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What is 'Reinsurance'

Reinsurance, also known as insurance for insurers or stop-loss insurance, is the practice of insurers
transferring portions of risk portfolios to other parties by some form of agreement to reduce the
likelihood of having to pay a large obligation resulting from an insurance claim. The party that
diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of
the potential obligation in exchange for a share of the insurance premium is known as the
reinsurer.

Objectives of Reinsurance

The following are the main objectives of reinsurance:

1. Wide distribution of risk to secure the full advantages of the law of averages;

2. Limitation of liability of an amount which is within the financial capacity of the insurers; .

3. Stability in underwriting over a period; and

4. A safeguard against serious effects of conflagrations. Apart from these, sometimes an insurer
may undertake the insurance of certain risks at a higher rate of premium and may reinsure part of
these or the whole of it with some other insurers at a lower rate with the objective of earning of
profit out of it i.e., making profits by way of retaining the difference between the two premiums.

DEFINETION OF REINSURANCE RISK :-

Reinsurance risk refers to the inability of the ceding company or the

primary insurer to obtain insurance from a reinsurer at the right time and

at an appropriate cost. The inability may emanate from a variety of

reasons like unfavourable market conditions, etc. Default risk by a

reinsurer also affects the ceding insurance company in an adverse manner

as it may affect their profitability.


Types of Reinsurance

Proportional
Under proportional reinsurance, one or more reinsurers take a stated percentage share of each
policy that an insurer issues ("writes"). The reinsurer will then receive that stated percentage of the
premiums and will pay the stated percentage of claims. In addition, the reinsurer will allow a
"ceding commission" to the insurer to cover the costs incurred by the insurer (mainly acquisition
and administration).

The arrangement may be "quota share" or "surplus reinsurance" (also known as surplus of line or
variable quota share treaty) or a combination of the two. Under a quota share arrangement, a fixed
percentage (say 75%) of each insurance policy is reinsured. Under a surplus share arrangement,
the ceding company decides on a "retention limit" - say $100,000. The ceding company retains the
full amount of each risk, with a maximum of $100,000 per policy or per risk, and the balance of
the risk is reinsured.

The ceding company may seek a quota share arrangement for several reasons. First, it may not
have sufficient capital to prudently retain all of the business that it can sell. For example, it may
only be able to offer a total of $100 million in coverage, but by reinsuring 75% of it, it can sell
four times as much.

The ceding company may seek surplus reinsurance to limit the losses it might incur from a small
number of large claims as a result of random fluctuations in experience. In a 9 line surplus treaty
the reinsurer would then accept up to $900,000 (9 lines). So if the insurance company issues a
policy for $100,000, they would keep all of the premiums and losses from that policy. If they issue
a $200,000 policy, they would give (cede) half of the premiums and losses to the reinsurer (1 line
each). The maximum automatic underwriting capacity of the cedant would be $1,000,000 in this
example. Any policy larger than this would require facultative reinsurance.

Non-proportional
Under non-proportional reinsurance the reinsurer only pays out if the total claims suffered by the
insurer in a given period exceed a stated amount, which is called the "retention" or "priority". For
instance the insurer may be prepared to accept a total loss up to $1 million, and purchases a layer
of reinsurance of $4 million in excess of this $1 million. If a loss of $3 million were then to occur,
the insurer would bear $1 million of the loss and would recover $2 million from its reinsurer. In
this example, the insurer also retains any excess of loss over $5 million unless it has purchased a
further excess layer of reinsurance.

The main forms of non-proportional reinsurance are excess of loss and stop loss.

Excess of loss reinsurance can have three forms - "Per Risk XL" (Working XL), "Per Occurrence
or Per Event XL" (Catastrophe or Cat XL), and "Aggregate XL".
In per risk, the cedant's insurance policy limits are greater than the reinsurance retention. For
example, an insurance company might insure commercial property risks with policy limits up to
$10 million, and then buy per risk reinsurance of $5 million in excess of $5 million. In this case a
loss of $6 million on that policy will result in the recovery of $1 million from the reinsurer. These
contracts usually contain event limits to prevent their misuse as a substitute for Catastrophe XLs.

