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Chapter 5 Features and operation of non-proportional reinsurance treaties 5/7

The insurer thus wishes to protect its gross retained liability per risk of £50m by means of a working
excess of loss reinsurance of £45m in excess of £5m per risk. Therefore, for all risks that the insurer
writes under £50m, which would theoretically go to its net account (as the surplus reinsurance would not
operate on risks under £50m) the insurer would retain the first £5m of any loss from each risk and the
further £45m of any loss from each risk would be covered by the working excess of loss reinsurance.
Risks greater than £50m would have to be ceded to the surplus in proportion to the size of the risk and
the loss would have to be recovered in accordance with the ceded proportion.
Example 5.5 takes this premise a stage further.

Example 5.5
Risk X: sum insured £120m; gross loss £20m
Loss to surplus treaty: £20m × (£70m/£120m) = £11.66m
Loss within retention (before excess of loss): £20m × (£50m/£120m) = £8.34m
Excess of loss: £8.34m – £5m = £3.34m
Therefore, the insurer would pay £5m of the loss which is its retention under the excess of loss, the excess of loss
reinsurer pays £3.34m and the surplus reinsurer £11.66m, equalling the gross loss of £20m.
Risk Y: sum insured £40m; gross loss £12m
Loss to surplus treaty: £12m × (0/40) = 0
Excess of loss: £12m – £5m = £7m

Therefore, the insurer would pay £5m of the loss which is its retention under the excess of loss, the excess of loss Chapter
reinsurer pays £7m and the surplus reinsurer would pay nothing, as the original risk was not ceded to the surplus
reinsurance as it is within the insurer’s risk retention. 5
If both the losses affecting Risk X and Risk Y can be attributed to the same event, the direct insurer must itself bear
the deductible of £5m per risk twice. On the other hand, the reinsurer also grants the per risk excess of loss cover
twice where two or more covers have been agreed.

Common account protection Reference copy for CII Face to Face Training
While accepting that excess of loss reinsurance was designed to protect an insurer’s net account either Refer to chapter 3,
section A3A for
in conjunction with proportional treaty arrangements or as the only form of reinsurance purchased, it common account
might be necessary to arrange protection for the account of both the reinsured and its proportional reinsurance
reinsurers. This is known as common account reinsurance. It may be because the treaty reinsurer’s own
retrocessions do not provide the necessary protection or because the treaty is unduly exposed by certain
risks falling within its scope. The provision of such protection could also make the treaty more attractive
to prospective treaty reinsurers.

Common account arrangements occur most frequently with quota share treaties as there is a consistent,
Occur most frequently
direct involvement between the parties participating in the reinsurance and the original insurances. Both with quota share
parties to the proportional treaty share the benefits brought by excess of loss protection for the common treaties
account. The cost of the common account cover is also shared, although, occasionally, the reinsured
pays for this in its entirety.
Example 5.6
An original insurer has a quota share proportional treaty to which it cedes 40% of its business. The total liability to
both parties can still be very high, especially in the case of a number of claims all arising from the same ‘event’ or
accumulation of circumstances. The insurer may decide that it wants to limit its liability, irrespective of the existence
of the quota share treaty, and buy extra non-proportional cover. On the other hand, the insurer and the quota share
reinsurer may agree to purchase the cover to protect both their interests (for the ‘common account’). The protection
for them would be on a non-proportional treaty basis, noting the interests of the insurer and its interested reinsurer.
Figure 5.1 shows how this arrangement looks when expressed diagrammatically.