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5/2 M97/February 2018 Reinsurance

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
This chapter features explanations of the following terms and concepts:
Accumulation of loss Aggregate excess of loss Buffer excess of loss Cash call limit

Catastrophic loss event Cession bordereaux Clash excess of loss Common account
Deductible Event limits Excess First loss
Gross net retained premium Gross written Limit of cover Losses occurring during
income (GNRPI) premium (GWP) (LOD) basis
Per risk cover Reinstatement Retention Risk excess
Risks attaching during Stop loss treaty Umbrella excess of loss Working excess of
(RAD) basis loss cover

5
Chapter A Main features and operation of non-proportional

reinsurance treaties

With non-proportional reinsurance the balance of any loss which exceeds an agreed limit will be met by
Balance of any loss
exceeding an agreed the reinsurer, usually up to a contractual maximum. The amount assumed per loss by the reinsured is
limit is met by the variously known as the deductible, retention, the excess or sometimes the first loss. The reinsurer’s part
reinsurer
of the loss is known as the limit of cover, this being the defined amount it will pay in excess of the Reference copy for CII Face to Face Training
amount of loss borne by the reinsured. The contract is for a fixed period.
Let us consider an insurance company 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, that is £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.
Example 5.1
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’s Reinsurance Reinsured’s
retention recovery additional
unreinsured
retention
1 £150,000 £150,000 Nil –
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 excess of loss. In non-proportional reinsurance, a series
of ascending layers may protect an account on a vertical basis and this is called an excess of loss programme.