence of legal liability for pure
commercial reasons, whereas without prejudice settlements are those made with no
admission of the existence of any liability under the terms of the original policy.
Example 8.3
Faraday entered into a settlement agreement with its insured which recited, among other
things, that it was ‘by way of compromise, and without prejudice to or waiver of their
respective positions … and without the London market insurers admitting liability’.
Faraday’s reinsurance contract, however, excluded from its reinsurer’s (Copenhagen Re)
‘follow settlements’ obligations both ex gratia and without prejudice settlements. The
Court held that the compromise settlement was plainly a without prejudice settlement
and so fell outside the clause in the reinsurance contract (see Faraday v. Copenhagen
Re (2006)
(2006)).
Follow the fortunes clause

A typical example of a follow the fortunes clause is as follows:
It is the intention of this Agreement that, in all matters falling within its scope, the
Chapter 8
reinsurers shall, to the extent of their interest, follow the fortunes of the reinsured in
every respect.
Refer to Such clauses are common in proportional reinsurances where reinsurers are much less
chapter 7,
section B4C for concerned about second guessing their reinsureds, and are complemented by errors and
errors and omissions clauses.
omissions clause
D Implied terms
Contract terms may be implied by:
• common law;
For the courts to imply a term by law, a party must show that such a term is necessary to
give business efficacy to the contract, is consistent with the express terms of the contract
and would have been agreed by the parties (see Reinsurance Practice and the Law
chapter 10, Clyde & Co LLP).
• statute law;
• previous dealings between the parties; or
• trade custom or usage.
The requirements for a term to be implied by trade custom or usage are that the custom or Consistent with the
usage must be notorious, certain and reasonable, universal in the context of the particular express terms of
the contract
trade, business or market, and consistent with the express terms of the contract.
D1 Inspection
In Phoenix General Ins. Co. v. Halvanon Ins. Co. (1985), Hobhouse, J, implied a right of
inspection into a facultative obligatory reinsurance treaty where no wording had been
agreed. However, in the absence of special circumstances, it may be that there is no general
implied right of inspection.
In a case where the wording had been agreed, Hoffmann, LJ said:
reinsurers are free to stipulate for whatever rights of inspection they please. This is a
matter of commercial negotiation between the parties. If they are not entitled to
inspection as a matter of contractual right and a dispute arises, English law gives
them no procedural means of inspection unless….
This may mean that reinsurers are unable to uncover defences that greater rights of
inspection would have revealed. This is a commercial risk that they accept at the time when
Sail v. Farex (1995)
the contract is made (Sail (1995)). In short, the wording reflected the parties’
bargain and, if required, could have included an inspection clause and a price set for
the right.
D2 Costs and expenses

In Colin Baker v. Black Sea & Baltic Insurance (1996)
(1996), the courts were asked to consider
whether, in relation to a proportional reinsurance, there existed an implied obligation on
reinsurers to indemnify the reinsured for its proportion of the reinsured’s own costs and
expenses. In addition to original indemnity costs and expenses, the costs and expenses at
issue had been incurred investigating, settling and defending claims.
According to Millett, LJ:
what was needed was evidence of a universal and acknowledged practice of the
market for reinsurers to pay such costs whether this is expressly provided for in the
treaty or not; or (to put it another way) that it is well understood by underwriters
that if it is not intended that the indemnity should extend to the legal costs and
expenses of the reinsured, these need to be expressly excluded. There is no such
evidence.
Be aware
Later, the House of Lords upheld the Court of Appeal’s decision but said that it was not
clear that no such evidence of a universal practice was available.
Chapter 8
D3 Arbitration
Arbitration agreements are self-contained and ancillary to the commercial contracts to
which they relate. An express provision is required. Similarly, it is not possible to use general
words of incorporation to incorporate the arbitration agreement in an underlying contract
into the overlying contract (see section C2, specifically Pine Top v. Unione Italiana
Anglo-Saxon Re (1987)).
D4 Irrelevant terms
Section 11 of the Insurance Act 2015 provides an example of a term implied by statute law. Reinsurers cannot
The Act prohibits reinsurers from relying on a breach of a term that is entirely unconnected rely on a breach of
a term that
to the loss that actually occurred in order to exclude, limit or otherwise avoid liability for that is entirely
loss. For example, a facultative reinsurer of an ‘all risks’ property policy may not use a breach unconnected to
the loss
of a burglar alarm warranty to disclaim liability for a loss caused by a fire. This is because the
breach was not, on the facts, relevant to the loss.
This ruling applies to any express or implied term which, if complied with, would tend to
reduce the risk of a loss:
• of a particular kind;
• at a particular location; or
• at a particular time.
It does not apply

It does not, however, apply to any term which defines the ‘risk as a whole’. The Law
to any term which Commissions have suggested that this may include terms which define the geographical
defines the ‘risk as
a whole’
area in which a loss must occur, or the age, identity, qualifications or experience of the
operator of a vehicle, vessel or aircraft. It remains to be seen quite how this phrase will be
interpreted by the courts.
Importantly, the reinsured who uses this defence must be able to demonstrate ‘that the
non-compliance with the term could not have increased the risk of the loss which actually
occurred in the circumstances in which it occurred.’
Therefore, in the case of a theft where a burglar alarm has not sounded because it was in
need of repair, but the warranty states that it must sound and be in full working order, the
reinsured would not be able to satisfy this requirement. This is because the breach obviously
caused the loss which actually occurred in the circumstances in which it occurred.
D5 Late payments
Section 13(A) of the Insurance Act 2015, as introduced by the Enterprise Act 2016 on
4 May 2016, provides another example of a term implied by statute law. Under this section, if
the (re)insured makes a claim under the contract, the (re)insurer must pay any sums due in
respect of the claim within a reasonable time
time. This applies to all reinsurance contracts
entered into on or after 4 May 2017 which are governed by the laws of England and Wales,
Scotland or Northern Ireland.
It is stated that a ‘reasonable time’ comprises a reasonable time to investigate and assess the
claim. The matters that may be taken into account are non-exhaustive, but examples are
listed, such as the type of (re)insurance, the size and complexity of the claim, and
compliance with any relevant statutory or regulatory rules or guidance. There is also a
defence where a (re)insurer has reasonable grounds for disputing the validity or value of
the claim.
If breached, the (re)insured is entitled to recover contractual damages which, in most cases,
are restricted to compound interest.
The term was introduced in part to address the unfairness highlighted in Sprung v. Royal
Insurance (1997)
(1997). After Mr Sprung’s business was vandalised, his insurance claim was
rejected and, as he was unable to pay for repairs, his business collapsed. Mr Sprung
Chapter 8
proceeded to successfully sue the insurers, but his indemnity did not include a sum to
recompense him for the loss of his business because, at that time, there was no right to
damages for late payment.
It is permissible to contract out of these provisions, but not in respect of deliberate or
reckless breaches of the implied term. Note that there is a one-year-limitation period within
which to bring an action, commencing from the date at which full payment of the sums due
under the contract is made.
Reinforce
Before you move on, make sure that you understand the difference between express and
implied terms and how they apply in reinsurance contracts.
E Limitation
Typically, all civil legal systems fix a period beyond which a claim against another may not be
pursued. This period is generally referred to as the limitation period
period. Where proceedings
have not been commenced within that period, the claim is said to be time-barred.
Under English law, the limitation period relating to contracts, including reinsurance
contracts, is to be found at s.5 of the Limitation Act 1980
1980, ‘an action founded on simple
contract shall not be brought after the expiration of six years from the date on which the
cause of action accrued’.
The limitation period does not operate automatically to bar claims six years after the date of Limitation period
accrual. Time-bar is a defence available at the discretion of the reinsurer, not the court. The does not
automatically bar
cause of action itself is not extinguished, rather it becomes unenforceable if the defence is claims six years
made out. In other words, it is the remedy not the right that is barred, reflecting the public after date of
accrual
policy principle that the law does not recognise stale claims.
The limitation period runs from the date when a cause of action accrues which, in this
context, is when the reinsured’s liability is ascertained by agreement, award or by judgment
Halvanon Ins. v. Companhia de Seguros do Estado de São Paulo (1995)
(Halvanon (1995)). For the avoidance
of doubt, the date of discharge of that liability to the original insured is irrelevant. So, if no
claim form (formerly, writ) is issued or arbitration proceedings commenced within six years
of that date, the debtor will be able to deny liability for the debt on the basis that it is time-
barred.
In Halvanon, the reinsured issued a claim form which detailed sums owed by reinsurers. It
attempted to produce evidence that such monies had fallen due within six years of the
commencement of the proceedings on the premise that the cause of action did not accrue
until presentation of the account.
Steyn, LJ, disagreed:
In the absence of special clauses … the cause of action arises when the underlying
liability is ascertained by agreement, by award or by judgment. It is not postponed
until the rendering of an account.
The limitation period may be amended by agreement. In the reinsurance contract, the Limitation period
parties may agree that the cause of action accrues from a date other than that stipulated by may be amended
by agreement
the Limitation Act (for instance, if later, the date of delivery of periodic accounts). It is clear,
however, that a reinsured cannot extend the limitation period by failing to submit accounts
to its reinsurer.
Additionally, rather than commencing proceedings – if, for example, settlement negotiations
are well advanced – the parties may enter into a Standstill Agreement or, in the USA, a
Tolling Agreement. Such an agreement has the effect of suspending the running of time
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from a specified date, and is usually on terms that defences that have arisen (for example,
time-bar) are preserved.
Be aware
The limitation period may also be extended by written acknowledgement and part
payment.
F Measures to avoid disputes

The consequences of disputes can be very serious for all parties. Disputes can result in
claims being repudiated and uncollected, professional indemnity claims for brokers and loss
of reputation.
A number of situations that give rise to disputes can be avoided by monitoring and review
procedures. In this section we have examples of actual situations that caused disputes, with
notes on how the issues could have been prevented or how they were resolved.
F1 Not complying with claims clauses

CGX Insurance Company wrote motor and employer’s liability and was protected by a motor
and liability excess of loss programme. The reinsurance programme was subject to a claims
co-operation clause. This specified that all claims involving death, brain damage or spinal
injury should be reported to reinsurers immediately, irrespective of the level of the initial
reserve. CGX’s procedure was to only advise reinsurers of claims that were reserved at
monetary amounts that exceeded the retention of the first excess of loss layer. CGX also had
a procedure to initially enter into their system a reserve of £100 for each bodily injury claim,
with the intention of updating the reserve once medical reports and legal opinions had been
received.
In practice a number of these claims, which involved spinal injury or brain damage, were
reserved at £100 for about two years. On receipt of medical and legal reports, the individual
reserves on some of these claims jumped to between £1m and £4m. At that point CGX
reported the claims to the reinsurers. Reinsurers repudiated liability on the grounds that
these losses were reported two years late.
Meanwhile, with the assistance of the reinsurance broker, CGX held internal claims seminars
and upgraded internal systems and procedures to ensure that all serious bodily injury claims
were reported immediately to reinsurers. Ongoing discussions were held involving CGX, the
broker and the reinsurers. CGX apologised, explained that the late reporting was a genuine
oversight and advised of the new procedures that were now in place. The reinsurers finally
agreed to pay the claims.
This situation would never have occurred if CGX had the correct internal procedures at the
outset. This case was finally resolved amicably, but reinsurers would have been within their
rights to repudiate the claims, which totalled several million.
There have been a number of other cases where reinsurers have categorically repudiated
liability where there have been clear cut breaches of the claims reporting and claims co-
operation clauses.
Chapter 8
F2 Non-disclosure of material information

BLG Insurance Company wrote property insurance through various overseas agencies. This
was protected by a surplus treaty with a Cat XL programme for the net retention.
Several years after the surplus treaty was first placed, BLG decided to cede a number of
smaller risks to the surplus treaty that were previously 100% retained. BLG wrote letters to
reinsurers to advise of this change. There were however several reinsurers who BLG
inadvertently omitted from the circulation list and which were never advised. There was no
endorsement to the placing slip or to the treaty wording, and no formal update to the
information presentation.
A hurricane caused a huge loss to BLG’s Caribbean account. Virtually all the risks damaged
by the hurricane were the smaller risks that BLG had previously retained 100%, but which at
the date of the hurricane had been ceded to the Treaty. BLG submitted a claim to the surplus
treaty reinsurers.
All the reinsurers initially disputed the claim on the grounds that ceding the smaller risks was
never specified in the placing information. BLG produced the letters that were sent advising
reinsurers of the change and the reinsurers that received the letters eventually agreed to
settle their share of the claim. The reinsurers that did not receive the letters, however,
repudiated liability on the ground of non-disclosure and that left BLG with a sizeable amount
that was uncollected.
The proportion of the risks ceded to the surplus treaty could not be added to the ultimate
net loss for purposes of recovery from the Cat XLs. Excess of loss treaties specifically
exclude claims amounts that cannot be recovered from other treaty arrangements.
Key measures that can be taken to avoid inadvertent non-disclosure include:
• A thorough review of the information and slip wording before each renewal to ensure all
information and coverage is correct and adequate for the forthcoming year.
• Quarterly or half yearly review meetings to cover the reinsured’s activities and
developments and to ascertain if any changes should be made to the treaty documents
that would need to be agreed and signed by all reinsurers. The reviews could also include
a cross check of the information. Significant changes could be advised to reinsurers by
way of an ‘information endorsement’ to be signed by all reinsurers.
All reinsurance treaty contracts contain an inspection of records clause. This allows
reinsurers to visit the reinsured’s offices and look through all manual and electronic files
relevant to the business reinsured. Reinsured’s that are deliberately, or inadvertently, guilty
of non-disclosure run the risk of being caught out.
Chapter 8
Key points
The law applicable to reinsurance contracts
• A contract of reinsurance is a distinct and separate contract from the underlying contract of
(re)insurance.
• A contract of reinsurance is subject to the general rules governing contracts and, therefore,
requires for its valid formation offer and acceptance, consideration and legality.
• A contract of reinsurance is subject to the special rules governing insurance contracts, for example,
utmost good faith, indemnity and insurable interest. It is also subject to the duty of fair presentation
under the Insurance Act 2015.
Interpreting contractual documents – key issues and case law
• Reinsurance contracts are subject to the ordinary principles of construction (or interpretation):
– The court must give effect to the expressed intention of the parties.
– Words should be given their ordinary and natural meaning. However, if the meaning of the word
has been settled by a court, or if a word has a technical meaning, it is presumed that such
meanings were intended.
– Context may come from either within, or exceptionally, outside the terms and conditions of the
– Extrinsic evidence may be sought to elucidate technical meaning, to resolve ambiguity or
absurdity or, as envisaged by Lord Hoffmann in ICS v. West Bromwich BS (1998), to ascertain
what a reasonable man, having the background knowledge and information of the parties at the
time of the contract, would have understood the parties to have meant.
• The courts continue to make use of the long established rules of construction, but now as
presumptions or guidelines. These include the Parol Evidence Rule; contra proferentem; standard
printed terms which are overridden by those terms specifically agreed by the parties, which may,
for example, have been written, typed or stamped; and ejusdem generis.
Chapter 8
Express terms
• A warranty is a contractual promise made by a reinsured as to past or existing facts (or ‘state of
affairs’), or to its own future conduct. A breach causes the reinsurance cover to be suspended until
remedied (if it can be).
• A condition precedent is a contractual promise which must be performed to bring a valid contract
into force or, once in force, to make the reinsurer liable under that contract. On breach, the reinsurer
is discharged from liability to pay a particular claim. The breach has no impact on future claims
under the contract.
• A condition is a contractual promise under which the reinsured promises to perform some action. A
reinsured’s right to recovery is not dependent on the act being completed. A reinsured is entitled to
claim damages for loss caused by the breach.
• An innominate term is another contractual promise where the remedy for breach depends on the
seriousness of the breach. Where the breach is serious, a reinsurer may be entitled to repudiate the
contract. Where it is minor, the remedy would be in damages only.
• The parties may use incorporation clauses to import the terms of the original insurance contract
into the reinsurance contract.
• A common issue for the parties to a reinsurance contract is whether original claims may be
aggregated for the purposes of a claim under that contract. The issue may be addressed specifically
by aggregation clauses e.g. the hours clause or alternatively, the parties must look to the reinsuring
clause and to the basis of the limit and retention.
• The meaning of an event or occurrence is:
– A unifying factor allowing a number of individual losses to be aggregated and treated as a single
happening.
– An ‘event’ is what has happened as opposed to the reason for what has happened. It is
something that happens in a particular time, at a particular place and in a particular way.
– The individual losses must be sufficiently closely connected to the event by reference to the
unities of time, locality, cause and motive.
– The individual losses must have a causal connection to and must not be too remote from the
aggregating event.
– The assessment is objective, to be made from the perspective of the informed observer and is a
matter of intuition and common sense.
• Follow clauses attempt to find a balance between, on the one hand, a reinsured wishing to avoid
investigating and agreeing a loss a second time, the first time when responding to a claim under an
insurance contract and the second time for the purpose of claiming under a reinsurance contract
and, on the other hand, a reinsurer not wanting to be bound to respond to all of the reinsured’s
original claim payments, of whatever nature.
• Follow the settlement clauses bind reinsurers where the claim as recognised by the reinsured falls
within the risks covered by the reinsurance contract as a matter of law, and the reinsured acted
honestly and has taken all proper and businesslike steps in settling the claim.
• Loss settlement binding clauses bind reinsurers provided the settlements are within the terms and
conditions of the original and reinsurance policies.
Chapter 8
Implied terms
• Contract terms may be implied by common law, by statute law, by previous dealings between the
parties, or by trade custom or usage.
• Arbitration agreements are self-contained and ancillary to the commercial contracts to which they
relate. An express provision is required. Similarly, it is not possible to use general words of
incorporation to incorporate the arbitration agreement in an underlying contract into the overlying
contract.
• The Insurance Act 2015 prohibits reinsurers from relying on a breach of a term which is entirely
unconnected to the actual loss to exclude, limit or otherwise avoid liability for that loss. Terms
affected by this provision are those which seek to reduce the risk of loss of a particular kind or at a
particular location or time.
• The Insurance Act 2015 also imposes an obligation on reinsurers to pay any sums due under the
contract within a reasonable time. On breach, the reinsured is entitled to recover contractual
damages.
Limitation
• Under English statute law, the limitation period relating to reinsurance contracts is six years. This
allows a reinsurer to reject claims made more than six years after the date on which the original
right to make a claim came into existence (or accrued).
• The limitation period may be extended by agreement between the reinsured and reinsurer.
Measures to avoid disputes
• The consequences of disputes can be very serious for all parties, leading to claims being repudiated
and uncollected, professional indemnity claims for brokers and loss of reputation.
• A number of situations that give rise to disputes can be avoided by monitoring and review
procedures.
Chapter 8
Question answers
8.1 Overstatement rather than understatement of the loss record.
8.2 False. Under the laws of England and Wales, a warranty must be construed to
produce the same effect in back-to-back insurance and reinsurance contracts.
8.3 In the context of a follow the settlements clause: no, the onus is on the reinsurer to
plead and prove any failure to act in a proper and businesslike manner.
Chapter 8
Self-test questions
1. What part does a ‘reasonable search’ play in the duty to make a fair presentation of
the risk?
2. What formal requirements are necessary for an ordinary contract?
3. What is the test for a term to be implied by common law?
4. What is contra proferentem?
5. Describe a warranty and the effect of its breach by a reinsured.
6. According to Evans, LJ, in Caudle v. Sharp (1995) what three elements are required
for an event?
7. What is a limitation period?
8. Describe the inherent tension in follow (or loss settlement) clauses.

Chapter 8
Reinsurance market
9
outcomes
Learning objectives
Introduction
Key terms
A Nature of the reinsurance market 9.1
B Global reinsurance markets 9.1
C Captive insurance companies 9.1
D Market cycles 9.2, 9.3
E Financial strength ratings 6.5, 9.1
F Mergers, acquisitions and reinsurer failures 9.1
G Terrorism 9.1
Key points
Question answers
Self-test questions
Learning objectives
• discuss the structure, operation and regulation of reinsurance markets;
• describe the composition, size and capacity of principal global reinsurance markets;
• explain the main characteristics and operation of captive insurance companies;
• describe the evolution of market cycles and their impact on underwriting performance
and reinsurance capacity; and
• discuss the importance of financial strength ratings in the placing of reinsurance.
Chapter 9
Introduction
A market is any place that brings together a buyer and a seller to agree a price to exchange
goods or services. A market can be very formal such as a shop, a financial market such as the
stock exchange or it can be a car boot sale, selling goods from a street corner or an advert in
a local newspaper. The various products on offer can be reviewed and a decision to buy or
sell made.
To align this concept more closely to our area of study we can consider what Professor
Carter, a specialist in insurance and a professor of economics, had to say about markets:
A perfect market is one in which a homogeneous commodity is traded among many
buyers and sellers who have easy access to one another and freely exchange
information on prices, terms and availability of the commodity.
Key terms
Broker market Captive insurance Domicile Financial strength

companies ratings
Hard reinsurance International Lloyd’s London Market

market Underwriting
Association (IUA)
Market capacity Market cycles National Association of Rating agencies

Insurance
Commissioners (NAIC)
Realistic disaster Risk financing Securities and Soft reinsurance market

scenarios (RDS) Exchange
Commission (SEC)
Solvency II Syndicates Terrorism Underwriting cycle
A Nature of the reinsurance market

In the reinsurance market, the commodity is reinsurance, which is bought and sold both
within the confines of local regional insurance markets, as well as between markets on an
international basis. The size, capacity and nature of reinsurance markets range greatly from
the small monopoly markets of certain developing countries to the large international
markets based in London, New York, Bermuda, Japan, Switzerland and other locations.
In fact, owing to technological advances in communications, many of these trading centres,
which may have been considered as separate entities only a few years ago, can now operate
largely as a single, highly competitive integrated market for the buying and selling of
reinsurance.
Question 9.1
In what fundamental way do insurance and reinsurance markets differ from most other
Chapter 9
types of market?
No clear division
There can no longer be a clear division between domestic and international reinsurance
between domestic markets. Due to the size and nature of many of the risks accepted by insurers today, there is
and international
reinsurance
a worldwide need to spread risk outside the confines of a national insurance market.
markets Companies which previously wrote predominantly domestic insurance and reinsurance
accounts are often able to participate in international reinsurance business.
In some markets, only locally established companies operate and their business is almost
exclusively domestic. In these instances, inwards foreign reinsurance may be restricted to
reciprocal exchanges. On the other hand, in the large, well-established markets, such as
London, the reinsurance of overseas insurers forms a substantial part of the business
transacted by both domestic and foreign reinsurers.
Chapter 9 Reinsurance market 9/3
Reinforce
Before you move on, remind yourself of the various buyers and sellers of reinsurance
(studied in chapter 1) operating in the markets.
A1 Consolidation
Consolidation of the reinsurance market and the experience of reinsurance failure have The security of the
caused insurers to be reluctant to place all of a programme with a single reinsurer. The reinsurer is a
paramount
security of the reinsurer is a paramount consideration for the insurer. consideration for
the insurer
Consolidation both in the insurance and the reinsurance markets has resulted in reinsurers
having fewer clients, and many of these have a financial strength equal to or superior to their
own. Insurers have fewer reinsurers with which to place their business and many,
recognising the importance of relationship over the long-term, carefully select a panel of
strong reinsurers. This gives the insurer a spread of security, and from the long-term
relationship, the expectation of stability of cover and pricing.
A2 Requirements for an international reinsurance market

There are a number of factors that allow the successful development of an ‘ideal’
international centre for reinsurance. In his book International Insurance and Reinsurance
Centres of the Future, Eric Herve-Bazin listed the requirements that a successful
international centre would need and these are summarised in this section.
A2A Political stability

Reinsurance is a long-term product. Both buyers and sellers of the product want to be sure Reinsurance is a
that the market will not change out of all recognition in the future. A concern would be that a long-term product
government might want to impose trading restrictions or even nationalise the entire
industry.
A2B Geographical location

For an international reinsurance market to be successful, it must have access not only to its
own internal insurance markets but also to any neighbouring foreign insurance markets.
With the development of information technology, instantaneous electronic communication
and widespread access to the internet, territorial location has – to some extent – reduced in
importance. Some major writers of reinsurance are increasingly taking into consideration the
attractiveness of a jurisdiction’s tax regime in deciding where to be domiciled
domiciled.
Consider this
this…
…
In this respect, consider the advantages that London has compared to, say, Beijing.
A2C Quality transport system

The market must be easily accessible by foreign insurers. This includes good air links to other
countries and reasonable internal travel arrangements available within the city in which the
market operates.
Chapter 9
A2D Developed communication systems

Communication systems have become more vital with the development of the internet. A
considerable amount of reinsurance business is transacted using telecommunication lines
and links need to be secure and readily available to ensure business success.
A2E Highly qualified personnel

There must be a pool of specialised staff available to service the industry; this means Must be a pool of
underwriters as well as support staff, such as claims and accounting personnel. This allows specialised staff
available to service
easy entry into the market for new reinsurers who can purchase staff from the existing pool the industry
of talent.
A2F Office space at competitive prices

The cost of office space in the central business district of a city can sometimes be
prohibitive, if available at all, and this has in the past prevented the development of some
markets. However, with the use of information technology the impact of these costs can be
marginalised.
Some reinsurers and brokers have moved some of their back-office requirements outside
the London Market to provincial locations, sometimes overseas, because of the reduced cost
of staff and office space. Nevertheless, most regard a head office presence in the heart of its
chosen market as essential.
A2G Multi-lingualism
The reinsurance market must be able to converse with its clients and understand the
information being sent to them. This means that a facility to translate into an acceptable
language must be available within the market.
A2H Stable legal and regulatory environment

The courts and regulatory authorities must be acceptable to the clients of the reinsurance
market and this includes the need for a legal framework adapted to the sector. For example,
English law has built up a large background of developed reinsurance law and is recognised
as a choice of law for disputes.
Regulatory
The regulatory authorities must be recognised as being sound and as not allowing reinsurers
authorities must be to set up with insufficient resources to provide security. This relates to the long-term aspect
recognised as
being sound
of the reinsurance industry: reinsurers must be available to pay losses sometimes many
years after the contract originally incepted.
A2I Liberal attitude by authorities

Authorities must allow the growth of the sector without imposing too many restrictions in
terms of bureaucracy and taxation. At first glance, this requirement may seem at odds with
those discussed in section A2H. In essence, reinsurers want the freedom to grow their
business whilst accepting the constraints that any proper regulatory and supervisory
framework is likely to want to impose.
A2J Quality family life

Where companies are unable or unwilling to recruit locally they have to consider importing
their own talent from elsewhere. Whether individuals will want to relocate is another matter.
Much will depend on the quality of life that the company is able to offer that talented
individual in the territory in which the relocation is proposed. Furthermore, the companies
will need to consider whether they can look after the aspirations of staff together with the
welfare of spouse and children.
A2K Time zone

With the advances in telecommunications, this has had less impact. However, staff do not
want to be working unsociable hours in the office for long periods of time. In a reinsurance
Chapter 9
market, staff need to be available to supply answers when their clients require them.
Therefore, there generally needs to be some overlap in the time zones between the relevant
markets, so that direct communication is available at least some of the time.
Activity
It is January and you are a reinsurance technician located in Zurich. Based on Central
European Time (CET) consider what time you would want to make a conference call to
your clients’ breakfast meeting in Chicago.
A2L Foreign presence

A country’s own
A country’s own reinsurers do not solely dominate the market. A strong foreign presence
reinsurers do not allows the development of international reinsurance rather than a strong concentration on
solely dominate
the market
the domestic market only. This reflects the cosmopolitan nature of the reinsurance
community.
A2M Strong national industry

The strength of the national industry of a country can help the development of the
reinsurance industry. For example, the growth of the German reinsurance industry was
possible mainly due to a strong domestic insurance industry.
A2N Centralisation
Where competition from other cities in the country or other cities in nearby countries is
limited, this is a distinct advantage in attracting reinsurers to a market. For example, in the
UK, although there are other regional centres such as Liverpool and Edinburgh, reinsurance
has always been conducted predominantly in London and any reinsurer looking to locate in
the UK will always look to London.
A2O Tight economic controls and developed financial centre

With the advent of alternative risk techniques, the location of a strong market is an
advantage to insurers looking for different ways of handling their risks away from the
traditional reinsurance placements. The location of a developed financial centre also
provides an additional source of clients and a possible additional source of capital when
looking to set up in or expand into a market. Reinsurers are interested in a relatively stable
economy.
Be aware
Strong inflation has an adverse effect on rate estimation and influences the estimation of
other costs, such as office space and staffing costs.
A2P Strong currency

Reinsurers do not want to be in an economy where the currency is under constant threat of
devaluation. This makes it very difficult to establish a reasonable perspective for the
development of long-term business relationships.
Be aware
Currencies fluctuate in value in relation to each other but, as a rule, reinsurers prefer to
conduct their business in so-called major currencies, such as GBP and US$. This is because
they are supported by the world’s biggest economies and are therefore less likely to be
predisposed to sharp movements in relative value.
A2Q Arbitration facilities

Most reinsurance contracts favour arbitration to litigation and so insurers and reinsurers Most reinsurance
prefer commercial centres that can provide an experienced pool of arbitrators and defined contracts favour
arbitration to
techniques of arbitration. Although arbitrations can be conducted anywhere, there is a litigation
desire to locate them in existing centres, such as London or New York, and when inserted
into wordings, arbitration clauses usually suggest a major existing centre as the seat of
arbitration.
A3 Extraneous environmental features

Chapter 9
Table 9.1 shows other market aspects which also affect the purchase of reinsurance.
Table 9.1: Extraneous environmental features

Price The price of reinsurance fell rapidly through the late 1990s; only following 9/11
and the collapse of the equities markets has there been any substantial increase.
After Hurricane Katrina in 2005, some areas of the reinsurance market, such as
natural catastrophe, energy and retrocession, responded positively but overall
there was not a substantial movement in the price and in some lines it actually fell.
There is also reluctance on the part of insurers buying, say, pecuniary loss classes
of reinsurance to want to pay more to prop up unprofitable property portfolios.
This shows that a number of different aspects affect price.
Availability and the relative strength of the equity markets are influencing factors.
As was seen when world financial markets were affected by the banking crisis in
2008, reduced values of equities and lower returns on investments meant that
management wanted a better return on underwriting capital, which resulted in
increased pricing.
Availability Following 9/11 there was a significant tightening of the capacity available within
the market due to the withdrawal or bankruptcy of several notable reinsurers, e.g.
Gerling and Highlands Insurance.
However, following Hurricane Katrina a number of new enterprises were set up,
notably in Bermuda, to take advantage of the post-9/11 potential rate increases.
As a result, there was not such a profound impact on the market.
Strength of Reinsurance companies become larger through mergers and acquisitions. With
competition the decline in the equities market, this trend has become less popular but in 2005
Swiss Re acquired GE Insurance Solutions, the fifth largest reinsurer worldwide,
from General Electric Company in a US$6.8 billion transaction. This made Swiss
Re the world’s largest reinsurer for a while. However, by 2010 Munich Re had
regained the top spot.
Developments in With the advent of electronic placement and claims collection, recovery times
loss exposures have decreased, putting a strain on the cash flow of some reinsurers.
This is a double-edged sword, as reinsurers can then apply similar pressure on
their retrocessionaires.
Potential claims Following 9/11, insurers and reinsurers have had to re-evaluate their potential
exposure to catastrophes and purchase reinsurance accordingly.
New products With a lack of capacity in some areas of the reinsurance market, insurers have
again reconsidered other financial alternatives to traditional reinsurance covers.
Financial markets A sharp decline in the value of financial markets in the early 2000s, followed by
an even more dramatic downturn in 2008, means that reinsurers can no longer
count on investment income as a means of offsetting reinsurance deficits. This
has affected the level and price of the reinsurance available.
While equities still play an important part in determining the pricing of
reinsurance, financially sound underwriting has become more prevalent as
companies seek a better underwriting return on capital.
Coverage The broader the coverage available the more likely that reinsurance will be
purchased. Conversely, coverage tends to be restricted in a hardening market.
The terrorist attacks of 9/11, and subsequent losses, raised the issue of how cover
could be made available for terrorism-related risks. Individual international
markets have devised innovative ways of providing cover, given the initial
intention of reinsurers to apply terrorism exclusions to the cover they provide.
Chapter 9
Question 9.2
Following major market losses such as 9/11, Hurricane Katrina and Hurricane Ike, what are
the likely effects on reinsurers’:
a. reserves;
b. return on capital;
c. terms and conditions of coverage;
d. EML calculations?
Learning point
Before you move on, make sure that you have a full picture of the requirements for a
successful international centre of reinsurance.
B Global reinsurance markets

As an introduction to the main markets for the acceptance of reinsurance, appendix 9.1
(available on RevisionMate) gives a sense of the size of the underlying (non-life) insurance
market by region. You may wish to take the time to look at it now.
We shall now review the main markets. For convenience, these have been grouped into a
number of principal regions where the underwriting of international reinsurance, often in
addition to a domestic account, has become an important feature of the financial sector.
Be aware
According to estimates compiled by Swiss Re’s Sigma team, total insured losses for the
global insurance industry in 2016 from natural catastrophes and man-made disasters
reached US$46bn and US$8bn, respectively, compared with total insured and uninsured
losses of US$175bn, highlighting the widespread lack of insurance protection globally
against catastrophic events.
B1 London Market
The London Market can be divided into two components: LloydLloyd’’s and the London Market London Market can
companies. The London Market companies have formed their own centralised unit – the be divided into
two components
International Underwriting Association (IUAIUA). Many of the participants within the London
Market are subsidiaries of international insurance companies. This gives them two
advantages:
• Substantial capital backing
backing, which allows them to participate in greater reinsurance risks
than they could if relying solely on their own capacity based on their own capital.
• Access to a wider range of business either coming into the London Market through such
channels as international brokers, or from business passed on from their parent company
arising from the domestic market.
The London Market has a positive impact on the UK economy, as its significant international
insurance and reinsurance business generally brings in substantial premium income.
Originally growing from a centre of international marine insurance, it also oversaw the
modern development of reinsurance, such as excess of loss reinsurance and many speciality
lines.
London is a recognised market leader in marine hull, energy, aviation, space and a few
speciality areas, such as political risks. This means that the London Market has a significant
market share in these areas and other markets will look to London to assess the rates for
these risks.
Useful website
An excellent way to keep up to date with changes in the London Market is to be a regular
visitor to www.londonmarketgroup.co.uk.
B1A Lloyd
Lloyd’’s
The Lloyd’s market, based in Lime Street, London, has operated for over 325 years. It is the
Chapter 9
Lloyd’s is the
world’s leading insurance market and the world’s third largest non-life insurer. It also world’s leading
insurance market
occupies sixth place in terms of gross global reinsurance premium income.
The Corporation of Lloyd’s, which manages the Lloyd’s market, is not itself an insurance
company. It is a society of members, both corporate and individual, who underwrite in
syndicates on whose behalf professional underwriters accept risks.
Capital is provided by the members, which may be investment institutions, specialist
investors, international insurance companies or individuals. Syndicates can comprise one
single corporate member, or any number of corporate and individual members, underwriting
severally for their own account.
Members of Lloyd’s are authorised to underwrite insurance both in the UK and in over 200
countries and territories worldwide. The agency businesses in the market, which employ the
underwriters and act for the members of Lloyd’s, are supported by Lloyd’s common
infrastructure. This offers technical expertise, information exchange and an efficient
processing capability.
The Lloyd’s market

Under the Financial Services Act 2012
2012, the Lloyd’s market and its participants are regulated
and its participants by the Prudential Regulatory Authority (PRA) and/or the Financial Conduct Authority
are now regulated
by the PRA and/or
(FCA). The Corporation of Lloyd’s and Lloyd’s managing agents are dual-regulated, that is,
the FCA prudential regulation by the PRA and business conduct regulation by the FCA. Lloyd’s
members’ agents and Lloyd’s brokers are both regulated by the FCA, but will also have to
meet certain Lloyd’s accreditation criteria.
Structure of the market
The Lloyd’s market is a subscription market. This means a number of separate syndicates
often participate on a risk, sharing premiums and claims, according to their respective share.
The majority of its business is introduced by accredited Lloyd’s brokers.
Syndicates are not

Members underwrite through syndicates that are not legal entities in themselves. Each is
legal entities in managed by a managing agent, which is authorised by the PRA in conjunction with the FCA.
themselves
The managing agents write insurance business on behalf of the member(s) of the syndicate,
which receive profits or bear losses in proportion to their share in the syndicate. Syndicates
are annual ventures, formed at the beginning of each underwriting year of account and
disbanded once the year of account is closed, usually after 36 months. This is done by way of
a reinsurance to close (RITC) policy to a successor syndicate.
The management and governance of Lloyd’s business is incorporated by Act of Parliament,
currently the Lloyd 1982. Under the Act, the Council of Lloyd’s is responsible for the
Lloyd’’s Act 1982
management and supervision of the market.
Useful website
The Lloyd’s capital base remains diverse and is currently capitalised at about £27.6bn. See
page 22 of Lloyd’s Annual Report 2017, which discusses capital for 2017. Find this by
going to: www.lloyds.com/investor-relations/financial-performance/financial-results and
navigate to the relevant year and report.
Chain of security
Three links in the
A unique feature of the Lloyd’s market is its capital structure, usually referred to as its chain
chain of security of security. There are three links in the chain:
Link 1 The syndicates’ assets, namely the premium held in trusts.
Link 2 Members’ funds at Lloyd’s, namely additional capital held in trust for the benefit of
policyholders in support the member’s underwriting at Lloyd’s. Each member, whether
corporate or individual, must provide capital to cover its underlying business risks at a
99.5% confidence level.
Link 3 Lloyd’s central assets are available, at the discretion of the Council of Lloyd’s, to meet
any valid claim that cannot be met from the resources of any member further up the
chain and include the Central Fund (to which each member makes annual
contributions of either 0.35% or 1.4% depending on length of membership), the
Corporation’s assets, subordinated debt and securities issued by the Corporation and a
‘callable layer’ (that is, up to 3% of a member’s overall calendar premium limits).
Through detailed analysis, the Corporation determines the optimum level of central assets,
seeking to balance the need for robust financial security against the members’ desire for
cost-effective mutuality of capital.
Chapter 9
Lloyd
Lloyd’’s brokers
Although Lloyd’s brokers were previously regulated directly by Lloyd’s, they are now
regulated by the FCA. However, Lloyd’s still controls the accreditation of Lloyd’s brokers
centrally, with applicants being required to meet certain criteria set by Lloyd’s. Additionally,
managing agents may now accept or place business from or through entities other than a
Lloyd’s broker. As at February 2019, there are 307 registered Lloyd’s brokers.
The role of a Lloyd’s broker is as follows:

• Advising clients on insurance types, wordings and the market. This role is often extended
to include wider advice on risk management and risk financing, including self-insurance,
alternative risk financing, and the formation and operation of captive insurance
companies.
• Placing the client’s insurance with suitable markets, in Lloyd’s and with London and
overseas companies. Although brokers do not take responsibility for insurer security, they
are expected to exercise great care in selecting markets that are solvent and secure.
• Preparing appropriate documentation, including cover notes and, in some cases, policies.
• Assisting in, advising on, and in many cases arranging, the payment of claims.
• Brokers are usually well versed in legal and other cover requirements and may supply
confirmation of cover where required to third parties.
Question 9.3
A broker’s remuneration has traditionally been derived from commissions and brokerages
based on cover placements. How can a broker obtain adequate remuneration for non-
insurance services it offers to its clients?
B1B International Underwriting Association of London (IUA)

The IUA is the representative organisation for international and wholesale insurance and IUA is both a trade
reinsurance companies trading through London. It is both a trade association, representing association and a
market association
its members’ interests internationally and a market association supporting the business
environment in London. The IUA’s key priorities are to:
• improve the efficiency of doing business in London;
• advance the development of market expertise and innovation; and
• influence public policy and compliance developments.
The non-Lloyd’s London Market was estimated to have been worth £18.331bn in terms of
gross written premium income in 2017 according to the IUA’s latest figures, set out in its
London Market Company Statistics Report 2018. Adding £7.984bn of gross written
premiums controlled by the London company market but written elsewhere gives a total of
£26,314bn which rivals the latest figures declared by Lloyd’s of £33,591m for 2017.
Governance
A company limited by guarantee, the IUA is governed by a board of up to 20 people, IUA is governed by
consisting of the chief executive and representatives elected annually by rotation by its full a board of up to 20
people
membership. Those so elected tend to be chairpersons and/or chief executives of insurance
and reinsurance companies or other senior market figures. A number of standing
committees oversee the main work of the association and report to the board.
Table 9.2 shows the three categories of membership available within the IUA.
Table 9.2: Categories of membership

Ordinary Denotes full membership status with voting rights and an active involvement in the
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governance of the association. Ordinary membership is open to international and

wholesale insurance and reinsurance companies operating in or through London.
Affiliate Caters for London Market companies that are either in run-off or that provide
professional services to the association’s Ordinary members.
Affiliate membership offers the benefit of the IUA’s information services without the
burden of supporting other services aimed directly at active London company market
insurers and reinsurers. In addition affiliate members may also, where appropriate, take
part in the IUA’s committee activity, but have no voting rights.
Associate Open to insurance and reinsurance companies outside London. Associate members
may attend the association’s annual general meeting, but have no voting rights. They
receive a basic publication service.
Question 9.4
Is the IUA empowered to comment on premium rates and renewal negotiations?
B2 Continental European markets

At the core of the European reinsurance markets are the professional reinsurance
companies. Once, the largest of these were to be found in Germany (where the oldest
existing reinsurance company, Cologne Re, now part of General Re, still operates),
Switzerland and France.
Regulation
Under the EU Reinsurance Directive implemented in 2005, EU reinsurers are regulated by
their ‘home state’ and are granted a passport to write business throughout the EU. The
Directive also heralded the arrival of the Solvency II legislative programme, implemented on
1 January 2016.
Solvency II
Solvency II introduced a new, harmonised EU-wide (re)insurance regulatory regime into all
introduces a new, Member States. It replaced the existing thirteen EU insurance directives (including the EU
harmonised EU-
wide (re)insurance
Reinsurance Directive). It has four objectives:
regulatory regime
• improved consumer protection;
• modernised supervision;
• deepened EU market integration; and
• increased international competitiveness of EU (re)insurers.
The Directive is based on a three pillar approach:
Pillar 1 Requires (re)insurers to demonstrate that they have adequate financial resources. All
reinsurers are required to maintain reserves and, in accordance with two solvency
requirements (namely, the solvency capital requirement (SCR) and the minimum
capital requirement (MCR)), capital and to comply with certain rules on investment.
Pillar 2 Deals with governance, internal controls and risk management processes.
Pillar 3 Deals with public disclosure and regulatory reporting.
Useful website
www.bankofengland.co.uk/pra/Pages/solvency2/default.aspx
Sources of business
A few of the largest professional reinsurers in Europe acquire much of their business by
direct marketing. This requires the representatives of those companies to travel or have
operations in many areas of the world.
Some smaller professional reinsurers also seek to write business through a direct
relationship with their ceding companies, but many will accept business through brokers in
order to keep their acquisition costs low. In the past, brokers based in Europe have played a
comparatively small role in reinsurance, with a few exceptions, but this position is changing.
Chapter 9
Reinforce
Before you move on, remind yourself of the ways in which brokers service clients’
business. Check your notes against chapter 1, section F5.
EU referendum
On 23 June 2016, the UK voted to leave the European Union (EU).
The UK Government invoked ‘Article 50’ of the Lisbon Treaty on 29 March 2017. In doing
so, the two-year negotiation period, which will result in the UK leaving the EU, began. This
means that, at the time of publication, the UK’s membership of the EU will cease on
29 March 2019. However, following the meeting of the EU Council in March 2018, a
withdrawal agreement was reached on the terms of an implementation period that will
apply following the UK leaving the EU. The implementation period is intended to operate
from 29 March 2019 until 31 December 2020, during which time EU law would remain
applicable in the UK, in accordance with the withdrawal agreement.
The implementation period forms part of the withdrawal agreement, which at the time of
publication is still subject to the approval of the UK Parliament before it can be ratified
and entered into force. Without the UK Parliament’s approval, EU membership will still
cease to apply to the UK from 29 March 2019, but without a negotiated agreement
between the UK and EU to replace it. Until 29 March 2019, the UK will continue to be a full
member of the EU, compliant with all current rules and regulations, and firms must
continue to abide by their obligations under UK law, including those derived from the EU,
and continue with the implementation of all legislation that is still to come into effect.
The longer-term impact of the decision to leave the EU on the UK’s overall regulatory
framework will depend, in part, on the relationship agreed between the UK Government
and the EU to replace the UK’s current membership.
note: The UK’s decision to leave the EU will have no impact on the
Please note
2019 CII syllabuses or exams. Changes that may affect future exam syllabuses will be
announced as they arise.
B3 US reinsurance market
The US reinsurance market is necessarily large given that the US domestic insurance The US reinsurance
industry is the largest in the world. Indeed, we can see in appendix 9.1 that US-domiciled market is the
largest in the world
insurers generated over US$794m of non-life premiums in 2016.
While it is difficult to determine the exact size of the US reinsurance market, according to
regulatory returns to the National Association of Insurance Commissioners (NAIC NAIC), more
than 3,800 reinsurers from over 100 jurisdictions assumed business from US cedants in 2014,
bringing much needed capacity and capital to the US market.
The Reinsurance Association of America reports that, in 2016, US$42.5bn of reinsurance net
written premium was recorded by the nation’s main US professional reinsurance companies,
and US$78.5bn was ceded to reinsurers domiciled offshore. Further, it is estimated that
US$45.5bn, or 58%, of that offshore premium was ceded to affiliates of US professional
reinsurance companies, the balance going to foreign reinsurers.
In a typical year, around twice as many premiums are ceded to offshore reinsurers that are
affiliated to a US cedant than to those that are not affiliated to a US cedant. Domiciles which
receive the highest amounts overall include Bermuda, the UK, Germany and the Cayman
Islands.
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In recent years, reinsurance capital has continued to migrate offshore to, among other
places, Bermuda, Switzerland and Ireland. In fact, the only new US-domiciled reinsurers have
been formed as US subsidiaries of offshore start-ups. A formerly broad and diverse US
domestic reinsurance industry appears to have been subsumed by offshore reinsurers
through various mergers and acquisitions, not least because its corporate tax rate is one of
the highest in the world.
Regulation
Insurance and reinsurance regulation in the USA is the province of individual US states. The 50 states
50 states cooperate with each other through the NAIC, which helps promote consistent cooperate with
each other through
national regulation. A reinsurer operating in the USA must satisfy the insurance regulations the NAIC
of the various states in which it does business and, indirectly, must satisfy the state
regulations pertaining to reinsurance that are placed on its insurers (for example, by posting
collateral to support claims).
Overall, the US reinsurance market is less regulated than the US insurance market. This is
based on the theory that the buyers and sellers in the reinsurance market are insurance
professionals and need less protection than the individual consumer when purchasing
insurance. Reinsurance regulation focuses on solvency, which has taken on increased
importance following the highly publicised failures of several US insurers during the 1980s
due to uncollectable reinsurance. To monitor solvency, the insurance departments of the
various states regularly conduct financial audits of reinsurers.
SOX is perhaps the