In catastrophe excess of loss, the cedant's retention is usually a multiple of the underlying policy
limits, and the reinsurance contract usually contains a two risk warranty (i.e. they are designed to
protect the cedant against catastrophic events that involve more than one policy, usually very
many policies). For example, an insurance company issues homeowners' policies with limits of up
to $500,000 and then buys catastrophe reinsurance of $22,000,000 in excess of $3,000,000. In that
case, the insurance company would only recover from reinsurers in the event of multiple policy
losses in one event (e.g., hurricane, earthquake, flood).

Aggregate XL affords a frequency protection to the reinsured. For instance if the company retains
$1 million net any one vessel, $5 million annual aggregate limit in excess of $5m annual
aggregate deductible, the cover would equate to 5 total losses (or more partial losses) in excess of
5 total losses (or more partial losses). Aggregate covers can also be linked to the cedant's gross
premium income during a 12-month period, with limit and deductible expressed as percentages
and amounts. Such covers are then known as "stop loss" contracts.

Risks attaching basis


A basis under which reinsurance is provided for claims arising from policies commencing during
the period to which the reinsurance relates. The insurer knows there is coverage during the whole
policy period even if claims are only discovered or made later on.

All claims from cedant underlying policies incepting during the period of the reinsurance contract
are covered even if they occur after the expiration date of the reinsurance contract. Any claims
from cedant underlying policies incepting outside the period of the reinsurance contract are not
covered even if they occur during the period of the reinsurance contract.

Losses occurring basis


A Reinsurance treaty under which all claims occurring during the period of the contract,
irrespective of when the underlying policies incepted, are covered. Any losses occurring after the
contract expiration date are not covered.

As opposed to claims-made or risks attaching contracts. Insurance coverage is provided for losses
occurring in the defined period. This is the usual basis of cover for short tail business.

Claims-made basis
A policy which covers all claims reported to an insurer within the policy period irrespective of
when they occurred.
Top 10 advantages or benefits of reinsurance
1. Reinsurance boosts Insurance Business
The major advantage of reinsurance is that it assists in the boom of insurance business. It enables
every insurer to accept insurance business as the total risk will be distributed among other
reinsurers.

If there is no reinsurance, the insurer may not be willing to take up risks, particularly when the risk
exceeds beyond his capacity to manage.
2. Reinsurance reduces the risks
The prime principle of insurance is to reduce risk. As the risks are spread across wider area, the
loss of the individual is minimized which gives the insurer the secured feel. The revenue of
insurance companies are stable due to reinsurance. It also helps the insurance companies to gain
knowledge about various types of risks and the basis of rating the risks in the future.
3. Reinsurance Increases Goodwill of Insurer
Reinsurance helps to boost the overall confidence and goodwill of insurer. When the insurer
develops confidence, he understands the nature of risks involved beyond his capacity.
So reinsurance increases goodwill of an insurer
4. Reinsurance Limits the Liability
Reinsurance motivates the insurers to undertake and spread the risks. Hence the liability of insurer
is limited to the maximum
5. Reinsurance Stabilizes premium Rates
The premium rates of insurance are stabilized by reinsurance. Generally, the premium rates are
calculated on the basis of the loss experienced by the insurer in the past, due to the risk concerned.
Reinsurance takes into account of all these data and fixes the premium rate according for various
types of risks under mutual agreement.
Thus reinsurance stabilizes the fluctuations in the premium rates of various types of risks.
6. Reinsurance Protects the Insurance Funds
The insurance funds of the insurer is well protected due to reinsurance. Additional security and
peace of mind is an added advantage of reinsurance for the insurer and the company that offers the
insurance.
7. Reinsurance Reduces Competition
The competitions between inter company is reduced as everyone work in a cooperative manner
and with the helping tendency in the insurance business. Thus reinsurance helps to control
competition and increase overall morale of the employees in the insurance business.
8. Reinsurance Reduces profit fluctuations
The reinsurance plans reduce, to a considerable extent the violent fluctuations in the profits of the
company. If on the other hand, heavy risks are retained by the original insurer, his profits are
greatly upset due to a heavy single loss.
9. Reinsurance Encourages new enterprises
It encourages the new underwriters, who in their early period of development, have limited
retentive capacity. In the absence of reinsurance facility, the tremendous growth of new enterprises
is doubtful.
10. Reinsurance Minimizes dealings
Due to the reinsurance scheme, the insurer is required to indulge in the minimum dealings with
only one insurer. In the absence of insurance facility, the insured will have to approach several
insurers to enter into various individual insurance agreement on the same property. This involves
considerable cost, loss of valuable time and slower down the pace of protection cover

Redus risk of reinsurance

Risk transfer
With reinsurance, the insurer can issue policies with higher limits than would otherwise be
allowed, thus being able to take on more risk because some of that risk is now transferred to the
re-insurer.

