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3/6 M97/February 2018 Reinsurance

Electing to place risks on an excess of loss basis is more beneficial administratively than on a
proportional basis. However, it means that the insurer could be liable for a number of losses that
otherwise would have been shared with its proportional reinsurers.
Example 3.2
Original risk: £60m which is shared equally between insurer A and insurer B with £30m each.
Insurer A has a surplus reinsurance treaty of nine lines with a retention of £3m, so its gross automatic capacity is its
retention of £3m plus 9 lines of £3m, in other words (£3m plus £27m) £30m.
Insurer B has facultative excess of loss reinsurance of £27m excess of £3m. This means that the facultative
3 reinsurance would pay any loss incurred by insurer B that exceeds £3m up to a total of £27m (i.e. giving B cover for
Chapter any original loss it sustains up to £30m).

When any loss to this original risk occurs, whether partial or total, insurer A can expect to recover 90%, or 27/30
from its surplus reinsurer. Conversely, insurer B’s facultative excess of loss reinsurance will only allow a recovery of
any claim where B’s share exceeds £3m.
Consider the following three losses:

Loss 1:£2m
Insurer A can recover 90% of its £1m share, so £900,000.
Insurer B recovers nothing because its £3m retention (or deductible) is not exceeded.
Loss 2: £5,500,000
Insurer A can recover 90% of its £2,750,000m share, so £2,475,000.

Insurer B again recovers nothing because its £3m retention (or deductible) is not exceeded.
Loss 3:£8m
Insurer A can recover 90% of its £4m share, so £3,600,000.
Insurer B can recover £1m because its £3m retention (or deductible) has been exceeded by this amount. Reference copy for CII Face to Face Training

It is apparent from example 3.2 that facultative excess of loss reinsurance is inappropriate for insurer B
if it expects to experience many losses at the lower level.
Estimated maximum loss (EML)
This is a calculation with particular relevance to property insurance underwriting that is intended to
Enables insurer to
calculate the extent of enable the insurer to calculate the extent of a worst case loss which is potentially less than the
a worst case loss maximum value at risk.
The EML is one of the many factors used in arriving at the premium and deciding how much of the risk to
accept, and then retain. It is a reflection of the maximum amount the insurer, and ultimately the
reinsurer, expects to lose in the case of one incident. It may be the total sum insured but is often less
because of risk characteristics such as incombustible materials used in construction, the installation of
sprinklers, the distribution of the risk over a wide area and the ‘compartmentalisation’ of the premises
into separate fire risks. For example, a factory could comprise three separate units, where each unit has
a sum insured of £3m. If there is space of at least 12 metres between each unit, the estimated maximum
loss would be assumed to be £3m, rather than £9m, because of the unlikelihood of a fire travelling
between each unit.
The EML calculation is not scientific, but can be a useful tool in assisting insurers and reinsurers in
arriving at an estimate of how much they can expect to lose and, therefore, how much of the risk they
may reasonably decide to accept. As far as the original insured, the client, is concerned, the insurers are
liable for the whole risk.