The Sarbanes
Sarbanes– –Oxley Act 2002 (SOX
SOX) is perhaps the single most important piece of
single most legislation affecting US corporate governance, financial disclosure and the practice of public
important piece of
legislation
accounting since the securities laws of the early 1930s. SOX was intended to raise standards
affecting US for auditing, transparency and board oversight following the Enron, WorldCom and other
corporate
governance
scandals. Among other things, SOX requires an issuer’s principal executive and financial
officers each to certify the financial and other information contained in the issuer’s quarterly
and annual reports.
Be aware
Complying with SOX is a major challenge for financial organisations and the executives
who lead them. Under s.404 of this landmark Act, executives have to certify that they
have established adequate internal controls and procedures for financial reporting – or
face criminal and civil penalties.
Another feature of the US reinsurance market is the statutory requirement for non-US
reinsurers to post 100% collateral for US cedants to take balance sheet credit for their
reinsurance. There is no such requirement for US licensed reinsurers. While the NAIC has
adopted revisions to its model law, the model remains voluntary and, even if fully and
uniformly implemented, a broad discretion remains for individual state regulators to
determine how they are to be applied in the cedant’s state. Under the model, non-US
reinsurers from ‘qualified jurisdictions’, that are rated by recognised rating agencies and
meet other criteria, can apply to become ‘certified reinsurers’. They would then be eligible to
post less than 100% collateral for reinsurance assumed from US cedants (for instance, from
75% down to 0% collateral according to financial strength ratings).
The NAIC has approved Bermuda, France, Germany, Ireland, Japan, Switzerland and United
Kingdom as qualified jurisdictions. The NAIC has made its model law an accreditation
standard and all states had until the start of 2019 to implement the relevant legislation to
remain accredited.
In September 2017, the US Treasury and the European Commission signed a Covered
Agreement which, once implemented, will ensure that foreign reinsurers are not
disadvantaged relative to locally domiciled reinsurers. Notwithstanding the significant
capital and solvency requirements to be met before equal treatment, this development
represents a significant step towards establishing a level playing field for foreign reinsurers
and should further federalise the regulation of reinsurance in the USA. In December 2018, HM
Treasury and the US Treasury signed a similar Covered Agreement between the UK and the
US, applying to insurers and reinsurers operating in the UK following Brexit.
Companies are also required to submit an annual report of the effectiveness of internal
accounting controls to the Securities and Exchange Commission (SEC SEC). Approximately
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1,200 foreign companies are listed on US exchanges and are subject to the same SOX
provisions as domestic companies. Foreign insurers face particular challenges in complying
with the internal controls requirements, including language, cultural and organisational
structures that are far different from those usually seen in the USA.
Useful website
www.sec.gov/
Broker market
Reinsurance
Reinsurance intermediaries play a prominent role in the US reinsurance market, with
intermediaries play approximately half of the US premiums ceded via the broker markets
markets. There are only a
a prominent role in
the US reinsurance
handful of direct US reinsurers; the number of US broker market reinsurers is many times
market higher. In recent years, the distinction between the broker market and direct market has
become blurred, with many direct writing reinsurers accepting business from brokers.
B4 Bermudian market
The Bermudian market has developed into an accepted part of the mainstream capacity of
the global reinsurance market and its main carriers have expanded across the globe (e.g.
about 13% of the capital at Lloyd’s is managed by groups whose parents originate from
Bermuda). It is also the world’s leading market for insurance-linked securities.
Bermuda primarily grew as a captive market as the offshore low tax regime gave it Bermuda primarily
advantages, particularly for US-based companies. This led to Bermuda becoming the grew as a captive
market
primary domicile for captives. Today, it is home to over 1,200 companies and, while the USA
remains the biggest source of captive business, accounting for over half of the insurance
formations, the picture is changing as many now have African, Middle and Far Eastern,
Australian and Latin American owners.
However, the Bermudian market has developed into a source of capacity with Everest Re,
PartnerRe, Maiden Re, XL Catlin and AXIS, among others, setting up to provide substantial
capacity. Originally the areas of excess liability and directors and officers were the main
focus of these groups, but they have expanded into new areas considering the
developments of reinsurance globally, especially the alternative risk transfer (ART) market.
Development of the Bermudian property/catastrophe market
By 1992, the global property/catastrophe market had endured an unprecedented five-year
run of costly catastrophe losses that included tornadoes, hurricanes and Piper Alpha. These
losses brought many insurers and reinsurers to the point of insolvency. The decline in the
number of active reinsurers and the reduction in underwriting capacity of others allowed for
the development of the property/catastrophe market in Bermuda.
Prior to 1995, the regulation of companies in Bermuda was perceived to be less rigorous than
in other markets. The country was characterised as a low tax environment with low entry
barriers for insurance companies. Government supervision and regulation were via a self-
policing model made up of industry members. These factors encouraged investment, but not
so much the protection of policyholders.
Proper regulation was needed if global markets were to accept Bermudian companies as The IAA tightened
viable mainstream suppliers of capacity. The Insurance Amendment Act 1995 (IAA IAA) up reporting and
solvency
tightened up reporting and solvency requirements and gave increased protection to requirements
policyholders. IAA also created four classes of companies, which separated single parent
captives from highly capitalised publicly traded companies of global reinsurers, and
permitted greater powers of intervention where an insurer risks becoming insolvent or being
in breach of the law.
Following 9/11, the Bermudian market reacted to hardening rates by seeing new companies
set up. Excellent infrastructure and flexible insurance regulations allowed them to start
quickly in order to take advantage of what was perceived to be a potentially good business
opportunity. These companies were well capitalised, had strong reinsurance backing and did
not have the loss experience of more established players.
Between 2002 and 2004, Bermuda carriers opened and expanded their operations in the
USA and Europe to maximise their visibility and provide capacity for clients. This underlined
Bermuda-based companies’ intentions to play a main role within the global
reinsurance arena.
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Bermuda’s insurance market has continued this trend of growth ever since. In 2017, the
Bermuda Monetary Authority reported that its market’s total insurance assets had reached
US$631.7bn as at the end of 2015 with net written premiums of US$108.5bn (that is,
US$45.4bn written by captives and the rest by the commercial sector).
Current status
Bermuda has become one of the world’s top three jurisdictions in the global market along
with the USA and Europe, and it is now the largest property catastrophe reinsurance market.
It also has a growing casualty market with a number of the US top ten professional liability
reinsurers.
Bermuda has 14 of
According to Standard & Poor’s 2017 reinsurer rankings: Bermuda has 13 of the top 40
the top 40 reinsurers (Europe has 9 and the USA has 6), although entities based in Europe still have
reinsurers
almost 55% of the net reinsurance premium written (USA 15%; Bermuda 12%). Bermuda
reinsurers make a significant contribution to the US economy. Bermuda is the leading
non-US supplier of reinsurance to US insurers, providing a critically important source of risk
capital for the US market.
Example 9.1
Bermuda’s reinsurers paid 30% of insured losses from 2005 Hurricanes Katrina, Rita and
Wilma, a sum greater than its European competitors. Furthermore, the Bermudian market
paid sums in excess of US$22 billion to rebuild the Florida and US Gulf coasts following
the hurricane seasons of 2004 and 2005.
Nonetheless, a more or less constant concern to Bermuda’s reinsurers is the possibility of

taxation by the US Government of US-sourced business, whether written directly or
indirectly by a Bermuda-based entity. As a result, reinsurers face an uncomfortable choice
between the advantages of a Bermudian domicile and access to the vast US market. Some
have already chosen to exit in favour of, for example, Ireland and Switzerland, while others
have stopped short of full re-domestication and opened subsidiaries there.
The tax and regulatory burdens placed on Bermuda-based companies are greater than
before, particularly with the introduction of regulations equivalent to the EU’s Solvency II.
B5 Asian market
B5A Japan
Historically, the Japanese insurance market was characterised by tight government
regulations under the Ministry of Finance. With the revision of the Insurance Business Law in
1996 came far-reaching deregulation of the sector, allowing insurers to establish subsidiaries
to write both life and non-life business. A fundamental component of this liberalisation was
the reform of the so-called ‘Rating Organisation’ in 1998. Its function is now reduced to
preparing and calculating non-obligatory standard policy conditions and referential pure
rates, which provide the market with some level of guidance. However, the final setting of
rates and margins is left to individual companies, with a few exceptions.
Usual for almost all

It is usual for almost all business to be channelled through agents and even the largest
business to be reinsurance companies accept business through an intermediary.
channelled
through agents Today, Japan has the fourth largest commercial insurance market in the world and its
domestic market is dominated by three mega groups: Tokio Marine, MS (Mitsui Sumitomo) &
AD (Aioi Nissay Dowa), and Sompo Japan NipponKoa. Between them, these control more
than 70% of non-life premium. The market also includes Toa Re – a top 40 global reinsurer –
and all major (re)insurance groups also have a presence. Interestingly, property (commercial
and domestic) is heavily under-insured in Japan and it is estimated to have the largest
protection gap in the world.
In recent years, investment returns have been low and the domestic market has continued to
shrink because of a declining population, declining manufacturing base and industrial assets
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and prolonged economic weakness. As a result, the mega groups have looked abroad for
growth by expanding into both mature and emerging markets by acquisition and by equity
participation. They have, however, been hampered in this by domestic regulations limiting
the size of any such investment to 10% of own assets. The regulator, the Japan Financial
Services Agency of the Japanese Government, has indicated that there are plans for
deregulation in this area. Insurers have also sought to reduce operational expenses as a
means of generating a return on capital.
All earthquake business written with regard to residential buildings is reinsured with the
Japan Earthquake Reinsurance Company (JER), which retrocedes part of the business to the
government and Japanese primary insurers on an excess of loss basis. Foreign reinsurers are
not included in this reinsurance scheme. Earthquake industrial insurance is predominately
reinsured internationally. Of the total ceded earthquake industrial exposure, it is currently
estimated that about 70% is ceded on a proportional or facultative basis. Covers are often
combined for wind and earthquake.
Following the earthquake and subsequent tsunami in 2011, the insurance market contracted
due to higher rates in fire and earthquake insurance and looked to diversify risk portfolios
away from those affected classes of business. By contrast, the reinsurance market remains
characterised by enduring long-term relationships.
Be aware
There is a preoccupation with earthquake coverage in the Japanese market because of
the level of seismic activity in this region.
B5B China
China is the world’s second largest economy and, according to Swiss Re’s Sigma, its China is the world’s
insurance market ranks as the third largest in the world. In 2016, total insurance premium second largest
economy
reached RMB3,096bn of which RMB1,352bn (or 44%) was in respect of non-life business.
For many years, the People’s Insurance Company of China (PICC) enjoyed a monopoly in the
insurance market. Today, the non-life insurance market is dominated by three insurers: PICC
P&C, China Pacific Property Insurance Company (CPIC) and Ping An P&C.
Many foreign insurers now operate in China, but their market share remains low for various
reasons. This is, however, expected to continue to grow sharply as more and more carriers
are permitted by the China Insurance Regulatory Commission (CIRC) to write compulsory
motor third-party liability insurance. Motor insurance comprises the largest share of China’s
non-life business and the next largest sectors are commercial property then agriculture and
liability.
As regards reinsurance, China Reinsurance is the nation’s largest reinsurer and, according to Increasing interest
A.M. Best’s 2016 ranking, the eighth largest global reinsurer. Foreign reinsurers with branch from global
reinsurers
operations include the major European carriers and Lloyd’s, but there is increasing interest
from global reinsurers in Bermuda and London in view of the country’s potential for growth.
In the meantime, it remains a fiercely competitive and highly regulated market.
The CIRC is committed to regulatory reform. For example, enhancements are planned to the
supervision of reinsurance business, which reaffirms its position that underwriting profits
should not be transferred abroad by way of affiliated reinsurance transactions. Interestingly,
it has also recently approved China National Petroleum Company (CNPC) to establish the
first onshore captive insurer in China. As China seeks to internationalise the RMB, China Re is
also looking to expand internationally and has overseas subsidiaries and representative
offices in London, New York and Hong Kong.
B5C India
As the second most populous nation and one with comparatively good economic prospects India presents
and low insurance penetration, India also presents huge potential opportunities to global huge potential
opportunities to
reinsurers. Since liberalisation under the Insurance Regulatory and Development Authority global reinsurers
1999, public sector exclusivity has been abandoned in favour of market-driven
Act 1999
competition and yet the market is dominated by the public sector undertakings: New India,
Oriental, National and United India. Strong distribution networks and large historic reserves
have ensured that these companies underwrite the majority of the non-life business. At
present, the vast majority of all non-life premiums are still distributed through legions of
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on-the-ground direct sales agents who are largely employed by those companies.
As the sole domestic reinsurer, government-owned General Insurance Corporation (GIC),
provides reinsurance to the general insurance companies in the Indian market. It receives an
obligatory statutory cession of 5% on each and every policy subject to certain limits, leading
many of those companies’ treaty programmes and facultative placements. GIC is reported to
have written net premium of US$4,675m in 2016.
Historically, no other reinsurer had a licence to carry out reinsurance business in India.
Overseas reinsurers either operated through representative (not branch) offices or
reinsurance intermediaries and satisfied a minimum rating stipulated by the insurance
regulator, the Insurance Regulatory and Development Authority of India (IRDAI). However,
in late 2015, laws were passed increasing the foreign investment cap in the insurance sector
to 49% and, crucially, permitting overseas reinsurers to open branch offices to carry out
reinsurance business in India.
As at October 2017, Lloyd’s, Munich Re, Swiss Re, Hannover Re and SCOR have all begun
operations through local branches.
B6 Other significant world markets

B6A Australia
In recent years, mergers and acquisitions have reduced the total number of private sector
insurers writing general insurance business in Australia. These companies are supervised
under the local Insurance Act and the largest are QBE, IAG and Suncorp.
Heavy buyer of
As Australia is prone to natural perils, it is a heavy buyer of catastrophe reinsurance and that
catastrophe market hardened considerably following the spate of natural disasters in the region in 2010
reinsurance
and 2011. Reinsurance capacity is provided mainly by local subsidiaries of European and
North American reinsurance companies, the London Market and Bermudian reinsurers.
Australia’s only top 40 global reinsurer is QBE. Practically all the reinsurance programmes
are placed by brokers. There are no special pools for natural catastrophe reinsurance. The
Australian Government did, however, establish a terrorism pool for commercial risks in 2003.
Question 9.5
What threat do you believe that bushfires pose to the local reinsurance market?
B6B Brazil
Following the abolition of the State reinsurance monopoly in 2007 with the enactment of
Law 126/07, registered foreign reinsurers may now carry out reinsurance business in Brazil.
IRB, the former holder of the monopoly, is now a ‘local’ reinsurer, and its regulatory functions
have passed to The Superintendence of Private Insurance (SUSEP). IRB is the continent’s
only top 40 global reinsurer.
Three classes of
According to the legislation, there are three classes of registration: local, admitted or
registration occasional. Each classification requires different levels of capital and allows access to
varying amounts of ceded risk.
After what had been seen by many (including the International Monetary Fund) as
protectionist amendments to the original legislation to protect IRB’s rapid loss of market
share, local reinsurers had to be offered at least 40% of each cession, and could cede no
more than 20% of premiums to affiliated, intragroup reinsurers abroad. Such companies
must also be established in Brazil with a minimum capital of BRL 60m, and are regulated by
SUSEP. Admitted and occasional reinsurers must also meet minimum requirements,
including a stipulated rating from an agency.
While the recent measures may have been criticised as, among other things, hindering
market access, local economic growth and the healthy spread of risk, Brazil continues to be
an attractive prospect for new business opportunities and many of the world’s largest
reinsurance groups are either registered, or have plans to register, as local reinsurers in one
of the world’s ten largest economies. Itau, Mapfre and Bradesco are the largest local
(insurance) carriers by premium income. The reinsurance market is dominated by local
reinsurers, such as IRB, Munich Re and Mapfre Re.
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Unexpectedly, the Brazilian National Council of Private Insurance (CNSP) issued a new
resolution in 2015 which provided for a five year timeframe for scaling down the intra-group
prohibition and mandatory cession rule from the beginning of 2017. It was planned that by
2020 the intra-group prohibition will move out from 20% to 75% and the mandatory cession
rule will have reduced from 40% to 15%. This resolution represents a significant step towards
a further liberalisation of the Brazilian insurance and reinsurance market.
However, in late December 2017, the CNSP issued two new rules (CNSP Resolution 353/2017
and SUSEP Circular 562/2017), which remove certain barriers limiting international
reinsurers’ access to the Brazilian reinsurance market. These two rules supersedes
information on minimum retention requirements, mandatory reinsurance cessions
requirements, and restrictions on intra-group cessions.
Useful website
Lloyd’s Market Bulletin Y5152 details these rules and can be found in the Lloyd’s Market
Bulletin archive: https://bit.ly/2NKHJoT.
C Captive insurance companies

In this section, we take a brief look at captive insurance companies, which were introduced
in chapter 1, section B6.
C1 What is a captive?
A captive is a special purpose vehicle created to manage and to finance risks emanating Provides insurance
from its non-insurance parent company. In its simplest form, it provides insurance to its to its parent
parent and, once established, operates like any commercial insurer. It operates on an
independent or ‘arm’s length’ basis as it collects premiums, issues policies and pays claims. It
requires capital and will be regulated – as a captive, not an insurer – where domiciled.
Captives are essentially a form of self-insurance whereby the insurer is wholly owned by the
insured.
Captives are particularly useful for businesses which have predictable losses or if cover for
particular or for emerging risks, e.g. cyber risks, is unavailable or too expensive in the wider
insurance market. A response to a hard market is often an acceleration of captive
formations.
C2 Types of captive
Captive insurers fall into two main groups, pure captives and sponsored captives.
C2A Pure captives

Pure captives are 100% owned, directly or indirectly, by their insureds. Examples include a
single parent captive writing only its parent’s risks, and a group captive established by, and
for companies with similar businesses or exposure and writing only their risks. Similarly, an
association captive writes only those risks of companies from a particular trade, industry or
service group.
There are a number of advantages and disadvantages of captives and we will look at these in
general in section C5. However the issue may be whether to go it alone or to join a group or
association captive. The benefits of the latter approach may include:
• improved forecasting;
• greater risk retention potential;
• mass purchasing power;
• reduced overheads; and
• increase loss control emphasis.
On the other hand, single member captives will not have issues with:
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• differing member needs;

• decision making;
• rating controversies;
• reduced confidentiality;
• additional management time; or
• the change and growth of participants.
Typically, the captive will either take the form of a stock company in which each investor
purchases shares, or a mutual to which capital is contributed. The risks are combined and
profit generated based on the proportion of ownership. A board or governing body will
manage the company according to its articles or bye-laws. You may have heard of risk
retention groups (RRG) in the USA as a common example of group captive. A RRG is formed
and operated pursuant to the Federal Risk Retention Act 1981 and owned solely by its
policyholders. It is, however, limited to writing liability insurance business in the state(s)
registered.
C2B Sponsored captives

Sponsored (or rental) captives are captives that are owned and controlled by parties (or
sponsors) unrelated to the insureds. They do not necessarily pool the insureds’ risks or
require insureds to contribute capital, but they do charge a fee for providing the core capital
and for organising and operating the captive.
A protected cell captive is an example of a rental captive that does not pool its insureds’ risk.
Instead, it maintains a separate underwriting account for each insured participant. These
accounts (or cells) are legally separated and protected from each other and from every
other participant’s cell. So, the assets in one participant’s account may not be used to pay
the liabilities in another’s account without an express agreement to do so. A segregated
portfolio company is another example of a protected cell captive.
Competitive captive management services exist in major captive locations. As we have seen,
Bermuda has used the infrastructure available to service the many captives within its
territory to support a property/catastrophe insurance sector and alternative casualty
market.
C3 Risk financing
Captives are a risk
If captives are a risk management tool involved in the identification, quantification and
management tool mitigation of the risks to which the parent’s businesses are exposed, the choice essentially
becomes one of how to finance them – in other words, whether to retain or to transfer those
risks. In theory, a company will be exposed to a range of risks as illustrated in figure 9.1.
Figure 9.1: Risk financing
Low frequency
Transfer High severity
Higher frequency
Retain centrally Manageable severity
Chapter 9
High frequency
Retain at operating company level Low severity
Original figure by Willis Towers Watson, reproduced with permission
In reality, consideration must be given to the availability and cost of insurance, the financial
strength of the parent and its ability and willingness to retain risk, as well as the amount of
capital available to commit to the captive.
Captives will typically begin by participating in the high frequency/low severity losses and,
as it becomes more experienced and stronger financially to support the retention of risk, it
will look upwards to the next layer. It is the remaining low frequency/high severity, or peak
risk, that captives transfer to the external insurance market or elsewhere. The captive market
has also prompted the growth of ART and represents a fundamental shift in the financing
of risk.
Learning point
Before you move on, check that you understand the difference between risk retention and
risk transfer.
C4 Domicile
The world’s largest captive domiciles are Bermuda, Cayman and the US state of Vermont.
These locations are primarily focused on US corporations and attract a limited amount of
business from outside the USA. Elsewhere, the captives of European parents tend to be
located in Guernsey, Luxembourg, Ireland and the Isle of Man. Lloyd’s has also admitted
captives as member syndicates.
There is much competition to attract captives between these locations. As a domicile there Much competition
is a balance to be struck between being ‘friendly’ and providing incentives for businesses to to attract captives
between these
locate there, and maintaining credibility as, for instance, a regulator of, and legislator for, locations
those businesses.
The choice of domicile by a parent will depend on, among other criteria, physical proximity
to the parent domicile, the quantity and quality of transport and communication links,
operation costs and fee levels, infrastructure for business, applicable taxes, regulation (in
particular, capital requirements), political stability and legal framework.
The parent company’s industry may also impact on domicile as some specialise in particular
types of risk. Fr example, Vermont is a leader in captives for medical malpractice coverage
and risk retention groups, and Cayman in captives for healthcare.
Activity
Captives are also rated. Find the current financial strength rating for a captive that you are
familiar with.
Example 9.2
Since its foundation as a haven for captives in 1981, Vermont has become the world’s third
largest captive domicile, despite other states competing aggressively for the new
formation business.
C5 Advantages and disadvantages of captives

The advantages can be summarised as follows:
• to reduce and/or stabilise insurance costs; predictability is important to chief financial
officers:
Chapter 9
– no overheads or profit or capital costs of the insurance company to bear,

– the reinsurance market offers flexibility; for example, if the underwriting cycle is at a
stage where cover is expensive, greater risk can be retained;
• efficient claim settlements, wordings, coverage;
• cash flow from investment income on retained funds and favourable terms of trade from
reinsurance firms (e.g. accounts quarterly in arrears) – the capital and retained funds
represent the captive’s surplus (excess of premiums paid compared to claims paid);
• capacity and leverage against insurance firms:
– access to reinsurance markets with their lower costs, flexible programmes and
capacity,
– captive’s surplus (ability to write new risks or offer supply if there is a lack of market
coverage),
– consolidation within (re)insurance markets reduces choice for clients;
• insurance arrangement continuity: the insurance industry still prefers not to offer
long-term contracts if possible; and
• risk management activities communicated:
– financial statements to summarise risk financing activities,
– segregated funds for risk management purposes only; no appropriations,
– senior management aware of risk issues,
– focus on risk management by all staff.
The disadvantages of captives are outlined as follows:
• capital requirements: the investment funds are tied up in the captive;
• captive management costs;
• limited spread of risk;
• possibility of crippling loss;
• traditional covers are often competitive on price;
• they tie up senior management time; and
• may experience prejudicial tax treatment if set-up in the state or country of the parent
domicile.
Be aware
In the USA, businesses usually go out-of-state for their captive formations. Forming in-
state captives rarely makes sense because of state premium or independently procured
taxes.
C6 Reinsurance of captives
A captive insurer may operate as either a direct insurer or a reinsurer:
• As a direct writing captive issuing policies to its insureds, the captive purchases
reinsurance in the commercial reinsurance market. Retentions will typically be high and
aimed at low frequency and high severity losses.
• As a reinsurance captive, the captive will issue policies to commercial (or fronting)
insurers licensed and admitted in the location of the original risks. In this way, the fronting
companies transfer the entire risk to the captive reinsurer.
In the USA, such fronting arrangements enable captives to comply with laws, imposed by
many states for automobile liability and workers compensation insurance, that require
insureds to provide evidence of coverage written by an admitted insurer. They may also
enable insureds to satisfy contractual requirements from business contracts – for example,
leases or service contracts – for cover from insurers with certain minimum financial ratings.
Insurers have access to claims handling and risk control services, and to excess risk transfer
capacity in a cost effective manner. In return, they receive a percentage of the gross written
premium and are careful to require collateral to secure the captive’s obligation. For example,
a letter of credit, a trust agreement funded by the captive’s assets and/or the retention of
original premium.
Chapter 9
D Market cycles
Non-life insurance typically goes through unpredictable price or, more appropriately,
underwriting cycles that extend over several years, leading to what are termed ‘hard’ and
‘soft’ markets by those working in those markets.
In economic terms, we could say that the underwriting cycle for both insurance and
reinsurance reflects the law of supply and demand. Supply for both is plentiful in profitable
times but scarce when an abnormally large loss, and more particularly, a series of large
losses, has affected the worldwide insurance and reinsurance markets.
In practical terms, the cycle is characterised by peaks and troughs that reflect the rise and Cycle is
fall of (re)insurance prices. It alternates between periods of soft market conditions, when characterised by
peaks and troughs
premium rates are stable or falling and (re)insurance is readily available, and periods of hard
market conditions, when rates rise, coverage becomes difficult to find, and (re)insurers’
profits increase.
Reinsurance is particularly susceptible to market cycles
cycles, since terms for both proportional
treaties and excess of loss contracts are agreed in advance of the actual treaty or contract
period. Whatever losses affect a reinsurance agreement during its currency, the agreed
terms at inception are rarely amended for that particular period.
Consider this
this…
…
Contrast this situation to that of an insurance company which is able to increase or reduce
its pricing for new and renewal business at any time it pleases. It will most probably have
sophisticated computer systems to implement rating adjustments with immediate effect.
You should be aware that some forms of reinsurance experience greater volatility in the
cycle than others. Price swings tend to be more pronounced in non-proportional
reinsurance, whereas in proportional reinsurance rates do not fluctuate quite so widely
because this business is more closely linked to the less volatile direct business.
In addition to the timing of reinsurance price changes, there are other important factors that
influence a reinsurer’s ability to manage its affairs, as we will see later. The buyer’s need for
reinsurance will also be assessed by the reinsurer that is approached for cover. At the same
time, the security of the reinsurer and market conditions will play an important part in the
buyer’s decision whether to purchase, what to purchase and how much to purchase. That
decision will also be affected by considerations of timing.
When market capacity is freely available, investment yields are high and results are
moderate to good, there is a greater likelihood that buyers can capitalise on ‘soft’ market
conditions by buying more reinsurance and at better terms.
When hard market conditions prevail, capacity (or capital) reduces as reinsurers withdraw or
reduce their acceptances, reinsurance terms harden and the economic laws of supply and
demand apply, with costs being driven up. The result is that the buyer may have to accept
tougher conditions, in the form of higher retentions or lower commissions or more restrictive
terms and conditions of coverage (e.g. exclusions), than they would have preferred.
Finally, the wider investment and tax regime environment can be relevant in the decision to The wider
buy reinsurance. When stock markets are high, buyers may have a choice of investing in investment and
tax regime
equities, for example, which are likely to provide a profitable and quick return, as opposed to environment can
purchasing reinsurance which they do not really need, provided they have the strength to be relevant in the
decision to buy
stand a limited number of unexpectedly large losses. reinsurance
In profitable years, the purchase of reinsurance can reduce the tax liability of insurers as this
is assessed on the net rather than the gross underwriting result and can offset the tax on
interest or profits on equities.
D1 Hard reinsurance markets

Chapter 9
Hard reinsurance markets tend to follow an abnormally large loss, and particularly a large
natural perils event loss, such as an earthquake, a severe windstorm and sometimes an
extensive flood, that affects a sizeable developed market, such as the south-eastern USA
where losses are measured in billions of dollars.
Example 9.3
Between August and September 2004 a series of four hurricanes – Charley, Frances, Ivan
and Jeanne – hit the Caribbean, including Florida and Alabama, occurring in a relatively
restricted region. The reinsurance market reacted to safeguard its interests at the next
renewal of such business.
If similarly large natural perils event losses occur simultaneously in different parts of the
world, such as storms and floods in New South Wales, Australia, in June 2007 while severe
windstorms rage in western Europe, then this further strengthens the resolve of the
worldwide reinsurance market. Many ‘first tier’ reinsurers purchase retrocession coverage
sufficient to cover two separate events, but the sheer number of large hurricanes
experienced in 2005 meant that some reinsurers simply ran out of coverage for the third and
fourth hurricanes that had devastated their inwards book of business.
In extreme circumstances, some reinsurance capacity is totally withdrawn from the market,
some is realigned into different layers of cover or different geographical areas, leaving those
reinsurers who remain active to negotiate the best renewal terms, coverage and conditions
that they can. Despite their financial strength, many reinsurers had to request additional
capital at the end of 2005 to maintain their solvency margins and to remain in business.
Retrocession
As we have already suggested, the retrocession market also plays an important role in
market also plays guiding the ‘first tier’ reinsurance market. Restrictions imposed by a retrocessionaire can
an important role
in guiding the first
limit the coverage that a reinsurer provides to its reinsured, unless the reinsurer is prepared
tier reinsurance to accept any difference in exposure for its net account. For instance, many
market
retrocessionaires impose restrictions on the number of reinstatements – say the original loss
plus one. The result of this is that reinsurers of that original insurance business sometimes
face the dilemma of whether they should allow reinstatement of a loss in the same event.
The practice differs between markets – it is quite common to restrict reinstatement in the
same event in the North American market, but less common elsewhere.
It is also rare that one single risk loss has a dramatic effect on hardening market coverage,
terms, conditions, warranties and exclusions, as reinsurance practice considers that a single
risk is just that, a single risk, and it would usually be restricted to a relatively narrow range of
market participants.
Be aware
A marine, energy or aviation loss would not necessarily affect the market perceptions of
the industrial or commercial fire market.
9/11 affected all

Nevertheless, there are exceptions where an incident occurs of such magnitude that its
insurance and effects reverberate around all insurance and reinsurance markets, the obvious one being
reinsurance
markets
9/11. This event gave rise to a dramatic hardening of both insurance and reinsurance markets
worldwide and is one that is perhaps unlikely to be repeated in the foreseeable future.
A season of major hurricanes can affect one sector of the market more than others, for
instance, property or offshore energy, whereas 9/11 affected many classes of business, such
as property, aviation, marine, personal accident and contingency business and led to a
hardening in most classes. The reinsurance market makes a natural reaction in such
circumstances: that is to apply substantial increases in pricing and restrictions in coverage
available following the year in question and beyond.
New entrants are now attracted to the reinsurance market by the prospect of enhanced
terms available, while others withdraw totally, whether voluntarily or for reasons of
insolvency.
The events of 9/11 also led directly to other critical re-evaluations of long-held underwriting
practices. One concerned the number of individual risks in purpose built, high-rise buildings
Chapter 9
(generally accepted to be 20 storeys or more). Historically, one individual risk might have
been considered as a group of three floors within the same high-rise building.
Question 9.6
What would the rationale be for this?
So, theoretically, a building of 30 floors could be considered as ten individual risks, and
written in its entirety by one insurance company. Providing such definition of ‘any one risk’
and underwriting guidelines had been agreed in advance by reinsurers, then those reinsurers
could hardly complain if the loss of the whole building resulted in ten single risk losses, all of
which would be recoverable from proportional or risk excess of loss protections. Until 9/11,
this possibility was considered very remote indeed and was an internationally accepted
method of insuring and reinsuring such buildings.
Another re-evaluation concerned so-called target or market risks and their accumulative
effect if not controlled within a national or local reinsurance market.
Most markets, apart from the USA, operate a co-insurance system between the insurance
companies working in that national or local market. If many insurance companies participate
on a co-insurance schedule for a target or market risk, then it follows that their individual
reinsurance arrangements will all be exposed to such large risks. In the absence of special
reporting requirements for such target or market risks, any reinsurer writing a portfolio of
different insurance companies within that market will be subject to a potentially large and
unknown accumulation potential.
Be aware
A target or market risk could be defined as a risk that is of great importance to the
national economy of the country concerned, and often one that requires the support of all
insurance companies operating in that country, and probably overseas support as well.
Amounts vary, but a US$1 billion sum insured would be a reasonable indication of size for a
target or market risk.
D2 Soft reinsurance markets

Reinsurance is cyclical. The reinsurance market is also prone to ‘talking rates down’ if there is
little worldwide loss experience to justify the continuation of charging high premium rates
and imposing onerous terms, conditions, warranties and exclusions, together with restricted
or restrictive reinsurance coverage.
A soft market typically arises after a period where there has been little major loss activity Arises after a
and competitive market forces, or rather the fear of such competitive forces, cause period where there
has been little
reinsurers to reassess their rating structures, the extent of coverage and how restrictive such major loss activity
coverage should be.
Reinsurance brokers, working on behalf of their insurance company clients, may also sense a
change in reinsurer attitude and encourage their clients to seek alternative quotations from
different reinsurance markets. This places a further strain on the relationship between the
insurance company and its reinsurers. Seeds of doubt are sown in the reinsurers’ minds as to
whether rates, terms and conditions should be maintained or relaxed for the forthcoming
renewal.
Example 9.4
The 2010 Atlantic hurricane and Northwest Pacific typhoon seasons were among the least
damaging on record, even though they were very active with 19 tropical storms and
twelve hurricanes recorded. However, none made US landfall – an unprecedented trend
for a season with so many. As a result, property catastrophe reinsurance rates dropped by
an average of 7.5% at renewal, with further softening seen throughout the market as
a whole.
There is also a shift in power in a soft market from reinsurers to insurance companies, who
(once again within reason) are able to obtain more favourable terms from their reinsurers.
Chapter 9
In a hard market, reinsurers often force insurance companies to retain higher retentions, but
in soft markets insurance companies sometimes seize the opportunity to purchase
reinsurance below the level of generally accepted prudent financial disciplines. We could call
this opportunism, as reinsurance supply is plentiful, and available at a price acceptable to the
insurance company’s financial planning requirements. Within this equation, there will always
be reinsurers willing to participate at such low levels, whether they are new entrants to the
market, or simply existing reinsurers prepared to compromise their beliefs to maintain
premium income levels.
Now that we have explained the background to both hard and soft reinsurance markets, we
can look at some important aspects concerned with managing the reinsurance
underwriting cycle.
D3 Managing the cycle

Reinsurer must be
While the cycle takes its course, a reinsurer must be able to diagnose the market situation
able to diagnose and implement its strategy in order to manage, as best it can, the changes inherent in the
the market
situation
cycle. The strategy should address all aspects of the business risks faced by reinsurers, in
particular, underwriting risk and operational risk. Key elements of that strategy are
demonstrated in table 9.3.
Table 9.3: Managing the cycle

Underwriters must know when to walk away from, or even cancel, particular
Maintaining strict
risks, territories and even markets, if prices fall below a prudent, risk-based
control of pricing
premium.
One tangible benefit of the risk-based capital approach adopted by various
regulators, such as the PRA and the Franchise Board at Lloyd’s, is that each
and every reinsurance agreement must be rated on a basis considered to be
technically sufficient, even if such rate bears little relationship to the so-
called commercial price available for that particular reinsurance deal.
That said, commercial considerations also enter the equation and they may
include the potential future cost of returning to these risks when rates
improve.
In pursuit of a balanced portfolio of reinsurance risks, underwriters should

Actively managing the
rigorously apply appropriate risk selection techniques and regularly
portfolio
consider the compatibility of those risks as a whole within the portfolio.
A determined stance is often required to maintain underwriting standards in
a softening market. In such circumstances, brokers and clients often place
underwriters under pressure to extend coverage and ease terms, conditions,
warranties and exclusions – even though the underwriter is known to
operate within a set of fairly rigid underwriting guidelines agreed by their
management.
It is often a challenge for reinsurers to maintain client relations in the low-
price phase.
Investment income over the actuarial life of the resulting liabilities is

Underwriting for
inherently uncertain and should ideally play no part in the underwriting
technical profit not
process. Accordingly, the underwriting operations are usually separated
investment income
from the asset management operations.
At one time, cash deposits would produce a healthy investment return and
improve nominal underwriting profits into even larger ones. In a low interest
rate and, more generally, a low investment return environment, this is no
longer possible and further emphasises the importance of underwriting for
technical profit, balancing underwriting strategies across various lines of
business, correct risk selection and a strict control on operating and
administration expenses.
It has been said that, in one sense, the low investment return environment is
the equivalent of a major insured catastrophe occurring every reporting
period.
It is important to align the interests of staff with those of shareholders, and

Gearing staff
incentives – such as bonuses – should be structured to reward value to
remuneration towards
shareholders over, for example, premium income alone.
profit and not volume
Chapter 9
In the past, many underwriters sought market share for its own sake, with
little regard for pricing or quality of the resulting portfolio of reinsurance
contracts originating from that market. Commercially, this approach was,
and is, known as a ‘loss leader’ philosophy, with reinsurers literally buying
their way into a market at prices considered totally inadequate by
established participants.
In hard markets, staffing levels are often increased, as are the benefits and
other remuneration rewards made to staff. On the other hand, in soft, or
softening markets, operating costs are rigorously controlled. This often
leads to redundancies, withdrawal of benefits and otherwise static pay.
Table 9.3: Managing the cycle

There is a cost to capital and the temptation to use it in unsustainable ways
Using capital efficiently
should be avoided. If rates are poor, participations may be scaled back.
Alternatively, participations may be withdrawn and the capital steered to
other more attractive lines of business (or elsewhere) where the rates are
better and a return is more likely, or returned to shareholders or from
wherever it came.
The redeployment of capital in this way demands a highly flexible and
ruthless approach to underwriting which can lead to problems, not least
when the market has corrected itself and rates improve sufficiently to make
it an attractive underwriting prospect again and reinsurers seek to re-enter
that market.
Typically, in such circumstances, there is a natural reluctance on the part of
the reinsured to allow a reinsurer back onto its programme,
notwithstanding, for example, a superior claims-paying ability over those on
its current panel. To many, trust and credibility has been lost. Indeed, many
reinsureds and reinsurers continue to subscribe to the traditional view that
reinsurance represents a long-term partnership, albeit reconsidered on an
annual basis.
Be aware
The Performance Directorate on behalf of the Franchise Board is responsible for setting
risk management and profitability targets across the Lloyd’s market. It lays down
guidelines for all syndicates and operates a business planning and monitoring process to
safeguard high standards of underwriting and risk management, thereby improving
sustainable profitability and enhancing the financial strength of the market.
Question 9.7
Why might the sacrifice of business have an adverse effect on the reinsurer’s
‘expense ratio’?
D4 Market capacity
A hard market attracts new entrants, as was evidenced by the new reinsurance capacity that A hard market
was established after 9/11. The majority of this new capital was located in Bermuda, in no attracts new
entrants
small part due to its favourable incorporation and taxation regime.
Following the spate of hurricanes in the USA in 2004 and 2005, it is estimated that over
US$30 billion in new reinsurance capital entered the market in late 2005 and
throughout 2006.
Be aware
Although there has been a huge increase in available reinsurance capacity since 2002 in
the form of ‘start up’ companies, recapitalisations, catastrophe bonds and ‘sidecars’, it has
also been estimated that some US$100 billion capacity had withdrawn from the
worldwide reinsurance market, some of it directly as a result of losses incurred in 9/11.
Chapter 9
Indeed, many insurance and reinsurance companies, such as Swiss Re, suffered a
downgrading of their security in the aftermath of 9/11. It is not unusual for insurance
companies to request that reinsurance capacity (and sometimes classes of business,
especially those concerned with liability or casualty accounts) is geared directly to the
financial strength rating of a reinsurer – perhaps 15% for AAA security, 10% for AA security
and 5% for A, and so on.
Nevertheless, even allowing for insolvencies occurring as a result of a succession of poor
annual results that collectively aggregated from the late 1990s onwards, there were
relatively few total withdrawals from the market despite the severe incidence of losses
during 2004 and 2005.
Reinforce
To summarise, market capacity is high during a soft market and low during a hard market.
A hard market attracts new entrants while a soft market discourages them.
E Financial strength ratings

Another feature of the world’s reinsurance markets is for reinsurers to be rated by a
third-party rating agency for their claims-paying ability.
If what is being bought and sold in these markets is the promise to pay claims, an evaluation
of the financial strength of the party proposing to make that promise is a key task for the
party proposing to accept that promise. Otherwise, the intended risk transfer may fail if, for
example, the reinsurer is in financial difficulties and, at worst, becomes insolvent.
Much demand for

Even though the reinsureds and their agents make their own evaluations, there is much
independent and demand on all sides for independent and external ratings of an insurance or reinsurance
external ratings
company’s ability to pay its claims. In fact, being rated could be said to be a prerequisite for
reinsurers wanting to conduct reinsurance business.
E1 Role of rating agencies

Ratings were not an important feature for many international companies outside North
America until relatively recently. In contrast, there has been a long history of rating debt and
rating claims-paying ability in the USA. Initially, rating agencies used information that was
publicly available but they were soon able to persuade companies that an informed and
accurate rating required a more detailed examination.
Today, because reinsurers realise that reinsureds are looking for financially secure reinsurers,
they will often invite one or more of the rating agencies into the company to provide an
assessment of its claims-paying ability. This inspection is not the same as a rating for the
issuance of debt. Debt assessment is separately evaluated. Although reinsurers usually ask
the rating agency to give it a rating, they still pay for such rating to be undertaken.
Effectively, a company will use the subsequent rating as a marketing tool to confirm its
financial security.
E2 Rating factors
Company ratings are assessed against broadly similar factors by each rating agency. A
typical range of factors would be an assessment of the company’s financial strength, its
operating performance and market profile, which culminate in an overall assessment of its
claims-paying ability.
In assessing a company’s financial strength, the rating agency will look at principal factors
such as:
• amount of capital and the company’s ability to access capital;
• quality and effectiveness of its reinsurance programme;
• adequacy of technical reserves;
• quality and spread of investments; and
• liquidity.
For its operating performance, it will look at factors such as:
• profitability;
Chapter 9
• sources of business, nature of premiums and investment income; and

• all aspects of its management experience and associated objectives.
Market profile represents the totality of the company’s activities, the way these activities are
undertaken, and the characteristics of the markets in which a company operates.
Typical considerations are:
• risks associated with the classes and territories in which business is written;
• competitive market research;
• general and financial management;
• underwriting and claims management; and
• exposure to large single risks and ‘event’ risk.
This last item could arise from contentious litigation caused by casualty or liability business,
perhaps as a result of a dispute with a trading partner. Losing an action at law could
significantly increase a reinsurer’s outstanding liabilities. Changes in legislation could also
materially increase a reinsurer’s existing and future liabilities, as could incurred losses arising
from catastrophic events caused by fundamental perils, especially if a rating agency
considers that the reinsurer has purchased insufficient retrocession coverage.
Activity
You may be employed by a company that has been ‘rated’ or have clients that have been.
You may even work for a rating agency. Look at a large company that you are familiar
with and discover what financial rating agencies have had to say about it.
Rating agencies have embraced the use of modern technology as an important underwriting Rating agencies
tool for reinsurers. In consequence, rating agencies may wish to evaluate a reinsurer’s have embraced the
use of modern
computer models for rating and pricing and its ability to model catastrophic events. The technology as an
agencies would almost certainly assess the actuarial disciplines used in calculating past, important
underwriting tool
present and future claims reserves, and premium pricing, if applicable. The ultimate aim is for reinsurers
perhaps to configure that reinsurer’s involvement in a particular loss scenario and, in effect,
‘test’ the reinsurer’s retrocession programme. Many actuarial techniques use stochastic
models to produce a range of results.
A stochastic model is a tool for estimating probability distributions of potential outcomes by
allowing for random variation in one or more inputs over time. Based on a set of random
outcomes, the experience of the portfolio or company is projected, and the outcome is
noted. This is then done again with a new set of random variables. In fact, this process is
repeated many, many times.
Computer modelling of realistic disaster scenarios (RDS
RDS) on an individual event basis has
been replaced or complemented by sophisticated dynamic financial analysis models that
stress test the entire operations of an insurance company or reinsurer.
In 2005 the highest number of tropical cyclones (27) and hurricanes (15) were recorded in a
single season in the North Atlantic, including the strongest hurricane ever recorded in that
area (Wilma at 882 hPa central pressure), the fourth strongest (Rita) and the sixth strongest
(Katrina) in a single season. These North Atlantic storms (together with other natural perils
events elsewhere) produced record worldwide insured property losses of US$83 billion. It is
probably fair to say that many computer modelling systems underestimated the loss
potential of the areas affected by the brutal succession of North Atlantic storms and many
insurers found that they had insufficient reinsurance protection.
Virtually all of the main rating agencies introduced new and enhanced capital adequacy
models and new methods of assessing catastrophe exposures for 2006 and beyond,
especially if the reinsurers were located in so-called peak zones.
Consider this
this…
…
Where do you think these ‘peak zones’ are situated?
The actions of individual rating agencies in stress-testing the analytical models of reinsurers
are of great importance with regard to catastrophic risk. In general terms, we could call this
Chapter 9
new type of analysis ‘enterprise risk management’ in that it embraces a better understanding
of risk assumption and risk management in all its diverse aspects.
Activity
Rating agencies continue to develop and finalise analytical and modelling systems. Follow
activity as it is reported in the insurance and reinsurance press.
In summary, we could say that these new capital adequacy models are an advanced form of
risk-based capital assessment.
E3 Ratings
Various phrases are used to describe the ratings depending upon the agency conducting the
analysis. Fitch, A.M. Best and Standard & Poor’s favour ‘insurer financial strength rating’
(IFSR). In each case, what is being provided is an opinion from that agency on the financial
strength and ability of the company to pay under its (re)insurance policies and contracts in
accordance with their terms and conditions (or similar).
All of the rating

All of the rating agencies use a scale of alphabetic indicators, with or without + or – signs, as
agencies use a the mark of the strength of their rating, with AAA being the best, descending through AA, A,
scale of alphabetic
indicators
BBB and so on. They also provide supporting definitions and make these freely available to
all entities operating in the insurance and reinsurance market. For example, an insurer rated
‘AAA’ may be said to have extremely strong financial security characteristics whereas one
rated ‘AA’ may only have very strong characteristics and another rated ‘A’ may only have
strong characteristics and be more likely than those with higher ratings to be affected by
adverse business conditions, and so on (Standard & Poor’s).
It will be appreciated that the ratings are designed to reference a broad standard or
benchmark, and identically rated companies might not be of the same quality. Rating
agencies thus offer a broad perspective in their evaluations due to the large number and
diversity of the companies involved.
E3A Outlook
Some ratings will also contain an outlook. This is where companies have distinctive business
trends. A rating outlook gives the rating agency’s view about the potential future direction
of a company’s rating, usually over the next 12, 24 or 36 months. Typically, outlooks can be
positive, stable or negative.
Example 9.5
In 2012, rating agency A.M. Best affirmed the financial strength rating of ‘A’ (Excellent) of
AXIS Specialty with a positive outlook reflecting its excellent risk-adjusted capitalisation,
consistently strong operating performance through varied market conditions and robust
enterprise risk management controls and the view that, given the current soft casualty
market conditions, it is well positioned with a diversified book of business and an
expanding worldwide infrastructure.
In this way, a positive outlook would indicate favourable business trends, which, ultimately,
could lead to a rating upgrade in the future. These ratings, although not in any way a
guarantee, or warranty, of a company’s current or future ability to meet its obligations, are
nevertheless important in terms of whether or not a reinsured should use a particular
reinsurer and how much exposure the reinsured should allow the reinsurer to accept.
It must be stressed that a reinsured is not under any obligation to accept or rely on security
ratings provided by a rating agency. There may be occasions when a legitimate business
reason exists for the reinsured apparently to ignore such information and continue to place
business with an ostensibly underperforming reinsurer.
Useful websites
www.standardandpoors.com
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www.ambest.com
www.fitchratings.com
E4 Sources of information
Rating agencies
In determining a financial strength rating, rating agencies are not only given access to
are given access to published material, such as the annual report and accounts and returns to regulatory
any information
required to make
authorities, but also to any other information the agency might require to make the
an assessment assessment. Examples of such material might include:
• strategic and operational plans;
• more detailed breakdown of financial information; and
• information about clients, sources of business and its production.
Rating agencies will usually request the completion of questionnaires. Additionally, they will
hold meetings with the company’s senior management. The meetings might also involve
management teams for individual business units, so that the agencies can discuss and
question many areas of the company’s management on strategy, business results and the
way in which market circumstances and operating situations are being addressed. Typically,
they will also base their ratings on information obtained from any other sources it considers
reliable.
Ratings are thus a combination of a quantitative, objective analysis of financial information
plus a qualitative, subjective analysis relating to the quality and depth of the management,
and whether or not its decisions are coherent, credible and operable.
Ratings look to the future as well as the past record and current status of the company.
Other users of rating agency services are aware that the agencies have privileged access to
information about a company, so this adds to the credibility of their evaluations.
E5 Ongoing review
Ratings are formally evaluated at least once every twelve months and following significant Ratings are
events, such as an ownership change, merger or recapitalisation. All ratings, however, are formally evaluated
at least once every
continually re-evaluated for other changes arising during the year, and agencies will try to twelve months
maintain regular dialogue with a company’s management. In the light of any developments,
the ratings can be moved up or down according to the assessment made of evolving
circumstances.
E6 Significance
The importance of financial strength ratings cannot be underestimated. A new company
would not usually receive a rating because it has no trading history. Rating agencies would
probably prefer to wait for three years of annual reports and accounts to be published
before they would consider assigning a rating. This is especially true for reinsurance
companies writing long-tail business. Some companies in the market might be of insufficient
size for rating agencies to consider them.
Example 9.6
In late 2008 A.M. Best assigned a financial strength rating of A- (Excellent) to Nissan
Global Reinsurance Ltd (NGRe) based in Hamilton, Bermuda. The outlook assigned was
‘stable’ and noted its excellent operating performance since the company’s incorporation
in 2005.
Without a rating, a reinsurer will sometimes have difficulty in attracting brokers and
reinsureds to place business with it. This is especially true if the start-up capital is considered
to be inadequate, irrespective of the perceived qualities of the individual managers and
other staff of that company. This applies both to new entrants to the market and to smaller
existing reinsurers.
Certain insurance companies will not place business with a reinsurance company unless it
has some form of ‘A’ rating, and they are perfectly within their rights to make such
stipulations. It therefore follows that, reinsurers with some form of ‘B’ rating, would not have
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the opportunity of writing that insurer’s business.