Income smoothing
Reinsurance can make an insurance company's results more predictable by absorbing larger losses
and reducing the amount of capital needed to provide coverage. The risks are diversified, with the
reinsurer bearing some of the loss incurred by the insurance company. The income smoothing
comes forward as the losses of the cedant are essentially limited. This fosters stability in claim
payouts and caps indemnification costs.

Surplus relief
Proportional Treaties (or “pro-rata” treaties) provide the cedent with “surplus relief”; surplus relief
being the capacity to write more business and/or at larger limits.[1]

Arbitrage
The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a
lower rate than they charge the insured for the underlying risk, whatever the class of insurance.

In general, the reinsurer may be able to cover the risk at a lower premium than the insurer
because:

The reinsurer may have some intrinsic cost advantage due to economies of scale or some other
efficiency.
Reinsurers may operate under weaker regulation than their clients. This enables them to use less
capital to cover any risk, and to make less conservative assumptions when valuing the risk.
Reinsurers may operate under a more favourable tax regime than their clients.
Reinsurers will often have better access to underwriting expertise and to claims experience data,
enabling them to assess the risk more accurately and reduce the need for contingency margins in
pricing the risk
Even if the regulatory standards are the same, the reinsurer may be able to hold smaller actuarial
reserves than the cedant if it thinks the premiums charged by the cedant are excessively
conservative.
The reinsurer may have a more diverse portfolio of assets and especially liabilities than the cedant.
This may create opportunities for hedging that the cedant could not exploit alone. Depending on
the regulations imposed on the reinsurer, this may mean they can hold fewer assets to cover the
risk.
The reinsurer may have a greater risk appetite than the insurer.
Reinsurer's expertise
The insurance company may want to avail itself of the expertise of a reinsurer, or the reinsurer's
ability to set an appropriate premium, in regard to a specific (specialised) risk. The reinsurer will
also wish to apply this expertise to the underwriting in order to protect their own interests.

Creating a manageable and profitable portfolio of insured risks Edit


By choosing a particular type of reinsurance method, the insurance company may be able to create
a more balanced and homogeneous portfolio of insured risks. This would lend greater
predictability to the portfolio results on net basis (after reinsurance) and would be reflected in
income smoothing. While income smoothing is one of the objectives of reinsurance arrangements,
the mechanism is by way of balancing the portfolio.

functions of a reinsurance company:

1)Increases stability and security.


As we have said, the major function of reinsurance companies is to spread out risk. This is
especially in the case of an unusual or widespread loss event, such as a hurricane or tornado.
2)Increases depth and width of coverage.
Whenhen an insurance company is secure and stable, and when it is protected well for all manner
of loss events, it can afford to offer more insurance policies. Also, it can offer a wider range of
insurance policies, thus improving business.
3)Helps with analysis and decision-making.
A reinsurance company won’t simply take an insurance company on as a partner. It nee to know
that the investment is worthwhile. The reinsurance company will help the insurance company
evaluate its reinsurance needs, devise an effective reinsurance plan, and analyze risks and risk
pricing.
4)Provides an array of services.
Reinsurance companies will also help the primary insurance company understand and coordinate
its reinsurance needs. This is done by providing technology, training, organization, management,
and even accounting.
Helps with expansion.
Because reinsurance companies provide security and take on risk, they give insurance companies
the opportunity to expand their business through launching new products services

Methods of Reinsurance

Treaty and Facultative InsuranceTreaty and Facultative Insurance


Reinsurance may be effected by two methods. The selection of these methods depends upon the
practice of insurers and the scope of their resources. These methods are:

Facultative Reinsurance; and


Treaty Reinsurance.
1. Facultative Reinsurance

This is the oldest method of reinsurance. This method is also known as “Specific reinsurance“.
Under this method, each individual risk is submitted by the ceding insurer to the reinsurer who can
accept or decline whatever sum they consider appropriate subject to the amount of their
acceptance being approved by the ceding insurer.

