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5/10 M97/February 2018 Reinsurance

If the deductible is too high, the reinsured finds it is paying a larger proportion of its net accumulated
losses than intended. If it is set too low, catastrophe reinsurers may find themselves being called upon
to pay a proportion of the normal losses that can be expected to attach to an account, which is not the
intention behind catastrophe reinsurance protection.
Quantifying the exposure to an accumulation of loss from any particular cause or event – and therefore
the amount of protection that may be required – has always been an exercise that is prone to error.
Example 5.8
An insurer may believe it has a maximum of 1,000 insured properties situated on a flood-prone stretch of coastline
in eastern England with each property having a loss potential of £300,000, giving an overall risk accumulation of
£300m. It arranges catastrophe excess of loss cover in layers of £250m excess of £50m. If its management
information is inadequate or incomplete and it actually has 1,500 insured properties giving an overall risk
accumulation of £450m, it is apparent that the catastrophe cover it has bought is inadequate. This miscalculation
could be for a variety of reasons, including a failure to properly account for additional exposures resulting from
acceptances on inwards reinsurances.

Although modern methods of recording, indexing and collating risks provide the reinsurer with much
more and better information than in the past, the possibility of catastrophic losses from natural perils,
riots and conflagrations is always increasing. This can be as a result of an increasing concentration of
risks subject to such perils due to the development of previously underdeveloped countries or regions.

Question 5.4
5 What other factors contribute to the increasing prospect of catastrophic losses occurring?
Chapter

It may be argued that a company should buy all the protection it can afford, bearing in mind that any
loss exceeding the total amount of cover available from the excess of loss programme will otherwise
have to be retained by the company in addition to its original deductible, thus increasing its overall net
retained loss.
If the company is operating in accordance with sound underwriting principles, there is a danger of being Reference copy for CII Face to Face Training
There is a danger of
being over-reinsured over-reinsured and paying for cover that is, in real terms, unlikely to be used. Although the company’s
total exposure on a sum insured basis may be quite high, the probability of all the policies involved
being total losses as the result of any one particular event will be much smaller. Therefore, the amount
of cover needed should be assessed as carefully as possible.
In the past, subjective judgments have been used to identify the amount of cover to purchase, such as a
simple multiple of the premium income generated by the exposed region or risks. Today, reinsurers
require more detailed information regarding earthquake, windstorm and other natural peril exposure by
region, so that the potential liability can be assessed more accurately. While such procedures may be
costly (in terms of both time and money), they benefit both reinsured and reinsurers in the long run by
eliminating, or greatly reducing, the incidence of buying excessive or inadequate levels of reinsurance
and inexact means of rating.
Determining the amount of catastrophe protection is not the end of the potential problems for the
insurer or for its reinsurers. The protection will respond to claims arising out of a catastrophic event but
deciding whether or not a particular set of circumstances constitutes a catastrophe can be difficult and
can frequently lead to disputes between the reinsured and its reinsurers.

Consider this…
We mentioned earlier that a catastrophic loss event should be located in time and place. Supposing we have an
earthquake that occurs on 1 January and an aftershock takes place six hours later but 100km away from the
earthquake’s epicentre. Do you think that insurers would always treat these as the same or separate events, or
would it depend on the definition of ‘event’?

A2 Stop loss treaties

A stop loss treaty reinsures aggregate losses arising in respect of a specific class or classes of business
rather than individual losses or aggregations caused by an event or occurrence. These types of
protection are long-stop protections and as such, apply after the benefit of all other prior reinsurance.
You may sometimes see stop loss referred to as ‘excess of loss ratio’.