The poorer the reinsurer’s rating, the more the reinsurer might be selected against. This
means that the reinsurer tends to be offered poorer-quality business that is proving hard to
place with reinsurers enjoying stronger financial security.
It follows that companies are very sensitive to movements in their ratings, a downward Companies are
rating inevitably raises concerns, potentially putting the downgraded reinsurer in the very sensitive to
movements in their
position of having to justify itself to its clients. In effect, ratings can become self-fulfilling ratings
prophecies, strengthening the position of strong companies and further weakening the
position of companies experiencing difficulties. Indeed, it has become common for
reinsurance treaties to contain a special termination provision, enabling reinsureds to
terminate the contract if the reinsurer fails to maintain a stipulated rating.
Unsolicited ratings can also create some irritation. Occasionally, rating agencies will give a
rating in advance of being asked to do so, when obviously they can only base their
assessment on published information. In such an event, the rating agency concerned will
clearly identify that any rating is based solely on information in the public domain. This was
the case initially for Lloyd’s syndicates. Subsequently, Lloyd’s invited Standard & Poor’s and
A.M. Best to undertake formal annual ratings with Lloyd’s cooperation. Lloyd’s syndicates
must now identify their potential loss involvements arising from RDS, an example of which
follows.
Example 9.7
One of the disaster scenarios is a hurricane, which cuts directly across offshore oil
platforms in the Gulf of Mexico, before making landfall in Texas and moving over the
densely populated Houston area. This test was introduced in recognition of, and to
examine, the significant correlation between onshore and offshore risks to hurricane
events.
The scenario and guidance draws on a wealth of underwriting experience and is used by
energy underwriters worldwide as an industry standard approach to offshore energy risk
management. This kind of active exposure management helped mitigate losses from
Hurricanes Katrina and Rita. Through its ongoing work on RDS, the Lloyd’s Corporation is
helping the market to prepare for each new storm season.
This form of ‘testing’ has been imposed by Lloyd’s but rating agencies will consider these
important disciplines to be only an adjunct to their own assessments.
Useful website
View the RDS Scenario Specification 2017 at http://bit.ly/2FxB77U.
F Mergers, acquisitions and reinsurer failure

Merger and acquisition activity has been a key feature of most reinsurance markets for a
number of years and this will continue. Reinsurance treaty contracts include a section in the
special termination clause that allows either party to cancel the treaty with immediate effect
in the event of a change of ownership or control or a significant reduction in capital.
Mergers
When a reinsurer that participates in a specific reinsurance treaty or programme merges
with another reinsurer, the reinsured must give full consideration to a number of
implications. These are the:
• financial security of the new merged entity: in most instances the capital structure and
premium income base will be much higher;
• underwriting philosophy of the new entity; and
• reinsurer’s participation in the treaty or programme.
To expand on this last point, if, for example two reinsurers merge that participate in the
same reinsurance programme with shares of 20% each, the combined participation of the
merged reinsurer would become 40%. The reinsured may decide that is too high a share for
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any one reinsurer. In practice, in these situations the reinsured usually adjusts the
participations at the next renewal date rather than at mid-term.
Acquisitions
The implications where a reinsurer has been acquired by another reinsurer could be more
serious. The financial security would usually be stronger, but the key questions would be
will the:
• reinsurer continue in the same name as a separate company or will be it closed, with all
the business being transferred into the new owning company; or
• new owning reinsurer be writing the same classes and business in the same territories?
Quite often the acquiring reinsurer will wish to discontinue certain classes or territories, or
write the same classes at different prices and conditions. From the reinsured’s perspective
that could mean they would need to replace that reinsurer’s share at the next renewal.
Failures
The implications of a reinsurer failing could be very serious. If a reinsurer goes into
liquidation, the reinsured will either not be able to recover any claims, or at best only recover
a small proportion of the claims due, depending on what the liquidator or statutory
successor can obtain from what is left of the company’s assets.
By invoking the special termination clause, the reinsured can at least stop ceding any further
risks or paying any further premium instalments to that reinsurer.
G Terrorism
Following 9/11 and its profound impact on the insurance and reinsurance market, the
following clause was introduced in the London Market to exclude terrorism in reinsurance
policies:
Notwithstanding any provision to the contrary within this agreement or any
endorsement thereto, this reinsurance agreement does not cover any loss, damage
or expense of whatsoever nature directly or indirectly caused by, resulting from,
happening through or in connection with any act of terrorism, regardless of any
other cause contributing concurrently or in any other sequence to the loss, damage
or expense.
For the purpose of this exclusion, terrorism means an act of violence or an act
dangerous to human life, tangible or intangible property or infrastructure with the
intention or effect to influence any government or to put the public or any section of
the public in fear.
In any action suit or other proceedings where the reinsurer alleges that by reason of
this definition a loss, damage or expense is not covered by this reinsurance
agreement, the burden of proving that such loss, damage or expense is covered shall
be upon the reinsured.
This reflects a similar clause that was also added to direct insurance policies.
In the past, terrorism was also recognised as part of a risk and included in the underwriting
considerations in the various insurance and reinsurance lines of business. This was mainly
related to cases in which terrorists were deemed responsible for arson, explosions or murder
of individuals or several persons.
Activity
When Bishopsgate (in the City of London) was attacked by terrorists in 1993, the
explosion damaged 278,000 square metres of space whilst an estimated £300m worth of
damage was inflicted on the buildings and businesses in the surrounding area. See what
you can find out about the attack at nearby St Mary Axe that occurred the year before.
Following 9/11, much higher figures have been put on possible loss impacts from terrorist
attacks. The potential for greater loss frequency of such major losses has also increased.
New criteria regarding safety obligations and contributory negligence apply in connection
with the liability of owners of means of transport, production plants and buildings. Of
particular importance to underwriting are loss potentials for very large losses, with the
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possibility of line of business clashes and policy accumulations.
G1 International perspectives on terrorism

Unsurprisingly, the approach that a country takes to the provision of terrorism cover varies
according to the territory in question and the perceived vulnerability its people and its
property have to the activities of terrorists.
G1A UK
Pool Reinsurance Company Ltd (Pool Re) was formed in 1993 in response to the succession Pool Re was
of attacks by Irish terrorists. A mutual, Pool Re provides reinsurance capacity to the UK formed in 1993
commercial property market with the Government standing behind it as the ‘reinsurer of last
resort’. In 2003, Pool Re’s cover changed from a facultative approach to treaty cover with a
per event retention.
The scheme uses the definition of an Act of Terrorism contained in the Reinsurance (Acts of
Terrorism) Act 1993
1993:
acts of persons acting on behalf of, or in connection with, any organisation which
carries out activities directed towards the overthrowing or influencing, by force or
violence, of Her Majesty’s government in the United Kingdom or any other
government de jure or de facto.
The terrorism cover provided by Pool Re members must be issued as part of a policy which
covers losses resulting from damage to commercial property. Terms and conditions that
apply to the general cover will also apply to the terrorism cover. Equally, monetary limits
that appear in the general policy also apply to the terrorism cover.
Be aware
In the event that the general commercial property policy states that losses below a certain
amount cannot be recovered from the insurer, then the same deductible applies to the
terrorism cover.
The only exclusions applying to the terrorism cover are for war and related risks and damage
to computer systems caused by virus, hacking or similar actions.
There is no exclusion for chemical, biological, radiological or nuclear contamination. The
terrorism cover provided by the Pool Re member is able, subject to the terms of the policy,
to respond in situations in which damage has been caused by such means.
Pool Re
Excluded Not excluded

War and related risk, Chemical, biological,
Damage to IT caused by virus, radiological or nuclear
hacking or similar contamination
There are some insurance companies and Lloyd’s syndicates which provide specific
coverage on a case-by-case basis. This type of underwriting is done on a strictly facultative
basis as considerable information has to be provided on each and every risk to ensure that
coverage can be given.
Useful website
www.poolre.co.uk
G1B USA
The Terrorism Risk Insurance Act (TRIA
TRIA) is a US federal law created in 2002. The Act
created a federal ‘backstop’ for terrorism claims. The Act was intended as a temporary
measure to allow time for the insurance industry to develop its own solutions and products
to insure against acts of terrorism. The latest renewal expires at the end of 2020 and is
Chapter 9
known as the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA TRIPRA) of 2015.
TRIA created a US
Although it does not currently buy reinsurance for its own exposures, TRIPRA created a US
Government Government reinsurance facility to provide reinsurance coverage to insurance companies
reinsurance facility
following a declared terrorism event. It established the Federal Terrorism Insurance
Program to administer a system of shared public/private compensation for insured losses
arising from acts of terrorism in order to protect consumers. TRIPRA only applies to acts
certified by the US Secretary of the Treasury, in consultation with the Secretary of Homeland
Security, as meeting the definition of a terrorist act. The event must also cause losses from at
least US$100m in 2015, increasing to US$200m by 2020.
Activity
In the USA an act of terrorism is defined as:
any act certified by the Secretary of Treasury, in concurrence with the Secretary
of State and Attorney General, to be an act that is dangerous to human life,
property, or infrastructure and to have resulted in damage within the USA (or
outside the USA in the case of a US-flagged vessel), or on the premises of a US
mission.
How does this definition vary from that used in other countries?
Each individual company has its own ‘trigger’ or ‘deductible’ linked to a percentage of its
premium income, which is currently 20%. When the trigger is activated, the Federal
Government pays 85% of insured terrorism losses in excess of the trigger, whilst the insurer
pays 15%. Following the latest renewal of TRIPRA, the Federal share has been reducing by 1%
per calendar year and will continue to do so until 2020, with a corresponding increase in the
insurer’s retention. Losses remain capped at US$100bn. Congress will determine how to
calculate any losses above this, if such an event occurs.
In respect of reinsurance contract renewals, reinsurers excluded TRIPRA-certified events.
However, insurers were then offered separate cover for domestic attacks, although this
typically excluded events including nuclear, chemical or biological weapons.
A standalone property terrorism insurance market offers coverage for both TRIPRA-certified
and non-certified risks, and enables companies to tailor capacity to their coverage needs. It
is estimated that there is upwards of US$10bn of terrorism capacity available in the US
market. Various factors dictate how much coverage is available for any single programme,
such as whether nuclear, biological, chemical and radiological cover is sought, although any
individual limit is likely to be in the range of US$500m to US$1bn.
G1C Europe
France
The position regarding insurance contracts is that victims are indemnified for terrorist
attacks occurring in French territory, as are French nationals abroad, via a State Fund.
Participation in the French terrorism reinsurance pool, GAREAT, is compulsory for all
members of the French Insurers’ Association (FFSA), including Lloyd’s. The pool is divided
into two sections:
• Large risks section: covers risks where the sum insured is €20m or more.
• Small and medium-sized risks section: covers risks insured below €20m.
Each section is protected by an annual aggregate excess of loss reinsurance mechanism.
GAREAT will cover all acts of terrorism, including those involving the use of nuclear
weapons. GAREAT private reinsurers and French State coverage makes no distinction
between nuclear and non-nuclear attacks. Only contracts with a fire guarantee must cover
terrorism. Therefore, GAREAT will no longer accept risks where there is no fire guarantee.
Activity
In The Netherlands, there is a Dutch Terrorism Reinsurance Company known by the
Chapter 9
abbreviation ‘NHT’. See what you can find out about its funding, capacity and maximum
exposures.
Germany
Germany’s response to the threat of terrorist losses was to form EXTREMUS Versicherungs-
AG at the end of 2002. Owned by German (re)insurers, EXTREMUS provides commercial
property and casualty cover, especially to small- and medium-sized businesses. The insurer
has a maximum annual cover of €10bn. Although reinsurers provide cover for the first
€2.5bn, the final €7.5bn layer is guaranteed by the state. The default deductible is €50,000
and there is no differentiation of risk, a structure that inevitably has led to criticism from
those who feel they are paying too much. Higher deductibles may be agreed with the
appropriate discount.
Terrorism cover
The position regarding insurance contracts is that terrorism cover must be included for
must be included personal lines policies and commercial lines policies up to a sum insured of €25m.
for personal lines
policies and
EXTREMUS provides optional cover in excess of €25m, principally for industrial losses
commercial lines arising from terrorism.
policies
There is also a terrorism pool in neighbouring Denmark.
Italy
Despite discussions, no government pool has been formed, leaving the private market to
provide cover. On a general basis, terrorism cover is provided on personal lines and most
small to medium enterprise commercial risks, provided the sum insured doesn’t exceed
€50m. On the reinsurance side, small amounts of cover can be purchased routinely with
write-backs available to extend protection.
Spain
The government-owned Consorcio de Compensación de Seguros (CCS) provides terrorism
cover on both a direct and reinsurance basis for events which occur in Spain. The CCS
provides both personal lines and commercial property cover in respect of insurance
contracts. Following the events of 2001, the CCS extended the cover to include business
interruption losses arising from so-called ‘extraordinary’ risks such as terrorism.
G1D Australia
ARPC administers
The Australian Reinsurance Pool Corporation (ARPC) administers the government’s
the government’s terrorism insurance scheme. The scheme provides reinsurance cover for terrorism risks
terrorism
insurance scheme
relating to commercial property and infrastructure and was established following the
withdrawal of cover after 9/11.
ARPC’s cover applies to any act, defined by the government as a ‘designated terrorism
incident’, which occurs in Australia. All eligible insurance contracts are deemed to include
terrorism risk cover, effectively rendering inoperative exclusion clauses. Eligible insurance
contracts are those that provide insurance cover for the loss of, or damage to, eligible
property located in Australia.
For reinsurance contracts, cover is as provided by the ARPC. Retentions are currently
A$100,000 (minimum) and A$10m (maximum) per carrier, per annum, and A$100m across
the industry per event.
As at October 2017, the pool retains the first A$350m of the scheme, a retrocessional
programme for the next A$3bn is in place with various global reinsurers and above that
there is a guarantee from the government of A$10bn.
G1E Canada
Canada has anti-terrorism legislation but none of it is insurance-related. Exclusions apply for
most insurance policies. Some reinsurance cover is available but typically for those
exposures regarded as low risk, such as in rural areas.
Learning point
Before you move on, evaluate the approach that each country listed takes to the provision
of terrorism cover. How does the approach fit the territory in question and the perceived
vulnerability its people and its property might have to the activities of terrorists?
Chapter 9
Useful website
For the latest information, visit the Organisation for Economic Co-operation and
Development (OECD) website and find the section detailing terrorism risk insurance
programmes by country. www.oecd.org/
Key points
Nature of the reinsurance market
• Reinsurance is bought and sold in both local and international markets.

• Ceding insurers prefer a spread of reinsurers offering security and stability.
• An ‘ideal’ international reinsurance market offers, among other things:
– political stability;
– good geographical access;
– quality transport and communication systems;
– a pool of specialised staff and competitively priced office accommodation;
– a stable legal and regulatory environment;
– developed financial infrastructure and a strong national industrial base;
– a strong currency; and
– good arbitration facilities.
• Extraneous environmental factors affecting reinsurance transactions are price, availability, the
strength of competitors, developments in loss exposures, claims potential, alternative products,
strength of financial markets, and extent of coverage being provided by ceding insurers.
Global reinsurance markets
• The London Market comprises of Lloyd’s and the IUA.

• Solvency II introduces a new harmonised EU-wide (re)insurance regulatory regime and is having a
significant impact on how companies use capital.
• New business is acquired through direct marketing although brokers are also used as an
introductory source because of the positive impact on acquisition costs.
• The US domestic insurance industry is the largest in the world and this is reflected in the size of the
US reinsurance market.
• Reinsurance regulation in the USA is the responsibility of individual US states although the NAIC
encourages consistent national regulation. The Sarbanes-Oxley Act 2002 is legislation affecting the
corporate governance of US reinsurers and affects foreign companies operating in the US market in
the same way.
• The Bermudian market has developed from a low-tax haven for captive insurance companies into
the world’s largest property catastrophe reinsurance market since its inception in 1993.
• The Asian markets comprise Japan (where the domestic market is dominated by a few Japanese
companies), China (where national companies had a monopoly until 2003 when certain foreign
reinsurers were allowed to set up branch operations) and India (where there is a national insurer
conducting business).
• Other significant world markets include Australia and Brazil.
Captive insurance companies
• A captive insurance company is a special purpose vehicle created to manage and to finance risks
emanating from its non-insurance parent company.
• Captives are particularly useful if the firm has predictable losses or if cover is unavailable or too
expensive in the wider insurance market.
• Common captive structures include single parent captive, a group or association captive and PCCs.
Chapter 9
• Captives tend to be domiciled in territories offering favourable tax and other fiscal advantages.
Market cycles
• Reinsurance is particularly susceptible to market cycles, since terms for both proportional treaties
and excess of loss contracts are agreed in advance of the actual treaty or contract period, and
rarely amended during that period.
• Price volatility is typically greater for non-proportional reinsurance business. Proportional rates
tend not to fluctuate quite so widely because this business is more closely linked to the less volatile
underlying direct business.
• Hard reinsurance markets tend to follow an abnormally large loss, and particularly a large natural
perils event loss.
• A soft market typically arises after a period where there has been little major loss activity and
competitive market forces.
• Managing the cycles includes:
– maintaining strict control of pricing;
– actively managing the portfolio;
– underwriting for technical profit not investment income;
– gearing staff remuneration towards profit and not volume; and
– using capital efficiently.
• Market capacity is high during a soft market and low during a hard market. A hard market attracts
new entrants whilst a soft market discourages them.
Financial strength ratings
• Rating agencies assess, and rate, the ability of reinsurers to pay claims.
• Typically, rating agencies will assess the company’s financial strength, its operating performance
and market profile become coming to an overall assessment of claims-paying ability.
• In assessing the financial strength of a reinsurer, the rating agency will consider:
– the reinsurer’s ability to access capital;
– the quality of its reinsurance programme;
– adequacy of its technical reserves; and
– its liquidity.
• In assessing its operating performance, the rating agency will consider:
– profitability;
– sources of business, nature of premiums and investment income; and
– all aspects of its management experience and associated objectives.
• Rating agencies use alphabetic indicators, such as AAA – with or without + or – signs – as the mark
of the strength of their rating, and provide supporting definitions.
• Ratings will be subject to formal evaluation at least once every twelve months and following
significant events, and to ongoing review throughout the year.
• Great importance is attached to financial strength ratings, especially so in the case of reinsurers
writing long-tail business. Without one, or one at an appropriate level, a reinsurer will sometimes
have difficulty attracting brokers and/or reinsureds to place business with it.
Mergers, acquisitions and reinsurer failure
• When a reinsurer merges with another, the reinsured must consider the financial security of the
merged entity, its underwriting philosophy and the extent of its participation in the treaty or
programme.
Chapter 9
• When a reinsurer is acquired by another, the reinsured will need to know whether it will continue to
write the same classes and business in the same territories or will it need to replace that reinsurer at
next renewal.
• If a reinsurer fails, the reinsured will not be able to recover all of, or even a proportion of, any claims.
It should invoke the special termination clause to stop ceding risks and paying premiums.
Terrorism
• Following 9/11, a clause was introduced in the London Market to exclude terrorism in reinsurance
policies to reflect a similar exclusion under direct insurance policies. However, insurance companies
and Lloyd’s syndicates do provide cover on a case-by-case basis.
• International perspectives on terrorism vary according to the perceived threat posed.
Question answers
9.1 Most other markets involve the buying and selling of tangible goods that can be
inspected and appraised. For insurance and reinsurance-related products this is not
the case, since what is being traded is a promise to pay in the event a specified
occurrence taking place.
9.2 a. Reserves have to be greatly enhanced in order to fund losses, leading to a
reduction of capacity and poorer underwriting results;
b. return on capital becomes less as poor investment returns and low interest
rates mean that investment income can no longer keep up with technical
underwriting deficits;
c. the tendency to increase the scope of cover is reversed as tighter controls and
more restrictive wordings are imposed;
d. EML calculations are re-evaluated as the sheer size of such losses means that
reinsurers have to reconsider on what basis they can accept large risks.
9.3 Fees need to be agreed with clients, preferably in advance, to reflect the value to the
client of the non-insurance service provided.
9.4 No, the IUA is a trade and market association and has no involvement or authority
over the commercial pricing decisions of its member companies.
9.5 Although Australia is considered to pose one of the highest bushfire risks in the
world, as spectacular as bushfires appear in media reports, they pose only a relatively
small threat to insurers and reinsurers. Despite increasing development at the
bushland/urban fringe, the risk posed to life and property is decreasing, due to
continuous improvements in firefighting techniques and mitigation of the bushfire
hazard.
9.6 A fire loss on one floor could possibly affect the floor below, say as a result of water
damage, and the floor above, perhaps through smoke damage, but that the
remaining floors of that building would be essentially unaffected.
9.7 By allowing business to lapse it is accepting decreasing premium volume at a time
when operating costs and administration expenses are static or even increasing.
Chapter 9
Self-test questions
1. List five of the characteristics that Herve-Bazin feels typifies an ‘ideal’ international
reinsurance centre.
2. What are the two main components of the London reinsurance market?
3. Identify the three links in the chain of security at Lloyd’s.
4. Name three European centres favoured for the establishment of captive insurance
companies.
5. Is reinsurance regulation in the USA conducted at a federal or state level?
6. What event encouraged new highly capitalised companies to set up in the
Bermudian reinsurance market?
7. Name three leading reinsurance markets in Asia.
8. What happens to reinsurance capacity and investment returns during the ‘soft’
phase of a market cycle?
9. When investment income is low, why is it essential that reinsurers work to a prudent
underwriting discipline?
10. How often are financial ratings on reinsurers usually evaluated?

Chapter 9
Property reinsurance
10
outcomes
Learning objectives
Introduction
Key terms
A Reinsuring a property account 10.1, 10.2, 10.5
B Underwriting features of proportional reinsurance 10.1, 10.2, 10.3, 10.5
C Underwriting features of non-proportional reinsurance 10.1, 10.2, 10.3, 10.5
Key points
Question answers
Self-test questions
Learning objectives
• discuss the underwriting considerations and the principles of rating that apply to property
reinsurance;
• explain the uses of different methods of reinsurance as they relate to property business;
• describe the ceding insurer’s needs for alternative types of property reinsurance;
• discuss the significance of accumulations of risk and the importance of estimated
maximum loss; and
• explain the main terms and conditions specific to property reinsurance.
Chapter 10
Introduction
In this chapter we shall look at how different types of reinsurance contracts and their
functions apply to property insurance. This process includes the way in which the various
types of arrangements operate, the choices open to cedants and the reasons for choosing a
particular option. We also need to bear in mind the underwriting implications from the
reinsurer’s perspective.
As a starting point, we shall consider what is meant by ‘property insurance’ and some of the
problems which primary insurers face in writing this class of business.
Key terms
Accumulation of risk Cash loss limit Ceded premium Estimated maximum

loss (EML)
Hours clause Incurred losses Individual risk retention Material information
Portfolio transfers Profit commission Reserves Special perils
Stop loss Sum insured Table of limits Target risk
A Reinsuring a property account

Covers insured
Property insurance covers insured property against losses arising from physical damage,
property against such as fire, flood and other extraneous sources. This includes specialised forms of
losses arising from
physical damage
insurance, such as fire, homeowners, engineering, machinery breakdown and electrical
equipment; however, it excludes all forms of transportation, such as ships, aircraft and motor
vehicles.
Question 10.1
What is the reason for this exclusion?
In practical terms, the insurance of property usually suggests protection against loss of
physical, tangible objects or assets, such as buildings, machinery, stock and personal
belongings as a result of an insured peril. It also relates to losses affecting other less obvious
types of ‘property’ such as money and data, not only in their physical forms, but as intangible
assets with invisible, high intrinsic values as well.
Example 10.1
The value of intangible assets such as data to a business was highlighted by the hacking of
Sony towards the end of 2014. Huge caches of confidential information, including
personal information about employees and their families, executive salaries and then
unreleased films, were dumped onto online file-sharing hubs, terrifying the entire
corporate world.
In addition, there are the costs that arise out of the interruption of a business through a fire
or some other fortuitous cause.
Be aware
Often bracketed with property insurance are so-called ‘pecuniary loss’ classes, which
include legal expenses and payment protection insurance. Such classes share the
Chapter 10
generally short-tail settlement characteristic of property insurance.

Chapter 10 Property reinsurance 10/3
Although the practice may differ between offices, the principal types of risks written in a
property department are:
• fire and special perils/material damage ‘all risks
risks’’, such as explosion, water damage, riot,
earthquake, burst pipes, flood, storm and many others;
• business interruption
interruption, covering the reduction in the gross profit as a result of a shortage
in turnover due to an insured peril;
• engineering risks associated with the explosion of boilers or the breakdown or collapse of
machinery and the subsequent interruption to the business; and
• contractors risks’’ against damage to plant or to buildings in course of erection.
contractors’’ ‘all risks
Other types of policies which may be found in the property department include:
• theft of property, usually arising out of violent entry or exit to or from the premises;
• goods in transit to cover loss or damage to goods while in vehicles; and
• money insurance to cover loss through ‘all risks’.
The property insurer typically has thousands of policies on its books covering property risks
against a wide range of perils and for varying sums insured. Although underwriters are by
definition ‘risk-takers’, their first concern is the possibility that any one or more of the risks
they cover is involved in a loss greater than they are prepared for or able to withstand. In
other words: greater than the amount they regard as a prudent retention, whether
individually or collectively.
A1 Individual risk retention

Let us consider retention in respect of individual risks against the peril of fire. Insurers know
that some types of risk are more likely to have a fire than others, because of the hazards
associated with them on account of trade processes or particular features of construction.
Example 10.2
A furniture manufacturer uses machinery, wood and other inflammable materials and is
likely to be a more hazardous risk than a modern, purpose-built office block. It follows that
as the likelihood of loss is smaller for the latter risk than the former, the insurer will be
more willing to retain a higher amount for it than the former.
The underwriter will have constructed a table of limits

limits. This will indicate, based on the Underwriter will
underwriter’s perception of different types of risk and the claims experience of them, the have constructed a
table of limits
amount of the sum insured (or estimated maximum loss when that is the insurer’s
underwriting basis) that the insurer is prepared to retain for each individual one, according
to its risk classification. Typically, the table denotes relatively higher retentions for the ‘good’
risks than the ‘bad’ as shown in table 10.1.
Table 10.1: Example table of limits

Risk classification Types of risk Insurer
Insurer’’s retention
1 Offices £1,000,000
2 Colleges, schools £800,000
3 Light engineering factories, hospitals, £600,000

churches
4 Textile factories, TV manufacturers £500,000
5 Furniture manufacturers £250,000

Chapter 10
These retention amounts are based on the sum insured, or estimated maximum loss (EML) (EML),
for the property and the classification of the risk. What these are will vary between
underwriters, according to their own perception of the hazards. An individual risk may be
reclassified upwards on account of features which make it more attractive, such as proximity
to the fire brigade or the presence of fire-extinguishing appliances. Similarly, a risk may be
given an inferior classification due to the high proportion of combustible materials used in its
construction.
Table is based on
The table is based on the likely maximum amount of damage caused by an insured peril to an
the likely maximum insured risk. There will be many risks for which the sums insured or EML exceed the retention
amount of damage
caused
and if the insurer wishes to accept the risk, it needs to have reinsurance facilities in place to
be able to do so. Otherwise, it may have to decline the risk or co-insure it. Therefore, the
concept of retention is important as it helps the underwriter to determine the amount of
reinsurance cover required.
A2 Estimated maximum loss (EML)

Calculation of retentions based on the sums insured for separate risks is modified by the
concept of EML.
EML
EML can be defined as ‘an estimate of the monetary loss which could be sustained on a
single risk as a result of a single fire or explosion considered by the underwriter to be
within the realms of probability’.
This concept considers the possibility that maximum loss will be less than the sum insured.
Example 10.3
A fire policy has a building sum insured of £1m. The insurer’s retention for such a risk,
based on the sum insured, is £750,000. The insurer’s underwriter ascertains that the
building is divided into two separate units with values of £600,000 and £400,000. If the
unit with the higher value (the ‘target’ risk) is totally destroyed, the underwriter’s liability,
or EML, is unlikely to exceed £600,000. In the knowledge that the sum insured is unlikely
to be paid in full as a result of a loss, the underwriter can accept and retain the whole of
the sum insured of £1m. Similarly, the EML may be less than the sum insured since the
nature of the risk is unlikely to lead to a total loss.
Therefore, the concept of EML allows the insurer to consider its expected exposure in
relation to its theoretical one, and to adjust its acceptance and its retention accordingly.
More complex situations include ones where, say, the EML has to take into account the
existence of an insured’s material damage and business interruption policies, or where the
risk is spread out over a wide geographic area. The material damage policy of a large
industrial company may insure all buildings and machinery worldwide in one sum, and
naturally the insurer will be anxious to find out the EML in relation to the risk with the highest
values – the target risk
risk.
A key issue is the

A key issue in arriving at retentions and for the calculation of EML in particular, is the
definition of a definition of a single risk. A building standing on its own in isolation is clearly a single risk.
single risk
However, separate buildings of normal, incombustible construction not separated from each
other either by an open space of at least 15 metres, or if adjoining, by a perfect party wall,
may be considered to be a single risk. Thus, several buildings on a site may constitute a
single risk. Reinsurers usually accept the reinsured’s definition of a single risk, although there
is no standard definition.
The calculation of EML will also reflect the insured peril; for example, flood may present a
much greater EML in a particular risk location than the peril of fire.
A2A EML error

Difficulty arises
Difficulty arises when the EML has been miscalculated, known as EML errorerror, and so the loss
when the EML that occurs is higher than was anticipated; for example, if the fire spreads to all parts of the
has been
miscalculated,
property, or the amount of damage in one part has been greater than expected. In such
circumstances the reinsurer’s liability is also greater than it would have been had the
Chapter 10
known as
EML error
retention been based on the sums insured. For this reason, some underwriters now base
their retention, not on the probability that the EML will be less than the sum insured, but on
the EML itself. Correspondingly, the insurer would accept less of the risk on offer, in order to
ensure that its actual loss would not exceed its retention.
Example 10.4
Let us return to the scenario in example 10.3.
A fire occurs and the resultant fire damage turns out to be £800,000. However, the
underwriters had set their retention at £600,000, based on the EML.
Question 10.2
What are the implications for a proportional reinsurer if the reinsurance has been fixed on
a ‘sum insured’ basis, but the EML for a particular risk is underestimated?
For risk excess, the reinsurer is liable for the increased amount of loss that falls to the layer.
For catastrophe excess of loss, unless there is a limitation, the increased net retention on
account of the error will aggregate with other net retentions arising from the same event. If
the EML error is substantial, there may be some argument as to whether this was a material
misrepresentation and could lead to a dispute over coverage of the risk.
A3 Accumulation of risk
The underwriter is also concerned about an accumulation of risks where, say, several
buildings in proximity to each other are damaged by a common cause or where there are
several insured interests in the same property, such as in a multi-tenure block.
Accumulation may also arise if the insurer already has a commitment on the risk through
co-insurance, or where an insured’s material damage and business interruption policies are
placed with the same insurer. These circumstances increase the likelihood of a higher loss,
and the insurer may need to modify its retention in respect of individual risks to ensure that
it is not exposed to an unacceptable level of losses.
Having introduced property insurance, we now turn to the underwriting considerations
inherent in the different reinsurance methods. Note that, in addition to the general
exclusions discussed in chapter 7, section E7, certain common exclusions appear in property
reinsurance contracts. There is a review of the main ones in appendix 10.1, available on
RevisionMate.
Reinforce
Before you move on, make sure that you understand how EML and EML error impact
property reinsurance.
B Underwriting features of proportional

reinsurance
Property insurance is suited to proportional reinsurance, whether by the facultative or the Suited to
treaty method. This is because it has clear insured values (unlike liability classes) and these proportional
reinsurance
make it easier for the reinsured to determine a retention and cession pattern. because it has
clear insured
A reinsurer in a proportional arrangement has undertaken to ‘follow the fortunes’ of the values
reinsured. It accepts a proportion of the premiums charged by the reinsured and pays the
same proportion of the claims, no matter what these amount to (subject to any imposition of
event limits to control catastrophe exposure). Since it has no direct influence over the
original rating of the insurance written by the reinsured, the reinsurer has to rely on
negotiating the terms and conditions of the reinsurance it provides to ensure that it receives
an adequate premium commensurate with the risk it is taking on.
Chapter 10
Apart from the general underwriting considerations that apply to all classes of business,
there are specific issues that property underwriters need to consider. We will look at these in
this section.
Understand the reinsured

reinsured’’s portfolio
Any risks or types of coverage that are to be excluded from the reinsured’s original portfolio,
or which reinsurers wish to specifically exclude from the reinsurance protection, is material
information and must be included in the data available during negotiation of the reinsurance
programme. Much of this information needed by the reinsurer – or the broker, if one is
involved – can be obtained from the reinsured by completion of a detailed questionnaire.
Analysis of the account to be reinsured should reveal the split between simple, commercial
and industrial risks. It should also reveal whether the account consists solely of direct
business or is to include inwards reinsurance business as this may present the proportional
reinsurer with a greater degree of risk. This is because inwards reinsurance cessions from a
variety of different sources may create risk accumulations for the reinsurer that can be
difficult to quantify.
The underwriter should identify the extent to which the original risks provide protection for
additional perils such as consequential loss, riots, windstorm and earthquake. In addition, the
balance between any hazardous and non-hazardous risks needs to be identified.
The reinsurer must maintain some degree of control over its own portfolio of liability, the
potential for delayed accounting and possible accumulation of risk. Therefore, it would be
considered material information to establish the territorial scope of the business, the
potential for aggregation of losses from natural disaster perils, such as earthquake and
windstorm, and whether there will be any particular exchange controls or trading
restrictions that may have an adverse effect on the servicing of the reinsurance.
Question 10.3
Why is it in the reinsurer’s best interests to ensure that its own portfolio of business covers
as wide a range of risks and territories as possible?
Know the reinsured

Understanding the experience and competence of the direct underwriter has a decisive part
to play in forming the underwriter’s opinion of the business being offered by the reinsured.
The reinsured’s experience in the class of business being reinsured is considered material
information, as inexperience or a poor record affects a reinsurer’s exposure to potential
major losses.
This flows into the next consideration. The reinsurer will want to understand the reinsured’s
attitude to risk: whether it is cautious or adventurous in its underwriting policy. Thus the
information on the amount it retains, or wishes to retain, is vital during the negotiation of the
reinsurance protection.
Consequently it will be important to establish the:
• amount of the reinsured’s maximum net retention for any one risk and for each class or
category of risk in the portfolio to be protected;
• relationship between the net retention and the treaty capacity required; and
• basis on which the net retention and, therefore, the treaty capacity, is being calculated so
it can be seen whether it is on an original sums insured or an EML basis.
Retentions based on original sums insured have a distinct advantage as the reinsurer knows
that it cannot be exposed for an amount greater than the sum insured. If an EML basis is to
be used, the reinsurer must establish that it is confident in the method that the reinsured is
using to calculate its EML figures. Any error in these amounts leaves the reinsurer exposed
for far greater amounts of liability than expressed as the EML limit.
The attitude of the reinsured’s management to the generation of premium income influences
Chapter 10
the reinsurer’s perception of the business being offered and any information to establish
their development philosophy would be material to negotiations. A company with a cautious
attitude to risk or which is operating within a recognised structure of original rates will
produce a stable premium income. If the company is aggressively seeking to increase its
market share it may be seeking new business by cutting established rates. While this may be
generating an increase in premium income, the relationship between the liability being
assumed and the reinsurance premium may be adversely affected.
Profitability
The relationship of net retention and treaty capacity to premium income must be
established. This is a prime indicator to the reinsurer of the profit potential of the business
being negotiated.
Example 10.5
The premium income on an account is £50,000 and the required treaty capacity is
£200,000. Therefore, it could take four years to recoup the amount from a single loss,
assuming that there were no further losses and no increase in the premium income.
If the treaty capacity was on an EML basis, it could take considerably longer.
In the case of a mixed portfolio of business, it would also be reasonable to expect this
breakdown of premium income to be available for each category or class of risk.
In addition, in order to give the reinsurer an indication of the potential for profit from the
proposed reinsurance, the reinsured would be expected to provide an exhibit showing the
results of the account to be protected over the past five to ten years.
These statistics should show:
• the development of the ceded premium from year to year (written and, if applicable,
earned); and
• the incurred losses
losses, preferably split between paid and outstanding;
• commissions, taxes and charges taken off the premium, and
• profit commission (in some circumstances).
How the reinsurance will work
The reinsured should also provide clear instructions as to its requirements in the actual
servicing of the reinsurance. These instructions should cover the following issues:
• Reserves
Reserves. Will the reinsurance be subject to the establishment of premium reserves
and/or loss reserves?
In some countries the withholding of reserves is a legal requirement for the reinsured. The Mentioned in
chapter 4,
retention of reserve deposits has an adverse effect on the reinsurer’s cash flow and many section D
underwriters try to resist them.
• Portfolio transfers
transfers. If the treaty is to be subject to incoming and outgoing portfolio
transfers of premiums and/or losses, will the amounts involved be adequate for the
liability that is being moved from one year of account to another?
• Accounts
Accounts. What conditions will apply to the presentation and settlement of the technical
accounts? The imposition of time limits for the rendering and settlement of accounts is
advantageous to the reinsurer as it assists in maintaining cash flow as well as enabling it to
monitor the performance of the reinsurance on a regular basis. Any provision for the
settlement of large losses outside the normal accounting cycle should be made clear and
agreed. This is defined in the treaty conditions as the cash call or the cash loss limit
limit.
• Period
Period. The contract will stipulate the period for which reinsurance is required and any
cancellation provisions that will apply. With proportional treaties it is usually agreed to
review them at each anniversary from the date on which the arrangement commenced.
• Commission
Commission. The level of ceding commission forms a major part of the negotiation of any
proportional reinsurance. It is the primary tool available to the underwriter in the pricing
of the cover given. Ceding commission can be at a flat percentage rate or on a sliding
scale. A flat percentage rate may be negotiated in combination with a profit commission.
• Brokerage
Brokerage. If the reinsurer is accepting the business through a reinsurance broker, then
the question of brokerage is a factor in successfully negotiating the reinsurance
arrangements.
Chapter 10
Be aware
When we refer to a premium reserve we mean the amount of money held by the reinsured
relating to premiums representing the unexpired portions of the policies or contracts as at
a certain date. It can be based on a formula of averages of issue dates and the length
of term.
A loss reserve is an estimate of the amount the reinsurer expects to pay for the reported
claim and may include amounts for loss adjustment expenses.
Activity
Find out the typical level of brokerage (as a percentage of premium income) that would
be paid for a proportional treaty acceptance.
A final key issue is the total amount of reinsurance requested. Too much cover will result in
the reinsured paying unnecessary premium while too little leaves the reinsured with
additional and unrecoverable net retained losses.
Retention will also

The scope and size of any event protection is influenced by the extent to which the
be influenced by reinsured’s portfolio of risks is exposed to the possibility of an unexpected disaster or
the financial
strength of the
unpredictable aggregation of claims. This will undoubtedly affect not only the total limits of
reinsured the reinsurance but also the size of the reinsured’s retention. This retention will also be
influenced by the financial strength of the reinsured as well as its aggregated liabilities in any
one area.
B1 EML failure clauses

A proportional property treaty that expresses the treaty limits on an EML basis without any
EML failure restrictions would give the reinsured full sum insured protection, even in the
event of an EML failure.
Example 10.6
A nine line surplus treaty has a maximum cession limit of €18m EML any one risk.
A risk of €20m EML for 100% has a 50% EML and therefore a sum insured of €40m.
The reinsured retains €2m EML (10%) and cedes €18m EML (90%) to the surplus treaty.
A fire occurs that causes a loss of €30m for 100%, which is much higher than the
calculated EML and in this instance there has been an EML failure.
The reinsured’s retained loss is €3m (10%) and the loss to the surplus treaty is €27m.
The accuracy of EML calculations can vary from one company to another and certain
countries have higher levels of EML failures than others. The accuracy of EMLs mainly
depends on the quality of surveyors. Larger risks are usually surveyed and the surveyor will
assess the construction, layout, contents, fire doors, fire prevention methods, etc and
calculate the estimated maximum loss that could be caused by a fire. Surveyors, even the
best and most experienced ones, can get the calculation wrong; e.g. misunderstanding how
inflammable some of the contents were. Intervening factors can also cause fire losses to be
greater than the EML, e.g. arsonists throwing ignited petrol bottles into a building at
different locations causing the fire to spread far more quickly than would normally be
expected.
Some fire proportional treaties include an EML failure clause, which restricts the extent that
the reinsurer follows the fortunes in the event of an EML failure. These clauses can apply
where the reinsured has had a relatively high number of fires resulting in EML failures. EML
failure clauses specify that the treaty will only pay claims up to a limited amount above the
EML, which would also be well below the sum insured value.
Other restrictions that reinsurers could apply are:
• Minimum EML factors
factors. A treaty limit could be subject to a minimum EML of, say, 50%. If
the reinsured has calculated an EML of 20% for any one risk, that EML would have to be
increased to 50% for purposes of ceding to the treaty.
• Sum insured only limits
limits. If the reinsurer does not want to carry the risk of any EML failure
whatsoever, the treaty limits could be purely on a sum insured basis. Some treaties that
Chapter 10
previously had EML treaty limits were converted to a sum insured basis following poor
results.
B2 Suitability of proportional reinsurance to

property risks
Property insurance is essentially short-tail in nature, that is to say, losses are usually known
about by the insurer soon after they occur and it does not have the latency that is found in
liability classes. On the whole, claims tend to be settled relatively quickly, although
complications and disputes can arise with large claims, meaning that they remain unsettled
for a few years.
The short-tail nature of property lends itself to the accounting of proportional treaties on a
portfolio transfer or clean cut basis. This method brings an early element of finality to the
results of the reinsurance. They can of course be accounted on an underwriting year basis.
This method allows liability under original policies to run off to natural expiry and losses to
extinction, i.e. when all incurred losses have been fully and finally settled.
It is preferable that a reinsurer analyses its business on the basis of the reinsured’s revenue
year and the reinsurer’s revenue year. While the reinsured’s figures will report one year at a
time, the reinsurer may have a more unclosed account at any time, due to the delays in
reporting or submitting periodic technical accounts. On an underwriting year basis, the
length of the development period is dependent on the class of business.
Question 10.4
What is the typical development characteristic of a property account?
With proportional business, the reinsurer follows the original premium rates set by the
reinsured. Provided that those original premium rates are adequate, the reinsurer should, in
the long run, make a profit. The only way that a reinsurer is able to affect the rating of
proportional treaties is to exercise a careful control over the level of commission that the
reinsurer returns to the reinsured. This is how the term ‘exchange commission’ originates.
Most reinsurers plan loss ratios, so the addition of the planned or projected loss ratio plus Most reinsurers
commission, other deductions such as taxes and/or brokerage, plus any planned profit or plan loss ratios
return on capital provision, including the cost of any in-built or specific excess of loss
protections on that treaty, will give the reinsurer a clear indication of whether that treaty will
ultimately be profitable or not.
The way in which the reinsurer influences the pricing of a proportional reinsurance is by
negotiating the level of ceding and profit commissions to be allowed by the reinsured. This is
a key feature of proportional reinsurance underwriting. If the reinsurer permits the reinsured
to deduct higher commissions than those involved in acquiring the business or administering
the reinsurance, the reinsurer is effectively charging a lower reinsurance rate. If the results of
the treaty are currently profitable, and are envisaged to remain so, then it will be easier for a
reinsured to negotiate and the reinsurer to agree to preferential commission terms than it
would be if the account continued to produce poor results.
Alternatively, if the commissions allowed by the reinsurer are less than those applicable to
the reinsured’s business, the reinsurer is effectively charging a higher reinsurance rate and, in
theory, that should allow the reinsurer to increase its profits relative to the risk ceded. As
mentioned previously, the commission structure may be arranged to reflect a sharing of the
profits or the losses of the treaty through profit and loss ‘corridors’. This is a further
illustration of the flexible approach that reinsurers sometimes use to make the placement of
a treaty more attractive.
Many reinsurers now prefer to use a sliding scale of commission rather than a combination of
flat commission and additional profit commission, as this gives an immediate result at the
end of a treaty period. It is generally agreed that sliding scales of commission are easier to
Chapter 10
use for treaties accounted on an annual ‘clean-cut’ basis.
Question 10.5
Why are sliding scales of commission more complicated to administer for treaties
accounted for on an underwriting year basis?
C Underwriting features of
non-proportional reinsurance
The reinsured may envisage ceding large volumes of premium for individual risks, many of
which will never suffer a loss. In these circumstances the reinsured may prefer to effect a
non-proportional excess of loss contract. This will allow it to bear all losses in their entirety
up to a specified fixed monetary amount, known as the deductible or retention, and to
recover any amounts above this sum up to a figure that the reinsurer specifies as its limit.
This form of cover can be applied both to individual risks and on a treaty basis.
Many of the underwriting considerations that were relevant under proportional reinsurance
would also apply here. However, there are additional factors to bear in mind.
With property reinsurances, the amount of reinsurance at any one level or on any one
reinsurance policy is usually limited. In order to negotiate the correct amount of cover
required by the reinsured, information regarding the number of reinstatement provisions to
be included in the cover must be available. If reinsurers are prepared to grant this extension
of cover, the terms that will apply to the calculation of any additional premium must be set
out clearly in the final negotiated contract.
Consider this
this…
…
As the excess of loss reinsurer is not proportionately sharing the premium and claims on
the reinsured’s original portfolio of risks, it may be more greatly exposed to loss,
particularly in the early years of any such arrangement. Any fund built up by the receipt of
reinsurance premiums will inevitably be low in relation to the possible major loss.
Relevance of
Therefore, the relevance of historical loss detail is even more significant in influencing any
historical loss predictions of future losses and the consequent price of the reinsurance.
detail is even more
significant The nature of the reinsured’s business should be clearly defined. It is important to know
whether it is specialising in one specific class of business or writing a general book of risks.
In view of the possible exposure to catastrophic losses, information regarding the
geographical locations of the reinsured’s operations is essential information. This is
particularly important if the reinsured is exposed to, or offering cover for, natural perils such
as earthquake or windstorm.
Excess of loss reinsurances can be particularly exposed to losses as the result of a failure in
the calculation of EMLs. This is especially important with risk or working excess of loss
covers, where the reinsurer is expecting to receive a number of losses in any one period of
reinsurance. The reinsured should confirm whether it is using original sums insured or EML
predictions on which to base its retentions.
Considerations for the reinsured
Gives the reinsured
Non-proportional reinsurance in all its forms gives the reinsured considerable flexibility in
considerable arranging a balanced reinsurance programme. It provides cover for losses to large risks and
flexibility in
arranging a
the ‘catastrophe’, while the facultative contract provides capacity that may not be available
balanced to the proportional treaty. However, the reinsured must also be careful in deciding to choose
reinsurance
programme
this type of cover, particularly where the ‘working’ excess of loss treaty is being considered
as a replacement for the proportional treaty; these contracts operate at a similar level, but
the choice has markedly different implications.
In opting for an excess of loss working treaty, the reinsured must consider the level of the
deductible. This is because it has to bear all the losses in full up to the deductible, in addition
to those that exceed the limit of cover selected. If the reinsurer pitches the deductible at too
high a level, the reinsured may have to fund more losses than it anticipated if the loss
Chapter 10
experience deteriorates.
Question 10.6
What are the likely consequences of pitching the deductible at too low a level?
Although catastrophe treaties are not comparable with proportional treaties in regard to Reinsured must
their function, the reinsured must take care when considering this type of cover to record its also ensure that
there are no ‘gaps’
commitments, which could aggregate for the purposes of, e.g. earthquake, flood, hurricane between
or other environmental perils. Failure to do so could result in the maximum probable loss different layer
(MPL) and the deductible being similarly underestimated, and the limit of the reinsurers’
cover being inadequate. The reinsured must also ensure that there are no ‘gaps’ between
different layers.
Issues for the reinsurer
The underwriting of non-proportional contracts is also fraught with problems for the
reinsurer. In general terms, these contracts present several characteristics which the
reinsurance underwriter has to face:
• the reinsurance underwriter is distant from the reinsured’s original rating structure;
• premiums charged are small in relation to potential liabilities;
• many treaties can be hit by the same catastrophe;
• there are large differences in the exposure as shares and limits vary; and
• the reinsurance portfolio is difficult to balance as it consists of many contracts, with many
reinsureds, each addressing its own markets and types of risk.
the reinsurance portfolio is

difficult to balance as it the reinsurance underwriter
consists of many contracts, is distant from the
from many reinsureds, each reinsured’s original rating
Characteristics
addressing its own markets structure
of contracts
and types of risk
there are large premiums charged

differences in the are small in relation
exposure as shares to the potential
and limits vary liabilities
many treaties can
be hit by the
same catastrophe
As far as individual treaties are concerned, the basis of cover is important, whether a per risk
or catastrophe/event cover, as it reflects the expected frequency and level of losses. The
reinsurer should ascertain the pertinent facts about the risks to be run. For this reason,
reinsurers often ask the reinsured to complete a questionnaire, the answers to which should
reveal the size, nature, sums insured and complexity of the portfolio.
Be aware
Such a questionnaire should also determine the risk profile in relation to how many risks
are commercial, industrial or residential, and their relative values. This information is
important in assessing the risk premium for catastrophe treaties.
The reinsurer will also consider and record:

• how the risks are distributed geographically and the possibility of risk accumulation;
• the perils covered; and
• whether there is a susceptibility to catastrophe perils such as hurricanes or earthquakes.
Question 10.7
Why does the reinsurer need to assess its own exposure?
Chapter 10
The reinsurer may not wish to participate in all layers of the programme. It may consider its Reinsurer may not
exposure in relation to a catastrophic loss situation to one insurer too excessive and, wish to participate
in all layers of the
therefore, it will wish to confine its involvement to certain, non-consecutive layers. The ways programme
in which the reinsurer can control its exposure will also be of importance.
In an event or catastrophe treaty, this will be expressed through the:

• hours clause;
• limits of their exposure to any one layer; and
• terms of reinstatement.
In per risk treaties, the number of free reinstatements given and the size of the event limit in
relation to individual risk deductibles are important. In this latter type of treaty, the reinsurer
will want to know how the reinsurance is exposed to the different categories of risk and in
particular, those of poorer classes. Another consideration is that if the deductible is relatively
low, the treaty will frequently be called into play. The basis of fixing retentions for categories
of risk is important, so it is essential to know if they are based on sums insured or EMLs.
Besides making sure that it is obtaining a reasonable premium for the risk it is running, the
reinsurer should also consider the desirability of the business in terms of the:
• classes of risk written;
• length of time the reinsured has been in business; and
• reinsured’s premium and loss record.
The contract terms in relation to the adjustment of the premium, and the minimum,
maximum and deposits that apply, are important factors in ensuring that the reinsurer
obtains a fair premium.
Finally, how the management views the nature and relationship of reinsurance contracts is
an important matter. There must be a certain amount of trust between the parties and the
reinsurer should be made aware of the reasons for the cover being requested in the first
place. If one party seems to be resolved to exploit the other and a sense of partnership is
absent, the relationship is unlikely to last for any length of time.
C1 Facultative excess of loss

This type of
A facultative excess of loss arrangement is very useful for insurers who have to obtain
contract is additional capacity, usually at short notice. This type of contract is especially suitable for
especially
suitable for large
large industrial risks that are not covered under a proportional treaty or where the treaty is
industrial risks already full. It is also used to cover EML error and has become popular with captives to cover
the large exposures associated with their parent companies’ business. Theoretically, the
reinsured should be able to retain more premium income, which would otherwise have been
given away under the proportional contract.
From the reinsurer’s point of view, an adequate premium must be charged for the cover, and
this may be a substantial part of the original premium. The reinsurer will also be concerned
about the details of the risk, e.g. its construction, location and loss prevention procedures, as
well as the loss ratio and the amount of the reinsured’s retention in relation to the whole risk.
Question 10.8
What would the reinsurer’s purpose be if it consulted its risk register at this point?
C2 Risk excess of loss

