Page 97 - M97TB9_2018-19_[low-res]_F2F_Neat2

Chapter 4 Features and operation of proportional reinsurance treaties 4/25

F Cession and event limits

Consider this…
Can you think which type of treaty is particularly exposed to natural and other catastrophe perils?

Reinsurers are particularly concerned if proportional treaties are exposed to natural perils that could give
rise to a catastrophic event. We must not forget that many proportional treaties are designed to protect
single risks and not to provide free or underpriced catastrophe exposure on an unlimited basis.
Under all proportional reinsurance treaties, the exposure of the reinsurer on an ‘any one risk’ basis is
defined and limited. In certain countries, there is a substantial risk of an accumulation of losses arising
out of a single loss event. Typical examples of this exposure are losses due to natural perils such as
earthquake, windstorm and flood.
Quota share treaties are particularly exposed to natural perils as an agreed percentage cession must be
Quota share treaties
made on all business falling within the reinsured’s retention. This could involve many private dwellings, are particularly
so any quota share thus exposed could provide substantial catastrophe coverage. Both reinsured and exposed to natural
perils Chapter
reinsurer recognise this exposure and impose special conditions to accommodate it.
It is important, both for the reinsured and the reinsurer, that adequate records are maintained on the 4
total exposure of such natural or other perils to the portfolio. This enables them to arrange adequate
catastrophe excess of loss protection and, at the same time, to control the total amount of business that
they accept.

F1 Cession limits
To assist the reinsured in keeping and maintaining accurate records of total exposures to the portfolio,
procedures need to be in place to monitor the total amount of business accepted and this, in turn,
allows adequate levels of reinsurance to be put in place. The actual amount of the cession limit is
negotiated between reinsured and reinsurer.

Be aware Reference copy for CII Face to Face Training
This is important because there is a special reporting clause known as a cession limit. This requires the reinsured to
advise reinsurers on a periodic basis of the total of all business exposed to natural perils and ceded to the
proportional treaty, be it surplus or quota share. The actual amount of the cession limit will be negotiated between
reinsured and reinsurer and market conditions will dictate the limit that is finally agreed. A lower limit would restrict
the reinsurer’s exposure while also limiting the premium ceded to the treaty.

F2 Event limits
If reinsurers consider that a natural perils event could seriously affect the treaty, then they might impose
another special clause, known as an event limit. The calculation of a proportional treaty event limit will
also be the subject of negotiation between reinsured and reinsurer, but its operation is often far from
transparent.
The treaty event limit acts as a ‘first loss’ limit, beyond which treaty reinsurers would not be liable if the
The treaty event limit
event limit were to be exceeded following a natural perils loss affecting a proportional treaty. Some acts as a ‘first loss’
reinsurers allow the ‘fallback’, or amount greater than the event limit, to be added to the reinsured’s net limit
retained loss for the purposes of any recovery from its catastrophe excess of loss programme. Other
reinsurers state that any ‘fallback’ is not allowed to increase a net retained loss as liabilities could not
be quantified at the negotiation stage of the original catastrophe excess of loss protection, nor any
premium calculated in advance for such additional and unknown liabilities.
The situation is further complicated if both cession and event limits are imposed on a proportional treaty
and the cession limit is exceeded at the date of a natural perils loss, but that natural perils loss remains
within the stated treaty event limit. This raises the question of whether the event limit should be reduced
by the proportion that the cession limit has been exceeded at the date of loss. The reinsured has also
paid reinsurers in good faith for their share of ceded premiums for such amounts that exceed the
cession limit. There are many other combinations, and these examples are deliberately contentious.
Be aware
Cession limits and event limits can be applied separately or in tandem.