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Chapter 1 Purpose of and the parties involved in reinsurance 1/5 Chapter

Example 1.1 1
A hotel complex with an overall sum insured of £100m is offered to insurer A, which only wishes to retain £20m for
its own account. Placement of the risk can be achieved either with the support of reinsurance or by the use of
co-insurance.

Reinsurance allows insurer A to accept the whole risk and pass on £80m to one or more reinsurers. If a loss occurs
at the hotel complex, insurer A is fully liable up to a maximum of £100m but it can recover up to £80m from its
reinsurers. There is no direct contractual relationship between the hotel complex and the reinsurer(s) and so, in the
event that the reinsurer(s) default on its obligations to insurer A, insurer A would still be fully liable to the hotel
complex up to the total sum insured of £100m.
In comparison, if co-insurance is used and insurer A wishes to accept no more than £20m on this risk, the hotel
complex will have to find other insurers B, C, D and so on to accommodate the remaining £80m in equal or unequal
shares. If a loss occurs, insurer A is only liable up to £20m and the hotel complex would recover other shares of its
loss from the other co-insurers. Each co-insurer, including insurer A, has a direct contractual relationship with the
hotel complex, and so, in the event that the co-insurer(s) default on their obligations, insurer A would only be liable
to the hotel complex for its share of £20m.

A2A Mutual funds/risk retention groups
Some industries set up mutual funds or risk retention groups in order to manage its risks and purchase
reinsurance directly from the reinsurance market if there is a lack of insurance capacity, or such
insurance capacity is only available at prohibitive cost.

Flood Re
Flood Re is a not-for-profit scheme funded by insurers which exists as a result of a joint initiative between the UK
Government and insurers. It aims to help households situated in flood risk areas find affordable home insurance.
Flood Re collects an annual tax from home insurers in the UK and places this into a centrally managed fund. This
allows insurers to pass on the flood risk from policies that are eligible for the scheme to Flood Re. When an insurer
pays a valid claim made as a result of a flood, it is reimbursed from the central fund. Reference copy for CII Face to Face Training

A3 Provides security
Another reason for the purchase of reinsurance is that the insurance company wants to be relieved of
some of the uncertainty of loss. This can be achieved by the purchase of reinsurance, although it is
important of course to check the security of the reinsurer to ensure it is able to fulfil its commitment to
pay in the event of a loss occurring that is recoverable under the terms of the contract agreed between
the insurer and reinsurer.

Consider this…
How can an insurer satisfy itself that a reinsurer it intends using will fulfil its commitment to pay in the event of a
reinsured loss?

A4 Increases stability in results

The insurer can also avoid fluctuations in claims levels from year to year and within a year by the
purchase of reinsurance. Again, parallels can be drawn here between the motives that persuaded the
insured to purchase insurance in the first place.

A5 Increases confidence
We are already beginning to see that reinsurance is not the only option open to an insurance company
Reinsurance is not
that wants to protect its trading position while seizing opportunities to expand its business into new the only option
products and markets, but at the same time growing its core business. Opportunities may exist to
transfer risk into financial markets and investors in insurance companies may invest with confidence –
safe in the knowledge that a number of risk uncertainties have been removed in this way. This can create
a ‘virtuous circle’ for insurers by boosting share price and attracting more investment. That said, insurers
are generally prudent with regard to the choice of risk transfer vehicles and may nevertheless maintain a
certain amount of their risk management in traditional reinsurance carriers.