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Chapter 4 Features and operation of proportional reinsurance treaties 4/23

Proportional reinsurance has its foundations in ‘sharing’ arrangements – the reinsured and the reinsurer
sharing in the fortunes of the original business. Therefore, if there is an expectation that heavy losses
may be incurred, some form of loss participation clause may be adopted to ensure a more equitable
distribution of the net loss between the reinsured and its reinsurers. This can be explained as a reverse
profit commission situation whereby the loss above an agreed loss ratio would be redistributed so that
the reinsured bears some portion of a very heavy loss rather than the reinsurers bearing the whole
burden.
Example 4.13
In the event that the loss ratio for the treaty exceeds 100%, the reinsured bears 25% of all losses in excess of this
figure.

In order to operate equitably between the reinsured and the reinsurer, any such clause should take a number of
issues into account and seek to establish the obligations of both parties to the contract as unambiguously as
possible. The key points to be addressed and included in any wording are:
• definition of the extent of the reinsured’s liability, for example, ‘If the loss ratio of any treaty year exceeds X% the
reinsured shall bear Y% of the amount by which the loss ratio exceeds X%’; Chapter
• provision for how the loss ratio shall be calculated;
• definition of incurred losses and earned premiums; 4
• the limit of the percentage borne by the reinsured of earned premiums for each treaty year; and
• when any such calculation shall be made.

Such a clause would appear to penalise a reinsured but it should be remembered that the intention is to
redress any unusually heavy loss situation.
Be aware
Should the results improve and the loss ratio fall below the trigger point then the loss participation clause would not
operate. Reference copy for CII Face to Face Training

D Premium and claims reserves

Premium reserves and claims (or loss) reserves are a means by which the reinsured may hold monies
during the term of the treaty for later release to the reinsurer.
The premium reserve deposit is a proportion of the ceded premium whereas the claims or loss reserve
deposit represents the estimated amount of losses outstanding at a given date. The retention by the
reinsured of such deposits is a legal requirement in some countries.
Premium reserves and claims or loss reserves are mainly held in cash or established by a letter of credit
Mainly held in cash or
issued to the reinsured by the reinsurer on funds in a mutually acceptable bank. The letter of credit established by a letter
facility should clearly define the terms on which it is held by the reinsured and its drawing rights of credit
thereon.

D1 Premium reserve deposits

The premium reserve deposit was developed as a safeguard for a reinsured to meet justified claims in
case the reinsurer, for whatever reason, could not meet its obligations.
Consider this…
Think about the impact of the reinsured and the reinsurer being situated in different hemispheres, continents or time
zones. The transfer of monies may be delayed at a time when the reinsured urgently requires funds.

The clause is a legal requirement in some countries, including a number of states in the USA. However, many
reinsurers strongly resist its inclusion.