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10/6 M97/February 2018 Reinsurance
• The reinsured will have fixed or will wish to fix its retained amount of any one risk, or its retention, at
particular levels. This information is of vital importance to the negotiation of the reinsurance
protection as it indicates the reinsured’s attitude to risk: whether it is cautious or adventurous in its
underwriting policy. Consequently it will be important to establish:
– the amount of the reinsured’s maximum net retention for any one risk and for each class or category
of risk in the portfolio to be protected;
– the relationship between the net retention and the treaty capacity required; and
– the basis on which the net retention and, therefore, the treaty capacity, is being calculated so it can
be seen whether it is on an original sums insured or an EML basis. Retentions based on original
sums insured have a distinct advantage as the reinsurer knows that it cannot be exposed for an
amount greater than the sum insured. If an EML basis is to be used, the reinsurer must establish
that it is confident in the method that the reinsured is using to calculate its EML figures. Any error in
these amounts leaves the reinsurer exposed for far greater amounts of liability than expressed as
the EML limit.
• The relationship of net retention and treaty capacity to premium income must be established. This is a
prime indicator to the reinsurer of the profit potential of the business being negotiated. For example, if
the premium income on an account is £50,000 and the required treaty capacity is £200,000, it could
take four years to recoup the amount from a single loss, assuming that there were no further losses
and no increase in the premium income. If the treaty capacity was on an EML basis, it could take
considerably longer. In the case of a mixed portfolio of business, it would also be reasonable to expect
this breakdown of premium income to be available for each category or class of risk.
• The reinsurer must maintain some degree of control over its own portfolio of liability, the potential for
delayed accounting and possible accumulation of risk. Therefore, it would be considered material
information to establish the territorial scope of the business, the potential for aggregation of losses
from natural disaster perils, such as earthquake and windstorm, and whether there will be any
particular exchange controls or trading restrictions that may have an adverse effect on the servicing of
the reinsurance.
Question 10.3 Reference copy for CII Face to Face Training
Why is it in the reinsurer’s best interests to ensure that its own portfolio of business covers as wide a range of risks
and territories as possible?
• In order to give the reinsurer an indication of the potential for profit from the proposed reinsurance,
the reinsured would be expected to provide an exhibit showing the results of the account to be
protected over the past five to ten years. These statistics should show:
– the development of the ceded premium from year to year (written and, if applicable, earned); and
– the incurred losses, preferably split between paid and outstanding
commissions, taxes and charges taken off the premium, and
profit commission (in some circumstances).
• The reinsured should also provide clear instructions as to its requirements in the actual servicing of
the reinsurance. These instructions should cover the following issues:
– Reserves. Will the reinsurance be subject to the establishment of premium reserves and/or loss
reserves?
Be aware
When we refer to a premium reserve we mean the amount of money held by the reinsured relating to premiums
representing the unexpired portions of the policies or contracts as at a certain date. It can be based on a formula of
averages of issue dates and the length of term. A loss reserve is an estimate of the amount the reinsurer expects to
pay for the reported claim and may include amounts for loss adjustment expenses.
10 – As mentioned in chapter 4, section D, in some countries the withholding of reserves is a legal
requirement for the reinsured. The retention of reserve deposits has an adverse effect on the
Chapter – Portfolio transfers. If the treaty is to be subject to incoming and outgoing portfolio transfers of
reinsurer’s cash flow and many underwriters try to resist them.
premiums and/or losses, will the amounts involved be adequate for the liability that is being moved
from one year of account to another?
