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Chapter 4 Features and operation of proportional reinsurance treaties 4/27

Key points

The main ideas covered by this chapter can be summarised as follows:
Main features and operation of proportional reinsurance treaties
• There are two main types of proportional reinsurance treaty.
• A quota share treaty is an obligatory ceding treaty where the insurer cedes a fixed percentage of all its risks within
agreed parameters. The reinsurer accepts all the cessions made, usually subject to a maximum amount any one
cession.
• Quota share treaties are used in the following situations:
– where a newly formed company needs a sufficiently large per risk capacity to enable it to attract business;
– where the risks ceded are homogeneous, and have a relatively similar profile;
– where the highest level of ceding commission is required;
– where reciprocal exchanges are required;
– where reinsurers’ support is needed after a period of poor loss experience;
– where it is desired to share risk within a network of subsidiary companies; Chapter
– where financial assistance is required from the reinsurer;
– to reduce net retained income in order to improve or protect solvency requirements; and 4
– to smooth abrupt variations in the loss ratio from one year to the next.
– •However, the effect of facultative carve-outs is to isolate, and treat separately heavy catastrophe exposed risks.
• With surplus treaties, the insurer is obliged to cede all risks greater than its chosen retention within the scope of the
treaty and the reinsurer must accept all such cessions.
• The insurer can arrange second, third, fourth or more surplus treaties if additional capacity is required.
• The insurer may have risks of dissimilar size and quality, and using a surplus treaty allows them to avoid having to
cede the same fixed proportion of each and every risk, as would be the case under a quota share.
• Facultative obligatory (‘fac/oblig’) treaties accommodate the placing of numerous individual cessions.
• With fac/oblig treaties, the insurer at its option chooses whether to cede a risk while the obligation falls upon the
reinsurer to accept all such cessions. Reference copy for CII Face to Face Training
• A fac/oblig treaty operates like a surplus treaty where the available capacity is expressed as a multiple of the
reinsured’s gross retention.
• A fac/oblig treaty may be used to provide additional capacity or to allow a reinsured to maintain sufficiently high
acceptance limits on large or target risks.
Main accounting methods
• Under the underwriting year basis of cover the inception date of each policy issued by an insurer determines the
treaty year to which that policy is ceded.
• A method of accounting has evolved whereby the lengthy underwriting year accounting process has been
shortened in effect to a single year by the transfer of portfolio between the reinsurer of one year and the reinsurer of
the next. This is ‘clean cut’.
• Premium portfolio transfers are used to transfer unexpired liability under a treaty from one reinsurer to another.
Commissions and deductions
• By applying ceding commission to the reinsurance premium the reinsured recovers some of the administration and
acquisition costs incurred in the production of the original portfolio of business.
• The way in which commission is calculated depends on:
– the type of reinsurance arrangement involved;
– the past history of profitability of the account;
– the current state of the reinsurance market; and
– the insurer’s administration and acquisition costs.
• The forms that commissions can take include:
– flat-rate commission;
– profit commission, but calculated on a flat-rate basis;
– sliding scale commission; and
– loss participation or reverse profit commission.