An excess of loss treaty may be used by the property insurer as an alternative to
proportional reinsurance, to cover all the risks on its books. It may make this decision where,
on the basis of its past experience, it can bear a specified deductible for all the claims it is
likely to have, but where it needs protection for the difference between the deductible and
the total sum insured for which it is liable.
Chapter 10
Example 10.7
An insurer has a book of fire and special perils business with sums insured ranging from
£0–500,000. It considers its maximum retention on any one risk to be £100,000 and it
knows from experience how many losses there will be, on average, that exceed this figure.
Unfortunately, it cannot know which of its risks will be affected. Instead of reinsuring them
all on a proportional basis and ceding premium in the process, it can arrange a non-
proportional treaty to cover it for losses in respect of all its risks above £100,000 and up
to £500,000. This would be expressed as an excess of loss treaty for £400,000 excess of
£100,000 per risk or each loss.
The deductible chosen would relate to the reinsured’s normal retention for a category of risk. Deductible chosen
This type of treaty is an alternative to a proportional treaty and is commonly referred to as a would relate to the
reinsured’s normal
working layer, as it is knowingly exposed to losses and is expected to be active in providing retention for a
recoveries for claims within the cover. This means that in our example 10.7, the reinsured will category of risk
be protected against losses in excess of £100,000 for all such risks with a sum insured up to
£500,000. The reinsurer’s ‘limit’ will be up to the balance of £400,000 as illustrated by
figure 10.1.
Figure 10.1: Risk excess of loss
£400,000 (limit) XS
£100,000 (deductible)
£100,000 retention/deductible
The reinsured pays all losses below £100,000 in their entirety and the first £100,000 of every
loss larger than £100,000. Let’s apply this to our example 10.7.
Example 10.8
A risk with a sum insured of £350,000 suffers a loss of £89,000: the reinsured pays the
whole amount.
A loss of £250,000 for the same risk: the reinsured would in the first instance pay the
whole of the £250,000.
The reinsured is then entitled to recover the amount in excess of the £100,000 deductible,
that is, £150,000, from the reinsurer.
Where the sum insured on a property exceeds the capacity of the treaty, the reinsured is
responsible for the difference between the sum insured and the treaty limit, in addition to its
deductible. Thus, in essence, the excess of loss reinsurer’s limit is fixed.
Example 10.9
Continuing with example 10.7, one of the properties included within the treaty has a sum
insured of £600,000, which exceeds the capacity of the treaty.
For this property, the reinsured is responsible for:
£600,000 – £500,000 (treaty limit) + £100,000 (the deductible).
The effect of this type of treaty is that the reinsured pays for all of the claims within and up Reinsured pays for
to the deductible for any type of risk within the portfolio, but is able to recover sums in all of the claims
within and up to
excess of that amount from the excess of loss reinsurer, up to a defined monetary limit. A the deductible
Chapter 10
feature of this type of contract is that the cover can be ‘reinstated’ after it has paid claims,
usually for a defined number of times. There are also some ‘high level’ risk excess of loss
contracts, which protect the reinsured against EML error.
Several individual risks all insured with the reinsured may be affected at the same time by
the same event. For example, several buildings on an industrial estate belonging to different
parties are damaged by an explosion. The insurer would have to pay each claim and then
look to the excess of loss reinsurer for a recovery in respect of each risk
risk, for the amount
exceeding the deductible.
Question 10.9
How do reinsurers avoid giving potentially unlimited cover in per risk treaties for
numerous losses attributable to the same incident?
It is vital to understand what an event is in relation to reinsurance and why it is important. An

event is the incident giving rise to a claim under the treaty on account of a single occurrence.
It is important, as it may be used to determine the extent of the treaty’s liability. This is best
illustrated by an example.
Example 10.10
A reinsured has a per risk treaty for £400,000 excess of £100,000 with five
reinstatements and sustains losses from Buildings A to G in the same event. In the absence
of an event limit the claims recoveries the reinsured can make are as shown in the
following table.
Claims recoveries
Building Sum insured Loss Reinsurance recovery
A £500,000 £350,000 £250,000
B £500,000 £400,000 £300,000
C £250,000 £250,000 £150,000
D £750,000 £750,000 £400,000
E £450,000 £400,000 £300,000
F £600,000 £600,000 £400,000
G £600,000 £500,000 £400,000
£2,200,000
However, if an event limit of four times the one risk limit of £400,000 is included, the
recoveries are limited to £1.6m. In that situation the reinsured has to meet the difference
between £1.6m and the £2.2m that it would have been able to recover without that
limitation. This is, of course, in addition to its own retention of £100,000 for each
individual risk.
The reinsured will still be faced with the possibility of numerous losses arising out of one
event. Many of them will be below the retention of the per risk excess of loss cover. This type
of treaty, with or without an event limit, may be of value in the design of a reinsurance
programme by being to the benefit of catastrophe excess of loss covers.
C3 Catastrophe excess of loss

A non-proportional treaty can be arranged on what is known as an event or catastrophe
basis. In property reinsurance the catastrophe excess of loss cover is usually placed to
protect a reinsured’s net account, this being the amount of exposure retained after laying off
risk to other reinsurances. In marine reinsurance, by contrast, excess of loss usually protects
an account on a per risk and catastrophe basis.
Example 10.11
An insurer is covering the peril of windstorm. A hurricane causes damage over a
widespread area and the insurer is faced with claims from thousands of property owners,
including shops, homes, farms, hospitals, schools, offices, warehouses and manufacturing
Chapter 10
businesses, many of whom would have been well within the reinsured’s retention in
respect of any one risk. The total cost to the insurer is vast. However, the reinsured has
arranged a catastrophe non-proportional treaty providing cover for £2m excess of £1m
any one loss occurrence, allowing the insurer to underwrite risks up to a capacity of £3m
in total to cover the MPL in one area.
In the event of a major catastrophe causing a total loss to the cover, the reinsured pays for
the total of the individual losses and recovers up to the limit of £2m.
The MPL may be regarded as higher than this figure and insurers may therefore also buy
additional cover ‘in layers’ above the first level of non-proportional cover. Figure 10.2
illustrates this arrangement, using the figures from our example 10.11.
Figure 10.2: Catastrophe excess of loss
£3,000,000 (limit) XS
£2,000,000 (limit) XS
Example 10.12
Continuing with example 10.11, let us suppose that the total damage caused by the
hurricane results in the reinsured having to pay losses of £5.5m. Subject to any co-
reinsurance, it recovers £2m from the first layer, thereby exhausting that cover and £2.5m
from the second layer, which would still have £500,000 of cover available for future
losses.
Therefore, the reinsured has cover to protect it above its retention or deductible up to a Reinsured has
specified limit, or limits, where the cover is arranged in layers, should an event or cover to protect it
above its retention
catastrophe cause damage over a widespread area resulting in losses to many small risks, or deductible up to
the cumulative effect of which could be financially severe for the reinsured. a specified limit
Catastrophe treaties are intended to protect the reinsured against the risk of an
accumulation of claims arising out of a specific, unexpected, sudden and external
happening which:
• can be located in time and place; and
• is the proximate cause of each and every loss giving rise to the claim under the treaty.
C3A How losses are defined

Sometimes it can be difficult to separate the circumstances that together constitute the
catastrophe; take damage by earthquake tremors, all following each other in a short space
of time.
Consider this
this…
…
An important consideration is whether this chain of events represents one or more
earthquakes.
To the ordinary person, they would probably all constitute the same seismic activity and
therefore the same earthquake. This is an important issue for the reinsured, because if all the
tremors are regarded as separate earthquakes, the reinsured has to bear the deductible for
each one and there may even be no claim to the treaty. Obviously, this would not have been
the intention when the cover was arranged.
To avoid disputes, reinsurers have introduced the hours clause
clause. This recognises the Refer to
chapter 7,
difficulties in defining the damage arising out of perils of nature such as earthquake, and section D4 for the
others such as riot or civil commotion in the context of a specific event. hours clause
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The clause serves to provide a definition of when the treaty covers all damage arising out of
the same insured event within a specified number of hours, although in reality there may be
interludes when there is no activity.
There is a variety of these ‘hours clauses’ in use: a specimen of one such clause is set out here
for ease of reference.
Example hours clause

The term ‘Loss Occurrence’ shall mean all individual losses arising out of and
directly occasioned by one catastrophe. However, the duration and extent of any
‘Loss Occurrence’ so defined shall be limited to:
A. 72 consecutive hours as regards a hurricane, typhoon, windstorm, rainstorm,
hailstorm and/or tornado
B. 72 consecutive hours as regards earthquake, seaquake, tidal wave and/or
volcanic eruption
C. 72 consecutive hours and within the limits of one City, Town or Village as
regards riots, civil commotions and malicious damage
D. 72 consecutive hours as regards any ‘Loss Occurrence’ which includes
individual loss or losses from any of the perils mentioned in A, B and C above
E. 168 consecutive hours for any ‘Loss Occurrence’ of whatsoever nature which
does not include individual loss or losses from any of the perils mentioned in
A, B and C above
and no individual loss from whatever insured peril which occurs outside these
periods or areas, shall be included in that ‘Loss Occurrence’.
The Reinsured may choose the date and time when any such period of
consecutive hours commences and if any catastrophe is of greater duration than
the above periods, the Reinsured may divide that catastrophe into two or more
‘Loss Occurrences’, provided no two periods overlap and provided no period
commences earlier than the date and time of the happening of the first recorded
individual loss to the Reinsured in that catastrophe.
The hours clause is also incorporated into property treaties where weather perils are insured,
which can affect property over hundreds of square miles and last several days, as in the case
of flood, hurricanes, tornadoes and cyclones. Here, the imposition of the clause will have the
effect of limiting the reinsurer’s liability for one weather condition. The commencement of
the hours period is chosen by the reinsured, but the operation of the clause cannot
commence before the date and time of the first loss reported to the reinsured.
Example 10.13
An insurer has a catastrophe per event cover in respect of storm and flood for $6m in
excess of $2m, with one reinstatement. A 72 hours clause applies. A tornado rages for a
period of seven days. In the event that the tornado causes most damage to property at
the beginning and end of this period, the insurer will choose to recover for days one to
three and days five to seven. The limit of cover and the retention would apply to each
72-hour period, assuming that the clause does not exclude reinstatement of cover for the
same event.
The number of
The number of hours varies from peril to peril; typically, 72 hours is appropriate for
hours varies from earthquake and weather perils. It usually represents the period during which the reinsured
peril to peril
has suffered the highest level of losses. In serious and long-lasting weather conditions there
may be more than one claim arising out of the same major catastrophe or event, but the
periods covered by the hours clause must not overlap.
Catastrophe treaties are not intended to cover the loss arising out of a large single risk, such
as a multi-storey office block, which is severely damaged by an explosion, nor the
underestimation of the EML for one risk. Reinsurers try to safeguard themselves by ensuring
that the catastrophe deductible is substantially higher than the working deductible by
imposing a two risk warranty on the catastrophe treaty; more than one risk has to be
Chapter 10
damaged by the insured peril before the catastrophe treaty will operate. Alternatively, the
reinsurers ensure that the deductible for the event cover will be not less than that for two or
more risks under a per risk or ‘working’ treaty.
Finally, to ensure that the reinsured maintains acceptable underwriting standards, does not
retain an irresponsibly small portion of any loss, and settles the loss in a responsible fashion,
some catastrophe reinsurers insist that the company co-reinsures in all layers of its own
catastrophe programme, usually to an extent of between 2.5% and 5%. This also ensures that
the catastrophe is apportioned throughout the market.
Catastrophe covers also have a limited number of reinstatement provisions, which only allow
the cover to be hit by a certain amount of loss before it is exhausted. For catastrophe excess
of loss, it is usual to limit the reinstatement to one at 100% additional premium.
C4 Stop loss
Stop loss is particularly suitable for those classes which are subject to volatile loss ratios. An Particularly
example of such a class is the insurance of crops against hailstorm, as one storm could suitable for those
classes which are
destroy a whole year’s crop and result in a disastrous underwriting result. subject to volatile
loss ratios
The reinsured needs some form of protection which enables it to maintain an acceptable loss
ratio if the results for a particular year are adverse. A stop loss treaty (sometimes referred to
as excess of loss ratio) can be arranged to meet this eventuality. The purpose of the cover is
to restrict the annual aggregate losses to a predetermined percentage of the annual
premium. The cover operates after all other reinsurance recoveries have been made and the
reinsured usually has to be in a loss position.
To ensure that the reinsured maintains prudent underwriting standards, it will be expected
to participate in any loss to the cover to the extent, say, of 10%. So that the reinsurer’s
liability does not fluctuate widely with variations in the reinsured’s premium income, a
monetary limit is usually specified in addition to the percentage figures.
Example 10.14
A stop loss treaty designed to protect an account with an estimated net premium income
of $10m for the year may provide cover for 90% of 30% of net premium income or a
maximum payment by the reinsurer of 90% of $3.3m whichever the lesser, in excess of
120% of net premium income or $10.8m whichever the greater.
C5 Rating methods
In this section we look at examples of the burning cost method and the exposure method of Main approaches
to reinsurance
reinsurance pricing. We also review the key considerations in the rating of non-proportional pricing
treaties. introduced in
chapter 6,
section B
C5A Burning cost method
The pure burning cost of a layer of reinsurance cover can be calculated by expressing the
losses for which the reinsurer would have been liable as a percentage of the premium
income for the account being protected. Although this provides a basic factor for assessing
the potential rate for the excess of loss cover, especially for low level and working covers,
other considerations need to be applied, for example:
• Do the loss figures represent the anticipated final cost of the claims? This may not be such
an issue for property claims but will be an important factor in liability classes of business.
• Are there significant or noticeable fluctuations in the costs of claims from one year to
another? This may indicate an unbalanced portfolio as a result of the underwriting policy
of the reinsured. The reinsurer should try to understand the reasons for such fluctuations,
possibly by comparing the loss experience with that of similar treaties from the same area.
• What level of loading factor would be appropriate to allow a margin for expenses and
profit? These loading factors vary from risk to risk and class to class and are customarily
expressed as ‘improper’ or ‘top heavy’ fractions, for example:
100
= 25% loading
80th
100
Chapter 10
= 33.33% loading
75th
A loading should also be included to allow for claims arising before the reinsurer has been A loading should
able to build a fund to meet them and for the fact that the reinsurer is supporting the also be included
reinsured with its capital and security.
Contracts written on this basis are negotiated with a minimum and a maximum rate, so that
the reinsured is rewarded for a good claims experience and the reinsurer is compensated for
a poor loss experience within boundaries. Burning cost layers also have a deposit
premium to provide positive cash flow in advance and usually a minimum premium – often
equal to the deposit premium – to ensure that the reinsurer receives a known return for
providing cover.
C5B Exposure method

Whereas the burning cost method is based on past experience, the reinsurer may adopt the
exposure method of rating for facultative and excess of loss ‘working’ treaty contracts. This
is based on the principle that as the deductible declines in relation to the average value of
the band into which a risk could be placed, the reinsurance premium should rise. This is
because in a total loss there is a greater likelihood of the deductible being surpassed and the
claim affecting the reinsurer.
Be aware
The same is not necessarily true of partial losses.
For a given exposure of deductible to limit, the reinsurer would base its premium on a risk
profile, or groups of risks of similar value placed in ‘bands’. A reinsured’s property risks may
be sorted into bands with an average value calculated and the deductible expressed as a
ratio of the average value for each band.
Example 10.15
Taking a deductible of £100,000, the ratio to the average value of each band would be as
follows:
Average value of band Aggregate premium for band Deductible average value
£ £ £
1 70,000 1,575,000 143
2 135,000 4,050,000 74
3 170,000 3,825,000 59
4 260,000 1,950,000 38
5 380,000 570,000 26
6 430,000 322,500 23
Total 12,292,500
As the deductible declines in relation to the average value of the band and the reinsurer’s
ratio increases, the reinsurance premium should rise. Using the type of scale depicted in
figure 10.3, the reinsurer would calculate for a layer of excess of loss cover the percentage of
the reinsured’s premium income for each band for a portfolio, such as the one described, and
with a deductible of £100,000, as follows.
Chapter 10
Figure 10.3: Exposure method
40
30
A axis
20
10
0
25 45 65 85 100
B axis
Figure 10.3 is an example of a rating diagram, which a reinsurer may use to ascertain the
proportion of the reinsured’s premium income for each band of risks, according to values or
sums insured, assuming a deductible in the first instance of £100,000. The A axis shows the
percentage of the reinsured’s premium income for the band/class of risk. The B axis denotes
the ratio of the deductible to the average value of the band/class of risk.
If average value for band = £135,000 and deductible = £100,000:
100
Ratio = × 100 = 74%
135
For this ratio of deductible to average value of the band, and using the diagram, the
reinsurer will want 12% of the premium income of the band for the cover, according to its
experience and the formula it uses. Other reinsurers may have similar rating diagrams but
their values may be different.
Table 10.2: Exposure method

Deductible/average value Reinsurer
Reinsurer’’s % Portion of reinsured
reinsured’’s
% of premium premium for band
£
143 nil nil
74 12 486,000
59 15 573,750
38 21 409,500
26 28 159,600
23 31 99,980
Total premium 1,728,830
This amount can be converted into an appropriate percentage of the reinsured’s total risk
Chapter 10
premium and may be further loaded to take account of expenses, contingency and profit to
the reinsurer.
C5C Key rating considerations

The key features for the calculation of the excess of loss premiums for a catastrophe
programme are the:
• perils that give rise to the catastrophe exposure, e.g. earthquake, hurricane, flood etc;
• aggregate of the sums insured exposed, after taking into account per risk reinsurance, for
the specific peril and in a specific region. The market has identified regions of exposure
throughout the world, that is, geographical locations where a catastrophe event is likely
to occur;
• estimated MPL from the aggregate of the exposures for a peril in a region. The MPL will be
less than the total exposure for a peril in a region because there is unlikely to be total
destruction. However, the assessment of the amount of destruction will differ according
to the peril, the region and the reinsurer’s own individual assessment; and
• total premium required for the catastrophe peril in respect of the MPL. This is an
assessment made by the reinsurer. A reinsurer may assess that the catastrophe premium
requirement is 15% of the reinsured’s gross net premium income (GNPI).
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The catastrophe premium must be distributed between the amount retained by the
reinsured (the deductible) for any one event, and the excess of loss programme, which is
usually made up of a number of layers. The distribution of premium follows a similar concept
to the rating of risk excess of loss. Reinsurers have different rating techniques, but
essentially they relate to the probability of an event resulting in a loss at different amounts
relative to the MPL. The deductible and cover is expressed as a ratio of the MPL.
Be aware
There is an ‘inverse’ relationship between the deductible ratio and the requirement for
catastrophe premium on the excess of loss layers and so, as the former becomes higher
the latter becomes lower.
There are limits to this rating concept, particularly for top layers where, irrespective of the
technical requirement, the reinsurers will require a minimum premium for the exposure.
Reinsurers will not provide unlimited catastrophe excess of loss reinstatements, and there
are a variety of ways that premiums can be calculated. Consider the following scenarios,
based on one reinstatement, starting with the most common method first.
Example 10.16
A treaty runs from 1 January 2017 for twelve months. Cover is $20m excess of $6m. Losses
from the ground up of $13m occur on 1 July. Ultimate premium is $X.
Scene 1: Reinstatement at 100% additional premium (100% as to time and pro rata as to
amount).
Premium is X × 50%.
Scene 2: Reinstatement at 100% additional premium (pro rata as to time and pro rata as to
amount).
Premium is X × 50% × 50%.
Scene 3: Reinstatement at 50% additional premium (pro rata as to time and pro rata as to
amount).
Premium is X × 50% × 50% × 50%.
Chapter 10
However, the total reinsurance premium for higher layers of cover will be less, since the
underlying cover, as depicted in this example, will be taken into account.
The rating of stop loss covers tends to be dealt with on an individual basis and the concept The rating of stop
of ‘payback’ is evident. This depends essentially on an assessment, by the reinsurer, of the loss covers tend to
be dealt with on an
maximum exposure presented by the portfolio and a subjective anticipation of the individual basis
possibility of a total loss. The reinsurer then charges a level of premium which will generate
sufficient income over a number of years to fund a total loss. This is loaded to allow for
partial losses and expenses and to provide for some profit.
Other general considerations in the rating of non-proportional treaties concern the ratio of
the cover to the reinsured’s underwriting limits. Clearly, the reinsurers do not wish to be
providing high levels of cover while the reinsured remains relatively unexposed. It is also
important to ascertain whether the reinsured arranges its retention on actual sums insured,
EMLs, or a combination of both, as the reinsurer’s liability will be affected. The reinsured’s
experience in the business, along with information relating to premium growth and loss
amounts, frequency and trends, particularly in relation to the deductible and limit, are also of
significance. The reinsurer will also wish to consider how many free reinstatements, if any, it
is prepared to give in arriving at the rate.
The calculation of the premium should take into account minimum and maximum rates and Take into account
the extent to which the premium is adjustable in light of the treaty’s experience and the minimum and
maximum rates
reinsured’s income. Finally, allowance must be made for expenses, brokerage and profit and
perhaps a security loading.
Chapter 10
Key points
Reinsuring a property account
• Property insurance covers insured property against losses arising from physical damage such as
fire, flood and other extraneous sources.
• ‘Property’ is an inclusive term and embraces:
– fire, perils and related material risks;
– business interruption;
– theft;
– goods in transit;
– data; and
– ‘money’.
• Recognising that different types of risk present different hazards, a property insurer’s table of limits
will indicate the amount of the sum insured (or EML) which it is prepared to retain for individual
risks, according to its risk classification.
• EML can be defined as ‘an estimate of the monetary loss which could be sustained on a single risk as
a result of a single fire or explosion considered by the underwriter to be within the realms of
probability’. It allows the insurer to adjust its retention by considering its expected exposure in
relation to its theoretical one.
• An ‘EML error’ has occurred when the EML has been miscalculated and leads to a higher loss than
was anticipated. If the EML error is substantial, reinsurers may, in theory, allege that material
misrepresentation has taken place.
Underwriting features of proportional reinsurance
• Property insurance is suited to proportional reinsurance, whether by the facultative or the treaty
method because, unlike liability classes, it has clear insured values.
• Reinsurers need to consider:
– risks to be excluded from the reinsured’s original book of business;
– the split between definable classes of risk;
– the extent to which additional perils are covered;
– the experience of the reinsured’s underwriters;
– the reinsured’s attitude to risk as reflected by its underwriting policy;
– the relationship of the net retention and treaty capacity to the reinsured’s premium income; and
– the results of the account to be protected over the past five to ten years.
Other considerations include portfolio transfers and accounting protocol.
• Some proportional treaties include an EML failure clause, which restricts the extent that the
reinsurer follows the fortunes in the event of an EML failure.
• Property claims tend to be settled relatively quickly and are said to be ‘short-tail’ in nature, which
lends itself to the accounting of proportional treaties on a portfolio transfer or clean cut basis.
• The reinsurer influences the pricing of a proportional reinsurance by negotiating the level of ceding
and profit commissions to be allowed by the reinsured.
• Many reinsurers prefer to use a sliding scale of commission rather than a combination of flat
commission and additional profit commission, so as to achieve an immediate result at the end of the
treaty period.
Chapter 10
Underwriting features of non-proportional reinsurance
• The number of reinstatement provisions to be included is crucial since the amount of reinsurance
cover at any one level or on any one reinsurance policy is usually limited.
• Excess of loss reinsurances can be particularly exposed to losses as the result of a failure in the
calculation of EMLs.
• Non-proportional contracts present a number of characteristics which the reinsurance underwriter
has to face:
– the reinsurance portfolio is difficult to balance as it consists of many contracts, from many
reinsureds, each addressing its own markets and types of risk;
– there are large differences in exposures;
– many treaties can be hit by the same catastrophe;
– premiums charged are small in relation to potential liabilities; and
– the reinsurance underwriter is distant from the reinsured’s original rating structure.
• The reinsurer may also consider and record how the risks are distributed geographically and the
possibility of risk accumulation, the perils covered and whether there is a susceptibility to
catastrophe perils.
• With reference to treaty terms and conditions, reinsurers can control their exposure to risk as
follows:
– In an event or catastrophe treaty, by the hours clause, limits of exposure to any one layer and
terms of reinstatement; and
– In a per risk treaty, by the number of free reinstatements given and the size of the event limit in
relation to individual risk deductibles.
• Facultative excess of loss cover is useful for insurers who have to obtain additional capacity, usually
at short notice.
• A per risk excess of loss treaty may be used by a property insurer as an alternative to proportional
reinsurance, to cover all the risks on its books and where, on the basis of its past experience, it is
prepared to accept a specified deductible for all losses.
• Catastrophe excess of loss cover is usually placed to protect a reinsured’s net account against a
major catastrophe affecting a number of individual losses which in total exceed the selected
deductible.
• A defined loss occurrence in property treaties may be subject to an hours clause.
• Stop loss treaties restrict annual aggregate losses to a predetermined percentage of the annual
premium and applies after the operation of all other reinsurance recoveries.
• Rating of non-proportional property business, depending on the type of arrangement, may involve
either burning cost or exposure methods.
• The reinsurer bases its premium on a ‘risk profile’, or groups of risks of similar value placed
in ‘bands’.
• There is an ‘inverse’ relationship between the deductible and the reinsurer’s ratio, so as the former
decreases so the reinsurer’s premium increases.
• The key features when calculating catastrophe excess of loss premiums are:
– the perils that give rise to the exposure;
– the aggregate of the sums insured exposed;
– the MPL;
– the total premium required for the catastrophe peril in respect of the MPL as a percentage of the
ceding insurer’s GNPI; and
– the reinsurer’s estimation of the probability of an event resulting in loss at different amounts
relative to the MPL.
• Reinsurers will not provide unlimited catastrophe excess of loss reinstatements.
• The reinsurers do not want to be providing high levels of cover while the reinsured remains
relatively unexposed.
• The premium calculation must allow for expenses, brokerage, profit and a security loading.
Chapter 10
Question answers
10.1 Marine, aviation and transport and motor vehicle classes are covered under more
specific forms of insurance.
10.2 The reinsurer would be liable for its proportion of the claim including the reinsured
part of the error, as the risk is ceded according to the EML.
10.3 So that there is an improved chance of the losses from one risk or area being offset
by the profits from another.
10.4 Without over-generalising too much, a property account would involve mainly
short-tail losses.
10.5 The underwriting year basis might involve accounts rendered over a period of
perhaps three to five years making it impossible to arrive at a profit calculation in the
short term. That said, it is still possible to adjust commissions under the scale from
the end of the second development year onwards with the final adjustment being
made when all losses have been fully and finally settled.
10.6 If the reinsured chooses a deductible which is too low, more claims will be made to
the non-proportional contract than intended. This might result in the number of
reinstatements available being used up and the reinsurance cover exhausted before
the end of the period of reinsurance. It also has an adverse impact on the reinsurer
with the cover generally being insufficiently priced for the risks undertaken.
10.7 It may be faced with the problem of aggregation of risks from a number of reinsureds
and therefore needs to be certain that it does not exceed a prudent exposure in
terms of catastrophe cover. This information is also important when the reinsurer
comes to place its retrocession cover.
10.8 To determine whether it already has any commitments for the risk in question and if
it has it may reduce its line on the proposal or decline to give cover.
10.9 Reinsurers usually incorporate an event limit within the contract to avoid having to
pay countless losses that stem from the same occurrence.
Chapter 10
Self-test questions
1. What is meant when a reinsurer is said to be ‘following the fortunes’ of a ceding
insurer under a proportional property treaty?
2. What is the chief advantage for a property reinsurer when the proportional treaty
capacity is expressed as an original sums insured rather than an EML basis?
3. Why are proportional treaty property reinsurers keen to apply conditions to the
presentation and settlement of technical accounts?
4. How does a property reinsurer influence the pricing of a proportional reinsurance
treaty?
5. Why should a ceding insurer exercise caution when deciding to choose a ‘working’
excess of loss property treaty as a replacement for a proportional treaty?
6. Why would a reinsurer under a catastrophe excess of loss programme wish to
confine its involvement to defined, non-consecutive layers?
7. Why are some risk excess of loss property treaties referred to as ‘working’ layers?
8. What is the effect of an ‘hours’ clause?
9. How is a stop loss treaty distinct from other forms of non-proportional treaty
covering property risks?
Chapter 10
Chapter 10
Casualty reinsurance
11
outcomes
Learning objectives
Introduction
Key terms
A Reinsuring a casualty account 10.1, 10.2, 10.3, 10.5
B Motor 10.1, 10.3, 10.5
C Personal accident 10.1, 10.3, 10.5
D Employers
Employers’’ liability 10.1, 10.3, 10.5
E Workers
Workers’’ compensation 10.1, 10.3, 10.5
F Public liability 10.1, 10.3, 10.5
G Products liability 10.1, 10.3, 10.5
H Professional indemnity 10.1, 10.3, 10.5
I Medical malpractice 10.1, 10.3, 10.5
J Trade credit, surety, political risks, fidelity insurance and 10.1, 10.3, 10.5
bonds
K Miscellaneous risks 10.1, 10.3, 10.5
L Claims management 10.3, 10.5
Key points
Question answers
Self-test questions
Learning objectives
• list the main categories of casualty business, together with their characteristics;
• discuss the underwriting considerations for each category of business;
• describe the use of different methods of reinsurance as they apply to casualty business;
• explain how accumulations of risk can arise from the combination of more than one class
of casualty business and the measures that can be taken; and
• discuss the problems and solutions surrounding the operation of casualty claims.
Chapter 11
Introduction
‘Casualty’ is a term that originated in the USA and is now used to describe both US and
international business. It is closely aligned to the UK term ‘liability’ and the two are
interchangeable. Liability as a class refers to those forms of insurance that indemnify the
‘first’, or insured party, in the event that it is legally liable to pay compensation to a third
party. Liability can be established in court, through arbitration or through negotiation
between the lawyers for either side which, in the end, stops short of a court appearance.
Note: when limits of indemnity and legal requirements are considered in the following
sections, these relate to English practice.
Key terms
Accumulation Bloodstock insurance Bonds Clash cover
Contingency Employers’ liability (EL) Employment practices Extended warranty

liability (EPL) insurance
Fidelity guarantee Financial loss Group personal Incurred but not

accident insurances reported (IBNR)
Known accumulations Livestock insurance Losses occurring Medical malpractice
Motor own Motor third-party Personal accident Political risks

damage (MOD) liability (MTPL)
Products liability Products recall Professional indemnity Public liability

(PI)
Risks attaching Surety Trade credit Unknown

accumulations
Workers’ compensation
A Reinsuring a casualty account

In its broadest sense, casualty or liability can refer to classes that do not conveniently sit in
other departments such as the property department. These additional types of business may
not involve liability to a third party, yet may still be written in the casualty department. These
could include personal accident and sickness covers as well as other lines of business dealt
with in this chapter. A third term for these classes is ‘accident’ business, which again could
refer to a department writing some catch-all classes.
Covers loss
In contrast to all other types of insurance, liability insurance does not cover loss or damage
sustained by third to the policyholder or insured. Instead it covers loss or damage sustained by third parties.
parties
Since liability insurance covers only loss or damage to third parties and associated defence
costs, it is not based on any known insured value. Therefore, liability insurers use the
expression ‘limit of indemnity’ instead of ‘sum insured’.
In view of the long periods of time that may lie between the causation, the occurrence and
the reporting of claims, liability insurance has a particularly high late claims potential. Any
class of business offering compensation to a third party is potentially long-tail business.
Example 11.1
An average medical malpractice claim takes four to five years from the time of the alleged
negligent medical care until the claim is settled or closed. This is broken down as follows:
a. from the day of alleged negligent medical care until the claim is filed is typically 18
months;
b. from the time the claim is filed until it is settled or closed, if it does not go to trial, will
be two to three years; and
c. if the claim goes to trial, it will be at least four years before it is settled.
Chapter 11
Chapter 11 Casualty reinsurance 11/3
Liability insurance is also exposed to a high risk of change because, among other things, it is Liability insurance
more susceptible than other classes of insurance to changes in law and legal philosophy, as is exposed to a
high risk of change
well as to technical advance. This risk of change and the late claims potential makes the
building of reserves, including those for so-called incurred but not reported (IBNR
IBNR) claims,
of particularly great significance in liability insurance.
To allow reasonable business analysis and control of the results, the statements of account
for proportional reinsurance treaties are generally rendered on an underwriting year basis.
Activity
Before you move on, can you recall what is meant by the underwriting year basis of
accounting? Write a brief summary.
A1 Types of loss
In liability insurance loss can be categorised as bodily injury, property damage and pure
financial loss
loss.
Types of loss
bodily pure
injury financial loss
property
damage
Be aware
When we talk about pure financial losses we are referring to a loss where there is no need
for bodily injury or property damage to have occurred. Losing money as a result of acting
on negligent professional advice would qualify would be a pure financial loss, for example.
When distinguishing between these types of loss, especially between material damage and
pure financial loss, the differences between the laws and court practice in the various
markets need to be taken into account.
A2 Underwriting information requirements

A reinsurance underwriter has the following requirements when considering a liability
reinsurance contract:
• Gross written premium (GWP) for the past five to ten years.
• Information on the reinsured’s underwriting policy and principles, the way it manages
claims, and the measures it has in place to maintain and improve underwriting
performance.
• Determination of portfolio structure in terms of risk composition, limits of indemnity, and
the extent and definition of any US exposures in the portfolio.
• Knowledge of whether annuity payments are customary or not in the market in question.
• Information on whether interest payments, including court interest, are customary in the
markets in which it operates.
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If the application for cover relates to a proportional treaty, the following information is
needed:
• Run-off triangles on underwriting year or accident year basis over the same period,
showing both paid and outstanding claims.
• Detailed presentation of gross cost structure, such as the average agent commission,
internal costs and charges.
• Reinsurance brokers’ commission.
• Costs of any excess of loss cover for the common account.
• Loss ratio of past years; forecast of claims development for at least the next two years.
• Reinsured’s business plan.
• Analysis of reinsured’s balance sheet in order to check solvency.
If the application for cover relates to a non-proportional treaty the following information is
required:
• Serial loss potential from products, professional, employers’ and environmental liability
business.
• Information on individual claims from ground up (FGU) by accident years, split between
amounts paid and reserved, over a minimum five year period.
• The price or wage indices used to develop the cost of claims.
• Information on the reinsurance required in relation to treaty structure and layering.
A3 Scope of the reinsurance treaty

Geographical
All reinsurance contracts should contain a clear and positive description of the treaty’s
scope of cover material scope of cover. In addition, the geographical scope of cover of the reinsurance
should be clearly
defined
treaty must be clearly defined.
Be aware
Terms that are unclear can lead to complications. References to ‘cover is provided for all
policies written in the XY department’, or ‘cover includes all policies classified by the
reinsured as XY business’ may create difficulties when defining eligible risks.
Precise clauses and definitions are particularly important for liability classes as there are a
number of different interpretations of the issues that could arise. An instance would be the
time limits applied to cover.
In proportional reinsurance treaties, underwriters should follow the primary insurer’s time
limits on cover.
In excess of loss treaties, the following points should be borne in mind:
• When issuing a losses occurring form of cover, it is necessary to ensure that there is a
clear definition of the loss occurrence, which matches that of the underlying policy.
• Where reinsurance is granted on risks attaching basis, the liability extends to all risks
underwritten in a given reinsurance year. Since, in this case, the reinsurer’s liability
matches the term of the original policies, no original policy with a period of more than
twelve months must be ceded to the treaty.
A4 Types of reinsurance purchased

The usual forms of
The usual forms of reinsurance purchased are quota share and excess of loss treaties. The
reinsurance decision whether a quota share or an excess of loss treaty is more appropriate depends
purchased are
quota share and
partly on the primary insurer’s capital structure and partly on the risk profile of the portfolio.
excess of loss Surplus reinsurance treaties are rather rare in liability insurance.
treaties
Facultative reinsurance is popular in some specialised circumstances, but in general treaty is
the preferred option. This is because liability reinsurance is especially about longer-term
relationships between the insurer and their reinsurers, which matters given the nature of the
losses that occur in liability insurance.
Chapter 11
In the rating of casualty reinsurance, a key factor is the need to revalue past claims and to
evaluate future development. For treaties that have experienced a frequency of loss, such as
low level excess layers, the burning cost method can be used. In such cases, the anticipated
final cost of the claims is an important element in the rating, as allowance has to be made for
future development of long-tail liabilities. If there is no loss experience, rating is based on
exposure analysis or benchmarking against market analysis.
A5 Combining classes for reinsurance

While reinsurance of whatever type may be purchased for each element of the casualty Several casualty
account, several casualty classes are often combined in one treaty. This is especially true for classes are often
combined in one
smaller clients whose book is most likely to be dominated by motor, as their other liability treaty
accounts tend not to be large enough to warrant separate excess of loss treaties. Combining
classes under quota share treaties is also very easy, and different levels of ceding
commission can be accommodated.
Table 11.1: Combining classes for reinsurance

Advantages Disadvantages
• In many cases, reinsurance requirements are • Reinsured unable to split reinsurance costs
similar across the classes, thus one treaty for all accurately between departments.
classes can be suitable.
• Calculation and payment of instalments and • A common retention level across all classes for
adjustments allows for ease of administration. excess of loss cover may not be attractive for a
reinsured if its combined account is dominated
by motor business.
• Allows small companies in particular to include • It is more difficult for the reinsurer to exercise
classes too small to warrant separate underwriting judgment, as the results of
reinsurance treaties within their main treaty. different classes are obscured.
• Can maintain flexibility by purchasing different • Different classes of business may end up
limits under excess of loss treaties for different subsidising each other.
classes.
A reinsured’s motor account would be capable of sustaining a high reinsurance retention,

but its public liability or employers
employers’’ liability (EL
EL) accounts might be a fraction of the size but
would still have to carry the same retention under a combined protection. This issue can be
overcome, however, by applying different retention levels within the same programme.
A5A Example reinsurance programme covering several casualty

classes
In this section we are going to consider an example where the structured reinsurance
programme takes into account the premium income levels and policy limits for each line of
business. The programme provides the required ground up cover per class plus an allowance
for costs. Reinsurers would be asked to write this as a programme and not to just choose
specific layers. The classes with lower limits, and also lower premium income levels, need
lower retentions. Classes with higher limits and higher premium incomes, especially motor in
this example, can afford higher retentions. The higher retentions help to keep the
reinsurance costs at sustainable levels. Let us look at the figures.
Chapter 11
Table 11.2: Policy limits and premium income per class

Class Maximum limit any one policy or risk Estimated GNPI for
the forthcoming
Euros
year
Euros
Fidelity guarantee 1m 750,000
Personal accident 100,000 any one person 1,600,000

2m for known accumulations or for any one event
Employer
Employer’’s 5m any one risk 2,750,000
liability, public and
For example, if two layered policies for the same risk are
products liability
issued, the combined limit for the two policies will not
exceed 5m.
Motor 6,100,000 any one event any one claim irrespective of 12,000,000
the number of victims
1,220,000 for third party property damage
These are the statutory limits for the country in which the
reinsured is domiciled
The limits are in line with the European Union Directive on
motor insurance, which stipulates that each member
country must apply the following minimum limits:
• 1,600,000 per person or 6,070,000 any one event for
third party bodily injury.
• 1,220,000 for third party property damage.
In this case the country has opted for the event limit for
third party bodily injury instead of the limit per person.
Programme structure
Layer Classes covered Applicable

premium
Euros
income
Euros
250,000 excess of 250,000 Fidelity guarantee and personal accident 2,350,000

two reinstatements
250,000 excess of 500,000 Fidelity guarantee, personal accident, 5,100,000

employers’, public and products liability
three reinstatements
1.25m excess of 750,000 Fidelity guarantee, personal accident, 17,100,000

employers’, public and products liability and
six reinstatements
motor
3.5m excess of 2m Employers’, public and products liability and 14,750,000

motor
three reinstatements
2m excess of 5.5m Motor only 12,000,000

two reinstatements
A6 Clash cover
Typically, writing a casualty account exposes a reinsured to accumulation risks, that is, to
multiple retentions when two or more of its insureds suffer a loss from the same occurrence.
This exposure is increasingly countered with a clash excess of loss reinsurance policy,
providing protection on an event basis.
Example 11.2
A chemical plant has an explosion that injures workers and neighbours. The plant’s insurer
could trigger its casualty clash coverage if the insurer wrote both the plant’s workers’
Chapter 11
compensation policy and its general liability policy.

The market remains relatively small, but larger insurers are showing a renewed interest with
small or midsize carriers being the most common buyers. Large carriers have shied away
from casualty clash coverage since the 1990s because of pricing and terms.
While property catastrophe losses tend to receive most attention, casualty catastrophes are
often more severe.
Activity
High-profile casualty events include the dotcom bubble burst, the accounting debacles
involving Enron and WorldCom, not to mention the US subprime mortgage market and
the Madoff Ponzi scheme. Find out what you can about these catastrophes and how each
of these events destroyed tremendous amounts of shareholder capital and led to
economic damages that dwarf the most severe property catastrophe damages.
In 2016, insured property catastrophe damages were estimated at US$54 billion worldwide,
while the financial crisis of a few years earlier is estimated to have had an economic impact
of more than US$1 trillion.
While insurers are becoming adept at modelling for property catastrophe exposure and
accumulation, modelling for casualty catastrophes appears to lag some way behind. Insurers
need to look more closely at the relationships between companies in certain industries and
how they can use casualty catastrophe modelling as a risk management tool.
Having described the main issues with respect to reinsuring liability business, let us now look
into the various classes and special considerations that apply. Note that certain common
exclusions appear in casualty reinsurance contracts. You can see a typical list of them (other
than motor) in appendix 11.1. There is a separate list for a motor account in appendix 11.2.
These appendices are both available on RevisionMate.
Learning point
Before you move on to look at the various classes of liability insurance, make sure that you
understand the three types of loss in liability insurance, the underwriting considerations
and the types of reinsurance purchased.
B Motor
Motor third-party liability (MTPL
MTPL) and motor own damage (MOD MOD) business often accounts Results are of
for more than 50% of primary insurance premiums in the non-life segment. Consequently, its crucial significance
for the primary
results are of crucial significance for the primary insurer’s business success. Such an insurer’s business
important class of business also places special demands on the reinsurer and consequently
needs to be handled with great care.
B1 Interests of primary insurers/reinsurers

When first entering a market segment, or developing a new product, a primary insurer will
generally prefer a quota share treaty.
Question 11.1
Why would excess of loss not represent an equally valid choice for such an insurer?
When, on the other hand, business is yielding good results, primary insurers desire to reduce
quota shares in order to retain more of the premium income themselves. The reinsurer must
be careful of engaging in ‘pre-financing’ in the form of quota shares and incurring
corresponding initial losses, unless there are good prospects for a mutually long-term
arrangement of benefit to both parties.
Chapter 11
B2 Extent of cover and exclusions

In motor insurance, three different types of cover with entirely different contents are
offered. These are shown in table 11.3.
Table 11.3: Types of cover

Motor liability Liability insurance for material damage and personal injury losses to third
parties, including passengers, caused by licensed vehicles. In some markets,
losses caused by vehicle loads may also be covered.
MOD Insurance for damage to the policyholder’s own vehicle. Cover can be with
or without an excess.
Passenger accident Accident insurance for personal injury sustained by the driver and
passengers.
Be aware
There are coverage concepts particular to the USA, such as no-fault and strict liability
policies.
The levels of ground up cover required for all motor reinsurance programmes are based on
the original policy limits, which in turn are governed by the applicable statute in each
country. In the UK and certain other countries, it is still a legal requirement to have unlimited
cover for third party bodily injury. Reinsureds that issue unlimited policies would need an
unlimited top layer in their reinsurance programme.
In 2009 the European Union introduced a motor directive setting minimum levels at which
civil liability is to be covered by motor policies. From that date all EU insurers had to provide
cover for at least €1,000,000 per person or €5m per event or claim, irrespective of how
many victims are involved. Policy limits were far lower in a number of countries, so the
directive had a huge impact on a number of reinsured’s who, in line with local statute, were
issuing policies with limits as low as €500,000 per event in some cases.
Following a review of the Directive, these minimum limits were increased in 2015 to:
• €1,220,000 per victim or €6,070,000 per claim, whatever the number of victims for
personal injury; and
• €1,220,000 per claim, whatever the number of victims for material damage..
If a reinsured is domiciled in a country that applies the limit per person instead of the limit
per claim or event (irrespective of the number of victims), it has to decide how much vertical
reinsurance is required. This must be based on a realistic disaster scenario where a number
of persons are involved in the same accident, e.g. a coach accident where a number of
passengers are killed or injured, or a car crashing into a train on a level crossing.
As a result of the changes, a number of reinsureds, based in certain countries, increased their
ground up reinsurance protection from €500,000 to €50m over a period of two to
three years.
B2A Unlimited covers

Unlimited covers
Unlimited covers in motor liability insurance have an enormous risk and loss potential for
have an enormous both the primary insurer and the reinsurer. On the one hand, neither the primary insurer nor
risk and loss
potential
the reinsurer has unlimited funds at its disposal and on the other hand neither is in a position
to calculate a price for an unlimited cover that would be commensurate with the risk
involved. Finally, even the retrocession capacity for motor unlimited covers is declining
steadily. For these reasons unlimited covers are becoming steadily less available within the
reinsurance markets. This applies in markets both with and without a legal obligation.
Chapter 11
B2B Common motor exclusions

Here is an abbreviated list of common motor exclusions under treaty reinsurance, the main
categories being:
• exclusions for dangerous activities, such as racing and military vehicles;
• exclusions for hazardous cargo due to the danger of spillage or explosion;
• areas not properly covered by motor policies, such as aircraft and sea-going vessels,
goods in connection with trade, contractor’s plant not on a public highway;
• exposure to high-value third-party property damage, such as property alongside an
airport runway; and
• exclusions relating to areas of higher risk that are often waived but only in consideration
for a higher premium, e.g. coaches, passengers carried for hire and reward, self-drive hire.
These categories, therefore, cover:
• racing, rallies or speed trials;
• motor coaches, omnibuses, tramways and vehicles on rails, sea or in the air;
• loss, damage or liability for goods conveyed in connection with any trade on any vehicle
insured by the reinsured;
• ownership, operation, maintenance or use of any vehicle the principal use of which is:
– transport of high explosives,
– transport of any inflammable liquid,
– carrying of passengers for hire and reward,
– self-drive hire,
– contractor’s plant and equipment not on a public highway;
• airport service vehicles; and
• vehicles for use of military or law enforcement or emergency services.
Question 11.2
What is a reinsurer’s justification for excluding vehicles whose main purpose is not use on
a public highway?
Refer to appendix 11.2, on RevisionMate, to see a list of common exclusions that may appear
in a reinsurance protecting a motor account.
B3 Underwriting considerations
Motor business is generally characterised by attritional claims. In this situation the results are Motor business
influenced primarily by developments in the small and mid-sized claims range and are is generally
characterised by
characterised by high frequency, rather than high severity, losses. attritional claims
For example, in recent years, claims for whiplash – a neck injury caused by sudden
movement of the head forwards, backwards or sideways – have increased. According to the
National Health Service, injuries have soared despite improvements in vehicle safety and a
sharp reduction in the number of reported accidents involving other personal injury.
Whilst increased safety standards have reduced the number of deaths and permanent
disabilities resulting from road accidents, compensation awards have increased.
Compensation awards for individual deaths or injuries of between GBP/ Euros/US$ 1m and
5m are not uncommon.
A serious accident could occur that creates the risk of a major loss in terms of personal injury
and/or property damage.
Activity
A coach crashes into another coach causing a number of passengers to be killed or left
permanently disabled.
The total claim amount includes the combined total awarded to each passenger plus the
Chapter 11
costs of the own damage and third party damage of the two coaches.
B4 Underwriting information requirements

A reinsurer will make a number of general enquiries about a potential cedant’s business,
including the:
• premium volume of motor business in the client’s overall portfolio;
• composition of the portfolio, including third party liability, own-damage, passenger
personal accident, sums insured and vehicle categories;
• limits being written by the reinsured in respect of bodily injury and property damage;
• extent of ‘overseas’ exposure being written;
• extent of any exposure to losses from natural perils;
• attitude and management philosophy of the reinsured to high-risk vehicles, such as sports
cars and other specialised vehicles;
• attitude and management philosophy of the reinsured to high-risk drivers, such as young
or inexperienced drivers or drivers with serious driving-related convictions;
• reinsured’s exclusion list;
• coverage, if any, that the insurer provides for any fleets or other concentrations of
vehicles at any one location;
• triangulation of detailed loss statistics showing clearly whether these loss figures contain
any allowance for IBNR; and
• reinsured’s approach to periodical payment orders (PPOs), including an explanation of
how it reserves for the corresponding claims (present and future).
Example 11.3
In the event that buses, coaches and petrol tankers are not excluded, reinsurers could be
expected to reconsider the reinsured’s criteria with regard to the selection and rating of
its original risks. There could be concerns over the number of third party and
comprehensive liability, including passenger liability, policies that the reinsured is issuing.
B4A Proportional treaties

If the application for cover relates to a proportional treaty the following information is
needed:
• GWP or similar key figure for past ten years;
• run-off triangles on accident year basis over same period, showing paid and outstanding
claims;
• comprehensive description of gross cost structure including average broker commission
and internal costs;
• deductions from original premium to be met by the reinsurer;
• costs of any XL for common account;
• loss ratio for five past years and predictions for at least the next two years;
• risk profile; and
• personal injury discount rate/Ogden rate.
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Personal injury discount rate/Ogden rate

The personal injury discount (or ‘Ogden’) rate applies to the process by which damages
paid to seriously injured individuals, in relation to future losses and expenses, are adjusted
to reflect the fact that those damages are received in advance of the losses and expenses
being paid because the funds are invested to generate a return.
On 27 February 2017, the Lord Chancellor announced changes to the discount rate used
to calculate personal injury claims. It has been reduced from 2.5% to –0.75%, with effect
from 20 March 2017. This rate implied that the Government expected that a claim
recipient investing the damages settlement over their remaining life would get a negative
return on investment, and the insurer must top up the expected loss.
This issue is of particular interest to liability and motor insurers. The change in discount
rate immediately inflated reserves and the cost of lump sum payments made to claimants
as insurers were forced to re-assess each open claim file in the light of the new discount
rate. The cost of this change is being met primarily by the reinsurance industry as motor
insurers and most liability insurers have reinsurance protection. However, in the longer
term reinsurance premiums will rise and the cost of this increase will be passed down to
policyholders.
Following the reduction of the discount rate for personal injury claims, the UK motor
market net combined ratio (NCR) deteriorated from 100% in 2015 to 109% in 2016. EY
estimated the overall cost of the Ogden rate change to insurers and reinsurers to be
£3.5bn across all lines of business.
A consultation was held following the unexpected cut and the outcome incorporated into
the Civil Liability Act 2018
2018, which received Royal Assent on 21 December 2018. The Act
introduces a new method by which the personal injury discount rate is to be calculated.
The Act also dictates that the first review of the rate must commence within 90 days of
Royal Assent, i.e. before 19 March 2019 and be completed in 140 days (i.e. on or before 6
August 2019). At the time of writing (January 2019) a consultation process had
commenced. You are advised to monitor the insurance press for the outcome of this
review.
B4B Non-proportional treaties

If the application for cover relates to a non-proportional treaty the following information is
needed:
• details of vehicles with sums insured exceeding 50%, 75% and 100% of the deductible;
• maximum possible known accumulation for MOD;
• general loss information;
• average claims expenditure for each vehicle category which would include privately
owned motor vehicles, taxis, buses, and so on;
• information on individual claims FGU, especially those which are, or have the potential to
be, subject to a PPO;
• the price or wage indices used to develop the cost of claims; and
• information on the reinsurance required in relation to treaty structure and layering.
B4C Accumulations
In MOD insurance, accumulation risks occur, especially as a result of natural hazards such as Risk of
earthquakes, windstorms, floods and hail. The risk of accumulation losses in MTPL, on the accumulation
losses in MTPL
other hand, plays a less significant role. Accumulation losses from natural perils can be plays a less
defined in the treaty by means of the hours clause. significant role
B5 Types of reinsurance purchased

Facultative
Motor liability, MOD and passenger accident can all be reinsured facultatively. However,
interest in the facultative sector is very small and is generally only for risks that are excluded
from treaties on account of their quality, such as dangerous goods or airport vehicles, or
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where vehicle values or limits of indemnity exceed treaty limits.

