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5/6 M97/February 2018 Reinsurance

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 which the reinsured has
determined that it is prepared to retain itself. Each and every loss which 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.
5 Since there will be a number of policies in the reinsured’s portfolio which have an exposure in excess of
Chapter 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
in the case of this having been incorrectly calculated. Consequently, such treaties are often referred to
as working covers.

Consider this… Reference copy for CII Face to Face Training
Why do you think the term ‘working covers’ is an appropriate way to describe such arrangements?

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 perceived by reinsurers 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 cover
Reinsurance cover
must be designed on must be designed on a per risk basis which means that each loss is regarded separately per risk. Where
a per risk basis 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). 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 which 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.