The reinsurer is offered a copy of proposal form which contains details of risk such as the sum
assured, salient features of the risk, perils covered, rate of premium and period of insurance etc.
The reinsurer will go through the contents of the proposal form thoroughly and decide whether to
accept or reject the risks. If he decides to accept, he should specify the amount for which he would
accept the reinsurance. In case, the risk is not fully accepted, the original insurer may again have
to approach another insurer for the balance.

For example, ‘X’ insurance company has received a proposal for Rs.1,00,00,000. The retention of
the original insurer (i.e. X co) is Rs.50,00,000 and for the balance of Rs.50,00,000, he approaches
the insurer ‘A’ who accepts for only Rs.25,00,000. The original insurer may again have to
approach insurer ‘B’ for the balance of Rs. 25,00,000.

Any alteration, in the terms and conditions made by the original insurer is to be intimated
immediately to the reinsurers. The claim is to be settled according to the ratio of risk accepted by
each insurer.

2. Treaty Reinsurance

Treaty reinsurance has been defined as

a formal, legally binding agreement or a treaty (agreement) between the principal and the reinsurer
that the reinsurer shall accept without the option of rejecting, a specified proportion of the excess
on any risk over the insurer’s limit of retention.

Thus, under this method, there is an agreement between the ceding company and the reinsurance
company that amount of every risk over and above the retention shall automatically be transferred
to the reinsurance company. As soon as the original insurer accepts the risk, the excess above the
retention is automatically reinsured.

For example, if the total sum insured on any risk is Rs.2,00,000 and the retention is Rs.20,000 the
balance of Rs.1,80,000 is reinsured. Accordingly premiums are also paid to the reinsurers in the
same proportion. In the even of loss, insurers also pay the compensation in the same proportion.

Treaty reinsurance may be

Quota share treaty;


Surplus treaty and
Excess of loss treaty.
1. Quota Share Treaty

Under this method, the ceding company is bound to cede and the reinsurer is bound to accept a
fixed share of every risk coming within the scope of the treaty.

This method is especially suitable for an insurer

recently established with a small premium income; or


entering a new class of business for which it may not have the necessary experience; or
to protect a hazardous class of insurance, where selective ceding is difficult.
This method is highly beneficial to the reinsurer. The liability of the reinsurer attaches as soon as
the ceding office assumes the risk. Then, the ceding office provides the accepting office with full
details of each cession, copies of proposal papers. It does not give the insurer an option of
acceptance or rejection.

It enables the reinsurer to consider any marked divergence of underwriting standards and if
persistent to its disadvantage, it may indicate the need for revision or cancellation of the treaty in
respect of new business.
2. Surplus Treaty

Under this method, the insurers agree to accept the surplus i.e., the difference between ceding
insurers’ retention and gross acceptance. Surplus treaties are arranged on the basis of ‘lines’. A
‘line’ is equivalent to the ceding insurer’s retention.

For example, a treaty may be arranged on a ten line basis. Under this arrangement, the insurers
will accept automatically upto ten times the retention of ceding insurer.
forexampal f
f the gross acceptance is more than Rs.11,00,000, then the surplus treaty will absorb only Rs.10
lakhs and the balance will have to be reinsured facultatively. It is usual to arrange a second surplus
treaty to take care of such excess amount. This method is the most popular and greater part of the
reinsurance business is now done under this method, as it does not lay down any right rules.

It is of particular advantage to the ceding office as it saves a lot of time and expenses and
simultaneously provides for the reinsurance facility. However, it is not suitable for policies with
higher sums insured or where the limit of indemnity is very high.

3. Excess of Loss Treaty

This is a non-proportional method of reinsurance. The reinsurance protection arranged is not


linked with the sum insured but comes into operation when the total net loss suffered by the
insured due to one event exceeds the figure agreed in the treaty.

