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Chapter 1 Purpose of and the parties involved in reinsurance 1/3 Chapter

A1 Spreads risk 1
Insurance was developed to cover people for a risk that they could not avoid, to protect them from the
financial consequences of that risk and – in contracts of indemnity – to put them in the same financial
position that they were in immediately prior to the loss.

Reinforce
Remind yourself from earlier studies of the difference between a contract of indemnity and one offering set benefits.

The risk transfer options available are illustrated in figure 1.1.

Figure 1.1: Risk transfer options

Risk

Avoid Prevent Limit Transfer Accept/retain

Sprinklers/ Solid Put up
Live in a cave Insure
extinguishers construction with a loss

In much the same way, although an insurance company cannot avoid risk, it must take on risk in order to
An insurance
earn premium. This is, after all, the insurer’s core business. Therefore, in a similar way an insurance company must take
company will consider its own attitude to risk. on risk in order to Reference copy for CII Face to Face Training
earn premium
Figure 1.2: Insurers’ risk transfer options

Risk

Avoid Prevent Limit Transfer Accept/retain

Add Fix retention and Put up
Decline risk Reinsure
warranties limit of insurance with a loss

Losses can arise in different ways. Those which an insurer would wish to avoid or minimise by the use of
Losses can arise in
reinsurance may be of catastrophic proportions and stretch the financial resources of an insurer without different ways
reinsurance to breaking point. Reinsurance acts as a cushion to protect insurers against such
eventualities. Bear in mind that a ‘catastrophic loss’ can mean a very large loss on an individual risk, as
well as a large loss resulting from an accumulation of losses arising from a single catastrophic event.

Consider this…
Which of the above descriptions of ‘catastrophic loss’ best fits the terrorist attack at the World Trade Center (9/11)?