Page 46 - M97TB9_2018-19_[low-res]_F2F_Neat2

2/6 M97/February 2018 Reinsurance

A disproportionate amount of premium may have to be ceded to reinsurers on small good risks which an
insurer would otherwise prefer to retain net for its own account. As we will see in chapter 4, this problem
can sometimes be overcome by the arranging of specific types of surplus treaties where the reinsured
2 has the option to vary its retention according to its perception of the quality of the risks ceded.
Chapter A3 Distinctions between proportional and non-proportional methods of

reinsurance
Both treaty and facultative reinsurance can be divided between proportional and non-proportional
reinsurance. The different types and how they operate are explained in the next chapters but a basic
introduction is as follows.
Proportional reinsurance is where an insurer cedes a proportion of a risk to the reinsurer who accepts
An insurer cedes a
proportion of a risk that share in the risk, receives the same share of the premium and pays the same share of the claim. So,
if the reinsurer accepts 20% under what is termed a ‘quota share’ of the insurer’s motor account, it
would take 20% of the premium and pay 20% of the claims.
• The original limits of liability, premium and claims are shared between the insurer and reinsurer in an
agreed proportion.
• The treaty is said to ‘follow the fortunes’ of the coverage provided in the original policy.
• Proportional reinsurance can be regarded as a partnership between the insurer and the reinsurer.
• There can be an administrative burden as the reinsured portion of each individual policy has to be
calculated.
• Large premium incomes are generated but profit margins are often small.
• It sometimes contains catastrophe exposure, for which it is difficult to quantify the probable
maximum loss.
• Technically, the exposures are unlimited – that is to say every risk ceded has a claim potential to the
full amount reinsured.
In the case of non-proportional reinsurance, the reinsurer only pays losses when they exceed a specified Reference copy for CII Face to Face Training
retention by the reinsured; this retention is most often expressed as a monetary amount.

Example 2.2
If an insurer’s motor account was protected by a reinsurance of £100,000 excess of £50,000, the reinsurer would
indemnify the insurance company for a loss once a loss exceeded £50,000 but only up to the maximum indemnity
of £100,000, in excess of £50,000, available under the contract for that loss. Any amount in excess of £150,000
would be the original insurer’s responsibility.

• The retention of the reinsured is a monetary barrier before the reinsurers become involved.
• The relationship between insurer and reinsurer tends to be shorter-term than in proportional treaty
relationships.
• The excess of loss premium is calculated for the limit of liability of the treaty, whereas in proportional
reinsurance the reinsurer receives a proportion of the original premium from each policy written.
• Non-proportional reinsurance is easy to administer as individual policies do not have to be considered
separately.
• The premium incomes may be small relative to the level of liability accepted but the profit margins can
be large.
• The loss frequency will vary depending upon the retention and be rated accordingly. However,
underwriting measures taken by the reinsurer can be used to limit exposure. Examples are the
selective use of reinstatement conditions or the use of exclusions. We will look at these aspects again
in chapter 7.
Activity
It is useful to understand the ‘inverted’ relationship between frequency and severity. Using a graph consisting of a
vertical (y) axis representing frequency or probability, and a horizontal (x) axis representing severity, draw a curve
plotting the characteristics of, say, satellite reinsurance losses.