Question 11.3
Why is it that MTPL, MOD and motor personal accident policies tend to be reinsured
under separate treaties?
Treaty
Nevertheless, MTPL/MOD risks can, in principle, be covered by means of a quota share
treaty, provided sufficient information is available on the portfolio and the primary insurer’s
financial background. In cases where the business is entirely new, comparative figures for
the market involved need to be used. In addition to quota share treaties, the risk of major
losses can also be covered by means of excess of loss covers. The risk of major losses by
natural hazards in respect of MOD is covered by a catastrophe excess of loss.
In view of the extensive, and widely disparate, requirements for quota share reinsurance, the
most common form of reinsurance cover for motor is excess of loss loss. Excess of loss covers
are generally rated using burning cost rating programmes.
In motor personal accident insurance, where reinsured separately, quota share reinsurance
can be supplemented or replaced with surplus reinsurance. From time to time, motor
personal accident insurance is also covered under general personal accident treaties.
C Personal accident
Provides
Personal accident insurance provides protection against the economic consequences,
protection against usually in the form of loss of earnings, of accidents. Unlike workers
workers’’ compensation
the economic
consequences of
insurance, which is obligatory in many countries, the cover provided under personal
accidents accident insurance applies not only to accidents at work but worldwide for accidents of any
kind whether at home, while travelling, during leisure time, during sports activities, and in
road traffic. This is known as 24-hour cover. Any of the elements of cover mentioned can be
catered for in isolation or alongside 24-hour cover. Personal accident insurance is offered to
individuals or to groups of employees in one policy.
C1 Extent of cover and exclusions

Personal accident insurance generally covers the following types of benefits. In the event of
injury caused by an accident, all or part of a sum fixed at the time the policy is arranged is
paid out on a fixed-sum basis.
Table 11.4: Extent of cover and exclusions

Disability benefit Lump sum benefit or annuity in the event of permanent damage to health,
the amount of benefit usually being determined on the basis of the degree of
disablement referenced to an embedded dismemberment schedule.
Death benefit Lump sum benefit following accidental death.
Daily allowance Lump sum benefit per day of occupational disability caused by an accident.
The benefit is usually limited to a maximum payment period of one year.
Daily hospitalisation Lump sum benefit per day of hospitalisation as a result of an accident with
benefit benefit again usually limited to a maximum payment period of one year.
Medical expenses Indemnification of medical expenses actually incurred, usually on a

subsidiary basis, after any payments by private and statutory health
insurers. As an indemnity insurance type of benefit, this is the main
exception to the principle of fixed-sum benefits under the remainder of the
policy.
C2 Underwriting considerations
In personal accident business, underwriting considerations turn mainly on the disability and
death benefits provided under standard policies. Where reinsurance is concerned, major
losses and accumulations of losses are of prime importance. The risk of major losses arises
where personal accident insurances have high sums insured, which are often reinsured on a
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facultative basis. Accumulation risks arise where a number of insureds gather in the same
place or are exposed to the same peril.
Be aware
In the case of death or disablement, a high sum insured could be considered to be one
that exceeds six times the insured person’s annual income.
The following underwriting considerations affect the reinsurance of a personal accident

account:
• Limit per person and the limit for known accumulations.
• Ratio of retention to liability.
• Premium volume of accident business in the client’s overall portfolio.
• The composition of the portfolio in terms of individual and group business, sums insured
and risk types.
• Gross results for the past five years. For a fledgling business, sight of a business plan may
be stipulated.
• Information on major losses and known accumulations.
• Comparison of the primary insurer’s rate to the market level.
• Following 9/11, the accumulation from terrorism has become a substantial concern and
reinsurers seek to avoid this risk wherever possible.
• In the case of high levels of sums insured, the moral hazard of the person insured may
need to be clarified, including why this level of benefit is needed.
• Finally, especially where standard exclusions are concerned, the relevant market
conditions should be taken into account.
C3 Accumulations
Where several insured persons are affected by one and the same accident event, the term Important to
used is an ‘accumulation of persons’. Where an insured person has taken out several distinguish
between known
personal accident policies, there is a ‘policy accumulation’ in the event of a loss. It is also and unknown
important to distinguish between known accumulations
accumulations, which are usually reinsured on a accumulations
facultative basis, and unknown accumulations
accumulations. In the case of known accumulations, the
insurer knows before the risk attaches which insured persons and sums insured are exposed
to a common risk of accident.
C3A Known accumulations

Known accumulations are seen in cases where teams of professional sports players, ships’
crew or mine workers are all covered by group personal accident insurance
insurance.
Example 11.4
On 6 February 1958, the Manchester United football team were involved in an air crash in
Munich where a total of 21 people were killed. Given the levels of remuneration received
by top-flight professional footballers today, if such a tragedy were to be repeated the
known accumulation risk would be vast.
C3B Unknown accumulations

An unknown accumulation may occur where several persons insured with the same insurer
may, by chance, be affected by a natural disaster. The insurer is not aware that individual
risks can accumulate. In an individual case it may be difficult to define the precise scope of
cover, with the result that obligatory reinsurance treaties often do so pragmatically, by
defining the risks that are regarded as a known accumulation and are therefore excluded.
A distinction is also made between known and unknown accumulations for the purposes of
choosing which form of reinsurance is preferred.
C4 Types of reinsurance purchased

Facultative business is written in respect of all standard personal accident insurances, such
as individual, group, travel, aviation, work and leisure accident covers. Personal accident
insurance may be written facultatively on a standalone basis, without the reinsurer
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necessarily having a treaty relationship with the reinsured.

Important for the

With group personal accident insurances, it is important for the reinsurer to set an
reinsurer to set an appropriate accumulation limit or an annual limit to sums insured.
appropriate
accumulation limit With personal accident insurance, containment of the moral hazard and professional claims
handling have an important role. Care must be taken to ensure that the cedant’s net
retention is appropriate, so that the interests of the cedant and the reinsurer converge.
Facultative
For individual personal accident insurances covering death benefits, where the only type of
loss is a total loss claim, quota share represents an appropriate form of reinsurance. For the
other types of benefits, proportional participation is also appropriate in order to prevent
insurers’ and reinsurers’ interests from diverging.
Be aware
In the case of excess of loss covers in respect of disability benefits, it may be possible for
the insurer to carry out stringent claims settlement to decline once the disablement
exceeds the excess point.
For group personal accident insurances, proportional reinsurance and catastrophe excess of
loss covers are both common. For short-term known accumulations, for which there are only
relatively small reinsurance premiums, facultative reinsurance tends to be in the form of a
catastrophe excess of loss, since there are no claims handling costs for small losses. As a rule
maximum cover is one year or, in the case of short events or journeys, for the period
concerned.
For each enquiry, minimum information would be the name of the policyholder and of any
insured person(s), the number of persons, their age, manual or non-manual occupation and
claims experience.
Question 11.4
Why would the policyholder’s state of health also be relevant?
Treaty
The object of personal accident reinsurance is always to make the sums insured
homogeneous. Surplus reinsurance treaties are especially suitable for individual personal
accident business and known accumulations, while a quota share treaty or per-risk excess of
loss treaty is only appropriate in exceptional cases, such as death only covers. For
compensating major loss accumulations, catastrophe excess of loss per event treaties are
the best solution.
D Employers
Employers’’ liability
EL insurance is
Employers’ liability (EL) insurance is compulsory and was born out of State intervention into
compulsory the area of compensation for accidents and illness at work.
The Employers
Employers’’ Liability (Compulsory Insurance) Act 1969 states that all employers
conducting business in the UK must insure against ‘liability for bodily injury or disease
sustained by its employees and arising out of and in the course of their employment’.
Exceptions to this rule are central and local government, the police, the civil service,
nationalised industries and businesses solely employing family relations. Such insurance
must be with an authorised insurer.
The Act prevents policies being subject to ‘prohibited conditions’, which would allow
insurers to repudiate claims for, e.g. failure to notify the insurer of a claim within a stated
time, or the employer failing to take reasonable care to protect its employee against the risk
of bodily injury or disease in the course of employment. However, insurers can reclaim
compensation paid to employees from the insured employer where usual insurance
conditions have not been complied with.
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D1 Extent of cover and exclusions

Most EL insurance policies use the wording of the Act to define the extent of cover provided. Most EL insurance
The key phrases are as follows: policies use the
wording of the Act
• Employees
Employees: defined as ‘any person under a contract of service or apprenticeship’ with the to define the
extent of cover
insured as witnessed in the master/servant relationship. There are various legal provided
precedents attempting to define who is a ‘servant’ when many people are working as
contractors, temporary employees and so on. A contract for services does not involve a
master/servant relationship and the person is simply performing particular tasks for a fee.
• Arising out of and in the course of their employment
employment: death, illness or disease must be a
result of, e.g. an accident sustained by the employee whilst carrying out their
employment. This is a question of fact.
In the UK cover is compulsory for £5m in respect of claims relating to any one or more
employees arising out of any one occurrence.
All subsidiaries can be covered by one policy of at least £5m. Commonly, indemnity is now
given for a primary £10m with an option to purchase higher excess layers if appropriate.
Costs are included within the policy limit. There is no limit to the number of occurrences that
may give rise to losses during the currency of the original policy. Reinsurance is generally
bought to respond accordingly.
Be aware
Any number of qualifying accidents could take place during one period of insurance and,
subject to the indemnity limit applying to any one occurrence, the insurer would be liable
on each occasion.
Liability arises mainly in tort, although sometimes in contract. There may be an accumulation Liability arises
of claims where a number of employees are involved in a major incident, or where individual mainly in tort
employees claim for bodily injuries sustained in separate events.
D2 Underwriting considerations
Much of the information that is required for EL insurance is also needed for workers’ Refer to section E
for workers
workers’’
compensation. In addition the following are required: compensation
• Any schedules of the benefits specified in the workers’ compensation statutes of the
countries in which the reinsured is operating.
• A clear understanding of whether any benefits can be increased retroactively. It is
important, in assessing their potential liability, for reinsurers to be aware, when benefit
limits are increased, whether the new limits will apply only to workers sustaining injury
after the date of the benefit increase or also to existing claimants.
• Details of any situations that give rise to accumulations of employees in hazardous
environments.
• A policy profile that shows limits and attachment points if the insured is writing excess
layers.
In the USA, EL policies are increasingly under attack by employees suing their employers for Coverage under
alleged discrimination on the basis of sex, race or religious beliefs. The coverage under US US policies is wider
policies is wider than that found in UK policies, and so the possibility of recovery under these
policies is also wider.
Several cases such as Splunge v. Shoney
Shoney’’s (1996) ($60m) and Central District of Illinois
Equal Employment Opportunity Commission v. Mitsubishi (1998) ($34m), which involved a
number of plaintiffs, have revealed a tendency towards an increase in frequency and severity
with a greater case complexity resulting in higher defence costs.
Activity
Other landmark US cases include Patterson v. PHP Healthcare Corp. (1996) and Johnson
v. Spencer Press of Maine, Inc. (2004)
(2004). Investigate the relevance of these cases.
The focus of internal practices and procedures is also concerning due to the increased
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possibility of the use of cyberspace where harassing material could be sent via email and the
internet.
D2A Accumulations
Until 1 January 1995, EL reinsurance was granted on an unlimited basis, in the same way that
it still is for motor liability. However, after the 1988 Piper Alpha disaster and the
accumulation of losses that excess of loss reinsurers had to bear as result, reinsurers only
grant cover on a limited basis and as a result, insurers accordingly reduced the cover they
were willing to give.
The problem of unknown accumulations of risk to insurers and reinsurers was revealed by
the Piper Alpha disaster. However, these problems do not just relate to offshore locations,
but also to such as a large fire in a multi-tenant office block, where an insurer could find that
it is the EL insurer for more than one of the employers on the site. Again, following 9/11,
reinsurers had to look at remodelling their potential unknown accumulations. These losses
would be accumulated as one event for the purpose of reinsurance recoveries under excess
of loss contracts.
D2B Occupational disease

There have been considerable losses to the insurance industry as a result of occupational
disease. Occupational diseases typically result in a large number of claims from affected
employees, even though the award to each employee tends to be modest.
EL business is
EL business is generally written on a losses occurring basis. Thus a loss is defined as
generally written occurring during the time the employee was exposed to a particular disease-causing agent,
on a losses
occurring basis
such as asbestos. These diseases can take many years to develop and insurers can find
themselves paying out under policies issued decades earlier. This introduces a significant
IBNR element to this account.
The long-tail nature of the account makes it very unpredictable. Despite this insurers have to
try to predict levels of claims in the future, taking into account inflation, as well as possible
future changes in legislation (if retrospective) or in case law, which may affect insurers’
liability. Advances in medical techniques enable doctors to identify work-related injuries and
disease, which can lead to higher numbers of claims being made.
Industrial diseases include asbestosis and mesothelioma, which are conditions caused by the
inhalation of asbestos fibres. Silicosis results from the inhalation of silica in mines and
quarries. Industrial deafness is associated with many years spent working in noisy
environments, such as in shipyards and foundries. In today’s environment, illness through
stress can also be considered an occupational disease, liability for which could fall on the
employer.
Be aware
Tenosynovitis describes a condition more commonly known as tendonitis and is the
inflammation or irritation of a tendon. Tendons are the tough, white, stringy and rubbery
fibrous cords that link muscles to bones. They help release the power created by a muscle
contraction, which moves bones and joints. The tendons we can see on the back of our
hands move our fingers and are joined to the muscles in the forearm. Tendonitis is often
found in adults who do a lot of sporting activities and includes the occupational illness
known as repetitive strain injury caused by excessive use of machinery or keyboards.
The problem of industrial and occupational illnesses and diseases has been dealt with by the
reinsurance industry by the use of the ACOD/B clause. This defines each employee as an
event and thus each individual claim rarely exceeds the reinsurance deductible. Where a
sudden and identifiable accident occurs leaving a number of employees dead or injured, this
is deemed to be a single event for the purpose of reinsurance recovery. A copy of the
ACOD/B clause can be found in appendix 7.5 on RevisionMate.
D3 Types of reinsurance purchased

Excess of loss is
Facultative reinsurance has some application for large or unusual risks, which do not readily
the most popular fit into a cedant’s treaty arrangements. Some opportunities exist for proportional business,
form of coverage
but excess of loss is the most popular form of coverage. Cover would be on a losses
occurring basis but, with unlimited sideways reinstatements. EL reinsurance can be rated on
an experience or exposure basis.
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E Workers
Workers’’ compensation
Workers’ compensation insurance covers an employer’s liability for an employees’ injuries
sustained at work. This is generally in line with the relevant country or state’s workers’
compensation Act, which in many cases imposes strict liability. However, coverage is
generally limited to some degree, either by quantum or by time.
Example 11.5
In the USA, workers’ compensation is administered state by state, with public and private
funding sometimes operating in tandem. A few states have state-owned monopolies,
although in most compensation is provided solely by private insurance companies. In
some states indemnity is usually limited to two thirds of lost wages. Some southern states
impose a limit as to the length of time any injured party can claim for. The Federal
Government deals with its obligations to its own employees through regular
appropriations.
This class of business does bear certain resemblances to personal accident insurance.
However, there are serious dangers if the two are not differentiated, as accumulations under
workers’ compensation insurance can be significant and can seriously affect a reinsurer.
Example 11.6
In Sphere Drake Insurance v. Euro International Underwriting Ltd (2003)
(2003), Euro
International Underwriting Ltd (EIU) was granted underwriting authority for traditional
personal accident business. In fact, it wrote a large volume of workers’ compensation
‘carve-out’ reinsurance, which enabled a large part of the exposure arising from US
workers’ compensation risks, traditionally written in the property and casualty market, to
be placed instead in life and personal accident markets. During the 18 or so months when
the binding authority operated, EIU accepted a total of 119 contracts of reinsurance. The
court found for Sphere Drake on all material grounds. As a result it was able to avoid
losses alleged to have been in the region of US$250m.
This has consequentially had a severe impact on the coverage of workers’ compensation
insurance, especially the retrocession coverage of such.
E1 Reinsurance issues
Matters of this nature have made underwriters reluctant to issue facilities such as line slips,
binding authorities, broker covers and captive accounts. Other issues that concern
underwriters of workers’ compensation business include the following:
• Reinsurance treaties which do not exclude the common exclusions of war, civil war,
nuclear energy risks, radiation damage and terrorism.
• Treaties with no ‘change in law’ clause. Workers’ compensation insurance, because it is
strongly determined by statutes imposed by government or state legislature, is more
strongly influenced by potential changes in law than most other types of insurance.
• The manufacture, use, installation and removal of asbestos giving rise to asbestosis, and
other processes leading to other occupational diseases. Workers’ compensation
insurance, in the USA particularly and more recently in other developed countries, has
been strongly affected by claims for various types of asbestosis diseases from workers,
sometimes many years after they stopped working for the company. The increasing
claims from asbestosis and other environmental losses have forced many reinsurance
companies to increase their reserves substantially to take account of this issue.
E1A Accident and health (A

(A&
&H) insurance
Accident and health (A&H) insurance includes annual private medical insurance cover for Often written on a
hospital expenses, including operation, treatment and nursing costs. It is often written on a group basis
group basis covering the employees of a particular company. It is a major class of business in
the USA as medical insurance by the government is very limited. It is provided by employers
who arrange group insurance cover and is an important benefit for employees.
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In the USA, a large proportion of the population is insured by private medical insurance. Thus
the premiums tend to be actuarially calculated, taking claims trends and medical costs into
account. The policy period is usually limited either to expenses incurred and paid during the
twelve-month period, or to those first incurred in the policy period and paid within twelve or
24 months. The cover does not include occupational accident or illness, which are insured by
the workers’ compensation insurance. Reinsurers require information on the actuarial
reports, the claims handling and control methods, and the policy forms used.
Laws often require

Workers’ compensation ‘carve-out’, is cover for medical expenses incurred during the
payment of course of employment. Some states of the USA allow certain categories of employers to opt
lifetime medical
and disability
out of the otherwise compulsory workers’ compensation insurance and self-fund the medical
benefits costs with the support of insurance. The workers’ compensation laws often require the
payment of lifetime medical and disability benefits. In order for this business to be written as
a short-tail personal accident class, the insurance policy contains a commutation and/or
capitalisation clause, usually at five years, which provides for all outstanding claims to be
quantified, with a release of the insurer’s liability following settlement with the insured.
Be aware
A commutation clause is a provision that allows one party to pay cash to release the other
from all future obligations to pay claims after a certain period of time. It is common in
situations where the insurer wishes to settle and discharge all future obligations for claims
that would otherwise have a very long payment pattern.
E2 Differences between workers

workers’’ compensation and EL
insurance
Table 11.5 compares the key features of these two types of insurance.
Table 11.5: Workers

Workers’’ compensation v. EL insurance
Workers
Workers’’ compensation EL insurance
• Being a ‘no-fault’ system, the employee is not • Employee must establish legal responsibility on
required to prove negligence or breach of a the part of the employer in the form of proof of
legal duty on the part of the employer. negligence or fault, although sometimes
• Provides reasonable redress for economic loss. burden of proof is reversed or close to strict
liability.
• No common law ‘full’ compensation but instead
uses scales of compensation: • Contributory negligence is a consideration.
– medical care; • Common law ‘full’ compensation.
– cost of rehabilitation; • Tort law aims to put the injured in the position
enjoyed before the accident:
– lost earnings (70% of pre-accident earnings,
maximum amount); – full replacement of lost income, medical cost
etc.;
– funeral costs;
– pain and suffering; and
– benefits for surviving dependants (30–40%
of previous earning of deceased). – loss of amenities and loss of faculty.
• No compensation for pain and suffering.
EL/workers’
Workers’ compensation is the exclusive remedy in Germany, France, Austria and the USA. EL
compensation insurance is used in the UK, Ireland, Cyprus, Turkey and Taiwan, where public general liability
terminology
is often
policies are used. In the EU there is no combination of EL/workers’ compensation in one
interchangeable policy. Switzerland, Australia, Singapore, Hong Kong and Argentina all have combinations of
EL/workers’ compensation in the same wording. EL/workers’ compensation terminology is
often interchangeable and a full analysis of the applicable legal regime may be needed to
determine which system is actually in use.
E3 Underwriting considerations
Underwriting information requirements can vary according to the basis on which the
reinsurance cover is to be placed.
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E3A Proportional workers

workers’’ compensation business
Information requirements for proportional workers’ compensation business include:
• Underlying workers’ compensation law and the level of imposed indemnity.
• The level of autonomy that the insurance company has in determining degrees of
disability, applicable tariffs, rating regulation and the obligation to insure
high-exposure risks.
• The expertise of the insurance company regarding workers’ compensation business.
• What specific classes of business would be ceded to the proportional treaty?
• What, if any, is the extent of any North American exposure being ceded to the treaty?
• What is the territorial scope of the business being underwritten and is the liability
‘unlimited’? If not, details would be expected as to the limits being provided by the
cedant.
• Checks on costs of medical treatment, which involves containing the costs of medical
treatment using managed care. Managed care ensures that suggested medical
procedures are necessary and that alternative, less expensive treatments are also
considered.
• Portfolio balance in terms of risk categories according to degrees of hazard.
• Occupational diseases exposure.
• If the portfolio is not new, the assumptions used regarding the ultimate loss ratio and on
the run-off payout pattern for each underwriting year should be checked by use of a
mathematical model.
• If the portfolio is new, the rating approach used, both by the market in general and the
company specifically, should be checked by use of a mathematical model.
• Although variable premiums are generally to be avoided due to especially long and
hard-to-estimate run-off, loss participation and loss corridor clauses would be very
beneficial. This is because these ensure that the insurer maintains an active interest in the
losses that have impacted the reinsurance.
• Reinsurance treaties with a provision for automatic renewal should also stipulate a period
of notice for provisional cancellation, and the conditions should be renegotiable or
amendable at each yearly anniversary.
• Bordereau showing agreed detail on an underwriting year basis, for analysis of
development according to portfolio segments.
E3B Non-proportional workers

workers’’ compensation business
The requirements for non-proportional workers’ compensation business can be divided into:
• analysis and pricing;
• the definition of event;
• indexing;
• occupational diseases; and
• natural hazard exposure.
Analysis and pricing
• Analysis should be done on an accident year basis, with pricing linked to other casualty
classes, and with a suitable return on the premium to take account of any unexpected
adverse deterioration.
• In the case of catastrophe excess of loss per event programmes, the reinsurance treaty
should stipulate an annual aggregate or reinstatement limit of a maximum of the relevant
layer capacity.
• In determining exposure and pricing for catastrophe covers, any deductible or
self-insured retention policies should be taken into account.
• Potential accumulation exposure should be considered, taking into account the portfolio
shares of, say, construction companies, airline crews, transportation of other, relatively
large groups of people, or groups of professional athletes.
• In markets where workers’ compensation policies include an EL component, a sublimit or
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exclusion should be imposed.

• The conditions should be renegotiable or amendable at each yearly anniversary.
Definition of ‘event
event’’
• Agree a clear definition of event consistent with that used in other casualty classes.
• Avoid definitions solely dictated by the workers’ compensation insurer, or the social
insurance institution, concerning the time at which the point of indemnity is determined.
Indexing
• Use index clauses that are customary in the market and consistent with practice in other
casualty classes.
• Due to long-term exposure, special attention needs to be given to the effects of
hyperinflation on medical treatment costs.
Example 11.7
Arizona and North Carolina were the first US states to enact workers’ compensation fee
schedules in the late 1920s. However, the use of fee schedules only boomed in response to
hyperinflation in workers’ compensation medical costs, beginning in the late 1980s.
Occupational diseases
• Devote special attention to the effects of long-term exposure.
• Agree an occupational disease clause appropriate to the specific market in order to avoid
occupational disease accumulations, and stipulate a maximum cover for sudden and
accidental occupational disease accumulations or events within a maximum of 72 hours.
Natural hazards exposure
Especially when accumulation covers are involved, and depending on the market, special
attention should be devoted to heightened natural hazards exposure, such as earthquakes.
Where appropriate, a detailed analysis that produces separate workers’ compensation loss
scenarios for such events should be prepared.
E3C Accumulations
A single event can
Most of the issues discussed in section D2A apply here too, including the effect of unknown
lead to substantial accumulations. Since 9/11 there has been an acceptance that workers’ compensation
insured workers’
compensation
exposure was much greater than many realised. A single event, either natural or man-made,
losses can lead to substantial insured workers’ compensation losses and so models have been
developed and are beginning to be used to address the risks associated with more complex
known accumulations.
Consider this
this…
…
Ensure that you understand how accumulation patterns work in practice by studying the
following scenario. Reflect on the accumulation patterns that might apply in your own
workplace and that of a business that operates 24 hours a day and employs shift-workers.
An office contains workers who may arrive at 09.00 and leave by 18.00. This creates a
gathering of people during a clearly defined time frame and so the number of people
accumulating at the workplace can be estimated at various times throughout the day. This
pattern may be affected by shift-work distributing the presence of employees throughout
the day and night. Outside contractors could push the accumulation higher for temporary
periods of time, and sales staff may or may not be away on business.
Using this information it is possible to picture accumulation patterns for an office building
and model scenarios can be devised based on this information. If it can be calculated that
on average 75% of workers are in the office between 09.00 and 18.00, it is possible to
understand the implications of a terrorist attack or explosion on a particular office block.
Using modelling software and workers’ compensation databases, a familiarity can be
established with exposure to known accumulations and risk transfer strategies can be put
in place.
E4 Types of reinsurance purchased

Similar considerations apply to those found in EL insurance.
Facultative workers’ compensation business is usually limited to supporting existing treaty
relationships.
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Surplus reinsurance can be used for known accumulations, while a quota share treaty or per Surplus
risk excess of loss treaties are also used, provided the exposure is carefully monitored. The reinsurance can be
used for known
most common is excess of loss where accumulations can be limited by a strict event accumulations
definition.
Due to the generally imbalanced ratio between premiums and liability and to the high risk of
change in workers’ compensation, stop loss workers’ compensation business is considered
unattractive by the reinsurance market, although there are still some underwriters that will
consider this type of business.
Learning point
Before you move on, ensure that you understand the different reinsurance issues that
apply to EL and workers’ compensation insurances.
F Public liability
Public liability insurance covers a company’s legal liability in the event of injury, illness or
disease to any member of the public and/or loss of or damage to their property. In the UK, it
is estimated that up to one million public liability insurance claims are made each year and
the trend is growing rapidly as more people become increasingly aware of their right to seek
compensation.
F1 Extent of cover and exclusions

Liability insurance is intended to protect the policyholder from the financial consequences of Protects from
claims for compensation filed under civil law by third parties that have suffered loss or financial
consequences of
damage. claims for
compensation
The insurer’s function is both to protect the interests of the policyholder when a claim is
made by a third party and to compensate the policyholder when it is proven that a legal duty
exists and that duty has been breached.
A public liability account can consist of the following subtypes:
Personal liability The liability insurance of a person in their capacity as a private individual,
such as a pedestrian or a cyclist.
Public liability This insurance is concerned with the liability risk resulting from the
operations of a business, including environmental risks. It covers material
damage and bodily injury, as well as consequential financial losses.
Be aware
Insurers seek to control their exposure by placing restrictions on cover provided involving
very large values, such as aircraft, and property which is, or should be, the subject of more
specific forms of insurance, such as motor vehicles.
Common public liability exclusions under treaty reinsurance deal with a number of risk areas,
including:
• aircraft;
• vessels and anything to do with shipbuilding, docks, etc;
• motor vehicles;
• contractors engaged in building, wrecking, demolition or toxic waste;
• dams and subaqueous work;
• mining, quarrying and excavating;
• erection work on towers and other lofty buildings;
• gases and explosives;
• oil companies;
• tobacco;
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• asbestos; and
• pollution, other than that which is sudden and accidental.
aircraft
pollution, other vessels and
than that which anything to do
is sudden and with shipbuilding,
accidental docks etc.
motor
asbestos
vehicles
contractors
Common engaged in
tobacco public liability building, wrecking,
exclusions demolition, toxic
waste
dams and
oil companies
subaqueous work
mining,
gases and
quarrying and
explosives
erection and excavating
work on towers
and other lofty
buildings
F2 Underwriting considerations
Most of the
Most of the requirements for other lines of liability reinsurance also apply to a public liability
requirements will account. Additional information that should be available to assist the negotiation of
also apply to a
public liability
reinsurance protection for this type of account is:
account
• a detailed description of the reinsured’s portfolio of original risks, which shows the extent
to which the book of business consists of relatively simple risks, commercial and heavy
industrial risks; and
• details of the original policy limits issued by the reinsured and a profile of these limits and
premiums. This gives reinsurers an indication of liability that may attach to the excess of
loss reinsurance required. Table 11.6 shows what these could look like.
Table 11.6: Original policy limits

Policy limits No. of policies Total premium
£50,000–£100,000 1,250 £100,000
£100,001–£250,000 3,000 £450,000
£250,001–£500,000 2,000 £375,000
If the reinsured is accepting co-insurance or layered business then details of the type of
business and the limits being written is required.
Reinsurers want to
Reinsurers want to know whether there is the potential for accumulation with other
know whether reinsureds who subscribe to the same insurance programme. The attachment point written
there is the
potential for
by the reinsured would also be very important in assessing the accumulation of the risk
accumulation underwritten, and whether they had written a working layer or a catastrophe layer.
Chapter 11
Question 11.5
What are the different defining characteristics of working layers and catastrophe layers?
There are specific issues that an underwriter would look at in detail including:
• Is the nature of the classes of business written by the reinsured commercial or industrial,
large or small operations?
• What are the limits written in respect of bodily injury and property damage?
• What is the basis on which losses will be recoverable under the coverage provided –
losses occurring or risks attaching?
• What is the past loss history on a triangulation basis?
• Are the triangulation statistics compiled on the same coverage basis as the proposed
reinsurance?
Be aware
If the reinsurance is designed to pay for losses occurring during the period, the statistics
for the account to be protected should be presented on the same basis. Similarly, if the
reinsurance is designed to pay on a risks attaching basis, the statistics should be
presented accordingly.
• Do the loss statistics include an allowance for IBNR losses?

• What are the reinsured’s expected ultimate loss ratios for undeveloped years? These are
likely to be required for the previous year plus a projection for the current and next year.
• What changes has the reinsured made to its original rating and how might these affect
ultimate loss ratios?
• Do the original policies allow for legal costs to be inclusive or in addition to policy limits
and do they allow for the inclusion of awards for punitive damages?
Activity
Punitive damages, known in the UK as exemplary damages, are awarded where the
defendant’s conduct is found to be intentional, wilful, wanton or malicious. Courts may
permit an award of punitive damages in addition to compensatory damages, and are
intended to punish the defendant and to discourage the conduct of the type the
defendant engaged in.
In 1995, the Hollywood actor and former American Football star, OJ Simpson was
acquitted in a criminal trial of the murder of his ex-wife. In a subsequent civil case, the jury
awarded relatively modest compensatory damages against Simpson, but awarded the
families of the deceased tens of millions of dollars in punitive damages because the civil
jury found, in effect, that Simpson was guilty of murder. Check out the bizarre
circumstances of this celebrated case at https://bit.ly/1f8qplF.
• Is pollution coverage provided and is it restricted to sudden and accidental

incidents only?
• If any North American coverage is written by the reinsured then full details will be
required by reinsurers.
• What is the length of time taken to settle the average claim?
• What, if any, coverage is provided by the reinsured in respect of products liability
liability?
• The reinsured would also be expected to provide details of its exclusion list.
F2A Accumulations including pollutants

Pollution is an important consideration to reinsurers of public liability risks. Pollution is Pollution is an
usually covered as standard on a sudden and accidental basis only. This is so that only important
consideration to
accidents that occur at a particular place and time are insured, say, a sudden catastrophic reinsurers of public
spillage of chemicals or an explosion. liability risks
Chapter 11
Gradual losses, such as slow leakage from a tank over many years, would not be covered and
neither would intentional discharges of pollutants that result in damage. If pollution cover is
granted, it is usually issued under a separate policy, known as environmental impairment
liability, and not within the public liability cover. Pollutant accumulations can have serious
effects where an environmental liability insurance covers a company engaged in the food
processing industry.
F3 Types of reinsurance purchased

Facultative insurance is unusual for this type of business although may, perhaps, be used to
support an existing treaty relationship for particular aspects. Companies in a start-up
position, or those wishing to maximise their line size, could purchase proportional
reinsurance. Otherwise, excess of loss would be the usual route, sometimes in combination
with other liability classes. Cover is on a losses occurring basis up to the limit of indemnity
with an upper layer to cover ‘clash’ of one or more policies and costs in addition. Usually, the
reinsurance is granted with limited reinstatements, although the original insurance coverage
would not be limited for the period, other than for products liability.
Public liability cover is often rated on an exposure basis, as losses which affect reinsurers
tend to be infrequent and large and not ideally suited to historical burning cost rating.
However, if a carrier writes a large account there will be enough historical experience to
make an experience rating valid.
Infrequent large losses make excess of loss reinsurance suitable as it smooths peak losses for
the reinsured by absorbing only the upper part of the loss profile.
F3A Subsections to public liability

Householders’ legal liability is a form of public liability provided to private individuals under
their household buildings or contents policy. This covers their liability as homeowners or
occupiers in relation to other members of the public. Typical limits of indemnity can be £2m
or more.
Travel policies customarily contain a section to cover an individual’s public liability or, in this
case, personal liability. This cover is usually worldwide, with a higher premium chargeable to
those visiting the USA.
G Products liability
Insurance of the
Products liability insurance is the insurance of the liability for losses caused by faulty
liability for losses products.
caused by faulty
products
G1 Extent of cover and exclusions

Products liability is the legal liability of a producer towards third parties who have sustained
bodily injury or property damage caused by a defective product. It is defined as the
obligation to compensate for damage/losses occurring after the delivery of goods produced
or supplied, or the completion of works and/or the rendering of services. However, the cause
of such damage must result from product deficiencies already in existence before the
product or work was delivered or handed over to the customer.
Common products liability exclusions under treaty reinsurance include aircraft, explosives
and chemicals, alongside many of those considered in section F1.
Chapter 11
G2 Underwriting considerations
Reinsurers should expect the following additional information when negotiating coverage
for this class:
• Whether the reinsured provides cover for exports to North America? If so, it should be
able to provide details of any amounts as percentages of turnover and advise on its
underwriting attitude to such risks.
• Details of the maximum and average limit of any acceptance in the aggregate and
confirmation as to whether coverage is provided on an aggregate basis.
• To what extent defective design coverage is granted by the reinsured and confirmation
that products guarantee and products recall are both excluded from the original policies.
• Policy to be written on a claims-made basis due to negligent acts, errors or omissions
committed during a specific period prior to inception of the policy, say three years, and
during the policy period itself.
• A list of all other usual exclusions contained in the insured’s original policies.
G2A Accumulations including active ingredients

Accumulation for products policies is slightly different, in that the reinsurer would not
necessarily fear a large single loss occurring in one place, but rather a series of losses caused
by the same product, e.g. a pharmaceutical product could injure thousands of people.
Example 11.8
Thalidomide was a tranquilliser that went on the market in 1958. It was hailed as a ‘wonder
drug’ and was given to pregnant women as a cure for morning sickness. However, in the
late 1950s and 1960s, more than 10,000 babies in the UK alone were born with
deformities. Millions of pounds have since been paid in compensation.
It is for this reason that products liability policies contain an annual aggregate limit. Products
liability policies
Variations of product liability related policies include: contain an annual
aggregate limit
• products recall;
• products guarantee; and
• efficacy.
Products recall
Products recall insurance covers the costs of recalling all products within a particular batch
that was found to be faulty. Recall is initiated by the insured manufacturer and involves
advertising the fact, plus replacing the goods when they were brought in. This class involves
moral hazard in that insureds may recall products on the slightest grounds, maybe for public
relations purposes. It is not liability insurance as such and would therefore be excluded from
the standard reinsurance product.
Be aware
If it is known that a product is faulty it may be less expensive to underwrite the cost of
product recovery than to deal with an inevitable stream of insured losses at some point in
the future.
Products guarantee
Products guarantee insurance deals with the performance of a product and can be exposed
to a series of claims if a product malfunctions. Therefore, it can experience runaway claims
and is not the subject of liability coverage as no damage or injury has to occur.
Efficacy
The idea of efficacy refers to a product failing to perform the job for which it was purchased.
It is certainly debatable whether this should be the subject of insurance. It is not appropriate
to products liability insurance, as this has to involve bodily injury or property damage.
Chapter 11
Pure financial loss

Pure financial loss
Pure financial loss is excluded, as the purpose of a products liability policy is to indemnify
is excluded third parties for bodily injury, physical loss or damage caused by a product. Pure financial
loss would not have injury or damage as a requirement and, if it were included, would extend
the boundaries of cover to an unreasonable extent, allowing all types of unforeseeable
economic losses.
The potentially most serious accumulation in liability insurance is that caused by an active
ingredient. The resulting liability claims against a large number of manufacturers would have
an extensive impact on the entire insurance industry.
Refer to A serial loss can mean a considerable exposure. In such a case several people suffer loss or
chapter 7,
section D10C for injury as a result of the same act or omission by the policyholder, and this obliges the
claims series policyholder to pay compensation. Serial losses are limited in reinsurance through the
clause
inclusion of a serial loss clause in excess of loss treaties.
Example 11.9
The serial loss clause wording is used where a single insured has purchased a number of
pieces of equipment or parts from a single vendor. In this scenario, insurers may have
concerns with defects in design or manufacturing that reoccur in the product fleet and all
losses belonging to a series attributable to one and the same cause are treated as a single
occurrence.
In some cases this can lead to a disadvantage for the reinsurer when, by the treatment of a
number of individual losses as one occurrence, the deductible is exceeded. Nonetheless,
such a clause is necessary in order to restrict major serial losses for the reinsurer.
G3 Types of reinsurance purchased

Usually integrated
Product liability cover is usually integrated into a comprehensive general liability cover and
into a placed along the lines outlined for public liability, perhaps with a special provision relating
comprehensive
general liability
specifically to products liability with a sublimit. Otherwise it could be placed facultatively,
cover especially if the underlying company concerned was large or the goods were contentious.
Standalone treaty insurance is unusual but, where found, would be placed most often on an
excess of loss basis.
General liability or casualty reinsurance programmes can usually include employers’ liability
(or workers’ compensation) and public and products liability under the same excess of loss
programme. Most reinsurers that write general liability would be able to write such a
programme. Proportional reinsurance is more difficult to place for these classes.
Some casualty excess of loss reinsurance programmes go even further and include the
professional liability classes, such as professional indemnity, in addition to general liability.
The market for these programmes is more restrictive. The reinsured has to provide specific
information for each class and identify the reinsurers writing multi-line casualty.
H Professional indemnity
Some special forms of cover that may be offered in connection with insurance for business
enterprises are directors’ and officers’ (D&O) liability and employment practices liability
(EPL
EPL) insurance.
Professional liability insurance covers material damage, personal injury and pure financial
losses for particular professional groups or institutions, such as architects and engineers,
physicians and hospitals, lawyers, solicitors and chartered accountants.
H1 Extent of cover and exclusions

Cover relates to
Cover relates to the insured’s legal liability for financial losses caused to third parties,
the insured’s legal including customers, as a result of errors and/or omissions in the course of the insured’s
liability for
financial losses
profession. Financial loss in this context is ‘pure financial loss’, which is not consequent upon
caused to third a bodily injury or property damage loss. The professions can be broken down into four
Chapter 11
parties
branches.
Professions
legal, such as financial services, information technology, other professions

lawyers, notaries, including auditors, including consultants, and activities, such
attorneys tax advisers, trustees, software developers as surveyors, tour
and solicitors brokers and banks and network providers operators, advertising
and publicity
consultants
Professional indemnity (PI PI) is written in the UK on a claims made basis by both insurers and
reinsurers. Other jurisdictions still issue cover on a losses occurring or sometimes a losses
discovered basis, but claims made is increasingly becoming standard. Claims made is used
for PI as it is often difficult for insurers to ascertain when a loss or an event actually occurs.
Question 11.6
Supposing a lawyer negligently draws up a will for Mr Smith in 2013. Shortly after Mr
Smith’s death in early 2018, the executors discover that the will is not valid. As a result
there is a negligence claim against the lawyer. For the purposes of an insurance recovery,
which year’s policy would you expect to meet the claim?
Problems with claims made cover are experienced if an insured changes insurers. The
insured must be very careful to declare all possible future claims or circumstances to its new
insurer, but these will be excluded from future cover. Therefore, the insured must notify
these possible claims to its outgoing insurer.
The advantages of claims made cover for insurers and reinsurers is that it reduces the length
of the tail. It allows them to set a risk premium commensurate with the current risk.
Be aware
Compare this to the situation which faces EL insurers who in the current decade may have
to pay for losses which occurred in the 1960s. In some cases, claims for exposure to
agents of latent disease may not be submitted until now and thus totally inadequate
1960s premiums are having to pay for awards in the today’s ‘money and compensation’
climate.
Limits of indemnity are expressed as any one claim and sometimes with an aggregate for the Limits of indemnity
period, although this is not always true since some covers have unlimited sideways are expressed as
any one claim
coverage.
H2 Underwriting considerations
This is a specialised class of business and reinsurers will need to satisfy themselves that the
reinsured is sufficiently experienced and competent before committing themselves to
participating in any proportional reinsurance arrangement. In addition to this the reinsured
should provide:
• Detailed proposal forms giving information about the insured and the insured risk,
such as:
– precise description of the professional activity, including details on the level of training
and supervisory mechanisms;
– background information relevant to the risk, e.g. client structure and specimen
contracts;
– loss record;
– advertising and information brochures;
– original policy conditions; and
– original premiums.
• As the professional activity descriptions of the occupations to be insured are subject to
Chapter 11
changes and new types of professional activity emerge, details of whether up-to-date,
country-specific activity descriptions are available.
• Whether current or potential problem areas have been considered because risks are
becoming increasingly complex in economic, legal and technical terms, such as:
– losses emanating from long-tail risks having the inherent exposure to increasing cost
due to inflation;
– in case of insolvency, claims cannot only be made against the insolvent party, but also
against its professional advisers, a situation that is more likely to occur in times of
economic recession;
– the likelihood that there is an increasing exposure to foreign aspects due to
globalisation; and
– new professional activities needing new coverage concepts.
Example 11.10
In the UK, the Solicitors Regulation Authority has the power to take disciplinary measures
against members in cases of misappropriation from client accounts, money laundering
and mortgage fraud.
H3 Types of reinsurance purchased

Can be reinsured
This type of business can be reinsured on a facultative and treaty basis, and on both a
on a facultative proportional and non-proportional basis. Facultative would tend to be used to support
and treaty basis
incidences where the underlying insurance moves outside of the treaty relationship, such as
high exposure to the USA, which could be a treaty exclusion. However, some larger firms of
accountants and lawyers have actively sought placement of their higher layers of cover in
the reinsurance market.
Treaty relationships could also be both proportional and non-proportional, although
non-proportional reinsurance is recognised to be the usual basis.
I Medical malpractice
Although this type of insurance is in itself a type of PI, it is handled separately to the other
lines. It covers risks from the area of medical and paramedical services, which may lead to
claims for compensation arising from medical malpractice
malpractice.
The causes include negligence on the part of doctors, auxiliary and nursing staff,
shortcomings in the operation of a hospital and its ancillary facilities, mistakes in the
operation and maintenance of technical plant and equipment, and problems in the
organisation and administration of the institution or hospital.
Be aware
For a medical malpractice claim to be successful there is a need to show that the doctor,
nurse, dentist or other healthcare professional has done something that most other
people in their position would not have done. It does not necessarily follow that because
treatment has failed or an operation has gone wrong that clinical negligence has occurred.
Some operations, after all, come with risks, as do some medications.
As far as eligibility for cover is concerned, the diversity of medical institutions, from
single-doctor practices to university hospitals, and the broad spectrum of activities and
responsibilities of a physician, from general practitioner to senior physician in gynaecology
and obstetrics, all have to be taken into account.
Cover must be
However, compared to other professional liability covers, the scope of cover and conditions
subject to precise can only be influenced to a limited extent. This is because when granting insurance cover for
assessment of
each risk
losses relating to the exercise of medical activities, there is usually no scope for a large
number of special exclusions. The cover of such risks must, therefore, be subject to a
particularly precise assessment of each risk on its own merits, including both the subjective
circumstances of the policyholder and the form of the external, objective aspects of the risk.
Risks in the field of medicine differ considerably from country to country, in relation to both
the liability situation and the situation with regard to the physical and moral hazard. Even the
most idealistic medical workers can find themselves working under unhygienic conditions
Chapter 11
that threaten patients’ welfare. Cover must allow for this.

I1 Underwriting considerations
Reinsurers should bear in mind the following features when negotiating coverage for
this class:
• Depending on market practice, contracts may be written on an occurrence or a claims
made basis, although the claims made principle is typically preferred. For occurrence
policies, limitation of the extended reporting period should be agreed wherever possible.
Separate statistics should be kept for mixed portfolios.
• Aggregate limits especially for hospitals are generally considered essential.
• Medical malpractice cover is not usually included in an insurer’s umbrella policies.
• Exclusions usually apply where serial loss exposure exists, as in the case of AIDS or
hepatitis.
• Opportunities may exist to include public liability, environmental liability and EL risks for
the institution or practice as additional covers.
As is the case with other lines of PI, this class can be written on both proportional and
non-proportional basis and facultative and excess of loss, although generally excess of loss
reinsurance is preferred.
Question 11.7
Why is it likely that reinsurers will prefer to avoid multi-year periods for this type of cover?
Learning point
Before you move on, ensure that you understand how reinsurance operates for PI and
medical malpractice insurance.
J Trade credit, surety, political risks,

fidelity insurance and bonds
J1 Trade credit
Trade credit insurance covers the risk of a buyer not paying a seller sums due from a
trade-related contract for goods or services. While a sole trader may be an insured buyer in
respect of their business debts, trade credit underwriters will not insure payment of
personal debts.
Policies are generally written for a policy period of twelve months and specify maximum Policies are
terms of payment. The underwriter may specify limits of exposure on all buyers and include generally written
for a policy period
special conditions relating to security required, such as a guarantee from the directors of the of twelve months
buyer’s company. Policy conditions may also include a requirement to advise a specified
debt collection company within a short time after a debt becomes overdue for payment.
Where a policy includes an excess, deductible, aggregate first loss or minimum retention, the Underwriter
underwriter may offer a ‘discretionary credit limit’ where the insured may include a buyer for may offer a
‘discretionary
cover at a limit decided on between the underwriter and the insured. This facility depends on credit limit’
the underwriter examining the procedures used by the insured and being satisfied that such
decisions are taken responsibly. The underwriter may suggest that the business changes or
improves its credit control system.
It is possible to insure debts due from buyers who are not in the same country as the seller
and the risks insured may include:
• insolvency;
• ‘protracted default’ where payment is not made within a specified time after due date;
• failure of the exchange control authorities of the buyer’s country to permit transfer of
currency; and
• inability of the buyer to pay because of government action.
Chapter 11
Policies may be rated on turnover with insured buyers during the policy period, or on
exposure as declared at specified times during the policy period. Premium is sometimes
stated as a ‘flat’ premium amount fixed at inception, based on the underwriter’s overall
assessment of the risk represented by the trade and the buyers.
Be aware
Trade credit insurance is available to many businesses including wholesale. It is not so
appropriate to the retail sector where the viability of buyers is far more difficult to assess
and underwrite.
J1A Types of reinsurance purchased

Trade credit reinsurance can be written as quota share, excess layer or facultative, but the
latter usually refers to cover sought for single buyer policies or where there is one buyer with
a particularly large limit among those insured under a policy. The decision between quota
share and excess layer depends on the policy structure, the risk profile presented and the
capital available to the reinsured to support the level of risk to be assumed.
The reinsurance underwriter will analyse the loss history and also the risk distribution in
terms of the type of buyer expected to be included. Where buyers in countries other than
the seller’s country are to be insured, limits may be placed on the proportion of exposure
with specified countries or regions.
Activity
UK Export Finance is the UK’s official export credit agency and provides insurance to UK
exporters against non-payment by their overseas buyers. Visit UKEF’s website at
http://bit.ly/1JBJlcA.
Submissions to reinsurers usually contain information about the decision systems he

company uses and statements on the senior staff who decide underwriting policy and take
high-level decisions. Rating considerations include the experience of the senior staff and the
systems used, as well as the expectations set out in the budget projections for the profiles of
insureds and their buyers.
If any element of political risk is to be included in the cover then that may be subject to
loadings, based on the reinsurer’s view of the risk represented by countries or groups of
countries and these will be set out in the ratings that are applied.
Reinsurers will
Reinsurers will consider potential country risk, using published information (see e.g.
consider potential Transparency International’s Corruption Perceptions Index, which annually ranks countries)
country risk
or, perhaps, ratings supplied by specialist risk analysis agencies. They will take account of
the legal system, the general commercial morality and the possibility that a country, or a
region, may be subject to economic turmoil or political upheaval.
Useful website
www.transparency.org/whatwedo/publication/corruption_perceptions_index_2018
J2 Surety risks
Major contracts, especially government projects, often require the contractor to provide
security against failure to perform. This is usually expressed as a percentage of the contract
price. The contractor is often required to offer financial security that will be paid to the
principal in the event that, having placed a tender and won the contract, the contractor
declines to accept it, or sets an unreasonable date for commencement.
It is possible that all of these calls for security can be met by cash deposits, but this carries
several difficulties, including problems recovering the money subsequently. Contractors
often use on-demand bank guarantees, but these are treated as overdrafts and immediately
use up facilities and give no protection against ‘unfair calling’. This is where the principal
takes advantage of the on-demand character to claim the money, even if the contractor has
fully performed under the contract. It is possible to insure unfair calling in the political risk
market at Lloyd’s or with company underwriters, where the principal is a government or a
quasi-government body, such as a power undertaking.
Chapter 11
As an alternative to all of this, the contractor can obtain an insurance company surety
surety, which Surety bonds are
is written to pay the principal if contractual or pre-contractual obligations are not met. not contracts of
insurance
Surety bonds are not contracts of insurance. They are made available on recourse terms so
that, if the surety has to pay the principal, it is entitled to seek reimbursement from the
principal contractor. Unlike indemnity insurance, where the premiums effectively pay for any
losses, surety bond premiums are ‘credit and service fees’ charged for the use of the surety
company’s financial backing and guarantee.
Example 11.11
An architect submits a tender to plan and design contract works. Its bid is accepted by
the principal. A ‘bid’ bond assures that if the architect then does not agree to the job as
bid, the principal who requested the bid receives compensation, as time and expense is
incurred in having to seek further tenders all over again.
Sureties can be used for other purposes. A customs or duty deferment bond allows removal Sureties can be
of goods from a bonded warehouse before duty has been paid to the customs authorities. used for other
purposes
The structure of the relationships is similar to the earlier case.
J2A Underwriting considerations

Reinsurers will be concerned to know that the insurer does not take risk on for applicants
with low, non-investment grade, credit ratings and will specify acceptable risk categories.
Concentration risks in related companies or on the same contract, where sureties are being
issued for several subcontractors, will be defined and limited.
Accepting that the contracts and the sureties are subject to the laws of countries other than
the insurer’s or contractor’s country, the reinsurer will be careful to avoid unexpected or
unlimited claims arising from such local law. The terms of the reinsurance treaty must define
and limit the scope of the wording of the surety and the counter-indemnity.
The process by which the insurer selects applicants and the size and types of contract are
also relevant points in terms and rating. Rating is likely to be based on the quality of the
insurance company and its experience.
J3 Political risks
There are a number of problems when considering political risks as a peril.
Firstly, a common definition of what political risks are does not exist and so the peril ‘political A common
risks’ is described by a number of different terms, e.g. war, invasion, rebellion, revolution etc. definition of
political risks in
These terms are actually subcategories of various political risks and there are no common entirety does
definitions for these either (e.g. what exactly is a rebellion?). In addition, there are no not exist
common definitions describing the scale of these and the transition from one to another may
be floating (e.g. at what stage would a civil unrest become a civil commotion, an insurrection
or even a civil war?).
Secondly, there is generally no common agreement which institution/authority should
declare that political risk has occurred (except for terrorism in some countries).
Thirdly, the terms used can have different meanings depending on which jurisdiction is
applying it (e.g. dispossession). It therefore has to be clarified, for each market/jurisdiction
separately, whether/how the terms usually used to describe political risks are legally
defined.
Political risks can be covered under one of the following:
Chapter 11
Comprehensive Policies underwritten in the trade credit market rather than the political risk
credit risk insurance market.
Cover is provided for a limited range of political risks, such as failure of the
appropriate exchange control authority to remit foreign exchange after the
buyer has paid, but can also be extended to include any action of the nature of
a political risk which prevents payment, such as nationalisation of the buyer’s
business, and this would be reinsured on a trade credit treaty.
Pure political risks Reinsured on a political risk treaty and insured in the political risks market
covers among Lloyd’s syndicates or with specialist company insurers. Such policies
can cover the political risks mentioned above, but not the credit risk, and also
expropriation of assets, non-payment of dividends or interest, or
non-repatriation of capital equipment sent out to be used in capital projects,
failure of the central bank to pay or permit payment under an irrevocable
letter of credit or other guarantee and several other types of risk of a similar
kind.
Categories of political risks

Political risks can
Political risks can be categorised by focusing on two criteria:
be categorised by
focusing on two a. the person(s) or group(s) of persons committing the act; and
criteria
b. the motivation of the act.
According to these criteria, five main categories of political risks arise, irrespective of the
definition problems.
Category 1: War/civil war/warlike operations
a. person(s): two or more states or different social/ethnical or religious
Committing person(s)
groups.
b. Motivation: to secure/expand its power.
Motivation
Terms describing this category of political risks are, e.g. ‘war (whether war be declared or
not), warlike operations, civil war, invasion, act of foreign enemy, hostilities’.
Category 2: Overthrow of the government (through military or popular rising)
a. person(s): an organised political or military group, the civil population.
b. Motivation: protest against/overthrow the government.
Motivation
Terms describing this category of political risks are, e.g. military rising, mutiny, popular
rising, civil commotion assuming the proportions of or amounting to a popular rising,
insurrection, rebellion, revolution, military or usurped power, martial law or state of siege or
any of the events or causes which determine the proclamation or maintenance of martial law
or state of siege.
Category 3: Orders issued by a governmental or military authority
a. person(s): governmental or military authority.
b. Motivation: to intervene arbitrarily in the population’s property rights for political
Motivation
reasons.
Terms describing this category of political risks are, e.g. permanent or temporary
dispossession resulting from confiscation, commandeering or requisition by any lawfully
constituted authority.
Category 4: Disturbances
a. person(s): the civil population.
b. Motivation: to influence the government.
Motivation
Terms describing this category of political risks are, e.g. riots, strikes or lockouts, riots
attending a strike or lockout, civil commotion, vandalism and malicious mischief.
Category 5: Terrorism
a. person(s): acts of persons or groups of persons.
b. Motivation: to put the public in fear.
Motivation
These groups of political risks differ in their vulnerability and therefore also their insurability.
In general, category 1 (war/civil war/warlike operations) shows the highest vulnerability due
to the large geographical area, interference of military groups and/or large parts of the
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population, duration etc. In contrast categories 2–4 have declining vulnerabilities.

The borderline, especially between category 2 and 4, may be floating. An incident may start
as local civil commotion (category 4) and then escalate and become a popular rising
(category 2). The categorisation, therefore, also depends on the severity and the extent of
the incident.
Activity
What political risks can you imagine resulting from these landmark events?
• The dismantling of the USSR.
• The ‘Arab spring’.
• The Syrian conflict.

• Terms of cover.
• Duration of risks according to types of transaction or investment.
• Limitation of insurable countries.
• Maximum country limits.
• Standard exclusions.
• Relevant reporting requirements, depending on duration and type of risk.
• Use of market standard clauses.
• The reinsured has to have experience, either by the underwriter or the company, in the
political risk field.
J3B Types of reinsurance purchased

Specialist political risk underwriters have annual treaties. In addition, they may arrange Specialist political
facultative reinsurance to cover exceptional values or concentrations, such as a state- risk underwriters
have annual
sponsored scheme to encourage trade links. There are company leaders in this market as treaties
well as Lloyd’s leaders and frequently they write covers on syndicated slips. The reinsurer
should be aware of this practice.
Preference is for proportional reinsurance, as there are potential catastrophic accumulations
that could arise, e.g. a country nationalising an entire industry such as oil. Generally, by the
same measure, quota share is preferred to surplus treaties. In order to control the frequency
risk, some political risk reinsurers only seek to become involved on an excess of loss basis.
J3C Standard political risks exclusions

Standard political risk exclusions are as follows:
• any loss arising from insolvency or financial default of any party or person whatsoever,
except where the insured transaction is secured by a government-owned buyer or the
central bank of the foreign country, or where the official foreign exchange authority
refuses to give leave to make a foreign exchange transfer by revoking a previously agreed
licence;
• credit risks associated with transactions with private entities, unless they are
unconditionally guaranteed by a public entity, or the payment is secured by an
irrevocable letter of credit from a government owned bank;
• the ‘Five Great Powers’ war risk exclusion; and
• the nuclear detonation and ionising radiation exclusion.
Question 11.8
Would you expect losses arising from the actions of animal rights activists or those
campaigning for the rights of unborn babies to be covered as political risks?
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J4 Fidelity guarantee
Provide cover
The object of this class of business is to provide cover against loss caused by the dishonesty
against loss by of persons holding positions of trust. For some guarantees the protection goes beyond
reason of the
dishonesty of
dishonesty to cover losses caused by an error where, say, an estate of a deceased person is
persons holding wrongly administered due to a mistake of law.
positions of trust
J4A Extent of cover

There are different types of policy as follows:
• Commercial guarantees are designed to provide an employer with an indemnity against
the loss of money or stock caused by an employee’s default. A blanket policy goes further
and provides protection against the dishonesty of staff generally.
• Comprehensive and electronic crime bonds.
• Fidelity guarantee policies covering named employees or a specified position.
J4B Exclusions
Typical exclusions in this line of business would be:
• losses caused by a person who is known to have committed dishonest and
fraudulent acts;
• losses generally covered by other forms of insurance;
• losses resulting from bodily injury;
• indirect losses, e.g. loss of interest, losses due to business interruption;
• negligence, stocktaking or inventory losses;
• bankers’ blanket bonds;
• unauthorised trading and money laundering risks;
• liability risks;
• espionage, blackmailing, extortion, libel and similar risks; and
• other bonds and guarantees of any kind.
J4C Underwriting considerations

Where reinsurers are providing proportional coverage for this class it is especially important
that they have confidence in the reinsured’s ability to carry out appropriate underwriting
checks since they are effectively following the reinsured’s fortunes. Other considerations
include:
• the need to obtain comprehensive information about the original insured and a full claims
experience;
• the need for a detailed description of the insured’s activities, including accounting,
security and supervisory mechanisms in place to discourage, prevent and detect
dishonest activity;
• the cover limits applicable to each employee or position; and.
• a full description of exactly what risks it is that the insured wants to cover.
J4D Types of reinsurance purchased

fidelity guarantee
Facultative insurance is often used because fidelity guarantee is not a volume line of
is not a volume line business and this method allows the reinsurer to judge individual risks carefully. However,
of business
some treaty reinsurance is acceptable, provided there is a clear risk definition, as ‘any one
risk’ can mean:
• per employee/person;
• per event;
• per person and event;
• per year; or
• in the annual aggregate/per policy.
Surplus reinsurance treaties create some difficulties with regard to the administration of
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policies with varying sums insured.

Example 11.12
A policy provides for three risk categories, namely delivery driver, cashier and accountant,
with respective sums insured of £50,000, £150,000 and £250,000. While the net
retention under the surplus treaty amounts to £50,000, the highest sum insured of
£250,000 is the basis for the allocation of the whole policy.
J5 Bonds
Bonds are a form of surety insurance. Surety exists whenever one party guarantees Bonds are a form
performance by another party of an undertaking or obligation. A surety bond is a written of surety insurance
agreement, whereby the surety, who issues the bond, obligates itself to a beneficiary or
employer, to pay a stipulated amount in the event of breach or default of a contractor.
Be aware
Under a construction bond the insurance company stands as surety to the employer that
if the construction company is unable to complete the contract works, then the insurance
company will provide the financial means to do so.

The underwriter will want to:
• determine what the obligee wants guaranteed;
• determine underlying terms and conditions of the guarantee;
• evaluate the contractor’s qualifications; and
• assess if it is reasonable to expect the contractor to perform their obligations.
J5B Exclusions
The following is a list of typical exclusions for this class of business:
• Financial guarantees, which covers financial obligations in respect of any type of loan,
personal loan and leasing facility, granted by a bank or credit institution.
• Reinsurance of facultative or treaty reinsurance concession bonds.
• Commercial and/or political trade credit.
• Bonds without defined limitation in time and amount.
• Fidelity guarantees.
• Travel bonds.
K Miscellaneous risks
Four other classes of business, sometimes associated with the casualty department, are
worth special mention. We will consider them in this section.
Miscellaneous risks:
livestock/ extended
contingency cyber
bloodstock warranty
K1 Livestock/bloodstock insurance
Bloodstock insurance is the insurance of breeding horses, for example, thoroughbred
stallions, mares and foals.
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Livestock
Livestock insurance is the insurance of animals (typically farming animals) that are kept and
insurance is the used for profit. It is wider in scope than bloodstock insurance. Within this area there is also
insurance of
animals
the insurance of exotics, which covers insurance of more unusual animals such as ostriches
and zoo animals, and aquatics insurance which covers the insurance of fish, usually on
commercial fish farms.
Livestock/bloodstock insurance tends to be offered by a few insurers who make a speciality
of the class. Most interest is centred upon the high values found in the thoroughbred
racehorse field; particularly those stallions which retire to stud after an outstandingly
successful career on the racecourse. Such horses may be insured for many millions of US
dollars. Associated with them are the breeding and training establishments themselves and
the shipment of valuable animals from country to country.
Example 11.13
One of the five annual English Classic Races, the Epsom Derby is open to all
three-year-old colts and fillies, although, in practice fillies are seldom entered as Epsom
Derby runners. The 2019 Epsom Derby purse is an impressive £1.5m and the winner’s value
at stud many times more. However, even this amount of prize money pales in significance
compared to the US$10m on offer for winning the world’s richest horse race, the Group 1
Dubai World Cup.
A bloodstock policy may provide compensation for loss and expense as a result of mortality,
infertility, business interruption, loss of use, mare and stallion unavailability, among other
causes. In the UK, a horse owner has a public liability exposure for damage or injury to others
and the insurance can include third-party cover.
Question 11.9
What do you think would be the basis of indemnity for the loss of a horse as a result of its
death by injury, illness or accident?
Collection of
The collection of several such animals in stables gives rise to an accumulation exposure in
several animals the event of fire or contagious disease. The movement of racehorses by air, which is
gives rise to an
accumulation
becoming frequent as they participate in races on foreign tracks, also involves considerable
exposure accumulation of values in one aircraft.
Cattle can also represent considerable values in transit and, as the quality of stock is
improved, are beginning to be more generally insured. Here the insurer runs the risk of heavy
losses if animals are struck by an epidemic affecting farms over a wide area.
Be aware
Coverage can be for one animal or an entire wildlife park or zoo.
While certain diseases are eligible for compensation from government funds, such
compensation may only be partial. Also there are other diseases that can be equally
devastating, but where state compensation is not provided.
K1A Underwriting considerations

Reinsurers need to be satisfied with the competence and experience of the reinsured in
writing this business. The following information should be provided when negotiating
protection for such an account:
• What is the split, if applicable, in premium income between livestock and
bloodstock risks?
• What are the different types of livestock written within the original portfolio of risks?
• From what countries, regions or territories is business accepted by the reinsured?
• What are the reinsured’s policy and underwriting limits per animal, per farm or stable or
per location, such as country, region or territory?
• What veterinary facilities or expertise are available to the reinsured?
• How are accumulations of risk controlled and which business is exposed, or susceptible,
to epidemic situations such as foot and mouth?
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K2 Contingency insurance
Contingency insurance embraces a broad spectrum of risks which, by and large, defy Contingency
conventional categorisation. At one end of the scale are examples such as missing document insurance
embraces a broad
indemnities. However, cancellation of event and non-appearance indemnities can command spectrum of risks
substantial sums insured when major concerts or shows are involved and film producers’
indemnity is bought to compensate for calamities which may halt an expensive film
production.
Example 11.14
Some outdoor sporting events are subject to the vagaries of adverse weather conditions,
none more so than cricket. A test match can often be sold out in advance yet if any day’s
play is cancelled due to rain without a ball being bowled, advance ticket sales monies
have to be refunded, although the ground authorities would still incur considerable
standing costs. Such expense, including loss of revenue, can be insured under so-called
Pluvius or similar policies and then subsequently reinsured on a facultative basis.
Prize indemnities, ‘hole-in-one’ and loss of revenue through industrial actions are more
speculative examples of cover bought. Performance guarantee cover is a long-tail cover
purchased at the beginning of a construction/engineering project and is more related to
liability insurance.
K3 Extended warranty and breakdown insurance

Although existing for some years for private motor cars, extended warranty insurance
covering domestic electrical goods such as washing machines, refrigerators, vacuum
cleaners, televisions and DVD recorders is a more recent development. The schemes which
operate extend the original manufacturer’s guarantee for a further period, e.g. 48 months in
excess of the manufacturer’s 12-month period.
Extended warranty insurance usually covers the cost of repairs or replacement in the event
of breakdown due to faulty workmanship or material used in manufacture and is not
designed to provide full breakdown cover. Therefore, accidental damage and claims for
wear and tear are usually excluded. Such risks have high levels of homogeneity and so are
well-suited to proportional forms of reinsurance.
K4 Cyber insurance
The demand for cyber insurance is growing steadily in response to the increase in cyber
crime and to stricter data control regulations. If a company has its computer systems hacked
and data stolen it can incur several related costs. Customers can sue a company if their
personal or corporate data information is stolen, resulting in reputational or commercial
damage. Regulators can enforce improved cyber security measures and issue fines.
Customers can also hold the company liable for financial loss if credit card details or bank
account information is stolen.
Rectification costs can also be substantial. These include work related to data restoration,
replacement of damaged hardware, writing to all customers advising of a data breach and
the cost of public relations to repair reputational damage.
The market for cyber insurance has grown rapidly in recent years. Some professional
indemnity insurers can include limited cyber cover as an optional extension. There is also a
specialist market writing standalone cyber with a wide range of coverage options and 24
hour support following a cyber event.
Policy limits, especially for larger companies processing a large volume of credit and debit
card transactions, can be very high. This has given rise to a need for cyber reinsurance and
several key cyber insurers have purchased cyber reinsurance treaties.
Chapter 11
L Claims management
Claims handling is
For the insurer, claims handling is a particularly demanding task. This is due to the special
a particularly characteristics of casualty business. These characteristics include:
demanding task
• the need to clarify questions of liability, especially important for professional liabilities;
• long periods of claims settlement;
• problems of long-tail claims;
• influence of external factors, such as legislation, court decisions and economic
developments, e.g. exchange rate fluctuations; and
• building of reserves.
As a result of the problems described, the incorporation of a claims cooperation clause into
reinsurance treaties can be beneficial as it allows reinsurers to support this process. It is also
advisable to agree upon a claims notification clause, as this assists in the setting of adequate
loss reserve estimates, which allow for price increases due to inflation in the cost of
settlement of bodily injury claims. The reinsurer is thus able to deal more efficiently with the
long-tail-claim risk.
Be aware
The management of claims by the insurance companies is of vital importance to
reinsurance companies. The insurance company must ensure effective administration and
management of claims without compromising the quality of services or growing customer
expectation. If this does not occur there would be serious repercussions for both the
insurance company itself and the reinsurer.
To allow underwriting to be adapted quickly and specifically to the claims development, it is

necessary to have a continuous flow of information between claims departments and
underwriters so that loss experience can be taken into account. This loss information can
then be used as a basis for developing mathematical reserving models and rating tools.
Claims information is an important basis for decisions regarding the acceptance or non-
acceptance of business and its rating.
IBNR claims is the term used for claims that have happened but have not been reported to
the insurer. For excess of loss reinsurers, IBNR is an acute problem and arises from the late
notification of claims to the reinsurer by the reinsured.
The reasons are the reinsured:
• received a late notification and this is very prevalent for latent types of claims;
• may not have been aware of a claimant’s medical condition until a later stage of the claim
process; and
• simply undervalued the claim. This is known as incurred but not enough reported
(IBNER
IBNER).
As the reinsurer’s exposure is excess of the reinsured’s retention, IBNR tends to be a larger
factor for the reinsurer.
The particular problems that it presents to the reinsurer are:
• The past claims experience of a reinsured is not fully developed
developed. This means the
reinsurer must make an assessment of the IBNR and IBNER claims in order to have a
representative past claims experience for the calculation of the excess of loss reinsurance
premium.
• The reinsurer must reserve for all its liabilities
liabilities. Therefore, for proper reserving it must not
only reserve for the claims that have been reported and also make an assessment of those
claims that have not been reported but that will emerge at some point in the future, in the
form of reserves for IBNR and IBNER.
Consider this
this…
…
Consider how past experience of the portfolio or the industry as a whole helps a reinsurer
to assess the IBNR factor required to ensure its own reserves are adequate. It also helps it
to ensure that, where excess of loss premiums are calculated on the basis of the
reinsured’s own past claims experience, allowance is made for IBNR.
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It is important that the conditions underlying IBNR are minimised, which means achieving Important that the
prompt notification of claims and securing accurate claim estimates. conditions
underlying IBNR
Reinsurers seek to do this in the two ways: are minimised
By the extended claims The clause places a contractual obligation upon the reinsured to report
reporting clause claims to the reinsurer immediately the value exceeds a specified
percentage of the retention, such as 50% or 75%. The clause also specifies
categories of injuries that must be reported immediately to the reinsurer,
irrespective of the reinsured’s estimate of the claim or the liability.
The effect of the clause is that reinsurers are informed of a claim that is likely
to impact the treaty soon after the reinsured has received information on the
claim. The reinsurer may instigate enquiries immediately to verify the
reserve, and if it is concerned about the reinsured’s valuation, it is open to
the reinsurer to add an additional case reserve.
By technical claims The claims specialist of the reinsurer will visit the reinsured, examine the
audits case files and determine the claims reserve in those cases where the claim
has the potential to exceed the treaty retention. The reinsurer will often
agree with the reinsured the claims settlement procedure in order to bring
about the most economical settlement.
Learning point
You have now reached the end of this chapter on casualty reinsurance. Before you move
on, review the key points that follow – and revisit sections in the chapter to reinforce what
you have learned.
Chapter 11
Key points
Reinsuring a casualty account
• ‘Casualty’ is a broad category of business that is used to refer to classes that do not conveniently fit
under more specific headings.
• Liability insurance does not cover loss or damage to the policyholder or insured but loss or damage
sustained by third parties.
• Liability insurance has a high late claims potential and is also susceptible to a high risk of changes in
law and legal philosophy as well as that of technical advancement.
• Liability losses can be categorised as: bodily injury, property damage or pure financial loss.
• Significant underwriting considerations for liability reinsurance include:
– GWP for the past five to ten years;
– the insurer’s underwriting philosophy and principles;
– portfolio structure; and
– whether claims settlements include annuity and interest payments.
• If the application is for proportional treaty coverage the following additional information would be
needed:
– run-off triangles on an underwriting year basis over the same period, showing paid and
outstanding claims;
– details of costs including agents commission, internal costs and charges;
– reinsurance brokers’ commission;
– costs of common account excess of loss cover;
– the reinsured’s business plan; and
– assurances regarding the reinsured’s solvency.
• If the application for cover relates to a non-proportional treaty the following information would be
required:
– serial loss potential from products, professional, employers’ and environmental liability business;
– individual claims information split by accident years over a minimum five-year period;
– price or wage indices to develop the cost of claims; and
– information on the reinsurance required in relation to treaty structure and layering.
• The usual forms of reinsurance purchased are quota share and excess of loss treaties.
• Several casualty classes may be combined in one treaty for reinsurance purposes.
• Clash excess of loss reinsurance protects the reinsured against losses related to a single event
triggering claims from more than one policy, account or class.
Motor
• Motor insurance comprises:

– liability for third party property damage;
– liability for third party personal injury, including liability for passengers (together MTPL);
– cover for damage to one’s own vehicle (MOD); and
– benefits for accidents sustained by the driver or passengers.
• The reinsurer would wish to establish details of the insurer’s:
– premium volume;
– portfolio composition;
– cover limits for account subsets;
– ‘overseas’ exposures;
– natural peril exposures;
– management and underwriting philosophy;
– exclusion list;
– potential risk accumulation; and
– detailed loss statistics.
• In MOD insurance, accumulation risks occur especially as a result of natural hazards. The risk of
accumulation losses in MTPL plays a less significant role.
• Reinsurance cover for motor can be written on a quota share basis but excess of loss is most
common.
Chapter 11
Personal accident
• A typical list of benefits would include some, or all, of: death, disability, a daily allowance, an
allowance for hospitalisation and/or medical expenses.
• The underwriting considerations affecting the reinsurance of a personal accident account include:
– ratio of retention to liability;
– premium volume of accident business in the client’s overall portfolio;
– the premium volume split between individual and group business;
– gross results for the past five years;
– information on major losses and known accumulations;
– exclusions to be applied.
• Accumulation risks arise where a number of insured persons gather in the same place or are
exposed to the same peril.
• A distinction needs to be made between known and unknown accumulations.
• For individual business, quota share reinsurance may be appropriate; whereas for group business
proportional reinsurance and catastrophe excess of loss covers are used.
Employers
Employers’’ liability
• Cover applies in respect of the legal liability of the employer for employees sustaining death, illness
or disease resulting from an accident that arises out of and in the course of their employment.
• The reinsurance underwriter would want details of:
– schedules of the benefits specified in the workers’ compensation statutes;
– whether any benefits can be increased retroactively;
– details of any situations that give rise to accumulations of employees in hazardous environments;
and
– a policy profile that shows limits and attachment points if the insured is writing excess layers.
• Occupational diseases can result in a large number of claims from affected employees.
• Excess of loss tends to be the most popular form of reinsurance coverage.
Workers
Workers’’ compensation
• Workers’ compensation insurance covers an employer’s liability that arises from employee’s injuries
sustained at work and is generally in line with the relevant country’s or state’s workers’
compensation act (which, in many cases, imposes strict liability). Coverage is generally limited to
some degree either by quantum or by time.
• A&H insurance includes annual private medical insurance cover for hospital expenses, including
operation, treatment and nursing costs. It is often written on a group basis covering the employees
of a particular company.
• Unlike EL cover, workers’ compensation provides for a ‘no fault’ system so it is unnecessary for the
employee to prove negligence, reasonable redress for economic loss, and scales of compensation
(but no compensation for pain and suffering).
• Most of the accumulation patterns that concern reinsurance underwriters of EL business are also
relevant to the field of workers’ compensation.
• Reinsurance can be effected on a proportional or non-proportional basis and this will affect the
underwriting information required by the reinsurer. The most common form is excess of loss where
accumulations can be limited by a strict event definition.
Chapter 11
Public liability
• Cover provides protection against the financial consequences of claims for compensation filed
under civil law by third parties that have suffered loss or damage.
• The reinsurance underwriter would want details of:
– the nature of the classes of business written by the reinsured (showing the split between
commercial and industrial, large and small operations).
– the limits written in respect of bodily injury and property damage;
– whether the basis of coverage is ‘losses occurring’ or ‘risks attaching’;
– past loss history and whether an allowance for IBNR has been made;
– whether original policy coverage allows for legal costs;
– the extent of pollution cover; and
– details of the reinsured’s insurer’s exclusion list.
• Accumulations mainly arise from pollution risks which tend to be covered so that only accidents
occurring at a particular place and time are insured.
• Proportional reinsurance may be purchased by new companies although excess of loss reinsurance
is usually the most popular option.
Products liability
• Products liability is the legal liability of a producer towards third parties who have sustained bodily
injury or property damage caused by a defective product.
• Unlike public liability policies, products liability policies are subject to an annual aggregate.
• Underwriting considerations include concerns about exports to North America, whether original
coverage is provided on an aggregate basis, whether defective design cover is provided, and
exclusions contained in original policies.
• Accumulations can arise out of a series of losses caused by the same product due to a common
active ingredient.
• Reinsurance cover may be arranged along similar lines to public liability cover.
Professional indemnity
• Special types of cover exist in the form of D&O, EPL and PI insurance.
• This type of business can be reinsured on a facultative and treaty basis, and both proportional and
non-proportional.
Medical malpractice
• Causes of claims arise from negligence on the part of doctors, auxiliary and nursing staff,
shortcomings and mistakes in the operation and maintenance of technical plant and equipment,
and problems in the actions, organisation and administration of the medical institution.
• Reinsurance cover can be written on both proportional and non-proportional basis and facultative
and excess of loss, although generally excess of loss reinsurance is preferred.
Trade credit, surety, political risks, fidelity insurance and bonds
• Trade credit insurance covers the risk of non-payment to a seller by a buyer in respect of sums due
arising out of a trade-related contract for goods or services.
• Trade credit reinsurance can be written as quota share, excess of loss or facultative.
• Surety risk is concerned with the failure to perform contractual obligations.
• Reinsurers will be concerned to know that the insurer does not take risk on for applicants with low,
non-investment grade, credit ratings and will specify acceptable risk categories.
• Political risks can be covered under comprehensive credit risk insurance or pure political risk
covers.
• Fidelity guarantee covers the dishonesty of persons holding positions of trust and may relate to
named persons or the position or office itself.
• Bonds are also a form of surety insurance that applies when one party guarantees performance of
an undertaking or obligation by another party.
• An underwriter would want to determine what the obligee wants guaranteed and on what terms,
evaluate the contractor’s qualifications, and assess if it is reasonable to expect the contractor to
perform their obligations.
Chapter 11
Miscellaneous risks
• Livestock and bloodstock covers relate to animals used for breeding or for working purposes.
• Reinsurers would be interested in:
– the split in premium income between livestock and bloodstock risks;
– the different types of livestock within the account;
– the territories from which the livestock is accepted;
– veterinary expertise available to the reinsured;
– how accumulations of risk are controlled; and
– the susceptibility of the account to epidemics.
• Contingency insurance embraces a broad spectrum of risks, which includes: missing document
indemnities, event cancellation, non-appearance indemnities, film producers’ indemnities, prize
indemnities, loss of performance through industrial actions and performance guarantee.
• Extended warranty insurance can be purchased to cover domestic electrical goods. The scheme
operates by extending the original manufacturer’s guarantee and usually covers the cost of repairs
or replacement in the event of breakdown due to faulty workmanship.
• Cyber insurance is growing in response to an increase in cyber crime and data control regulations.
The policy limits can be high giving rise to a need for cyber reinsurance.
Claims management
• Claims cooperation clauses can help to clarify questions of liability.

• Claims notification clauses assist in the setting of adequate reserves.
• IBNR is the term used to describe claims which have not been reported to the reinsured. As the
reinsurer’s exposure is excess of the reinsured’s retention, IBNR tends to be an important
consideration for the reinsurer.
• IBNER is the term used to describe claims which have been undervalued by the reinsured.
• Reinsurers seek to achieve prompt notification of claims and to secure accurate claims reserves by
the extended claims reporting clause, and by technical claims audits.
Chapter 11
Question answers
11.1 Unlike excess of loss, quota share is an effective substitute for equity capital and
guarantees the insurer a contribution to every qualifying loss.
11.2 Such vehicles are, or should be, the subject of other more specific covers.
11.3 Each sub-class of a motor account has its own characteristics in terms of the
anticipated risk profile of losses, sums insured and limits of indemnity.
11.4 In the event that the policyholder is in a poor state of health, certain conditions may
need to be excluded, or terms of acceptance must provide for a deduction to be
made from benefits to take into account pre-existing illnesses and ailments.
11.5 The different defining characteristics are:
• A working layer is designed to pay losses that occur within an original policy limit
of indemnity.
• The lower the retention of the reinsured, the greater is the expectation of losses to
the reinsurer.
• A catastrophe layer is concerned with fewer but potentially larger losses.
11.6 Assuming the coverage is set up on a claims made basis, the trigger for the payment
of a claim in a given year is when the insured is first notified of it. In this case, since
the grounds for the claim were only discovered in the early part of 2017 and that is
when the claim is made, the claim will be under the 2017 policy.
11.7 Multi-year agreements severely limit the reinsurer’s ability to take early corrective
action in the event of a deteriorating or unacceptable loss experience.
11.8 Possibly, depending on whether the activities of such groups fall within the definition
of ‘political violence’.
11.9 Typically the insurer would pay the fair market value of the horse or a specified sum
insured, whichever is less.
Chapter 11
Self-test questions
1. How is a liability risk under a ‘casualty’ account distinct from a ‘property’ risk?
2. What is the difference between motor liability and passenger accident cover within
a motor account?
3. How can accumulations of risk arise for a motor treaty reinsurer?
4. Why is facultative reinsurance a feature of personal accident business?
5. What is the effect of EL insurance being written on a loss occurring basis?
6. What is the significance of ‘strict liability’ in respect of workers’ compensation
business?
7. Why would a reinsurer of a public liability account want to know if the ceding
insurer accepts co-insured business?
8. Why is professional indemnity cover usually written on a claims made basis?
9. Which class of reinsurance tends to be most suitable for fidelity guarantee
business, and why?
10. Why might bloodstock covers be extended to include public liability exposures?
11. Why is there not a need for breakdown cover as soon as a product is purchased?
12. What is the purpose of casualty clash excess of loss reinsurance?
Chapter 11
Chapter 11
Chapter 12
Marine and
12
aviation reinsurance
outcomes
Learning objectives
Introduction
Key terms
A Reinsuring a marine account 10.4, 10.5
B JELC Excess Loss Clauses 10.4, 10.5
C Reinsuring an aviation account 10.4, 10.5
Key points
Question answers
Self-test questions
Learning objectives
• state the risks associated with the main classes of marine and aviation reinsurance;
• discuss the underwriting considerations for each class of business; and
• explain the significant features of marine and aviation accounts.
Chapter 12
Introduction
In this section, we outline the extent of cover provided by the main classes within a marine
account and an aviation account, and describe the main considerations for reinsuring those
classes.
Key terms
Agreed value AVN 34A AVN 4 AVN 41A
AVN 61 AVN 64A and B Backup policy Cargo
Containerisation Exclusion clauses Freight Hull
Incidental aviation Incidental non-marine JELC Excess Loss Liabilities

Clauses
LSW 345A Passenger voluntary Personal accident Profit commission

settlement
Protection and Refinery exclusion Total loss only (TLO) Warsaw Convention
indemnity (P&I) clause reinsurance
A Reinsuring a marine account

A marine account may comprise any or all of the following classes of business:
• hull or ‘time’ account;
• cargo or ‘voyage’ account;
• liabilities;
• energy or ‘rig’ account;
• war;
• incidental non-marine; and
• incidental aviation.
hull or ‘time’
account
incidental cargo or ‘voyage’

aviation account
Marine account:
classes of
business
incidental
liabilities
non-marine
war energy or
‘rig’ account
Be aware
Incidental non-marine and incidental aviation are significant because a shipment of, say,
electrical components from the Far East to Europe can include stages of the journey
involving land and air travel, as well as passage by sea.
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Chapter 12 Marine and aviation reinsurance 12/3
It must be remembered that not all marine insurers, in the UK or elsewhere, necessarily Not all marine
underwrite all the above classes; therefore, their reinsurance needs may vary considerably. insurers
underwrite all
The proportion of the whole represented by any one of the above classes has a material classes
effect on the insurer’s assessment of its requirements. Depending on the composition of the
marine account, the purchase of a separate programme of protection for the assumed
reinsurance account may be necessary.
A1 Hull
The term hull usually includes all those risks underwritten on the original policy form and
may include risks other than actual physical damage to the vessel. so, for example, claims
arising from the operation of the running-down clause, which covers collision liability, are
likely to be included in an insurers’ hull account, rather than its liability account, since the risk
is part of the standard hull coverage.
The hull account will probably not be limited to ocean hull but might also include:
• builders’ risk – building (and launching) risks of vessels;
• fishing vessels;
• coasters;
• river hulls and barges; and
• yachts.
It could also include towage risks, which needs a highly specialised form of protection.
A1A Extent of cover and exclusions

The need for hull reinsurance arises partly from the fact that every insurer that writes original Very high values
hull insurance policies will find itself, at some time or other, with an involvement greater than are now to be
found in fleets
that which it feels it should prudently retain. A common cause of this is that very high values
are now to be found in fleets the world over and this is made more challenging for the
insurer by the fact that many fleets have an unbalanced structure – that is to say, a few peak
values followed by others considerably lower. This is a problem for the insurer that wishes to
maintain its percentage involvement in the fleet, but at the same time finds itself with
considerably more of the peak values than it thinks prudent.
This imbalance in values in a fleet can be extended to apply to an insurer’s entire hull
account and, above all else, is the reason behind the need for some form of reinsurance. The
reinsurance is needed to ensure that, in any loss situation, the insurer is left with an
involvement that represents an acceptable percentage of its premium income and which
would not ruin its hull account or, at worst, threaten its solvency. At other times, the insurer
may wish to reinsure a particular class or type of vessel or, indeed, classify its reinsurance
needs by way of a country of registration or ‘flag’ and by doing so, improve the quality of its
retained hull account.
Special mention must be made regarding yachts as these are often underwritten by a Yachts are often
specialised market. Even when written within an overall hull account, yachts are often underwritten by a
specialist market
separately identified and protected. While the values of yachts may not themselves be high,
particularly when compared with ocean-going merchants’ ships, the liabilities are often
many times the hull value and represent a special problem when arranging reinsurance
protection, particularly if liabilities are included in the hull policy.
The other feature of a yacht account is a possible imbalance of the account, i.e. the value of a
top yacht may be near, or even exceed, the total annual premium income from the whole
account.
Question 12.1
What particular risks are associated with yachts moored in a marina?
Yachts at anchor are considerably more likely than ocean-going vessels to be involved in
one storm, fire or natural hazard. This risk of accumulation in one event is sometimes of
particular importance when arranging the reinsurance programme of a yacht account.
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In a subscription market, such as London, it is possible for an insurer writing direct or

facultative reinsurance to regulate its line commitment on a hull with considerable precision.
Compare this to a country where it is the practice for one company to take 100% of the risk
and where, in all probability, it is not possible to achieve the spread of risk that is so
important to balance the account. In those countries and in other situations where an
original insurer is obliged to accept 100% of the value, there is a greater need for individual
facultative reinsurance to enable a higher percentage of the original risk to be insured.
Structure of the
The structure of the cover is usually based on the class of transportation, by which we mean
cover is usually the type and quality of the vessel. For this purpose different categories can be formed as
based on the class
of transportation
illustrated below:
• ocean-going hulls, classified 100 A1 in the Lloyd’s Register or equivalent, up to 15 years of
age and having a gross tonnage of more than 1,000;
• other marine vessels;
• coasters;
• tugs;
• barges, launches, including small boats;
• river and inland boats; and
• lighters.
Be aware
A lighter is a vessel having a stepped cargo deck for selective float loading and unloading.
The open-sided cargo deck is stepped upward in a plurality of steps from amidships to
both ends. A supporting hull is compartmented into a number of tanks.
Entire fleets are usually ceded to the treaty on the basis of ‘top and pro rata’. This approach
states that the top value of the largest vessel in the fleet is taken and for each unit thereafter
the same percentage, in relation to its respective insurance value, is ceded.
Hull conditions are

Hull conditions are on a named perils basis, including limited collision liability and are rarely
on a named valid for a period exceeding twelve months.
perils basis
A1B Underwriting considerations

All of the factors and general information referred to in earlier chapters, such as details of
the reinsured, the portfolio to be reinsured, claims experience, original policy sums insured
or limits of liability and exclusions, apply equally to marine risks.
It is important to remember that a marine hull account may be made up of ocean-going,
coastal, fishing and river craft. It may also include a significant private yacht account which,
due to the possible inexperience of the owners, may present a considerable liability
exposure.
While it may be possible to negotiate a treaty protecting the entire account or class, this
breakdown of the portfolio is a key underwriting factor for the reinsurer. One type of risk
may be consistently profitable in one geographical location, whereas another type of risk in
the same region may be unprofitable.
Commission paid by the reinsurer is the major factor in determining the cost of the
proportional reinsurance to the reinsured. Any commission should make allowance for the
usual acquisition costs incurred by the reinsured and this information should be available to
reinsurers. The reinsured will expect to receive an overriding commission to contribute
towards its own management and claims-handling costs. This may be included in the overall
commission percentage being sought.
Profit commission is another consideration with this type of reinsurance but it is contingent
on the reinsurer itself having made a profit. The amount of any profit commission is a matter
for negotiation when the treaty is being placed.
Be aware
Reinsurers cannot be expected to pay profit commission for isolated periods of profit. The
treaty has to show a solid record of profit over several years.
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Rating of marine covers is very similar to that of most other lines of business. For
proportional treaties the reinsurer would rate the business by setting terms for the treaty on
the basis of its past results. For non-proportional treaties the excess of loss premium must
cover normal losses, the reserve for deterioration, a fund for catastrophe losses, acquisition
costs and management expenses of the reinsurer and a margin of profit for the reinsurer. It is
important to understand from where and how the underlying principle for rating marine is
derived, because it directly affects the premium achieved by reinsurance treaties and also
reflects the way facultative reinsurance is rated.
For the rating of regular merchant marine vessels a two-pillar system is usually applied. One
of the pillars is the vessel value, represented by the sum insured, while the other is its
tonnage.
Question 12.2
What is the significance of the majority of marine policies being written on a valued basis?
As total loss and sum insured are irrevocably linked when it comes to a claim, they are also
linked for rating purposes. The premium charged for the total loss element in hull insurance
is expressed as a percentage of the sum insured. The tonnage, on the other hand, becomes
very important when considering partial losses or damage to the ship.
Consider this
this…
…
Would the cost of repairing a two-meter hole in the side of a vessel with a sum insured of
$100m be much different to the cost of repairing the same sized hole in vessel with a sum
insured of $50m?
As the size of the hole is the same in both cases, it is likely to cost the same amount of
money to fix.
The rate for the partial loss element is thus tied to the tonnage of the vessel and usually
expressed as a dollar amount per tonne.
Accumulations
Vessels can, and do, accumulate in the same risk area. An accumulation of values, well in Vessels can, and
excess of a single hull value can occur, for example, in a harbour or on a river. This, therefore, do, accumulate in
the same risk area
merits special consideration when assessing the need for any form of reinsurance.
Even when considering large ocean-going hulls, one must not lose sight of the fact that
several such vessels could be in the same area at the time of a major disaster, such as fire or
windstorm, or even an act of war.
Following the hurricane losses in 2005 and the resultant losses in the reinsurance market
worldwide, ‘natural perils’ recoveries were limited to two losses from the subsequent
renewals, with aggregate deductibles being sought at primary levels of the programmes.
Consider this
this…
…
Using the knowledge that you have gained so far, give some thought as to the type of
reinsurance that is most suitable for marine hull.
Suitable types of reinsurance

Due to the diverse nature of the risks that can be attached to such accounts, particular
attention has to be paid to the nature of the portfolio and the risks and liabilities that the
potential reinsurer is asked to assume. It is not unusual to see a higher proportion of
facultative reinsurance being used. A facultative reinsurance will be judged mainly on the
quality of the risk itself, with any long-term relationship between the insurer and the
reinsurer being of lesser consideration.
Be aware
This is because facultative reinsurance is used to deal with one-off situations and does not
infer a close or ongoing relationship between the parties to the reinsurance contract.
On the other hand, the terms and conditions available for any treaty reinsurance will be
mainly determined by the reputation and performance of the ceding company.
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Losses are divided

While for the reinsurance of marine hull, surplus treaties can be considered more common
proportionally to than quota share, administrative considerations are generally predominant in determining
the sums insured
the system of cover. The control and establishment of accumulations only present minor
difficulties, with subsequent adjustments not problematical. Losses are divided
proportionally to the sums insured; in most cases this distribution remains invariable for
twelve months. For hull, one of the usual clauses for automatic termination of the cover in
the case of war between certain world powers must be stipulated in the original conditions.
Furthermore, reinsurance treaties provide for the cancellation of war risks at any time, at
short notice (usually seven days).
The necessary factors and information that influence the negotiation of marine excess of
loss reinsurances are the same as those set out in the previous chapters. However, due to the
potential variety of individual risks within any one class, other specific information should be
available. The majority of these covers are established on a ‘per event’ basis. An alternative
may be to negotiate the cover on a per vessel basis.
The exact composition of the account should be available, detailing the lines written on
different types of vessel insured and the terms and conditions that apply to the covers. It
would also be important to determine whether facultative reinsurance exists that will benefit
the excess of loss reinsurer.
Maximum gross and net lines being written should be provided and loss experience figures
should cover as long a period as possible.
The reinsurer will also be interested to know:
• if there are any known accumulations or values in any one area, as may be the case where
a number of craft are moored in a harbour; or
• whether there are any special conditions to be applied, such as claims to be admitted only
if more than one vessel is involved in any particular incident.
Question 12.3
Why would the reinsurer want to establish if building risks are to be included?
Effective method
Total loss only (TLO
TLO) reinsurance is a highly effective method of covering a hull portfolio
of covering a hull against large losses. In hull business, the surplus reinsurance of large losses affecting
portfolio against
large losses
individual risks can present underwriting problems when deciding the criteria for
establishing and grading retentions. In addition, in the case of working excess of loss covers,
difficulties arise when calculating premiums according to the burning cost method.
TLO reinsurance is effected either by the facultative coverage of individual risks or, more
frequently, by way of facultative obligatory covers. Here the direct insurer reinsures only the
risk of a total loss, with the parties agreeing on specific premium rates and maximum
underwriting limits for the individual risk group up to which the insurer may reinsure the
TLO risk.
To avoid difficulties in establishing the replacement value, the sum insured of a hull policy is
always regarded as an agreed value decided on by the policyholder and the insurer. The
standard TLO cover contains a valuation clause, which states that a constructive total loss
may only be asserted if this cost exceeds the full sum insured.
This may force a ship-owner to have a ship repaired, even though such a repair can be
uneconomical. Under such circumstances, insurers have agreed to a ‘compromised total loss’
where the ship-owner keeps the wreck but insurers pay out a smaller amount than obliged
under the TLO policy.
Following this business practice in the direct insurance market, TLO reinsurance treaties
frequently provide cover not only for actual and constructive total losses, but also for
compromised total losses.
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A2 Cargo
Cargo refers to goods and merchandise imported or exported from or to various parts of the Insurable interest
world. Insurable interest exists on the part of both buyer and seller at some point during a exists on the part
of both buyer and
voyage and, as a consequence, the terms of any contract may provide either for the buyer or seller at some
seller to insure. Cargo is usually insured against all maritime and transit risks, including war point during a
voyage
perils. Freight can also be insured because, if cargo is lost or damaged, someone will have to
stand the loss of the cost of carriage.
Containerisation merits special consideration. This is because of aggregation of high limits
on one container ship or in any one container terminal ashore. A further reason is the
difficulty of establishing when any damage occurred to the contents, which are probably not
surveyed from the time of packaging to the time of unloading at a destination.
Containerisation has, to an extent, eliminated or reduced the incidence of theft and pilferage
claims. However, several instances are recorded of whole containers being stolen, complete
with contents, so creating a very different loss pattern for the goods in question and a
greater risk of a major claim than was likely before.

