CHAPTER SEVEN

RE-INSURANCE
 Re-insurance

 Reinsurance is the shifting of part or all of the insurance originally written

by one insurer to another insurer. The insurer that initially writes the business
is called the ceding company. The insurer that accepts part or all of the
insurance from the ceding company is called the reinsurer.
 The amount of insurance retained by the ceding company for its own account
is called the net retention or retention limit. The amount of the insurance
ceded to the reinsurer is known as the cession. Finally, the reinsurer in turn
may obtain reinsurance from another insurer. The process by which a
reinsurer passes on risks to another reinsurer is known as retrocession.
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• Reinsurance had a very simple beginning. When a risk that
was too large for the company to handle safely was presented
to an insurer, it began to shop around for another insurance
company that was willing to take a portion of the risk in return
for a portion of the premium. A few current reinsurance
operations are still conducted in this manner, but the ever-
present danger that a devastating loss might occur before the
reinsurance becomes effective led to the development of
modern reinsurance treaties.
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Types of Reinsurance Agreements

 There are two principal forms of reinsurance:

1. Facultative reinsurance and

2. Treaty reinsurance
 Facultative Reinsurance

 Facultative reinsurance is reinsurance on an optional basis. There is no

advance agreement between the ceding company and the re-insurer
regarding the sharing of risks and premiums. Under this arrangement a
primary insurer, in considering the acceptance of a certain risk, shops
around for reinsurance on it, attempting to negotiate coverage specifically
on this particular contract. Each risk, which is offered, is described and this
is shown to the prospective re-insurers who are free to accept or decline as
they see fit. A life insurer, for example, may receive an application for Birr
1 million of life insurance on a single life. Not wishing to reject this
business but still unwilling to accept the entire risk, the primary insurer
communicates full details on this application to another insurer with whom
it has done business in the past.
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 The other insurer may agree to assume 40 percent of any loss
for a corresponding percentage of the premium. The primary
insurer is under no obligation to cede insurance, and the
reinsurer is under no obligation to accept the insurance.
But if a willing reinsurer can be found, the primary insurer
and reinsurer can then enter into a valid contract.
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 The reinsurance agreement does not affect the insured in any
way. The insured is generally not aware of the reinsurance
process and the primary insurer remains fully liable to the
insured in event of loss.
 As stated earlier the insurer retains the right to decide whether
and how much of his risk to submit for reinsurance. The re-
insurer also retains the right to accept or reject any business
offered by the insurer.
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 Facultative reinsurance has the advantage of flexibility, since
a reinsurance contract can be arranged to fit any kind of case.
It can increase the insurer’s capacity to write large amounts of
insurance. The reinsurance tends to stabilize the insurer’s
operations by shifting large losses to the reinsurer.
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 The major disadvantage of facultative reinsurance is that it is
uncertain. The ceding insurer does not know in advance if a
reinsurer will accept any part of the insurance. There is
also a further disadvantage of delay, since the policy will not
be issued until reinsurance is obtained.
 Treaty Reinsurance

 Treaty reinsurance, also called automatic treaty means the primary insurer
has agreed to cede insurance to the reinsurer, and the reinsurer has agreed to
accept the business. All business that falls within the scope of the agreement is
automatically reinsured according to the terms of the treaty. Under automatic
treaty reinsurance the ceding insurer agrees to pass on to the reinsurer all
business included within the scope of the treaty, the reinsurer agrees to accept
this business, and the terms-e.g., the premium rates and the method of
sharing the insurance and the losses- of the agreement.
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 Treaty reinsurance has several advantages to the primary
insurer. It is automatic, and no uncertainty or delay is
involved. It is also economical, since it is not necessary to
shop around for reinsurance before the policy is written.
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 Treaty reinsurance could be unprofitable to the reinsurer
generally has no knowledge about the individual applicant and
must rely on the underwriting judgment of the primary insurer.
The primary insurer may write bad business and then reinsure
it. Also, the premium received by the reinsurer may be
inadequate. Thus, if the primary insurer has a poor
selection of risks or charges inadequate rates, the reinsurer
could incur a loss.
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There are several types of treaty reinsurance and arrangement,

including the following:
 Quota-share treaty
 Surplus-share treaty
 Excess-of-loss treaty

 Reinsurance pool
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 Quota-share treaty:- Under a quota –share treaty, the ceding
insurer and reinsurer agree to share premiums and losses based
on some proportion. The ceding insurer’s retention limit is stated
as a percentage rather than as a Birr amount. The insurance
and the loss are shared according to some pre agreed percentage.
For example, if a Birr 100,000 policy is written and the agreed
split is 50-50, the reinsurer assumes one-half of the liability; the
insurer and the reinsurer each pay one-half on any loss.
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 Surplus –share treaty:- Under a surplus-share treaty, the
reinsurer agrees to accept insurance in excess of the ceding
insurer’s retention limit, up to some maximum amount. The
retention limit is referred to as a line and is stated as a Birr
amount. Under surplus share treaty the ceding company
decides what its net retention will be for each class of
business. The reinsurer does not participate unless the policy
amount exceeds this net retention.
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If the amount of insurance on a given policy exceeds the
retention limit, the excess insurance is ceded to the reinsurer up
to some maximum limit. The primary insurer and reinsurer then
share premiums and losses based on the fraction of total
insurance retained by each party.
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 Excess-of-loss treaty:- An excess-of-loss treaty is designed largely
for catastrophic protection. Losses in excess of the retention limit
are paid by the reinsurer up to some maximum limit. The excess-of
–loss treaty can be written to cover (1) a single exposure, (2) excess
losses when the primary insurer’s cumulative losses exceed a
certain amount during some stated time period, such as a year. The
reinsurer agrees to be liable for all losses exceeding a certain
amount on a given class of business during a specific period.
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In contrast to quota-share reinsurance, in which the reinsurer
shares part of every loss, excess-of-loss reinsurance coverage
commits the reinsurer to pay part of a claim only after the
primary insurer’s coverage has been exhausted. The reinsurer
pays only the excess of loss beyond what the primary insurer has
retained.
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Such a contact is simple to administer, because the reinsurers
are liable only after the ceding company has actually suffered
the agreed amount of loss. Because the probability of large
losses is small, premium for this reinsurance are likewise small.
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 Reinsurance pool:- Reinsurance can also be provided by a
reinsurance pool. A reinsurance pool is an organization of
insurers that underwrites insurance on a joint basis.
Reinsurance pools have been formed because a single insurer
alone may not have the financial capacity to write large
amounts of insurance, but the insurers as a group can combine
their financial resources to obtain the necessary capacity.