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10/14 M97/February 2018 Reinsurance

Example 10.5
An insurer has a catastrophe per event cover in respect of storm and flood for $6m in excess of $2m, with one
reinstatement. A 72 hours clause applies. A tornado rages for a period of seven days. In the event that the tornado
causes most damage to property at the beginning and end of this period, the insurer will choose to recover for days
one to three and days five to seven. The limit of cover and the retention would apply to each 72-hour period,
assuming that the clause does not exclude reinstatement of cover for the same event.

The number of hours varies from peril to peril; typically, 72 hours is appropriate for earthquake and
The number of hours
varies from peril weather perils. It usually represents the period during which the reinsured has suffered the highest level
to peril of losses. In serious and long-lasting weather conditions there may be more than one claim arising out of
the same major catastrophe or event, but the periods covered by the hours clause must not overlap.
Catastrophe treaties are not intended to cover the loss arising out of a large single risk, such as a multi-
storey office block, which is severely damaged by an explosion, nor the underestimation of the EML for
one risk. Reinsurers try to safeguard themselves by ensuring that the catastrophe deductible is
substantially higher than the working deductible by imposing a two risk warranty on the catastrophe
treaty; more than one risk has to be damaged by the insured peril before the catastrophe treaty will
operate. Alternatively, the reinsurers ensure that the deductible for the event cover will be not less than
that for two or more risks under a per risk or ‘working’ treaty.

Finally, to ensure that the reinsured maintains acceptable underwriting standards, does not retain an
irresponsibly small portion of any loss, and settles the loss in a responsible fashion, some catastrophe
reinsurers insist that the company co-reinsures in all layers of its own catastrophe programme, usually to
an extent of between 2.5% and 5%. This also ensures that the catastrophe is apportioned throughout the
market.
Catastrophe covers also have a limited number of reinstatement provisions, which only allow the cover
to be hit by a certain amount of loss before it is exhausted. For catastrophe excess of loss, it is usual to
limit the reinstatement to one at 100% additional premium.

C4 Stop loss Reference copy for CII Face to Face Training

Stop loss is particularly suitable for those classes which are subject to volatile loss ratios; for example,
Particularly suitable
for those classes the insurance of crops against hailstorm as one storm could destroy a whole year’s crop and result in a
which are subject to disastrous underwriting result.
volatile loss ratios
The reinsured needs some form of protection which enables it to maintain an acceptable loss ratio if the
results for a particular year are adverse. A stop loss treaty (sometimes referred to as excess of loss ratio)
can be arranged to meet this eventuality. The purpose of the cover is to restrict the annual aggregate
losses to a predetermined percentage of the annual premium. The cover operates after all other
reinsurance recoveries have been made and the reinsured usually has to be in a loss position.
To ensure that the reinsured maintains prudent underwriting standards, it will be expected to participate
in any loss to the cover to the extent, say, of 10%. So that the reinsurer’s liability does not fluctuate
widely with variations in the reinsured’s premium income, a monetary limit is usually specified in
addition to the percentage figures.
Example 10.6
A stop loss treaty designed to protect an account with an estimated net premium income of $10m for the year may
provide cover for 90% of 30% of net premium income or a maximum payment by the reinsurer of 90% of $3.3m
whichever the lesser in excess of 120% of net premium income or $10.8m whichever the greater.

C5 Rating methods
Having introduced the main approaches to reinsurance pricing in chapter 6, section B, we look here at
examples of the burning cost method and the exposure method. We also review the key considerations
10 in the rating of non-proportional treaties.
Chapter C5A Burning cost method

The pure burning cost of a layer of reinsurance cover can be calculated by expressing the losses for
which the reinsurer would have been liable as a percentage of the premium income for the account
being protected. Although this provides a basic factor for assessing the potential rate for the excess of
loss cover, especially for low level and working covers, other considerations need to be applied, for
example: