CONCEPT OF REINSURANCE

 The Insurance companies generally take risks of insured in return for the premium. We know that these insurance companies are also prone to various types of risks.

Since they are engaged in Financial Services and hence risks related to finance is huge in modern scenario. These risks increase more and more after liberalisation of our economy. So, one of the most important acts of these insurance companies are to serve its Policyholders by safeguarding itself from various types of risks.

Unless the insurance companies manage their risks, they will not be in a position to effectively deliver their values to the customers and stay afloat in the business to achieve their goal. Thus, the risk management will be the most important aim of these insurance companies.

Reinsurance

The Australian Standard of Risk Management defines risk management as “The culture, processes and structure that are directed towards realising potential opportunities whilst managing adverse effects.”

There are various methods for reduction and mitigations of risks. Transfer of Risks is the one of them. The concept of Re-Insurance emerges, when an insurance company transfers some of its risks to another insurance company.

It is the insurance that is purchased by an insurance company (the “Ceding Company”) from one or more other insurance companies (the “Reinsurer) as a means of Risk Management.

The Ceding Company and the Re-insurer will enter into a Re-insurance Agreement which details the conditions upon which the reinsurer would pay as share of the claims incurred by the Ceding Company. The Re-insurer may be either a Specialist Re-Insurance Company (General Insurance Corporation of India) or can be another insurance company. 

TYPES OF REINSURANCE:

There are two types of reinsurance contracts;

i) Facultative Reinsurance; and

ii) Treaty Reinsurance.

LEST ‘S DISCUSS;

i) FACULTATIVE REINSURANCE: This type of Policy protects an insurance provider only for an individual, or a specific risk, or contract. If there are many contracts for reinsurance, then all shall be negotiated seperately by Ceding Company with Re-insurer. The Re-insurer has all right to accept or deny a facultative reinsurance proposal.

In this type of agreement, the Ceding Company (Primary Insurer) identifies which risks it wants to cover and which risks will be ceded to the reinsurer.

This type of reinsurance is less common because each policy is offered and considered on an individual risk basis.

Facultative reinsurance normally is purchased by insurance companies for individual risks not covered by their reinsurance treaties, for amount in excess of the monetary limits of their reinsurance treaties, and for unusual risks. Each facultative policy issued delineates the terms of each risk that is reinsured.

From above we can draw a conclusion that “Facultative Reinsurance is a case-by case reinsurance where each individual risk before acceptance, and exceeding the retention of the direct insurer, is presented to the reinsurer. Both the Direct (Ceding) Insurer and the reinsurer are free to present or accept the risk.

The Underwriting Expenses, and in particular personal costs, is higher for such business because each risk is individually underwritten and administered. Because the reinsurance underwriters have to evaluate each risk seperately and access accurately the risk involved in the policy. 

ii) TREATY REINSURANCE; it means Ceding Company and the reinsurer negotiate and execute a Reinsurance Contract. The reinsurer then covers the specified share of more than one insurance policy issued by the Ceding Company which comes within scope of that contract.

The Reinsurance Contract may oblige the reinsurer to accept reinsurance of all contracts within the Scope (know as “Obligatory” Reinsurance), or it may allow the insurer (Ceding Company) to choose which risks it wants to cede, with the reinsurer obliged to accept such risks (known as “Facultative Obligatory”).

After negotiations a Treaty (Reinsurance Contract) is issued by the reinsurance company to the Ceding Company reinsuring more than one policy.

A Treaty Reinsurance is a Partnership in which the insurer and reinsurer share risks at an agreed -upon level. Reinsurance Treaties can either be written on a “continuous” or” Term” basis.

A continuous contract has not predetermined end date, but generally either party can give 90 days’ notice to cancel or amend treaty.

LET’S UNDERSTAND TYPES OF TREATY REINSURANCE CONTRACTS

Treaty Reinsurance

Proportional Reinsurance

Non-Proportional Reinsurance

Quota Share Surplus Share Excess of Loss Stop Loss

i) PROPORTIONAL REINSURANCE; Under this type of reinsurance, the reinsurer will receive a prorated share of the premiums of all policies sold by the Insurance Company (Ceding Company) being covered and hence when claims are lodged the reinsurance company will bear portion of losses.

in proportional coverage, the reinsurance company will also reimburse the insurance company for all processing, business acquisition and writing costs. This is known as Ceding Commission. Proportional Reinsurance spreads the risk of loss and creates a broad identity of interests between the Cedent and the reinsurer, which effectively co-venture in relationship to their relative shares of the risk, even though only the cedent has contractual privity with the Direct Insured.

a) Quota Share Reinsurance

Under Quota Share Reinsurance, a fixed percentage of business premiums is shared with the reinsurer for the fixed percentage of claim.

Example: lets consider if there is a Rs. 100 loss under 75% Quota Share Reinsurance Contract, the Cedent would bear only Rs. 25/- of the loss and the reinsurer concurrently would bear Rs. 75/- of that loss.

In this contract percentage always shown the percentage of risk borne by the reinsurer. The portion of the risk that the reinsurer assumes is called the “Ceded Risk” and the portion that the Cedent keeps is referred to as the reinsurance “Retention”. 

b) Surplus Share Reinsurance

This is similar to Quota Share Reinsurance, but differs in that the portion of the reinsured policy the direct insurer retains is expressed as a fixed monetary amount, and the reinsurance may or may not apply from first rupee (i.e. the reinsurance may apply only in excess of the fixed Rupees  amount or the cedent and reinsurer may together share losses as they are incurred until the cedent incurs and amount equal to its overall retention).

Under a Surplus Share Agreement, the ceding company decides on a “Retention Limit”, – Lets consider there is Retention Limit of Rs. 100000 in a Policy reinsured. In this case the Ceding Company will retain the full amount of each risk, with a maximum Rs. 100000 per policy or per risk and balance will be transferred to the reinsurer. 

ii) NON-PROPORTIONAL REINSURANCE in this type of coverage the reinsurer will only get involved if the insurance company’s loss exceeds a specified amount, which is referred to as priority or retention limit.  

In this case the reinsurer does not have a proportional share in the premiums and losses of the insurance provider. The priority or retention limit may be based on a single type of risk or an entire business category.

a) EXCESS OF LOSS;

It can be;

i. Per Risk XL”

ii. Per Occurrence or Per Event XL

iii. Aggregate XL or Stop Loss

In Per Risk- the Cedent Insurance Policy limits are greater that the reinsurance retention.

Let’s consider an insurance company insured a Commercial Property with Policy Limits up to Rs. 1.00 Crore and then buy per risk reinsurance of Rs.50.00 Lakhs. If claim lodged for loss of Rs.60.00 Lakhs, in this case the Cedent Company has to bear Rs. 50.00 Lakhs and Rs. 10.00 Lakhs will be recovered from reinsurer.

In Catastrophe Excess of Loss- the Cedent’s retention is usually a multiple of the underlying policy limits, and the reinsurance contract usually contains a two-risk warranty (i.e. the are designed to protect the cedent against catastrophic events that involved more than one policy).

b) STOP LOSS: this is a product that provides protection against catastrophic or unpredictable losses. It is purchased by employers who have decided to self-fund their employee benefit plans, but do not want to assume 100% of the liability for losses arising from the plans.b. 

Under a Stop Loss Policy, the insurance company becomes liable for losses that exceed certain limits called deductibles.  

Companies providing health insurance for their employees through a self-insured plan often subscribed to stop loss policies in order to protect themselves against catastrophic claims.

Conclusion:  Insurance Companies are treated in category of Financial Institutions. They are custodian  of money received from Policyholders. They generally trade risks of others in lieu of payment of premium. Generally insurance contracts lasts more than one year and hence protection of interest of all stakeholders are important. We know that risk will come with money and to reduce or mitigate this risk and to keep insurance companies going on in the market they need to have a good Risk Management System.

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Disclaimer: The entire contents of this document have been prepared on the basis of relevant provisions and as per the information existing at the time of the preparation. Although care has been taken to ensure the accuracy, completeness, and reliability of the information provided, author assume no responsibility, therefore. Users of this information are expected to refer to the relevant existing provisions of applicable Laws and take appropriate advice of consultants. The user of the information agrees that the information is not professional advice and is subject to change without notice. Author assume no responsibility for the consequences of the use of such information.

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