Thus, under this method the original insurer has to decide the maximum amount which he can
bear on any one loss and seeks reinsurance under which the reinsurer will be responsible for the
amount of any losses and above the amount retained by the direct reinsurer. Such a treaty usually
contains an upper limit so that the insurer, for instance is content to bear the first Rs.20,000 of any
loss, the treaty reinsurers will bear any loss over Rs.20,000 but not exceeding, say Rs.2,00,000

In order to cover the catastrophe risks or risks beyond that maximum limit (Rs.2,00,000 in the
above case) an additional second layer ( further excess of loss) treaty may be negotiated. In case,
the direct insurer has not made any arrangement to cover the loss over and above Rs.2,00,000,
then he will have to bear all possible claims beyond Rs.2,00,000 Sometimes, the insurer may be
required to retain part of the cost in excess of the retention.

Thus, to keep the reinsurers directly involved in the cost, the treaty may, for instance, provide that
the reinsurer will pay only a part of the excess of Rs.20,000 e.g., 95% of the claims over Rs.
20,000 maybe paid by the reinsurers and the balance of 5% is met by the insured. Generally, the
retention is fairly high. In order to get protection under this category, the insurers have to pay an
agreed percentage of the annual premium income for that class of risk to the reinsurers.

This method is employed mainly to protect large catastrophic losses such as those caused by
Special perils fire insurance i.e. storm, flood, earthquake etc. or where their is an possibility of
conflagration in large storage areas or where large marine acceptances are involved in any ship
through different sources. It is also applied to protect legal liability classes i.e., motor third party,
public liability, products liability and workmen’s compensation risks. For example, a severe
mining accident may result in hundred of fatalities to workmen, resulting in a catastrophic loss.

What Are The Main Reasons For Reinsurance

It is probable that the reinsurer may have sufficient amounts ceded from a number of different
sources and unfortunately the cession may relate to the same risk. To relieve itself from this
undesirable accumulation, the reinsurer would itself have to resort to reinsurance companies. This
may be the principal reasons for reinsurance. There are some other reasons for reinsurance which
are given below:

i) Risk Minimization By Spreading: The basic concept of insurance is to spread the risk over as
wider an area as possible as so to decrease the burden of loss at each stage. The reasons for
reinsurance says, reinsurance facilitates a risk to be scattered over a much wider area and the
principle of insurance is taken well care of. This in fact helps in the ultimate viability of insurance
business.

ii) Risk Transfer: To an insurer, the need for reinsurance safeguard arises in the same way as the
insured needs insurance protection. But for reinsurance, the business of insurance would not have
developed to the extent of the present day growth.

iii) Flexibility : In the absence of reinsurance, insurers would have been bound to limit their
acceptance of risk only up to such an amount which they could possibly digest. In other words, the
insurers would have been unable to accept a risk beyond their financial strength or resources for
that class of business. As a result insurers’ service to the public would also have been limited.
Reinsurance gives flexibility to insurers by creating a condition which enables them to accept a
risk beyond their financial capacity or resources. The insuring community is also left care-free
with regard to various risks to which they are subjected to, irrespective of whatever may be the
value per single risk.

iv) Accumulation : Reinsurance reduces the possibility of getting involved in undesirable


additional risk-load, which is otherwise eminent from the accumulation of risks coming from
different sources. Examples of such accumulation are (a) heavy commitment on the cargoes of the
same vessel (b) heavy commitment on the cargoes lying in the same port possibly because of the
arrival of all vessels at the same time and (c) heavy commitment of an insurer on the property of a
particular hazardous locality from the view point of fire or conflagration fire. It is possible that the
various branches of an insurer, without knowing each other’s position, may commit individually
thereby giving rise to a situation of heavy unbearable commitment as mentioned in (a) (b) or (c)
above. Reinsurance reduces such worries of insurers and keeps down the pressure of accumulation
to a sustainable limit.

v) Development : The growth of an insurance company is particularly dependent on sound


financial standing, which is primarily based on the stability of profit and loss. Profit cannot be
expected if there is an untoward charge on the fund by way of claim which it cannot sustain or for
which there is no provision. Reinsurance tends to stabilize profits and losses and permits more
rapid growth of an insurance company.