It is not only certain insured objects, like living animals, that are generally excluded from
cargo treaties, but also high value cargo and isolated warehouse and storage risks, which
have no direct relationship with a marine risk. With regard to cargo and specie, the cover is
subject to a condition known as the Waterborne Agreement (that is, a marine market
agreement whereby underwriters will only cover goods against war risks while they are on
the vessel, subject to a time limit after arrival at the port of destination).
Be aware
Whereas non-marine markets tend not to cover any loss from war risks, the marine market
accepts some cover because while cargo is at sea the possibilities of accumulation are
more limited, and indeed once a war breaks out it is possible for ships to disperse and
reduce the potential for catastrophic losses. This allowance is restricted to cargo afloat, so
there is no cover while the cargo is being transported on the land part of its journey or in
storage.
In cargo insurance the structure of the cover is usually based on the type and quality of the The structure of
transportation. For this purpose different categories can be formed. the cover is usually
based on the type
Cargo and specie transported by: and quality of the
transportation
• ships classified 100 A1 in the Lloyd’s Register or equivalent, up to 15 years of age and
having a gross tonnage of more than 1,000;
• non-classified ships of more than 1,000 tons;
• ships and coasters of less than 1,000 tons;
• river or inland vessels;
• trains;
• lorries;
• regular airlines; and
• charter aircraft.
If there is a combined voyage involving marine and inland transportation, the underwriting
limit for the most exposed part of the voyage is determined and applied to the complete
combined journey, including the intermediate storage.
Be aware
We have referred several times to Lloyd’s Register classification – see www.LR.org. The
relevance of 100A1 is that:
• ‘100’ indicates the vessel is suitable for seagoing service;
• ‘A’ shows that the vessel is accepted into the appropriate Register class and is
maintained in good and efficient condition; and
• ‘1’ shows that the vessel has good and efficient anchoring and mooring equipment.
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A marine cargo account needs careful examination as the inherent risk may vary within
subclasses.
A cargo account is
A cargo account is particularly difficult to break down to individual risks as there are so
difficult to break many different types of cargo. Therefore, the reinsurer needs to have, or be provided with,
down to
individual risks
up-to-date knowledge of any current problems affecting the direct cargo market, so that it
can make a decision as to what effect, if any, those problems will have on the insurer’s
portfolio.
As it can be difficult to obtain an exact breakdown of the insurer’s cargo account, reinsurers
generally rely on an information sheet that should include:
• details of the normal lines written;
• the classes of business written or excluded;
• premium income for each class; and
• the loss records.
Any particularly high risks or high value commodities being covered, such as bullion or
specie, must be identified.
Question 12.4
We have made several references to ‘specie’ in these sections. What do we mean by this?
Specie may range from small sendings by registered mail or other specialist carriers to the
larger limit vault and premises risks. The insurance of the main precious metals and mining
companies may also be included. Finally, the general specie risk code also includes the
transit and storage of securities, which is a specialist area aligned to the bond market.
Any potential for accumulation of several cargoes at any one location, at any one time,
should be identified and advised.
The possibility of the value of a cargo or commodity increasing during a voyage due to
changes in market trading conditions, should also be taken into account, especially with
regard to the setting of the treaty limits that the insurer needs.
Accumulations
Particular
Particular difficulties occur in accumulation control, especially in the case of cargo
difficulties occur in insurances where the name of the carrying vessels may be unknown or only known after the
accumulation
control
completion of the voyage. The possibility for foreseen, known or unforeseeable
accumulations of cargoes insured under different policies, or different cargoes covered by
the same policy and transported by one sole vessel, constituting one sole risk, for the
reinsurer as well as for the insurer’s retention, should not be forgotten.
Quota share and surplus combinations are frequently used for cargo reinsurance. Cargo
accumulation control, not only in ports but also on vessels or other means of transport,
poses serious problems. Above all, subsequent adjustments to take into account different
consignments of merchandise on the same vessel are very laborious, since in the case of a
surplus treaty, the corresponding cession may have to be recalculated.
Where non-proportional reinsurance is to be used, the necessary factors and information
that influence the negotiation of marine excess of loss reinsurances are the same as those
set out in the previous chapters. However, due to the potential variety of individual risks,
other specific information should be available.
The majority of these covers are established on a per event basis. Care must be taken to
ensure that the definition of what constitutes ‘one event’ is clearly understood by the parties
to the reinsurance and is defined in the treaty wording.
With cargo risks in particular, the definition of what constitutes one vessel must be clear, as
disputes can easily arise where barges, lighters or other craft are used in the loading or
unloading.
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Learning point
Before you move on, check your understanding of the different underwriting
considerations for hull and cargo reinsurance.
A3 Energy
The peak values of offshore production platforms represent the greatest single unit value at Peak values of
risk in the marine underwriting market. It is, therefore, essential that the whole of the world’s offshore
production
reinsurance market is activated in one way or another to provide the capacity to reinsure the platforms
enormous risks being written by the direct market. Not only must the huge values of the represent the
greatest single unit
units themselves be considered; it must be borne in mind that further cover is usually value at risk
required for such risks to deal with the costs associated with pollution control.
Much energy business is placed in the market by way of a package
package, which may include the
hulls, cargo, liabilities and other properties on shore. As a result of the packaging of all the
classes, there is considerable demand for retrocession protection from those reinsurers who
wish to reduce or eliminate their commitment on one or more parts of the package. If
retrocession protection is limited, reinsurers seek to reduce their involvement to potentially
high exposures.
After the soft market conditions of the late 1990s had more or less prevented the attainment Refer to
section B2 and
of any onshore limits, the refinery exclusion clause was conceived for the purpose of appendix 7.1 on
excluding onshore risks from the transit and marine insurance market. RevisionMate

Table 12.1 shows the issues that will determine the parameters of cover offered by both
insurers and reinsurers of the range of energy risks, including that of transit to site.
Table 12.1: Issues affecting the parameters of cover

Towage risks This is an area of significant liability. Towing of platforms is extremely
hazardous and there must be a careful consideration of the experience and
the qualifications of the towage company concerned. At this stage the
insurance is one of a marine hull risk and rated appropriately.
Oceanographical and No onshore risk suffers as much as offshore oil and gas platforms from
meteorological risks weather-related hazards. Following losses from recent hurricanes,
underwriters are differentiating between older platforms in shallower
waters, where older design standards applied during construction are now
perceived to be unable to withstand an intense hurricane, and newer and
deep water structures where the damage potential is less severe.
Energy underwriters have not only to consider the single risk exposure,
which is substantial, but also the accumulated exposure that can come from
such natural catastrophes as hurricanes, earthquakes and tidal waves. Even
simple conditions such as fog have considerable potential to wreak havoc.
Currents These are a substantial source of danger for the stability and integrity of
offshore platforms. The continental shelves, where most such risks are
situated, have the strongest currents and these currents carry foreign
bodies which hit the pipes and materials of the platforms causing damage.
Engineering risks Although similar to the engineering risks faced by onshore risks, additional
cover issues are raised by the location of offshore installations, e.g. sinking
into the sea and damage caused by objects falling from ships. Vibration and
metal fatigue are of greater concern due to the salt water location.
Fire risks The fire risks of a platform are particularly serious. One only has to consider
the 1988 Piper Alpha loss to realise this. Production platforms have a
petrochemical plant, a hotel, a helipad and production facilities among other
things, all in a space the size of a football field lying on top of each other in a
series of layers. The maximum probable loss (MPL) for such a risk is 100%
and even more if the sue and labour clause applies.
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Be aware
The sue and labour clause would require the platform owner to make every attempt to
reduce or save the exposed interests from loss. Under the terms of the clause, the insurer
pays for such things as debris removal and loss minimisation costs incurred in carrying out
its requirements.
Activity
Ocean engineering is the branch of engineering concerned with the design, analysis and
operation planning of systems that operate in an oceanic environment. See what design
and execution facilities companies engaged in this line of work offer that could impact on
marine insurers and reinsurers.
Some capital markets and hedge fund capacity has emerged via products which plug the
gaps now appearing in programmes, for example, business interruption deductible buy
downs and excess windstorm capacity.

The rig account
The energy or, as it is often called, the rig account, may represent a significant part of a
may represent a marine portfolio and is kept separate from other business.
significant part of a
marine portfolio The value and limits of market covers are such that an excess of loss reinsurer would require
additional information, probably in the form of a detailed questionnaire. Questions to ask
include the following:
• What are the reinsured’s involvements or commitments in any of the major world market
placements?
• Are there any specific reinsurances in place that will be of benefit to the excess of loss
reinsurer?
• Is coverage provided in respect of war and terrorist risks, and is that liability attaching to
the reinsured’s war or rig account?
• If cover for drilling or production activities is provided by the insurer and allocated to the
rig account, then a schedule of these liability risks should be provided. A detailed loss
record covering at least the past five years should also be provided.
A3C Exploration and drilling

For the initial exploration and development of an energy risk, such as drilling an oil-well, the
following are the standard questions that would be raised:
• Name of principal and other insured parties.
• Description of all current and proposed energy exploration and development and
producing operations.
• Description of all discontinued operations for which cover is sought.
• The total estimate for the current year and next year, and actual for last year in respect of:
– annual payroll;
– annual receipts or sales; and
– the number of employees.
• A list and description of all claims and losses, insured and uninsured, during the past five
years involving the insured’s energy exploration and development operations where the
total paid and outstanding amounts, including legal costs and adjusters expenses, exceed
US$100,000 or equivalent.
• A schedule of insured’s proposed operations during the period of this insurance.
• Details of any directional wells which are drilled during the period of the insurance where
the borehole will deviate at least 80 degrees from the vertical.
• Details of any wells which are drilled during the period of insurance using ‘producing while
drilling’ techniques.
• Details of any extended reach wells to be drilled during the period of insurance.
• Limits.
• Retention.
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• Whether well out of control insurance is currently purchased.

• Previous insurance history.
• Name of the drilling contractors that the insured plans to use and the contractor’s
experience and loss record for the past five years.
Minimum deductibles of at least US$25,000 apply, with underwriters imposing specific
sublimits on making wells safe and extended re-drills.
Business interruption may only be available in the market on a contingent basis, except in Limited
exceptional circumstances. Limited earthquake coverage would also be normal. earthquake
coverage
Be aware
The Deepwater Horizon oil spill in the Gulf of Mexico was the largest accidental marine oil
spill in the history of the petroleum industry. It was caused by a sea-floor explosion on 20
April 2010. The explosion killed 11 workers on the platform above and injured 17 others.
The spill discharged 4.9m barrels of oil and caused extensive damage to marine and
wildlife, as well as to the Gulf’s fishing and tourism industries.
The US Government has identified responsible parties, which it is holding accountable for
all cleanup costs and other damage. BP led the project and is a major contributor to the
‘set-aside’ of US$4.5bn for Clean Water Act fines and a US$20bn compensation fund to
victims.
As a consequence, the cost of insuring offshore oil rigs in the Gulf of Mexico increased
significantly. Additionally, reinsurers now demand greater transparency on renewals and
more information on the direct market’s involvements in excess liability placements.
Accumulations
Several peak risks may be relatively near to each other, as in the North Sea, and it would be Additional
unwise to ignore the possibility of natural disaster affecting more than one unit in a single business
interruption costs
occurrence. Another problem is not just the substantial cost of the platform itself, but could be greater
additional business interruption costs. Where cover for business interruption is granted, it than the actual
physical damage
could be greater than the actual physical damage.
Traditionally energy risks are placed in the marine department and this continues. However,
a number of other lines can be involved too, and when rating these risks different issues
must be taken into consideration. With stationary objects there is a substantial element of
engineering underwriting to be considered, as well as the industrial fire insurance
perspective. As such, many of the energy risks have a very specific tailor-made design which
is generally reinsured facultatively.
A4 Liabilities
Another major class of marine insurance is generally described as marine liabilities. These
include anything from protection and indemnity (P P&I) and pollution to stevedores’ liability
and cover any liability legally incurred in connection with the furtherance of marine business.
Be aware
A stevedore is someone who is employed in the loading or unloading of ships and can
include dock workers, dockhands, longshoremen and lumpers.
Protection and Indemnity (P&I) clubs exist to fill the gap caused by insurers not being able to
cover all the risks faced by a ship-owner.

The P&I clubs cover a wide range of third-party liabilities and expenses arising from the Cover a wide range
owning or operating of ships. These include one fourth collision damage and other collision of third-party
liabilities
related liabilities, as well as liabilities for loss of life or bodily injuries.
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The main reason that marine liabilities require special mention is that, in many instances, the
claims arising from such risks tend to be settled a long time after the policy period has
expired. Greater care than usual must be taken to ensure that the security of the reinsurer is
of the highest order and that it will be in business at least ten years after the start of the
policy.

As the largest single source of marine liability probably emanates from the group of P&I
clubs in the London Market, reinsurers will want to know the specific extent of the insurer’s
involvement in this business. This may be protected to a certain extent by other specific
reinsurance, but the insurer’s net line should be established, as well as the extent of exposure
to pollution risks.
A detailed loss record is of particular importance to the reinsurance of such marine business,
as it is usual for marine excess of loss business to protect all types of liability with few, if any,
exclusions. Therefore, any assessment of price depends predominantly on the past results.
Reinsured would
When dealing with non-proportional reinsurance, the reinsured should ascertain that there is
be advised to take enough aggregate coverage in the shape of sufficient reinstatements written into the
out a backup
policy
contract. Should there be any doubt, the reinsured would be advised to take out a backup
policy to respond in the event that the basic policy runs out of reinstatements. Backup
policies, depending on factors such as the number of reinstatements, are generally
reasonably priced when taken out at inception but become expensive or impossible to
obtain after a series of claims has occurred.
Accumulations
Liabilities associated with marine risks arise when a large number of individual risks are
correlated in such a way that a single event affects many or all of these risks. It would not be
prudent to ignore the possibility of, say, a natural or man-made disaster affecting a large
number of individuals as a result of a single occurrence. Another factor, aside from the
damages paid to those affected, is the legal costs incurred in defending associated legal
actions.
Activity
The flooding and subsequent capsize of the roll on/roll off passenger ferry Herald of Free
Enterprise on 6 March 1987, resulted in the loss of 193 lives. Discover what you can about
the subsequent verdict of the coroner’s inquest jury with regard to those killed and their
dependants, and its effect on the insurers of the owners, Townsend Thoresen.

The extent to which marine liability risks are included in the portfolio should be considered.
With a marine account, liability risks may be assumed within a hull or even a cargo account,
where it is unlikely that any separate premium will be identifiable for the liability content. A
separate liability treaty may be arranged, in which case it would be important to ensure, as
far as possible, that the risks to be ceded contain a good spread of business over the various
types of liability that will be written.
The most usual

The most usual form of reinsurance in the marine liability field is non-proportional, but other
form of forms are also widely used. Due to the enormous limits required in this class of business, it is
reinsurance in the
marine liability
becoming increasingly important for a reinsurer to balance its account down to an
field is non- acceptable net line by way of reinsurance.
proportional
A5 War
This term can cover any risk from full war coverage on hull or cargo to ‘peripheral’
war-related risks, such as nationalisation, requisition, expropriation and deprivation. It also
covers terrorist attacks on ships and drilling rigs, not to mention riots affecting cargoes in
warehouses.

War risks are covered at special conditions, but always in conjunction with, and in the same
proportion as, the ordinary maritime risks.
Chapter 12

A way of reinsuring a war risk account is to cede to a proportional treaty and to buy excess
of loss cover to bring the net retained line to an acceptable and defined amount. When
negotiating war risks reinsurance on a marine account, detailed information is required
about the content of the account, since it may include a wide variety of risks not covered by
any institute war clauses. Reinsurers may reduce liability by placing limitations on the
coverage provided by the insurer.
Be aware
The paramount war clause relates to cargo and determines either that war risks cover is
subject to terms and conditions no wider than those of the relevant London Institute War
Clauses, or that the reinsured shall follow the limitations of the UK Waterborne
Agreement. War risks cover can be cancelled at seven days’ notice on either side.
Accumulations
The marine market has the expertise and the capacity to write war risks and it is usual for
marine reinsurers to include political risks in their war account. Such risks can be difficult to
define by the usual expression ‘any one event’. In this instance, a reinsurer may consider
some form of aggregate in respect of losses within a defined country during the contract
period.
The surest way for an insurer to reduce its war lines to an acceptable and definite net Reinsure on a
retained amount is to reinsure on a proportional basis and protect the retained line or proportional basis
percentage by an aggregate excess loss cover relating to all losses occurring during a year.
This avoids the problem of defining an event, but can also mean a heavy increase in the
outflow of war premium. This may be a tough choice for the insurer to make, but can be
preferable to relying on a market or legal decision regarding the final definition of ‘war’ to
avoid a substantial payment without the protection of reinsurance coverage.
B JELC Excess Loss Clauses

The London marine reinsurance market commonly contracts using the Joint Excess Loss
Committee (JELC
JELC) Excess Loss Clauses
Clauses.
The JELC is run by Lloyd’s and the International Underwriting Association (IUA), and The JELC is run by
promotes standardised wordings and clauses for excess of loss reinsurance contracts. The Lloyd’s and
the IUA
current version of the clauses is dated 1 November 2003 and comprises 16 clauses and an
annex of ten additional clauses. A copy is reproduced as appendix 7.1, which is available on
RevisionMate.
B1 Excess loss clauses

Together these clauses form the basic wording, if required, and include:
• Reinsurance clause
clause: a feature of this clause is the condition precedent to liability under
the contract stating that settlement by the reinsured is in accordance with the terms,
conditions and exclusions of the original policies (ex gratia payments are excluded).
• Event clause
clause: loss or damage must arise from one event – the market reinsures, and allows
aggregation, on an ‘event’ rather than a ‘cause’ basis.
• Exclusion clauses
clauses: these exclusions include war, seepage and pollution, war risks and
terrorism. The seepage and pollution (or environmental contamination) clause excludes
claims caused by seepage, pollution and contamination, although it does provide cover in
certain circumstances (e.g. a sudden event). The obvious conclusion to draw form this is
that claims from gradual pollution are excluded. Cover is also available when offered
within defined coverage types or liability regimes, or general average.
Similarly, there is a blanket exclusion for war and civil war risks, although the clause enables Blanket exclusion
cover to be readily given, provided it is on standard forms. for war and civil
war risks
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As regards terrorism risks, beyond this exclusion there is an additional clause to write-back
certain risks, for example, hull risks, port installations, offshore installations and pipelines,
and cargo in the ordinary course of transit. The standard clause ends with the statement ‘if
any reinsurer asserts that any loss, damage, liability or expense is not covered by reason of
this clause it shall be for the reinsured to prove to the contrary’, reversing the usual burden
of proof.
For greater clarity and transparency, one party, often the reinsured, will include a statement
(or letter) of understanding in the contract wording. Typically, this statement sets out, in
some detail, the reinsured’s understanding of the terrorism coverage afforded by the
combination of these clauses, making it difficult for reinsurers to disagree in the event of a
relevant claim. For completeness, the nuclear energy risks exclusion and the
extra-contractual obligations exclusion are also found here.
B2 Additional clauses
These clauses include the following.
Aggregate voyage extension (cargo) clause (Additional Clause B)
This clause allows a reinsured to aggregate cargo losses of the same nature and to treat
them as one event, provided that:
• it is not possible to split out the damage caused by the separate events; and
• the losses are in respect of cargo carried on the same vessel for the same or an
overlapping voyage.
In Axa Re v Field (1996)
(1996), an ‘event’ was defined as something which happens at a particular
place, at a particular time and in a particular way. However, because of the way in which
cargo is shipped, loss or damage is only discovered upon arrival at port and discharge. This
clause means that the reinsured avoids the problem of having to prove a particular loss on a
particular date in these circumstances.
Collusion clause (C)
This clause allows a reinsured to aggregate infidelity and fraud losses suffered by an original
insured in certain circumstances and to treat them as one event. Importantly, the original
losses must not have been settled as separate losses on the original policy, and must not
originate from separate original policies. Again, this clause helps to reduce and/or avoid the
practical issues that can flow from the legal definition of an ‘event’.
Liability exclusion clauses (LEC) A&B (E (E& &F, respectively)
The liability exclusion clause A (LEC A) begins with a blanket exclusion of all liability claims,
but then reinstates marine and aviation liability claims by specific mention of the cover
provided. Although similar to LEC A, liability exclusion clause B (LEC B) does not exclude
claims arising on ‘claims made’ or ‘losses discovered’ policies. There is the additional proviso
that the original claim must actually be ‘made’ or the loss ‘discovered’ during the period of
the original contract. This limits the ‘tail’ of such risks, meaning that once the expiry date has
passed, the reinsurer is off-risk.
Refinery exclusion clause (G)
The refinery exclusion clause is designed to exclude certain non-marine losses associated
with energy risks. It excludes – with certain caveats – all claims which arise from onshore
refineries, petrochemical or chemical plants and installations within their boundaries. It
allows a variety of limited inclusions (e.g. jetties, wharves, berths, piers and docks); however,
there is no liability cover whatsoever.
Chapter 12
B3 Other exclusion clauses

Other common exclusion clauses include political risk, financial guarantee and credit risk Common exclusion
exclusion clause (JELC Additional Clause I), and non-marine cargo exclusion clause. clauses include
political risk,
The exclusions detailed in a reinsurance protecting a cargo account may include: financial guarantee
and credit risk
1. Ship owner’s interest and/or freight. exclusion clause
2. Confiscation.
3. Advance loss of profit/delay in start-up/marine consequential loss, unless written in
conjunction with a marine cargo policy.
4. Cash in transit.
5. War on land.
6. Satellites, unless carried as cargo on a pre-launch basis.
7. Fish catch/fish farm.
8. Ocean tows.
9. Rolling stock.
10. Extended warehouse or storage risks beyond normal transit more than 120 days.
Similarly, the exclusions detailed in a reinsurance protecting a hull account may include
vessels over 25 years old.
C Reinsuring an aviation account

Within an aviation account, there may be airline hulls, airline liabilities, private aircraft,
products liability, satellite risks, not to mention personal accident and war risks, all of which
potentially produce a variety of exposures within each class and demand different
reinsurance solutions.
A brief list of common miscellaneous exclusions is shown in appendix 12.1 on RevisionMate.
C1 Hull
The standard aircraft hull policy is issued on what is known as an insured value basis. This Policy is issued on
expression refers to the insurers’ option, contained in the policy wording, to pay for or an insured
value basis
replace the aircraft in the event of a loss. On this basis, if an aircraft becomes an actual total
loss or constructive total loss (i.e. repair is uneconomic), the insurers have the option either
to pay the sum insured as stated in the policy or to provide the insured with a replacement
aircraft, provided one can be purchased for a sum not exceeding the insured value.
With the development of newer and faster types of aircraft, the second-hand value of
existing types may fall significantly and may be materially less than the insured value stated
in the policy. The insured may not, however, be guilty of deliberate over-insurance, as they
might have bought the aircraft with a mortgage and the mortgagees may have imposed an
obligation to insure for the amount of the original loan or purchase price. In such
circumstances, reinsurers usually support the purchase of a replacement aircraft, which they
may obtain for a sum materially less than the insured value, thereby effecting a considerable
saving in claims costs.
Few aircraft, even of the same type, are identical in their detailed equipment. The avionics
package, seating and furnishing layout may be quite different and it is often necessary for
insurers to pay additionally for the replacement aircraft to be modified so that it is a true and
fair replacement of the machine which was lost. Nevertheless, it may still be less expensive
for the insurers to adopt this course of action. The decision to replace often gives rise to
disputes with the insured.
Example 12.1
An aircraft operator has lost an aircraft and its insurers wish to replace it. However, the
aircraft operator is in the process of upgrading its aircraft and does not want to replace
the aircraft that was lost with one of the same type.
Chapter 12
If the insured does not want a replacement, the insurer is entitled to pay only the cash
equivalent of the sum that it would have cost them to replace. In these circumstances, the
broker or intermediary may become involved to help find an agreeable basis for the claim
settlement.
Most insureds seek to insure upon an agreed value basis, particularly when the underlying
aircraft are mortgaged. On this basis, the policy is endorsed to the effect that the value
stated in the policy is agreed by the insurers and reinsurers in advance and that, in the event
of total loss, this amount will be paid. The clause AVN 61 is the standard market clause (see
appendix 12.2 on RevisionMate).
Question 12.5
When allowing aircraft to be covered on an agreed value basis, why does any moral
hazard presented by the insured become a consideration?
Generally, reinsurers allow agreed values in a hull policy if the aircraft is new and of a type
that is in demand. The market value of the aircraft is unlikely to fall markedly during the initial
period of the insurance and the reinsurers are not, therefore, likely to be at any financial
disadvantage in the event of a total loss. As aircraft become older and their market value
declines in relation to their original value when new, it becomes difficult to establish a
realistic agreed value. Another difficulty may arise where an aircraft is old or is insured for
less than its replacement value.
Example 12.2
The cost of repairing a given amount of damage to a Cessna Citation Mustang is the same
irrespective of the insured value. To rebuild a wing will always cost the same, whether it is
for a brand new aircraft or one that is older. The cost of a new wing is a small proportion
of the value of a brand new aircraft, but will be a larger proportion of the value of an older
model.
The lower the sum

So, the lower the value of the aircraft in relation to its original value the more easily, with any
insured, the higher given amount of damage, that aircraft will become a total loss. The lower the sum insured,
the total loss risk
the higher the total loss risk and this must be taken into account when the premium is
calculated. In many branches of insurance this problem is dealt with by an average clause.
The aviation market’s version of the average clause was called a component parts clause
AVN 4. However, this clause is rarely used and then only on vintage-type aircraft or those of
Eastern European manufacturers, as most aircraft are now insured on an agreed value basis.
The majority of aircraft are rated for hull damage at an amount per cent of the insured value
of the machine, the rate varying particularly with the type of flying and past experience.
C1A Extent of cover and exclusions

For facultative placements, the reinsurer often imposes the aviation reinsurance
underwriting and claims control clause, AVN 41A or AVN 41B41B, if the Insurance Act 2015
applies (see appendix 12.3 on RevisionMate). Under its terms, the reinsurer is able to control
claims negotiation and settlements, determine the scope and details of the original policy
wordings and, most importantly, discover the original policy rates or premiums.
Question 12.6
Why might a reinsured be reluctant to agree to the terms of AVN 41A?
Air cargo and specie can be the object of a reinsurance treaty, the latter usually at special
conditions.
C1B Underwriting considerations

All the factors and general information that would be material to the negotiation of property
and liability risks that we have looked at in previous chapters apply equally to aviation risks.
Chapter 12
These include:
• details of the reinsured;
• the nature and composition of the portfolio to be insured;
• claims experience showing paid and outstanding losses;
• original policy sums insured or limits of liability; and
• scope of original cover given and exclusions.
In aviation, excess of loss reinsurance does not have the same inadequacies as surplus
reinsurance and there is no distinction between working layer and catastrophe covers.
However, due to the potential variety of individual risks within any one class, other specific
information should be available.
The coverage required under an excess of loss programme depends on two factors, the:
• reinsured’s retention per aircraft; and
• extent to which the reinsured must anticipate unforeseen accumulations as a result of
shares accepted from various sources.
The majority of these covers are established on a per event basis.
In aviation reinsurance, the premium may be calculated according to burning cost. However, Premium may be
since most aviation portfolios are unbalanced as compared to other classes, the burning cost calculated
according to
statistics are subject to random fluctuations. Consequently their value for the purpose of burning cost
calculating premiums is impaired. Therefore, it is important to consider the reinsurer’s actual
exposure under the excess of loss cover. The reinsurer must be aware of the breakdown of
the retained premium income and its development in recent years.
Example 12.3
The share of business written under hull policies may differ considerably from that written
in air cargo and specie or, if there are differences in the maximum retention under the
primary cover and the excess cover of original policies, there is a difference in exposure
for the two sections of cover.
Aggregate excess cover is a variation of excess of loss and is also referred to as a ‘self-
insured retention’. This is where the insured, usually in possession of a large fleet of aircraft,
carries an excess so large as to virtually act as its own insurer, except for catastrophes, and
with a correspondingly large reduction in premiums. Hence it is able to enter the reinsurance
market directly generally by means of a captive. Schemes commonly encountered are as
follows:
• The reinsurer pays the claims arising from any one accident exceeding a given figure.
• Similar to this, but the excess is a figure based upon a percentage of the total value of the
fleet. The insurer’s retained proportion may be limited to an aggregate amount during the
policy period.
With the growth of the captive insurance market within the airline industry, the use of Use of aggregate
aggregate excesses or self-insured retentions is an increasingly common feature of large excesses or self-
insured retentions
fleet policies. Where there is a substantial self-insured retention, reinsurers must be satisfied is an increasingly
of the ability of the insurer, or the captive insurance company, to respond to the self-insured common feature of
large fleet policies
retention where there are financial interests in the aircraft. The lease agreements noted by
the reinsurers may look to them to respond in the event of non-response from the insurers or
their captive insurance companies.
An arrangement is sometimes agreed whereby a return of premium is made to the insurers if
no claim is made during the policy period. Sometimes this takes the form of a straight no
claim bonus. In order to avoid competition on renewal, it is frequently made payable only if
the policy is renewed with the same reinsurers.
For major aviation contracts, this rebate is expressed as a profit commission on the balance
of premium less claims. The standard market clauses for profit commission provisions are
AVN 64A and B.
Accumulations
Care must be taken to ensure that the definition of what constitutes ‘one event’ is clearly
understood by the parties to the reinsurance and is defined in the treaty wording.
Chapter 12
A reinsurer writing foreign business is always faced with the possible accumulation of risk.
Evaluation of any statistics and loss records requires considerable experience and expertise,
as it is easy to misinterpret the information given without it. Keeping abreast of its known
accumulations, a reinsurer can also consider its own outwards reinsurance, or retrocession,
requirements.
Due to the importance of facultative placement and the close inter-relationship between
direct and inwards reinsurance placements in this field, the underwriting of aviation
insurance must be considered very closely.
Example 12.4
The crash of a P-51 Mustang at the 2011 Reno National Championship Air Races, which
killed eleven people, could result in losses exceeding $100m liability cover, involving
individual pilots, race subcontractors and vendors. The major liability costs may not be the
deaths – an average payout for aviation-related deaths in the US is now approaching
$5m – but for injuries. Cover is through the London Market, and initial legal actions are
likely to involve insurers’ investigation of disclosure, including aircraft modifications and
pilot competency.

Reinsurers are always particularly cautious in subscribing to any aviation reinsurance treaty
without first obtaining considerable detailed information. This is because there is always the
possibility that the insurer may abuse the facility by ceding poor quality business. Often, a
reinsurer commences business with a company on a purely facultative basis, in order to
establish liaison and have the opportunity of examining each piece of business in detail.
Subsequently, if the results warrant it, a form of treaty may be established.
Surplus treaties are

Any treaty reinsurance will have the terms and conditions available predominantly
regarded as determined by the underwriting performance of the treaty. Surplus treaties are regarded as
unsuitable for
covering hull risks
unsuitable for covering hull risks because the values insured of the various aircraft covered
under the original policy differ so significantly from one another that different cession
amounts would be required and this would be an unreasonable administrative burden.
Usually, airline policies do not show separate premium rates, but one uniform premium rate
for the entire fleet.
As in marine insurance, it is common for different treaty limits to be applied to the various
types of business covered under a quota share treaty. Sometimes the insurer will seek
reinsurance at different quotas for the various classes of insurance or risk categories. In such
cases, the insurer would merely promise variable quota cessions with a general framework of
retention limits, maybe between 25% and 45%, which it chooses at its discretion. The wider
the variability of its retention, the more freedom the insurer has in choosing the composition
of the portfolio ceded to the reinsurer.
Question 12.7
Why do reinsurers try to avoid writing variable quota shares?
Consider this
this…
…
Before you move on to aviation liability insurance, consider the effects that the events of
9/11 had on this market.
C2 Liability
Limit an airline’s
In order to protect the new aviation industry from heavy losses for which they would be
liability to its unable to obtain insurance cover, the Convention for the Unification of Certain Rules
passengers to a
reasonable figure
relating to International Carriage by Air Air, commonly known as the Warsaw Convention
Convention, was
signed in Warsaw on 12 October 1929. One of the treaty’s main purposes was to limit an
airline’s liability to its passengers to a reasonable figure. The original limit was set at 125,000
gold francs, or approximately US$10,000.
Over the years, several amending protocols, supplementary instruments, rules and
regulation have been added which, collectively with the original Convention, are called the
Warsaw System.
Chapter 12
In 1999, the Montreal Convention amended the Warsaw Convention. This was brought about
mainly to amend liabilities to be paid to families for death or injury whilst on board an
aircraft.
The Convention for the Unification of Certain Rules for International Carriage by AirAir, i.e.
the Montreal Convention is a multilateral treaty adopted by a diplomatic meeting of states
that are members of the International Civil Aviation Organisation (ICAO). It amended
important provisions of the Warsaw Convention’s regime concerning compensation for the
victims of air disasters. The Convention attempts to re-establish uniformity and
predictability of rules relating to the international carriage of passengers, baggage and
cargo. The Montreal Convention protects passengers by introducing a two-tier liability
system. This eliminates the previous requirement where, in order to obtain more than
US$75,000 in damages it was necessary to prove neglect by the air carrier, which should
eliminate or reduce protracted litigation.
Under the Montreal Convention, air carriers are strictly liable for proven damages up to
100,000 special drawing rights (SDR), equal to approximately US$150,000.
Special drawing rights

A Special Drawing Right (SDR) is a composite unit of value for international transactions.
Its value is determined daily by the International Monetary Fund on the basis of a
weighted currency.
Where damages of more than 100,000 SDR are sought, the airline may avoid liability by
proving that the accident which caused the injury or death was not due to their negligence
or was attributable solely to the negligence of a third party. This defence is not available
where damages of less than 100,000.00 SDR are sought.
In addition to liability to passengers for death or bodily injury, the other principal liability
coverage is liability to third parties for death, bodily injury and property damage external to
the aircraft. Aircraft manufacturers may, for example, also be involved when action is taken
against airlines. Arguments raised against manufacturers are as follows:
• failure to exercise reasonable care in design of the product;
• negligence in the selection of material; and
• fault in construction or some shortcoming in the testing programme or in checking the
finished product.
Action can also be taken against other parties.
Be aware
Following the Lockerbie disaster in 1988, baggage security checks were deemed
inadequate.
Therefore, other parties also have to purchase sizeable insurance cover, such as products
liability, hangar keepers’ liability and airport operators’ liability.

The UK is a major centre for aviation reinsurance and a large volume of foreign reinsurance Large volume
and retrocession business is transacted in London. In recent years, this market has seen of foreign
reinsurance and
substantial consolidation, with fewer insurers writing larger lines. Airline operators have also retrocession
continued to increase in size, and are keeping ever increasing self-insured retentions. This, business is
transacted in
and the use of captive insurance companies, has blurred the distinction between what was London
traditionally classed as insurance and what is classed as reinsurance within the current
market.
In the immediate aftermath of 9/11, third-party legal liability cover for war and terrorists acts
was withdrawn. This forced many governments to step in and effectively become
guarantors of last resort to ensure that their aircraft industry had sufficient coverage to
continue flying.
Today, while full war risks cover remains readily available for hull and passenger liabilities,
such cover for third-party legal liability is expensive and limited. In general, cover of US$50m
is obtainable, more typically sub-limited up to US$150m; however, commercial options exist
for up to US$1bn for service providers and manufacturers, and up to US$2bn for airlines.
Chapter 12
Activity
Take a moment to review the war, hijacking and other perils exclusion clause (AVN 48B)
in appendix 12.4 on RevisionMate.

Claims experience
Claims experience in aviation is strongly influenced by the incidence of total losses and the
in aviation is numbers, age, and nationality of the passengers involved. This can lead to possibly
strongly influenced
by the incidence of
substantial fluctuations in the experience of the account. The use of statistical evaluation
total losses over longer periods may also not be feasible, as changes in aircraft sizes and passenger
liability would impact greatly on any predictions. Therefore, airline rates would, ideally,
reflect the international market, but this information might not be available to a domestic
insurance company. What such an insurer might do is to make use of facultative placements
in order to take advantage of such international reinsurance market knowledge.
Reinsurers are always particularly cautious in subscribing to any aviation reinsurance treaty
without first obtaining considerable detailed information, as there is always the possibility
that the insurer may abuse the facility by ceding poor quality business. Often, reinsurers
commence business with a company on a purely facultative basis, in order to establish
contact and to have the opportunity of examining each piece of business in detail.
Thereafter, if the results warrant it, a form of treaty may be established.
In the case of large or medium-sized airlines, it is common practice to reinsure the hulls and
the liabilities together in one contract.
The premium is calculated on the total fleet value and the amount of flying expected to be
done by those aircraft during the policy period. No additional premium is charged or return
of premium made, unless there is a substantial divergence from the figures given at the initial
quotations, say, plus or minus 5%. Other methods may be more appropriate in certain
instances, especially when the risk operates for only short periods, and facultative
reinsurance applies.
Example 12.5
Prototypes and machines in the course of development would either be rated on a
flying-hour basis or a rate or premium in full for a specified number of flying hours or
number of days on risk.
Delivery flights from a dealer to the customer may involve a premium being charged for
the flight involved, rather than pro rata of an annual amount. Long transoceanic flights in
small aircraft are especially hazardous.
An alternative method of rating makes a charge for each take-off and landing or for an
amount per hour or proportion of the hour that the aircraft flies. The theory is that the bulk
of the risk occurs during landing and take-off and so this is where the premium is earned.
Most privately owned light aircraft do not accumulate many flying hours, meaning that a
charge for take-offs and landings may be most appropriate in this case.
Accumulations
The nature of passenger liability claims is that a number of passengers are likely to be
affected by the same event.
The limits applied to the carrier’s liability under the Warsaw Convention are of little
assistance in dealing with passenger claims in most developed countries. Provided that the
contract of carriage is valid, and the passenger was killed or injured either on board an
aircraft or while embarking or disembarking, the liability of the carrier is indisputable. The
onus of proof tends to be reversed and the operator is considered liable unless it can prove
negligence by the claimant. There are many instances where the courts have set aside the
limits set out in Conventions but not the liabilities imposed, effectively leaving the carrier
with unlimited liability.
A tragic example of the manifestation of accumulations of passenger liability risk is where
two passenger-carrying aircraft are involved in a mid-air collision.
Chapter 12
Activity
In 1973, 68 people were killed when, during a strike by air traffic controllers, two Spanish
aircraft collided in mid-air over France.
A Spanish Airlines DC9 from Palma, Majorca to London was in collision with a Spanish
chartered Coronado 990 aircraft 27,000 feet above Nantes, in western France. The pilot
of the Coronado, Captain Antonio Arenas-Rodriguez, was able to land his damaged
aircraft safely at a military airfield in Cognac. All 108 people on board the Coronado
escaped injury, although most suffered shock symptoms and were distressed.
The French Civilian Air Controllers Association (SNCTA) had been on strike illegally and
military air traffic controllers had been operating France’s air control system. The Chief of
Staff of the French Air Force suggested that the Coronado was to blame for inappropriate
manoeuvres.
This case created many conundrums in the assessment of liability. Were French air traffic
controllers culpable for being on strike illegally? Find out more by visiting:
https://bbc.in/1qJ5R8t.

The extent to which aviation liability risks are included in the portfolio should be considered. The extent to
With an aviation account, hull and liability risks may be assumed together and it is often which aviation
liability risks are
impossible to identify any separate premium for the liability content. Where a separate included in the
liability treaty is arranged, the reinsurer would hope for a wide spread of business both by portfolio should be
considered
subclass and geographically.
The most usual form of reinsurance in the aviation liability field is non-proportional, but other
forms are also widely used, although surplus treaties are regarded as unsuitable for covering
aviation legal liability risks. Facultative reinsurance can be used where treaty reinsurance is
deemed inappropriate. Extremely high limits are invariably required for this class of
business, and so it is important for a reinsurer to balance its account down to an acceptable
net line. As in marine insurance, it is common for different treaty limits to be applied to each
type of business within the overall account.
C3 Personal accident
Personal accident policies are not contracts of indemnity. They are typically provided to
pilots, other crew members, passengers or others using an aircraft, such as observers or
maintenance crew. Cover is often given on a group scheme basis, perhaps including ground
crew, clerical or management staff. Alternatively, cover can be provided while flying only,
full 24-hour, or a combination of the two. Cover applies while the insured person is
performing their duties or while making a journey to or from their place of work.
Cover is provided in a number of different ways, including: Cover is provided
in a number of
• Short-term policies to cover a specific event such as an air show or parachuting display different ways
or to cover a journey or holiday.
• Annual policies taken out by an individual
individual.
• Group schemes taken out by an employer covering their staff, with the sum insured
either based on the individual’s position in the company or as a multiple of their salary.
Aircraft operators will frequently have schemes covering their staff that are not
necessarily restricted to aircrew.
• Automatic seat personal accident cover – aircraft operators will often take out a policy
based on the seats in an aircraft, covering any occupant of those seats.
Question 12.8
Why would an aircraft operator consider offering personal accident benefits to
fare-paying passengers?
Unlike passenger legal liability, where an operator must be legally liable, the specified
amount will be paid regardless of fault and settlement will therefore be more prompt. This is
a popular form of coverage, especially with industrial operators.
Chapter 12
An additional form of cover that aircraft operators sometimes take alongside their
passenger liability cover is passenger voluntary settlement
settlement. Again there is no need to prove
liability but the clause will contain a condition that the passenger, or crew member if cover is
extended, shall execute a full legal discharge. This means they agree to waive their legal
rights against the aircraft operator, its employees and any person or organisation the
insured had agreed to indemnify or hold harmless. If they decline to do this, no payment
would be made under this coverage. The current market extension is AVN 34A 34A.

Cover will provide a capital sum insured for each category of staff. In the event of an
accident to an insured person, a percentage of the sum insured will be paid depending on
the type of injury. These are shown in the schedule of compensation and are typically:
• death;
• total and irrecoverable loss of sight of one or both eyes;
• loss of one or two limbs;
• total and irrecoverable loss of sight of one eye and loss of one limb;
• permanent total disablement other than total loss of sight of one or both eyes or loss of
limb;
• temporary total or partial disablement;
Limitation on the
The last benefits shown are weekly benefits and a limitation on the number of weeks for
number of weeks which those benefits are payable will be included.
for which some
benefits are For many risks placed in the London Market, the percentage of the capital sum applicable to
payable
each benefit is expressed according to a scale of benefits. In other cases, the schedule of
benefits may contain great detail, perhaps even extending to the percentage of the capital
sum to be paid for the loss of the tip of a finger.
In addition, medical expenses incurred in relation to the temporary disablement benefits are
covered, up to a specified percentage of the claim payable under those benefits. Cover will
contain various provisions including:
• Compensation can only be paid under one item of the schedule of compensation for the
consequences of one accident to an injured person, except where temporary partial
disablement precedes or follows temporary total disablement.
• No weekly benefits will be paid until the total amount is known and agreed.
• Compensation is only paid if the death, injury or disablement occurs within twelve months
of the date of the accident. In the case of permanent total disablement this must last for
twelve months.
The wording contains definitions of certain terms to clarify intent.
Be aware
‘Accident’ means a sudden, unexpected, unusual, specific event which occurs at an
identifiable time and place, but shall also include exposure resulting from a mishap to a
conveyance in which the member is travelling.
Exclusions include:
• War and civil war.
• Radioactive contamination.
• Engaging in certain occupations or leisure pursuits, which entail a greater risk of injury.
This does not mean these activities are uninsurable, simply that detailed information may
be needed and extra conditions imposed.
• Air travel except as a passenger in a properly licensed multi-engine aircraft operated by a
licensed commercial air carrier. Depending on the details of individual cases this exclusion
is frequently deleted or modified.
• Attempted or actual suicide, intentional self-injury or injury arising through a state of
insanity.
• AIDS or AIDS-related complex (ARC).
• Deliberate exposure to exceptional danger (except in the event of an attempt to save
human life), criminal acts or being under the influence of alcohol or drugs.
Chapter 12

As in mainstream personal accident business, reinsurers are primarily interested in the death
and disability benefits given under original policies.
When reviewing an aviation personal accident account the reinsurer would regard the
following information as relevant:
• Limit per person and the limit for known accumulations.
• Premium volume of personal accident business in the overall aviation account.
• The composition of the portfolio in terms of 24-hour or occupational risks only.
• Underwriting results for the past five years.
• Insurer’s involvement in major market losses.
• Known accumulations on major flying routes.
• Whether standard exclusions apply or if any special extensions of cover apply.
Accumulations
Obvious accumulation risks arise where large numbers of passengers are in the same aircraft Obvious
and exposed to the same perils. Unlike a generic personal accident account, where accumulation risks
arise where large
accumulations can be known and unknown, with a bespoke aviation personal accident numbers of
account the original insurer knows before the risk attaches which insured persons and sums passengers are in
the same aircraft
insured are exposed to a common risk of accident. However, unknown accumulations can
still arise, for example, from collision.
Known accumulations can be limited to the number of passengers and crew on an aircraft or,
in the case of ground risks, those members of staff within an airport concourse or hangar.
They also help to determine an appropriate form of reinsurance, since provision can be made
for the maximum group size or overall limit of liability.
Surplus reinsurance treaties are quite common for aviation personal accident business
where there are known accumulations. The reinsurer will ensure that the cedant carries an
appropriate net retention, so there is no conflict between the interests of the cedant and
reinsurer.
Catastrophe excess of loss per event treaties are the best solution for major loss
accumulations.
Facultative business is written in respect of group covers, especially so for short-term known Facultative
accumulations where reinsurance premiums are relatively small. Facultative reinsurance business is written
in respect of group
tends to be in the form of a catastrophe excess of loss, due to the absence of large claims covers
administration costs for small losses.
A quota share, or a per person excess of loss, treaty may be suitable in cases such as death
only covers since the only type of loss is a total loss claim. For other covers where non-death
benefits are included, proportional participation is appropriate in order to prevent the
reinsured’s and the reinsurer’s interests from diverging.
C4 Space risks
Satellites are technically and technologically complex, highly specialised and subject to a
high risk of total loss. For these reasons, engineering issues play an important part in risk
assessment and so leading satellites insurers today employ engineers or retain them as
consultants. Many disciplines are applied to the manufacture of a satellite and a launch
vehicle. Mechanical, electrical, electronic, dynamic, computing and communications
expertise are all needed.
Be aware
For each satellite insured, a unique evaluation is conducted to determine the amount of
risk associated with the asset, which partially determines the insurance rate. The other
aspect that determines the insurance rate is the amount of capital, or capacity, available in
the insurance markets for space insurance. This theoretical capacity is affected by two
major factors, namely, the number and size of satellite insurance claims paid historically
and the impact claims have on the confidence of the industry. Both of these issues have a
knock-on effect to reinsurance markets.
Chapter 12
Once in orbit the

The differences between underwriting a satellite and an aircraft risk mainly arises from the
repair of a satellite fact that the aircraft can be physically maintained and repaired but, once in orbit, the repair
is difficult and
often dangerous
of a satellite is difficult and often dangerous. If a satellite loses on-board fuel, it cannot be
replaced. Consequently, some lifetime orbit will be lost. The same applies if any part of the
solar array is damaged. Some electrical power will be permanently lost. Repairs or recovery
of satellites in relatively low orbit is only possible by shuttle.
Many parts of the satellite are what is known as ‘single point failures’, that is to say their loss
will compromise all or major part of the operation sections of the system and prematurely
end the mission. For this reason satellite insurance tends to be written as total loss coverage
because almost all launch failures result in a total loss.
Partial losses do occur on the satellites themselves; e.g. one communication channel can fail
while all others continue to function fully. Every satellite is designed with a certain lifespan in
mind, but malfunctions can occur due to mistakes made in construction or when the satellite
is being deployed in orbit. These can include power unit failures due to faulty wiring or the
failure of a solar panel to properly extend. Nevertheless, since so much is expected of the
satellite for such a long time, coverage will respond on a total loss basis if 50% or more of the
operational capability or orbital lifetime is lost.
In recent years, satellite technology has made tremendous advances with better batteries,
more efficient solar power panels, faster computers and other elements, increasing the
average life of certain categories of satellites above fifteen years. At the same time, the
increased flexibility offered by satellites means that they can be reprogrammed far more
quickly and efficiently than before – making their replacement less urgent. A failed satellite
can have half of its lifetime remaining, or all of its lifetime but only half of its communications
capability, and be settled as a total loss claim. Since it takes, typically, two years to build and
launch a replacement satellite, the functional half of the satellite may still be a valuable asset.
Insurers’ salvage
Insurers’ salvage rights are not straightforward and tend to be based on a proportion of the
rights are not available revenue although, in practice, they would negotiate to sell the satellite back to the
straightforward
insured for an agreed lump sum. Selling a satellite to a third party is rarely practicable due to
its specialised design, licensing and other regulatory issues.

Space cover is split into the launch and in-orbit phase. Cover is available for pre-launch
transit to site, launch and early orbit (i.e. the launch risk and up to one year in orbit) and
in-orbit. Service interruption and loss of revenue cover is also available.

In assessing risk, the underwriter must consider the background of the satellite manufacturer
and the satellite design. They should consider the following questions:
• Have they generally been successful at producing reliable satellites of the type under
consideration?
• Do they have adequate resources? Do they procure components from reputable and
reliable suppliers?
• From where is the satellite being launched? Certain sites such as ex-Russian military
launching pads are deemed as uninsurable sites.
Since satellites are so specialised, these general questions must also apply to the particular
risk being assessed. It has been the case that two perfectly good electrical components,
performing exactly as designed, will not perform when expected to work together in space.
This means that the heritage of component parts is important in the technical assessment.
Remember too, it is not often possible to survey the site of damage as is usually the case
with an aircraft.
Satellite insurance
Inevitably, satellite insurance includes an element of product guarantee. If a component fails
includes an in orbit, the chances are that it was manufactured improperly or installed incorrectly. Even
element of product
guarantee
though launch insurance does not attach until the launcher engines are ignited and it is clear
that the failed component would not have functioned prior to launch, a claim would be paid.
It follows that the testing programme is an important part of the underwriting programme.
Chapter 12
As for all classes of business, statistics play a part in determining rates and terms, but the
satellite underwriter must remember that the relatively small number of satellites in
existence, compared to aircraft, can result in a potentially unreliable data sample.
The space exclusions clause (LSW
LSW 345A345A) addresses the reinsured’s loss or liability in respect
of any satellite or launch vehicle. It is reproduced in appendix 12.5, which is available on
RevisionMate.
Having made the decision to participate in a satellite risk, the underwriter must ensure that Policy terms and
the policy provisions are fair and reasonable, providing the reinsured with the coverage they conditions are
highly specific
need. Due to the individual nature of the satellites themselves, policy terms and conditions to risk
are also highly specific to risk.
Accumulations
Since certain launch vehicles have the capacity to launch more than one satellite, the
underwriter must keep up to date records of the accumulated participations on a given
launch. A launch manifest can change and the underwriter may find that two satellites it has
already underwritten may, unexpectedly, be due for launch together and the total
participation over the two might exceed the maximum permitted or maximum desired
participation. In such circumstances, the prudent underwriter will arrange facultative
reinsurance to return the total participation on the launch in question to an appropriate level.
Example 12.6
In February 2009, the reinsurance implications of catastrophic collisions in space
occupied the thoughts of satellite reinsurers when, for the first time since space flight
started in 1957, two satellites collided in orbit. Over that time some 6,000 satellites have
been launched and around 3,500 to 4,000 are still in orbit. Some have disintegrated while
others have exploded.
The collision involved an Iridium 33 communications satellite, and a Kosmos 2251 satellite,
the latter being the property of the Russian Space Forces. Both were destroyed. The
incident created an expanding cloud of debris that is now orbiting around Earth, posing a
risk to other orbital vehicles. The incident has increased the risk management problems
related to satellite insurance, although in this case neither satellite was insured.

