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5/4 M97/February 2018 Reinsurance

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 is the effect on the
What will be the company’s net retained premium
administrative costs and how income and does this support its
easy will it be to operate? overall business strategy?

Other factors
influencing
the decision

Is reinsurance required solely to control
exposures to losses or is it required Does the company want to use
5 to assist with other financial reinsurance as a means of
Chapter capacity or easing or meeting solvency by use of reciprocal exchanges?
expanding its book of business
considerations, such as increasing
requirements?

Ease of use
A major attraction of the excess of loss treaty is its simplicity of operation, particularly where the need
A major attraction of
the excess of loss for reinsurance is deemed to be more important for the control of exposure to loss rather than other Reference copy for CII Face to Face Training
treaty is its simplicity financial considerations. The insurer must ensure that its retention and the amount of cover it purchases
of operation
are sufficient to meet its foreseeable needs but after that, it need no 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 reinsurers will be liable for all losses greater than this amount up to
the limit specified.
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.

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?

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
applicable to the exceptionally large claims to the account, of which there could only be very few and
which occur infrequently.
The operation of the principle of a deductible to be 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…
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.