vi) Prediction For Rating : An insurer needs to have large number of similar cases in his book for
the purpose of predicting an accurate rating structure. But assuming a large number of similar
risks is in itself undesirable unless some precautionary measure is taken. It may not also be
possible to get a large number of similar cases by an insurer because of the operation of numbers
of insurers in the market. Whatever it is, reinsurance takes care of such a situation in both the
ways. On the one hand it provides protection to the insurer by way of providing unsustainable
losses, and on the other creates a forum of getting large number of similar cases through
reciprocity.

vii) A New Insurer who has recently started transacting insurance business cannot certainly
develop and possibly cannot survive in the absence of reinsurance protection.

viii) Capacity Relief : Reinsurance which allows the company (reinsured) to write the bigger
amounts of insurance.

ix) Catastrophe Protection: The aim of reinsurance is to protect the company (reinsured) from a
large single, catastrophic loss or more than one big losses.

x) Stabilization :It helps to the betterment of the overall operating results of the reinsured’s from
year to year.

xi) Surplus Relief : Reinsurance heals the strain on the company’s (reinsured) /cedent’s surplus
during rapid premium growth.

xii) Market Withdrawal : Reinsurance provides a way for the reinsured company to withdraw it
from a market or business or from a geographic area.

Beyond the above 12 reasons for reinsurance, there might have some other reasons identified in
today’s reinsurance business.

type of general insuarance :-


1) Motorotor Insurance: Motor Insurance can be divided into two groups, two and four
wheeled vehicle insurance.
2) Health Insurance: Common types of health insurance includes: individual health
insurance, family floater health insurance, comprehensive health insurance and critical
illness insurance.
3) Travel Insurance: Travel insurance can be broadly grouped into: individual travel policy,
family travel policy, student travel insurance, and senior citizen health insurance.
4) Home Insurance: Home insurance protects a house and its contents.
5) Marine Insurance: Marine cargo insurance covers goods, freight, cargo, and other
interests against loss or damage during transit by rail, road, sea and/or air.
6) Commercial Insurance: Commercial insurance encompasses solutions for all sectors of
the industry arising out of business operations

Types of LIC Life Insurance:

1)Endowment plan
2)Money Back policy
3)Pension Plan
4Term Insurance
5)ULIP Plan
6)Group Plan
1. Endowment plan:

Endowment Plan is a participating non-linked plan which offers an attractive combination of


protection and maturity benefit. In case of uncertain death of the policy holder LIC offers financial
protection to the family of the insured. Moreover at the time of maturity a lump-sum amount is
paid under this plan.

In this policy declare a bonus every year. The bonus declared is not payable immediately. Bonus is
payable only when the policy matures or in case the policy holder dies.

LIC of India, endowment policies still plays a major role of the insurance policies it sells.

2. Money Back policy:


The money-back policy is a popular insurance policy. It provides life coverage during the period
of the policy and the maturity benefits are paid in installments by way of survival benefits at
regular intervals, instead of getting the lump sum amount at the end of the term. It is an
endowment plan with the benefit of liquidity.

In this policy declare a bonus every year. The bonus declared is not payable immediately. Bonus is
payable only when the policy matures or in case the policy holder dies. The bonus is also
calculated on the full sum assured.

3. Pension Plan:

LIC Pension Plan is most suited for senior citizens and those planning a secure future, so that you
never give up on the best things in life.

This pension plan help the individual to save money for future so that the life can be secured after
the retirement.

4. Term Insurance:

Term Insurance is a protection and traditional plan which provides financial protection to the
insured’s family in case of unfortunate demise with very low investment.

It is a pure life cover policy. Under this policy, against payment of regular premium, the insurer
agrees to pay your beneficiaries the sum assured in event of your premature death during policy
term. However, if you survive till the end of the policy term, nothing is payable to you.

5. ULIP Plan:

Unit Linked Insurance Plan (ULIP) is a combination of insurance as well as investment. In ULIP
returns are depends on investment performance. This ULIP plans are more costly than Term and
Endowment plan. A part of premium paid are assigned towards the life cover, while the remaining
portion is invested in various equity and debt schemes. The way ULIP is performs just like Mutual
Funds.

6. Group Plan:

The Group plan is a protection to groups of people. This scheme is ideal for employers,
associations, societies etc. and allows you to enjoy group benefits at really very low costs.