Reinsurance protection can be arranged on a proportional basis, catastrophe excess of loss,
as well as facultative cover for one-off risks.
Learning point
Make a note of the key learning points for satellite reinsurance. Compare them to the
published key points that follow this section.
Chapter 12
Key points
Reinsuring a marine account
• A marine account may comprise any or all of the following classes of business:
– hull, often called the ‘time’ account;
– cargo, sometimes referred to as the ‘voyage’ account;
– liabilities;
– energy, often called the ‘rig’ account;
– war;
– incidental non-marine; and
– incidental aviation.
• Hull includes builders’ risk, fishing vessels, coasters, river hulls and barges, and yachts.
• Insurers are likely to have a hull account comprising low and high values creating imbalance.
Reinsurance can correct this so that in any loss situation the ceding insurer is left with a net
involvement that is not a threat to its solvency.
• Yachts are often underwritten by a specialised market and, even when written within a hull account,
are often separately identified and protected.
• Subscription markets, such as London, allow a ceding insurer to control its line commitment more
easily than in a market where it is normal for one insurer to take 100% of the risk.
• Reinsurers need details of the portfolio to be reinsured, claims experience, original policy sums
insured and exclusions.
• The majority of hull risks are written on a valued basis.
• A greater proportion of facultative reinsurance may be found than in other classes of business.
Surplus treaties are more common than quota share.
• TLO reinsurance is a highly effective method of covering a hull portfolio against large losses.
• Cargo includes goods, merchandise and containerised commodities.
• The structure of cover is usually based on the type and quality of the transportation.
• The reinsurer’s underwriting enquiries will centre on:
– details of normal lines written;
– the classes of business written or excluded;
– premium income for each class;
– loss experience; and
– high risk or high value commodities to be covered.
• Accumulations occur when cargoes covered by different policies are transported on the same
vessel.
• Quota share and surplus combinations are frequently used for cargo reinsurance.
• In the form of offshore drilling platforms, energy risks include towage risks, oceanographical and
meteorological risks, currents, engineering risks, and fire risks.
• Accumulations exist when peak risks are situated in close proximity in a major offshore oil field.
• Many energy risks are reinsured facultatively because of the special underwriting attention needed
by associated lines, such as engineering.
• Marine liability includes protection and indemnity, pollution risks and stevedores’ liability.
• The most usual form of reinsurance in the marine liability field is non-proportional but other forms
are also used.
• War is a term that can cover any risks from full war coverage on hull or cargo to ‘peripheral’ war-
related risks such as nationalisation, requisition, expropriation and deprivation, as well as terrorist
attacks.
• Reinsurance is placed on a proportional basis with the retained line protected by aggregate excess
loss cover.
Chapter 12
JELC Excess Loss Clauses
• The London marine reinsurance market commonly contracts using the JELC Excess Loss Clauses.
• Together the clauses form the basic wording and include a reinsurance clause, an event clause and
exclusion clauses.
• Additional clauses include the aggregate voyage extension (cargo) clause, the collusion clause, the
LEC A&B, and the refinery exclusion clause.
Reinsuring an aviation account
• The standard aircraft hull policy is issued on an insured value basis which allows for a payment, or
replacement of the aircraft following a loss.
• Most aircraft operators seek to insure upon an agreed value basis, particularly when the underlying
aircraft are mortgaged.
• For facultative placements, the reinsurer often imposes the aviation reinsurance underwriting and
claims control clause, AVN 41A.
• The coverage required under an excess of loss programme depends on two factors:
– the reinsured’s retention per aircraft; and
– the extent to which the reinsured must anticipate unforeseen accumulations as a result of shares
accepted from various sources.
• A reinsurer may initially do business with a ceding insurer on a facultative basis and subsequently, if
the results warrant it, a form of treaty (usually quota share) may be established.
• The liability regime surrounding passenger travel is founded upon the Warsaw Convention 1929,
where the main purpose was to limit airline passenger liability to a reasonable sum. Today, parties
typically agree to waive all previously agreed limits on recoverable damages for passenger injury
and death.
• The UK is a major centre for aviation reinsurance and a large volume of foreign reinsurance and
retrocession business is transacted in London.
• In the aftermath of 9/11, the withdrawal of third-party liability cover for war and terrorist acts forced
many governments to step in and effectively become guarantors of last resort to ensure that their
aircraft industry had sufficient coverage to continue flying.
• War risks and related cover is once again available but the price is high.
• Claims experience is influenced by the incidence of total losses and reinsurers are reluctant to
subscribe to any treaty without first obtaining detailed underwriting information.
• Hull and liability risks may be assumed together and it is often impossible to identify any separate
premium for the liability content.
• The form of reinsurance most used for aviation liability is non-proportional, although facultative
reinsurance can be used where treaty reinsurance is deemed unsuitable.
• Personal accident ‘benefit’ cover may be provided to pilots, other crew members, passengers or
others using an aircraft such as observers or maintenance crew.
• Personal accident cover is provided in a number of ways, including:
– short-term policies to cover a specific event;
– annual policies taken out by an individual;
– group schemes taken out by an employer; and
– automatic seat personal accident cover.
• Obvious accumulation risks arise where large numbers of passengers are in the same aircraft or
within the same airport concourse and are exposed to the same perils.
• Surplus reinsurance treaties are quite common for aviation personal accident business where there
are known accumulations. Quota share or a per person excess of loss treaty may be suitable for
death only covers.
• Space risks are technically and technologically complex, highly specialised and subject to a high risk
of total loss. Maintenance and repair of satellites in orbit is difficult and highly dangerous.
• Underwriters must consider the background of the satellite manufacturer and the satellite design
when assessing risk.
• Space cover is split into the launch and in-orbit phase. Service interruption and loss of revenue
cover is also available.
• Reinsurance can be arranged on a proportional basis, catastrophe excess of loss, as well as
facultative cover for one-off risks.
Chapter 12
Question answers
12.1 A large number of yachts moored in one location are susceptible to loss or damage
all arising from the same event and represent considerable risk accumulation.
12.2 In event of a total loss, the sum insured will be paid even if it is higher or lower than
the market value of the ship at the time of the loss.
12.3 Increases in value during the construction period may exceed any estimates on
which the insurer’s line was based.
12.4 This term refers to valuable commodities such as bullion and precious stones. Specie
business, usually written in the marine account, includes other niche products such as
insurance for cash carriers and safe deposit vaults.
12.5 During an aircraft’s utility cycle its market value will begin to deteriorate rapidly and
an agreed value settlement will allow a reinsured to recover more than the hull is
actually worth. In these circumstances a ground fire could be started deliberately if
the aircraft operator is in financial difficulties.
12.6 In the event that the facultative placement is with another insurer, the reinsured may
be wary of sharing its rating and other information with a potential competitor on
other similar lines of business.
12.7 One of the advantages of straightforward quota share treaties is the ease of
administration associated with this type of reinsurance: this benefit is partially lost
when the retained share is not consistent across the whole account. The reinsurer will
also take the view that its reliance on the complete absence of anti-selection is
compromised if the reinsured is able to choose its retention according to the risk
category it selects.
12.8 Such a facility may be seen as an inducement to fly and a value added benefit that
sets the airline apart from its competitors. Also, in the event of a passenger
sustaining injury a guaranteed payment may persuade that passenger not to pursue
a court action for negligence that could potentially prove much costlier for the
aircraft operator.
Chapter 12
Self-test questions
1. Why is the cover provided by marine reinsurers not limited to risks encountered
at sea?
2. What is meant by ‘freight’ in connection with a cargo account?
3. Reinsurance treaty limits need to recognise that the value of cargo can increase
during a voyage. How can this happen?
4. What is the significance of meteorology in the transaction of marine reinsurance?
5. How will the ‘actual total loss’ of an aircraft hull be settled when coverage is set up
on an insured value basis?
6. What is the effect of clause AVN 61?
7. In what way do reinsurers use a no claim bonus as a means of encouraging a
ceding insurer to renew a reinsurance commitment?
8. Why are surplus treaties reckoned to be unsuitable for aviation hull risks?
9. What justification might there be for citing an aircraft manufacturer when
dependants of a victim pursue compensation following a fatal air crash?
10. ‘Personal accident coverages are benefit policies rather than contracts of
indemnity.’ Explain this statement.
11. How can accumulations of risk arise for a satellite reinsurer during the
launch phase?

Chapter 12
Self-test answers i
Chapter 1
self-test answers
1. As the business of insuring an insurance company or underwriter against suffering too
great a loss from their insurance operations and allowing an insurance company or
underwriter to lay off or pass on part of their liability to another insurer which they have
accepted.
2. Insurers may not want a concentration of liability for one type of business, class of risk,
geographical area or other classification. By effecting reinsurance as part of a risk
management strategy they are able to achieve a spread of risk.
3. They have a pressing need to divest accumulations of risk that arise in the area from
which they receive business, either voluntarily or compulsorily. This is especially so if
that area is prone to natural hazards, such as windstorms and earthquakes.
4. To generate profits for the owners of the reinsurer and to produce premiums that can
be used for investment purposes. Insurers themselves can also act as reinsurers in order
to spread risk and to balance the inflow and outflow of premiums.
5. A company set up to transact Islamic reinsurance and accepts business from Takaful
ceding companies. The Takaful system is based on mutual cooperation, shared
responsibility, joint indemnity, common interest and solidarity between groups of
participants.
6. In the UK, brokers must be authorised and regulated by the FCA. In the USA, each state
has specific laws to regulate the activities of brokerage firms complemented by limited
Federal involvement.
ii M97/March 2019 Reinsurance
Chapter 2
self-test answers
1. Three from:
• where additional capacity is needed;
• where the risk is excluded from the insurer’s treaty arrangements;
• where the original risk is ultra-hazardous;
• where the insurer does not wish to expose its treaty reinsurer to the risk;
• where there are unique commercial, financial or strategic reasons.
• where the insurer is new to a particular market segment, the reinsurer may not offer
a treaty facility until it is confident that the insurer’s underwriters are competent in
the disciplines concerned.
2. Three from:
• uncertainty;
• costly administration;
• delays in issuing policy documentation;
• disclosure of information;
• undue influence of reinsurer;
• loss of control.
3. Three from:
• automatic cover;
• contribution to costs;
• profit commission potential;
• ease of administration;
• simplified accounting procedures;
• computer technology.
4. Proportional reinsurance is where an insurer cedes a proportion of a risk. The reinsurer
accepts that share in the risk, a similar share of the premium and pays the same
proportion of the claim. Non-proportional reinsurance is based on the size of the loss
and not the reinsurer’s share in the risk.
5. Reinsurance is purchased by an insurer from a reinsurer. However, retrocession is a
transaction whereby a reinsurer cedes or passes to another reinsurer all or part of the
reinsurance it has itself assumed.
6. ART has become increasingly important as another method of transferring risk apart
from the purchase of conventional reinsurance. The word ‘alternative’ reflects the
possibility of a choosing different risk management tools. Examples of ART include:
• derivatives;
• multi-trigger policies;
• catastrophe bonds;
• contingent capital contracts;
• industry loss warranties (ILWs);
• reinsurance sidecars; and
• catastrophe futures.
7. CATEX is an electronic system where insurers can trade insurance risk and reduce their
exposure to large losses caused by catastrophes.
Self-test answers iii
Chapter 3
self-test answers
1. ‘As original’ is generally meant to cover all aspects of the original policy, including any
claims settlements that follow original settlements made by the original insurance
company. However, it is important that terms are clearly specified in the reinsurance
contract wording.
2. Besides buying facultative excess of loss reinsurance for its own protection, the
reinsured may decide it wants to protect the cession made to its proportional treaty
reinsurers too.
3. Reasons could range from:
• Requiring additional capacity to assume risks exceeding its existing limits.
• Lacking automatic cover in respect of the particular class of business concerned.
• Not wishing to expose its treaty reinsurers to a contentious or hazardous risk.
• Where certain risks are specifically excluded by the treaty reinsurers.
4. Estimated maximum loss is a calculation with particular relevance to property
insurance that is intended to enable the insurer to calculate the extent of a worst case
loss which is potentially less than the maximum value at risk.
5. Any three from:
• vulnerability of class of risk;
• other commitments on the risk;
• exposures from other nearby risks;
• particularly unattractive features of the risk.
6. The amount of the original premium to be paid to facultative non-proportional (excess
of loss) reinsurers relative to the risk they undertake increases as the excess or
deductible decreases.
iv M97/March 2019 Reinsurance
Chapter 4
self-test answers
1. The quota share is an obligatory ceding treaty where the insurer has to cede a fixed
percentage of all its risks within agreed parameters. The reinsurer is obliged to accept
all the cessions made, usually subject to a maximum amount any one cession.
2. 80% of the risk still has to be ceded to the quota share even if the reinsured could
comfortable retain 100%
3. By reducing net retained income.
4. The retained premium usually increases significantly as a number of the lower sum
insured risks previously ceded to a quota share would be retained 100% under a surplus
5. A severance of one part of a unit, usually involving a risky component of an account
offered for reinsurance leading to a parallel or secondary treatment and facultative
terms applied.
6. A second surplus treaty may only have larger risks, in which case, fewer cessions will be
made to it. This means that there is less premium available to build reserves against any
potential losses and such treaties may be subject to considerable fluctuations in results.
7. A facultative obligatory treaty allows individual cessions to be placed at the ceding
company’s option whilst the reinsurer is obligated to accept all such cessions.
8. The main purpose of premium portfolio transfers is to transfer unexpired liability under
a treaty from one reinsurer to another, usually at the anniversary date of the treaty.
9. The loss above an agreed loss ratio is redistributed so that the cedant bears some
portion of a very heavy loss rather than the reinsurer bearing the whole burden.
Self-test answers v
Chapter 5
self-test answers
1. For non-proportional treaties there is usually only one major reconciliation at the end of
the contract period, whereas proportional business tends to be accounted for on a
quarterly basis.
2. A per risk excess of loss treaty provides protection should a loss occur on an individual
original policy, whereas a per event treaty provides cover irrespective of the number of
possible risks affected by the loss.
3. The deductible is the monetary amount that the reinsured bears under an excess of loss
reinsurance.
4. An aggregate excess of loss contract covers the aggregate of losses, above an excess
point and subject to an upper limit, resulting from a single event or from a defined peril
over a defined, usually annual, period.
5. An umbrella excess of loss protects the reinsured against the exhaustion of some or all
of its excess of loss programmes so, for example, it responds after a loss has gone
through the layers of a particular programme. As the name suggests it sits above the
covers put in place for a number of classes.
6. Where minimum and deposit premiums based on the reinsured’s estimated underlying
premium income have been collected at the outset of the reinsurance contract, at year
end an actual figure relating to underlying premium income is obtained. In the event
that this is greater than the estimate, the reinsured pays an additional premium to the
reinsurer based on the agreed premium rate.
7. Burning costs are calculated by taking the aggregate of individual losses to the layer of
reinsurance coverage that is being considered, divided by the total rateable income on
a per year basis.
8. The GNEPI represents the earned premiums of the reinsured company during the
period for the lines of business covered net, meaning after cancellations, refunds and
premiums paid for any reinsurance protecting the cover being rated.
9. If ‘event’ is inadequately described the reinsured could claim more than once for the
same loss event.
10. Event limits prevent the reinsurer from being called upon to pay an aggregate loss
amounting to several times the reinsurance cover when one event affects a series of
individual risks.
vi M97/March 2019 Reinsurance
Chapter 6
self-test answers
1. ‘Horizontal’ limitation refers to restrictions in the number of reinstatements available,
while ‘vertical’ limitation describes each layer of cover in the treaty being limited in
amount, except when unlimited cover applies.
2. A surplus treaty.
3. Any two from:
• administrative ease;
• simplified premium calculations;
• convenience when the individual accounts are small.
4. The total of all losses caused by the same event that would coverable by the quota
share would be deducted from the gross loss.
5. Risk premium; external costs; internal costs; profits.
6. ‘Development’ or ‘triangulation’ statistics are important in ‘long-tail’ classes of business
because they allow the reinsurer to predict the financial cost of a claim by applying the
anticipated eventual loss experience for each underwriting year between a loss being
reported and its settlement.
7. Any three from:
• for all firm quote and firm order open market insurance and reinsurance business
placed by London Market brokers;
• for all marine open cargo covers and attaching declarations;
• for all declarations or off-slips attaching to line slips;
• for applicable declarations off limited binding authority agreements, with the
agreement of the coverholder, brokers and insurers.
8. • Grading all current and proposed security.
• Setting and monitoring aggregate exposure limits to each reinsurer.
• Monitoring market news and developments for information with security
implications.
Self-test answers vii
Chapter 7
self-test answers
1. Non-proportional reinsurers may assume liability for losses on risks attaching during a
specified period, for losses occurring during a specified period, irrespective of the
inception dates of the original risk or policies, or for losses discovered or claims made
during a specified period.
2. According to the usual definition of ultimate net loss (UNL):
• The sum actually paid by the reinsured in settlement of the claim, with the exception
of ex gratia claims, is included.
• Unless specifically excluded, expenses attributable to the claim – such as legal and
loss adjustment expenses – are included.
• Usual office expenses and salaries payable by the reinsured are excluded.
• All recoveries, salvages, subrogations and recoveries under reinsurances which are
to the benefit of this reinsurance are deducted.
3. A claims control clause allows a reinsurer to appoint adjusters to act on its behalf to
control the investigation, adjustments and settlements in connection with the claim
notified by the insured.
4. When a reinsured has incurred losses under more than one policy but arising from the
same occurrence or event, and the policies attach to different excess of loss treaty
periods.
5. Loss settlements made by the reinsured are binding upon the reinsurer provided they
are within the terms and conditions of the original policies and within the terms and
conditions of the reinsurance contract. The reinsurer undertakes to pay its share of
losses upon reasonable evidence of the amount paid by the reinsured being given to
the reinsurer.
6. The index clause should specify:
• The index to be applied and its value at the base date.
• Whether indexation applies to all claims or to bodily injury claims only.
• Whether an excess or franchise is to apply and, if so, at what percentage.
viii M97/March 2019 Reinsurance
Chapter 8
self-test answers
1. To make a fair presentation of the risk, the reinsured has a duty to disclose, amongst
other things, all that it ought to know. The Insurance Act 2015 defines this by reference
to all that should reasonably have been revealed by a reasonable search of information
available to the reinsured.
2. Offer, acceptance, consideration, legality and an intention to create legal terms.
3. A party must show that such a term is necessary to give business efficacy (or
effectiveness) to the contract, is consistent with the express terms of the contract, and
would have been agreed by the parties.
4. It is a doctrine used as an aid to interpretation which provides that ambiguity is
construed against the drafting party.
5. A warranty is a contractual promise as to past or existing fact, or as to future conduct.
On breach, reinsurance cover is suspended until remedied (if it can be).
6. i. A common or unifying factor which can properly be described as an event;
ii. the event must be causative of the individual losses, satisfying the test of
causation; and
iii. the individual losses must not be too remote from that event.
7. In relation to contracts, a limitation period is prescribed in s.5 of the Limitation Act 1980
as a six-year period which starts on the date a cause of action accrues, during which
proceedings to enforce that cause of action may be commenced, and beyond which a
court will not enforce that course of action.
8. On the one hand, the reinsured does not want to have to (re-)agree each loss with its
reinsurer and, on the other, the reinsurer does not want to be bound to respond to all of
the reinsured’s original claim payments.
Self-test answers ix
Chapter 9
self-test answers
1. Any five from:
• political stability;
• a good geographical location;
• a quality transport system;
• developed communication systems;
• highly qualified personnel;
• office at competition prices;
• multi-lingualism;
• a stable legal and regulatory environment;
• liberal attitude by authorities;
• quality family life;
• a favourable time zone;
• a foreign presence;
• a developed financial centre;
• a strong national industry;
• centralisation in one principal city or region;
• tight economic controls;
• a strong currency;
• good arbitration facilities.
2. Lloyd’s and the London Market companies, the latter represented by the IUA.
3. The syndicates’ assets, the Members’ funds at Lloyd’s and its central assets (for
example, the Central Fund, the Corporation’s assets, subordinated debt and securities
and a ‘callable layer’).
4. Three from: Guernsey, Luxembourg, Ireland and the Isle of Man.
5. Reinsurance regulation in the USA is at individual state level although interstate
cooperation is encouraged through the National Association of Insurance
Commissioners (NAIC).
6. The attack on the World Trade Center in September 2001.
7. Japan, China and India.
8. Market capacity is freely available and investment returns are high.
9. If investment returns are low, underwriting returns are necessary for profit.
10. Ratings are formally evaluated at least once every twelve months and following events
such as an ownership change, merger or recapitalisation. In addition, ratings are
continually re-evaluated for other significant changes that arise during the year.
x M97/March 2019 Reinsurance
Chapter 10
self-test answers
1. The reinsurer accepts a proportion of the premiums charged by the ceding insurer and
pays the same proportion of the claims. It has no direct influence over the ceding
insurer’s rating on whose terms and conditions it has to trust in order to receive an
adequate premium for its participation.
2. The reinsurer knows that it cannot be exposed to an amount greater than the sum
insured, whereas if an EML basis is used, the reinsurer is vulnerable to an error having
occurred in the insurer’s EML calculations.
3. The imposition of time limits for the presentation and settlement of accounts benefits
the reinsurer as it helps to maintain cash flow as well as providing an opportunity to
monitor underwriting performance.
4. Since its basic premium has to be proportional to that of the insurer, its main area of
influence is by negotiating the level of ceding and profit commissions to be allowed.
5. The insurer will have to bear all the losses in full up to the deductible, whereas a
proportional treaty would provide a contribution from the reinsurer in respect of all
qualifying losses.
6. As a means of controlling its loss exposure to one catastrophic event.
7. The description ‘working’ layer is used because the treaty is knowingly exposed to
losses at a low level and is expected to be active in providing recoveries for claims
within the cover.
8. It lays down parameters that define one loss ‘event’.
9. A stop loss treaty reinsures the performance of the insurer’s property account over a
period in time, usually one year, rather than one loss (in the case of a ‘risk’ or ‘working’
treaty) or one ‘event’ (in the case of a catastrophe treaty).
Self-test answers xi
Chapter 11
self-test answers
1. A liability risk relates to the award of compensation in the event that there is legal
liability to pay damages to a third party, whereas a property risk covers loss or damage
to goods or possessions of the party insured.
2. Motor liability describes a situation where legal liability exists on the part of the insured
person to a passenger in the insured vehicle, whereas passenger accident cover pays
benefits to the passenger, usually based on a predetermined scale, without there being
a need for legal liability.
3. Accumulations of risk mainly arise from the ‘own damage’ part of the account as a
result of the operation of natural perils.
4. Many personal accident risks are for short, non-recurring periods or relate to unique or
unusual events, and so are not suited to treaty reinsurance arrangements that are
renewed on a yearly basis.
5. Where occupational diseases take many years to develop each insurer, and reinsurer,
on cover during the manifestation period shares a responsibility to contribute to
the loss.
6. There is no requirement for an employee who has sustained a ‘scheduled’ injury to
prove negligence or breach of a legal duty on the part of the employer.
7. Reinsurers wish to discover whether there is accumulation potential with other ceding
reinsurers with whom they do business and that subscribe to the same insurance
programme.
8. Professional indemnity cover operates in circumstances where a pure financial loss
developing over a period of time is sufficient to produce a claim. Since there is no
identifiable accident in such cases it is extremely difficult to pinpoint a ‘loss
occurrence’ date.
9. Facultative reinsurance, because fidelity guarantee does not generate volume lines of
business and so a reinsurer can give risks individual consideration.
10. Public liability cover could be required by an owner whose horse comes into contact
with other animals or members of the public on other property or on the public
highway.
11. Most products are purchased with a manufacturer’s guarantee and so additional cover
is not needed until this guarantee expires.
12. Protection is provided for a ceding insurer from losses relating to a single event that
triggers claims from more than one policy or account.
xii M97/March 2019 Reinsurance
Chapter 12
self-test answers
1. Ceding insurers provide cover in their marine departments for risks that are incidental
to those encountered at sea, such as road, rail and air journeys undertaken to, or from, a
sea port.
2. Freight is the charge incurred by a cargo-owner or shipper for the transportation of
goods or commodities. It is an insurable item because if cargo is lost or damaged
someone will have to stand the loss of the cost of carriage.
3. Trading in commodities is responsive to changes in market conditions so, for example,
if the price of scrap metal increases due to a world shortage or an increase in demand,
any relevant cargo could dramatically rise in value before arriving at the port of
destination.
4. Static property situated at sea, such as drilling rigs and platforms, is especially
susceptible to damage by weather-related risks and so reinsurers are interested in the
ability of property reinsured to withstand, for example, the effect of high winds,
hurricanes and cyclones.
5. The sum insured as stated will be paid or a replacement aircraft will be provided if the
sum needed does not exceed the insured value.
6. AVN 61 is the agreed value clause that applies to total losses, but not to partial losses.
7. The no claim bonus would be allowable in the event that the reinsurance arrangement
is renewed with the same reinsurer.
8. Surplus is unsuitable because the values of aircraft covered differ so significantly that
the different cession amounts required would represent too great an administrative
burden.
9. Possible reasons could be:
• failure to exercise reasonable care in product design;
• negligence in material selection;
• shortcomings in construction or subsequent testing.
10. A benefit policy pays out an agreed sum on the occurrence of a defined event without
reference to the size of any financial loss actually suffered by the claimant. A contract
of indemnity, by contrast, will not pay out more than the extent of the financial loss
suffered.
11. The reinsurer may have participations on two satellites whose launch schedules are
changed and which are unexpectedly fired into space on the same launch vehicle.
xiii
Cases
A Friends Provident Life & Pensions Ltd v.
Sirius International Insurance & Ors (2005),
Alfred McAlpine v. BAI (2000), 8C1D
8C1D
American Centennial v. INSCO (1996), 8C3
Aneco Reinsurance Underwriting v. Johnson
& Higgins (2002), 8A1B
ARIG v. SASA (1998), 8C2 G
Assicurazioni Generali v CGU International Gan Insurance v. Tai Ping Insurance (No.2)
Insurance (2004), 8C4 (2001), 8B2
Assicurazioni Generali v. CGU International & General Accident Fire and Life Assurance
Ors (2003), 8C4 Corporation v. Tanter (‘The Zephyr’)
AstraZeneca Ins Co v. XL & Ace (2013), 8C4 (1984), 8A2A
Axa Re v. Field (1996), 8C3
H
B Halvanon Ins. v. Companhia de Seguros do
Brinkibon v. Stahag Stahl (1982), 8A2A Estado de São Paulo (1995), 8E
Hill & Others v. Mercantile and General
Reinsurance Co. (1996), 8C4
C
Castellain v. Preston (1883), 8A1C
Caudle v. Sharp (1995), 8C3 I
Central District of Illinois Equal Employment Insurance Company of Africa v. SCOR (1985),
Opportunity Commission v. Mitsubishi 8C4
(1998) (USA), 11D2 Investors Compensation Scheme v. West
Charman v. GRE (1992), 8C4 Bromwich BS (1998), 8B1
Charter Reinsurance Co Ltd v. Fagan (1996),
7B4E, 8C1B
Colin Baker v. Black Sea & Baltic Insurance J
(1996), 8D2 Johnson v. Spencer Press of Maine, Inc.
Commercial Union v. NRG Victory Re (1998), (2004) (USA), 11D2
8C4
K
D Kingscroft & Walbrook v. Nissan (1999), 7A
Deeny v. Gooda Walker (1995), 1F1 Kuwait Airways v. Kuwait Insurance (1996),
Delver v. Barnes (1807), 8A 8C3
Deutsche Genossenschaftsbank v. Burnhope
(1996), 8B1
Dornoch v. Royal and Sun Alliance Insurance L
(2005), 8B1 Lucena v. Crawford (1806), 8A1D
E M
Equitas v. R&Q (2009), 8C4 Mann v. Lexington (2001), 8C3
F N
Faraday v. Copenhagen Re (2006), 8C4 New Hampshire Insurance v. MGN (1997),
Fennia Patria (1983), 8A2A 8B2
xiv M97/March 2019 Reinsurance
P
Pan Atlantic v. Pine Top (1994), 8A1B
Patterson v. PHP Healthcare Corp. (1996)
(USA), 11D2
Phoenix General Ins. Co. v. Halvanon Ins. Co.
(1985), 8C1D, 8D1
Pine Top v. Unione Italiana Anglo-Saxon Re
(1987), 8C2, 8D3
R
Rainy Sky v. Kookmin Bank (2011), 8B1
RE Brown v. GIO Insurance (1998), 8C3
Re London County Commercial Reinsurance
Office (1922), 8C4
Re NRG Victory Reinsurance Limited (1995),
8A
S
Sail v. Farex (1995), 8D1
Scott v. Copenhagen Re (2002), 8C3
Sirius International Ins. v. FAI (2004), 8B1
Sphere Drake Insurance v. Euro International
Underwriting Ltd (2003), 8A1B, 11E
Splunge v. Shoney’s (1996) (USA), 11D2
Sprung v. Royal Insurance (1997), 8D5
V
Vesta v. Butcher (1989), 8C2
W
WASA v. Lexington (2009), 7A1E, 8A, 8C2
WISE (Underwriting Agency) Limited v.
Grupo Nacional Provincial (2004), 8A1B
xv
Legislation
C S
Civil Liability Act 2018, 11B4A Sarbanes–Oxley Act 2002 (SOX) (USA), 9B3
Consumer Insurance (Disclosure and
Representations) Act 2012, 8A1B
T
Terrorism Act 2000, 7E3
D Terrorism Risk Insurance Act (TRIA) (USA),
Damages Act 1986, 7D10F 7E3, 9G1B
Terrorism Risk Insurance Program
Reauthorization Act (TRIPRA) (USA), 9G1B
E
Employers’ Liability (Compulsory Insurance)
Act 1969, 11D
Enterprise Act 2016, 7B2B, 8D5
F
Federal Risk Retention Act 1981 (USA), 9C2A
Financial Services Act 2012, 9B1A
Financial Services and Markets Act 2000,
8A2C
G
Gambling Act 2005, 8A1D
I
Insurance Act 2015, 7A1D, 7B2B, 8A1A, 8A1B,
8C1A, 8C2, 8D4, 8D5, 12C1A
Insurance Amendment Act 1995 (IAA)
(Bermuda), 9B4
Insurance Regulatory and Development
Authority Act 1999 (India), 9B5C
L
Life Assurance Act 1774, 8A1E
Limitation Act 1980, 8E
Lloyd’s Act 1982, 9B1A
M
Marine Insurance Act 1906, 8A1A, 8A1E
R
Reinsurance (Acts of Terrorism) Act 1993,
9G1A
Road Traffic Acts, 7E3
xvi M97/March 2019 Reinsurance
xvii
Index
A non-waiver clause, 7B5
notice clause, 7B5
acceptance, 8A2A
severability clause, 7B5
access to records clause, 7B4A
several liability clause, 7B5
accident and health (A&H) insurance, 11E1A
termination of intermediary clause, 7B5
accident circle occupational disease
bonds, 11J5
(ACOD) clauses, 7D10G
exclusions, 11J5B
accounting, 4B
underwriting considerations, 11J5A
clause, 7C4
Brazil, 9B6B
clean cut, 4B2
brokerage, 10B
premium and loss portfolio transfer, 4B2A
brokers, 1F, 6C2C
underwriting year, 4B1
how they acquire business, 1F3
accounts, 10B
how they place business, 1F4
adjustable premiums, 5C1
how they service clients’ business, 1F5
adverse selection, 2C3A
legal requirements for, 1F1
aggregate and accumulation exposures,
Lloyd’s, 1F7, 9B1A
5C6B
role of, 1F2
aggregate excess of loss treaty, 5A3
buffer excess of loss, 5A4
aggregate extension clause (AEC) clause,
burning cost, 5C6A
7D10B
buyers of reinsurance, 1B
aggregation clause, 8C3
alternative risk transfer (ART), 2C
development and features of, 2C1
arbitration, 8D3 C
Asian market, 9B5 capacity, 1A2
asset management, 1A6 capital market solutions
Australia, 9B6A advantages and disadvantages, 2C3
aviation reinsurance, 12C captive insurance, 2C1, 9C
hull, 12C1 advantages and disadvantages, 9C5
liability, 12C2 companies, 1B6
personal accident, 12C3 domicile, 9C4
space risks, 12C4 reinsurance of, 9C6
risk financing, 9C3
types of, 9C2
B cascade protections, 5A4

cash flow advantages, 1A8
back-to-back cover, 7A1D
casualty reinsurance, 11A
back-up covers, 5A4
bloodstock insurance, 11K1
basis of cover, 5B
bonds, 11J5
claims made, 5B3
clash cover, 11A6
clause, 7D1
combining classes, 11A5
losses discovered, 5B3
contingency insurance, 11K2
losses occurring during (LOD), 5B2
employers’ liability, 11D
risks attaching during (RAD), 5B1
extended warranty and breakdown
basis risk, 2C3A
insurance, 11K3
Bermuda, 9B4
fidelity guarantee, 11J4
bloodstock insurance, 11K1
livestock insurance, 11K1
underwriting considerations, 11K1A
medical malpractice, 11I
boilerplate clauses, 7B5
motor, 11B
amendments and alterations clause, 7B5
personal accident, 11C
confidentiality clause, 7B5
political risks, 11J3
entire agreement, 7B5
products liability, 11G
intermediary clause, 7B5
xviii M97/March 2019 Reinsurance
professional indemnity, 11H commission, 10B

public liability, 11F clause, 7C5B
scope of treaty, 11A3 flat-rate, 4C1
surety risks, 11J2 loss participation, 4C4
trade credit, 11J1 profit (flat-rate basis), 4C2
types of loss, 11A1 reverse profit, 4C4
types of reinsurance purchased, 11A4 sliding scale, 4C3
underwriting information requirements, commissions, taxes and charges, 10B
11A2 common account reinsurance, 3A3A, 5A1D
workers’ compensation, 11E commutation clause, 7D10D
catastrophe compartmentalisation, 3A3B
bonds, 2C1A comprehensive credit risk insurance, 11J3
cover, 5A1D condition, 8C1C
excess of loss, 10C3 precedent, 8C1B
futures, 2C1E confirming placement, 6C3D
model, 6B1B, 6B2 consideration, 8A2B
Risk Exchange (CATEX), 2C1H contingency insurance, 11K2
catastrophe claims settlement clause, 7D11B contingent capital contracts, 2C1B
catastrophe excess of loss, 5F2A Contract Certainty Code of Practice, 6C3C
catastrophe excess of loss layers, 5C6B contract wordings, 7
catastrophe excess of loss programme, 5F2 facultative, 7A, 7A1
catastrophic loss, 1A1 treaty, 7A, 7A2
event, 5A1D contractual documents, 8B
ceded premium, 10B historical rules, 8B2
cession placing programmes, 6C3
clause, 7C1 rules of construction, 8B1
limits, 4F1 contractual relationship, 1E
change in law clause, 7D10H core business, 1C6
change in senior management, 1G corporate strategy, 1A9
China, 9B5B costs and expenses, 8D2
claims counterparty risk, 2C3A
clauses, 7C6, 7D6 credit risk, 2C3A
experience, 5C3 currency
handling clause, 7D6C clauses, 7B2A
information clause, 7C6A fluctuation clause, 7D9
made basis, 5B3 cyber insurance, 11K4
recoveries, 4E
reserve deposits, 4D2
series clause, 7D10C D
settlement clause, 7C6B deductible, 5A1D
claims analysis, 5C6A clause, 7D4
claims clauses, 8F1 derivatives, 2C1F
clash designing programmes, 6A
cover, 11A6 dispute resolution clauses, 7B3B
excess of loss, 5A4 disputes, measures to avoid, 8F
class of business considerations, 6A3
clause
common to proportional and non-
proportional wordings, 7B
E
eighths basis, 4B2A
non-proportional wordings, 7D
EML failure clauses, 10B1
proportional wording, 7C
employers’ liability, 11D
clean cut accounting, 4B2
differences with workers’ compensation,
co-reinsurance clause, 7B4G
11E2
collateral, 6C2D
extent of cover and exclusions, 11D1
combinations of treaties, 6A2
types of reinsurance purchased, 11D3
commencement clause, 7C3A
underwriting considerations, 11D2
Index xix
errors and omissions clause, 7B4C claims recoveries, 3B

estimated maximum loss (EML), 3A3B, 10A2 contract wording, 7A1
error, 10A2A excess of loss, 10C1
European markets, 9B2 main features and operation of, 3A
event non-proportional, 3A3
effect on aggregations, 5D2 wording, 7A1B
effect on reinsurance recoveries, 5D3 premiums, 3B, 7A1C
limitation clause, 7C10 proportional, 3A1
limits, 4F2, 5D wording, 7A1A
significance of and importance in defining uses of, 2A1A
an, 5D1 fair presentation, 8A1B
exceedance probability (EP) curve, 6B2B fidelity guarantee, 11J4
excess of loss, 5A1 exclusions, 11J4B
advantages and disadvantages of, 5A1B extent of cover, 11J4A
aggregate, 5A3 types of reinsurance purchased, 11J4D
back-up covers, 5A4 underwriting considerations, 11J4C
buffer, 5A4 financial strength rating, 9E
cascade protections, 5A4 agencies, 9E1
catastrophe, 10C3 factors, 9E2
clash, 5A4 ongoing review, 9E5
common account protection, 5A1D outlook, 9E3A
facultative, 10C1 significance, 9E6
per risk, 5A1D sources of information, 9E4
reinstatement premium protections, 5A4 finite risk solutions, 2C2
risk, 10C2 fixed percentage basis, 4B2A
stop loss, 5A2 flat-rate commission, 4C1
top and drop protections, 5A4 Flood Re, 1A2A
types of, 5A1D follow clause, 8C4
umbrella, 5A4 form, 8A1E
use of, 5A1A frequency and severity rating, 6B1C
use with other types of reinsurance, 5A1C
excess of loss programme, 5A, 5F2
excess of loss reinsurance G
pricing models, 5C6 global reinsurance markets, 9B
excess of policy limits (XPL) clause, 7B4D grading reinsurers, 6C2B
experience rating, 6B1A gross net retained premium income
exposure rating, 5C6A, 6B1B (GNRPI), 5A2
express terms, 8C
hierarchy of, 8C1
extended claims reporting clause, 7D10F
extended warranty and breakdown
I
implied terms, 8D
insurance, 11K3
incorporation clause, 8C2
extra contractual obligations (ECO) clause,
incurred losses, 10B
7B4D
indemnity, 8A1C
index clause, 7D10A
individual risk retention, 10A1
F industry loss warranties (ILWs), 2C1C
facultative excess of loss with an excess of information technology hazards
loss treaty programme, 3C2 clarification clause, 7E6
facultative obligatory treaties, 4A3 innominate terms, 8C1D
advantages and disadvantages, 4A3C insolvency, 6C2E
operation of, 4A3A clause, 7B4E
use of, 4A3B fund exclusion clause, 7E5
facultative reinsurance, 2A1, 3, 6A5 inspection, 8D1
advantages and disadvantages, 2A1B insurable interest, 8A1D
and insurer’s requirements, 3A insurance companies, 1B1, 1D3
xx M97/March 2019 Reinsurance
insurance corporations losses

regional, 1B4 discovered basis, 5B3
state-owned, 1B3 occurring during (LOD) basis, 5B2
insurance, principles of, 8A1
insurance-linked securities, risks of, 2C3A
insurer’s financial situation, change in, 1G M
interlocking clause, 7D7 managing general agent (MGA), 1F6
International Underwriting Association of marine reinsurance, 12A
London (IUA), 9B1B cargo, 12A2
investment income, 1C2 energy, 12A3
irrelevant terms, 8D4 exploration and drilling, 12A3C
hull, 12A1
JELC Excess Loss Clauses, 12B
J liabilities, 12A4
Japan, 9B5A war, 12A5
JELC Excess Loss Clauses, 12B Market Reform Contract (MCR), 6C3B
additional clauses, 12B2 market(s), 9A
excess loss clauses, 12B1 Asian
other exclusion clauses, 12B3 China, 9B5B
India, 9B5C
Japan, 9B5A
K Australia, 9B6A
know the reinsured, 10B Bermudian, 9B4
Brazil, 9B6B
capacity, 9D4
L consolidation, 9A1
Continental European, 9B2
late payments, 8D5
cycles, 9D
clause, 7B2B
global, 9B
law and jurisdiction clause, 7A1E, 7B3A
hard reinsurance, 9D1
law applicable to reinsurance contracts, 8A
London, 9B1
law, change in, 1G
requirements for an international, 9A2
legality, 8A2C
soft reinsurance, 9D2
liability clause, 7D10
US, 9B3
limitation, 8E
material information for reinsurers, 6C1
clause, 7B1
medical malpractice, 11I
limitations on choice, 2D
underwriting considerations, 11I1
limits clause, 7D4
mergers and acquisitions, 1G, 9F
liquidity risk, 2C3A
miscellaneous clauses, 7B4
livestock insurance, 11K1
Montreal Convention, 12C2
underwriting considerations, 11K1A
moral hazard, 2C3A
Lloyd’s, 9B1A
motor, 11B
brokers, 1F7, 9B1A
common exclusions, 11B2B
syndicates, 1B2, 1D2
extent of cover and exclusions, 11B2
loading, 6B3
interests of primary insurers/reinsurers,
London Market, 9B1
11B1
Lloyd’s, 9B1A
types of reinsurance purchased, 11B5
loss
underwriting considerations, 11B3
corridor clause, 7D10I
underwriting information requirements,
defining, 10C3A
11B4
participation clause, 4C4, 7C9
unlimited covers, 11B2A
portfolio clause, 7C7B
motor excess of loss, 5F1
multi-trigger policies, 2C1G
reserves clause, 7B2C
mutual
reserves (or deposits) clause, 7C8B
funds, 1A2A
settlements clause, 7D6B
insurance companies, 1B7
stop, 10C4
Index xxi
N premium
adjustable, 5C1
National Association of Insurance
and loss portfolio transfer, 4B2A
Commissioners (NAIC), 9B3
calculation for non-proportional
net retained lines clause, 7B4H
reinsurance, 5C
non-disclosure
calculation of, 4E
of material information, 8F2
clause, 7D2
non-proportional reinsurance, 5
clauses, 7C5
basic information required for rating, 5C2
components of a non-proportional
clauses, 7D
reinsurance, 5C5
clauses common to wordings, 7B
facultative reinsurance, 3B, 7A1C
detailed information required for rating,
national retention of, 1C5
5C3
portfolio clause, 7C7A
distinctions from proportional, 2A3
excess of loss treaty, 5A1
reserves (or deposits) clause, 7C8A
extraneous factors for rating, 5C4
premium, ceded, 10B
main features and operation of, 5A
pricing considerations, 5F1A, 5F2A
premium calculation, 5C
pricing techniques, 6B1
premium, components of a, 5C5
principles of insurance, 8A1
underwriting, 10C
products liability, 11G
non-proportional workers’ compensation
extent of cover and exclusions, 11G1
business, 11E3B
types of reinsurance purchased, 11G3
notification of claims (or loss) clause, 7D6A
underwriting considerations, 11G2
nuclear exclusion clause, 7E1
professional indemnity, 11H
extent of cover and exclusions, 11H1
types of reinsurance purchased, 11H3
O underwriting considerations, 11H2
occupational disease clause, 7D10G profit, 1C1
offer, 8A2A profit commission, 10B
offset clause, 7B4F profit commission (flat-rate basis), 4C2
original underwriting limits, 5C3 profitability, 10B
programmes
comparing the net experience of different,
P 6A4
payment clauses, 7B2 designing, 6A
payment of claims clause, 7C6C placing, 6C
per event cover, 5A1D pricing, 6B
per risk cover, 5A1D projected payments clause, 7D11B
period, 10B property reinsurance, 10A
period clause, 7B1A suitability of proportional reinsurance,
personal accident, 11C 10B2
extent of cover and exclusions, 11C1 property surplus treaty, 5F2
types of reinsurance purchased, 11C4 proportional facultative with a proportional
underwriting considerations, 11C2 treaty, 3C1
personal liability, 11F1 proportional reinsurance, 4
political risks, 11J3 accounting methods, 4B
standard exclusions, 11J3C cession limits, 4F1
types of reinsurance purchased, 11J3B claims recoveries, 4E
underwriting considerations, 11J3A claims reserve, 4D
pollution (or environmental contamination) clauses, 7C
exclusion clause, 7E2 clauses common to wordings, 7B
portfolio commissions and deductions, 4C
and asset management, 1A6 distinctions from non-proportional, 2A3
premium and loss transfer, 4B2A event limits, 4F2
transfer clause, 7C7, 7C7C main features and operation of, 4A
portfolio transfers, 10B premium reserve, 4D
xxii M97/March 2019 Reinsurance
premiums, 4E sellers of, 1D

quota share treaty, 4A1 soft market, 9D2
suitability to property risks, 10B2 State, 1D4
surplus treaty, 4A2 reinsured’s portfolio, 10B
underwriting, 10B reinsurer failure, 9F
proportional workers’ compensation reserves, 10B
business, 11E3A reTakaful companies, 1D5
public liability, 11F retrocedant, 2B1
extent of cover and exclusions, 11F1 retrocession, 2B
subsections, 11F3A features of, 2B2
types of reinsurance purchased, 11F3 retrocession market, 2B
underwriting considerations, 11F2 reverse profit commission, 4C4
pure political risks covers, 11J3 risk
acceptance of the, 6C3A
accumulation of, 10A3
Q excess of loss, 10C2
quota share solution, 4G1 retention groups, 1A2A
quota share treaty, 4A1 retention, individual, 10A1
advantages and disadvantages, 4A1C spread of, 1C3
operation of, 4A1A transfer, 1A1
use of, 4A1B risk XL, 5F2A
risks attaching during (RAD) basis, 5B1
R
rating, 10C5 S
burning cost method, 10C5A salvage and subrogation clause, 7D8
experience, 6B1A Securities and Exchange Commission
exposure, 6B1B (SEC), 9B3
exposure method, 10C5B security, 1A3
frequency and severity, 6B1C Committee, 6C2A
key considerations, 10C5C considerations for reinsureds, 6C2
reciprocity, 1C4, 6A, 6D sellers of reinsurance, 1D
retain gross profit, 6D1 sidecars, 1D7, 2C1D
spread business, 6D1 simultaneous settlement clause, 7D11A
record of cession clause, 7C2 sliding scale commission, 4C3
regional insurance corporations, 1B4 Solvency II, 9B2
regulatory changes, 1G special acceptances clause, 7B1D
reinstatements, 5E special drawing right (SDR), 12C2
clauses, 7D5 special termination clause, 7B1C
premium protections, 5A4 State insurance corporations, 1B3
reinsurance State reinsurance companies, 1D4
alternatives to conventional, 2C stop loss treaty, 5A2
assumed clause, 7E4 sunset clause, 7D10E
brokers, 1F surety risks, 11J2
buyers of, 1B underwriting considerations, 11J2A
casualty, 11A surplus treaty, 4A2
companies, 1B8, 1D1 advantages and disadvantages, 4A2D
differences from retrocession, 2B operation of, 4A2A
formation of contract, 8A2 second, third and fourth, 4A2B
hard market, 9D1 use of, 4A2C
law applicable to contracts, 8A surplus treaty solution, 4G2
main types of, 2A
motivation for selling, 1C
pools, 1B9, 1D6 T
preference, 6C1C Takaful insurance, 1B5
purpose of, 1A reTakaful, 1D5
Index xxiii
taxation advantages, 1A7

termination clause, 7C3B
terms
express, 8C
implied, 8D
territorial scope clause, 7B1B
terrorism, 9G
Australia, 9G1D
Canada, 9G1E
Europe, 9G1C
international perspectives, 9G1
UK, 9G1A
USA, 9G1B
top and drop protections, 5A4
trade credit, 11J1
types of reinsurance purchased, 11J1A
treaty reinsurance, 2A2
advantages and disadvantages, 2A2B
combinations of, 6A2
contract wording, 7A2
exclusions, 7E
factors determining the choice, 6A1
uses of, 2A2A
twenty-fourths basis, 4B2A
U
umbrella excess of loss, 5A4
underwriting
capacity, 1A2
non-proportional reinsurance, 10C
original limits, 5C3
policy clause, 7B4B
proportional reinsurance, 10B
year accounting, 4B1
Unique Market Reference (UMR), 7A
UNL clause, 7D3
US market, 9B3
utmost good faith, 8A1A
W
war and terrorism exclusion clause, 7E3
warranty, 8C1A
Warsaw Convention, 12C2
workers’ compensation, 11E
differences with EL insurance, 11E2
reinsurance issues, 11E1
types of reinsurance purchased, 11E4
underwriting considerations, 11E3
working covers, 5A1D
working excess of loss cover per event
(WXL/E), 5A1D

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Reinsurance

M97 Study text: 2019

Updates and amendments to this study text

Print edition ISBN: 978 1 78642 599 7

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Summary of learning outcomes Number of

Published February 2019 M97

Published February 2019 2 of 4

10. Understand the principles and Reading list

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Books (and ebooks)

Published February 2019 3 of 4

Factfiles and other online resources Exam technique/study skills

Journals and magazines

Published February 2019 4 of 4

2. Understand the different types of reinsurance

2.1 Outline the main types of reinsurance. 2A, 2D

2.2 Explain the difference between reinsurance and retrocession. 2B

2.3 Discuss the alternatives to conventional reinsurance. 2C

3. Understand the features and operation of facultative reinsurance

3.2 Calculate reinsurance premiums and claims recoveries for 3B

4. Understand the features and operation of proportional reinsurance treaties

4.2 Explain the main accounting methods for proportional 4B

4.3 Discuss different types of commission on proportional 4C

4.4 Discuss the use of premium and claims reserves. 4D

4.5 Calculate reinsurance premiums and claims recoveries for 4E

4.6 Discuss the use of cession and event limits in proportional 4F

5. Understand the features and operation of non-proportional reinsurance treaties

5.2 Explain the different bases of cover including risks attaching, 5B

5.3 Discuss the various types of premium calculation used in 5C

5.4 Calculate reinsurance premiums and claims recoveries for 5C

5.5 Discuss the purpose and use of reinstatements. 5E

5.6 Discuss the use of event limits in non-proportional reinsurance 5D

Syllabus learning outcome Study text chapter

6.1 Discuss the factors affecting the design of a reinsurance 6A, 6B

6.2 Discuss how proportional and non-proportional reinsurance can 6A

6.3 Discuss the material information required in the placement of 6C

6.4 Explain the use of reciprocity. 6D

7. Understand legal issues relating to reinsurance

7.1 Discuss the legal requirements for the formation of a reinsurance 8A

8. Understand reinsurance contract wordings

8.1 Discuss the main features of facultative and treaty wordings. 7A

8.3 Describe the main treaty exclusions and their importance. 7E

9.2 Discuss the characteristics of hard and soft markets. 9D

9.3 Discuss the management of the underwriting cycle. 9D

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2: Different types of reinsurance

3: Features and operation of facultative reinsurance