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SOME IMPORTANT TERMINOLOGIES

REINSURER
Meaning the person, body or company giving reinsurance cover. They protect the interest of
the insurer in case of loss/damage of the property or subject-matter insured and for which
the insure is liable under the policy of insurance.

CEDING COMPANY
Reinsurance is the transfer of insurance business from one insurer to another. The insurer
transferring the business is called the ‘principal’ or ceding or original office and the office
to which the business is transferred is called for ‘reinsurer’ or ‘guaranteeing’ office

CESSION
Means the amount of risk ceded for reinsurances, i.e., the amount reinsured.

RETROCESSION
Means reinsurance of reinsurance. A reinsurer may like to get his interest protected by
further reinsurance and so on.

RETENTION
The refers to the amount of risk retained by the ceding company. The balance us usually
reinsured. The amount of retention is basically dependent on the financial strength of the
ceding company for that class of business.

LINE
A lien is equivalent to retention, i.e., the amount retained by the ceding company. A
reinsurance arrangement is usually expressed in terms of “Line” meaning that if a ceding
company has got a ten-line or twelve-line reinsurance arrangement (TREATY0 it can
automatically cede or reinsure up to ten times or twelve times of the amount retained.

PRIMARY INSURED/ASSURED
This refers to the primary insured (assured) originally insuring the risk at the first
instance. He is one of the parties to the insurance contract and nit in the reinsurance
contract.

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REINSURANCE
Broadly speaking is reinsurance of insurance. Reinsurance is an arrangement whereby an
original insurer who has insured a risk insures a part of that risk again with another insurer.

“Reinsurance is an agreement between the insurance company that originally issues a policy
(the direct writer) and another organization (the reinsurer), the later agreeing to accept a
certain share of the former’s potential liability on the policy.
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“Reinsurance is a contract which one insurer makes with another to protect the first insurer
from risk assumed.”
---- Bethke Vs. Cosmoplitan Life Insurance Co, 262, APP 586

Original insurer
Reinsurance
Or
Agreement The insurer
The direct writer

Original insurance
agreement

The insured person

Figure: Reinsurance process

Reinsurance is the transfer of insurance business from one insurer to another. Its purpose
is to shift risks from an insurer, whose financial security may be threatened by retaining
too large an amount of risk, to other reinsurers who will share in the risk of large losses.

REASONS/FUCTION/ADVANTAGE/PRUPOSE OF REINSURANCE
There are many reasons why an insurance company would choose to reinsure as part of its
responsibility to manage a portfolio of risks for the benefit of its policyholders and
investors:

Risk minimization by spreading

The fundamental concept of insurance is to spread the risk and to reduce the burden of loss
at each stage. Reinsurance enables a risk to be scattered over a much wider area and the
principle of insurance is taken well care of. This really helps in the ultimate viability of
insurance operation.

Risk transfer
To an insurer, the need for reinsurance protection arises in the same way as the insured
needs insurance protection. But for reinsurance, the business of insurance would not have
developed to the extent of the present day growth.

Flexibility
In the absence of reinsurance, insurers would have been unable to accept a risk beyond
their financial strength or resources for that class of business. Reinsurance gives a
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flexibility to insures be creating a condition which enables them to accept a risk beyond
their financial capacity or resources.

Accumulation
Reinsurance reduce the possibility of getting involved in understand additional risk-load,
which is otherwise eminent from the accumulation of risks coming from different sources.

Development
The growth of an insurance company is particularly dependent on sound financial standing,
which is primarily based on the stability profits and losses. Reinsurance tends to stabilize
profits and losses and permits more rapid growth of an insurance company.

A new insurer
Who has recently started transacting insurance business cannot certainly develop and
possibly cannot survive in the absence of reinsurance protection.

Income smoothing
Reinsurance can help to make an insurance company’s results more predictable by absorbing
larger losses and reducing the amount of capital needed to provide coverage.

Surplus relief
An insurance company's writings are limited by its balance sheet (this test is known as the
solvency margin). When that limit is reached, an insurer can either stop writing new
business, increase its capital or buy "surplus relief" reinsurance. The latter is usually done
on a quota share basis and is an efficient way of not having to turn clients away or raise
additional capital.

Arbitrage
The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at
a lower rate than what they charge the insured for the underlying risk.

Prediction for rating

An insurer needs to have large number of similar cases in his book for the purpose of
predicting an accurate rating structure. It may not be possible to get a large number of
similar cases by an insurer in the market. Whatever it is, reinsurance takes care of such a
situation in both the ways.
 Firstly, it provides protection to the insurer by way of providing unsustainable
losses.
 Secondly, it creates a forum of getting large number of similar cases through
reciprocity.

TYPES/METHODS OF REINSURANCE
Broadly, there are three main ways through which reinsurance may be affected. These are:

1. Facultative reinsurance
This is the original form of reinsurance. Participation by reinsurer in a risk is not pre-
arranged through a standing treaty contract. Reinsurance has to be arranged by the insurer
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after getting a proposal of insurance from the would-be insured and preferably before
giving any cover to the proposer. Normally, after getting a proposal for insurance, the
insurer decides as to how much he can retain on that particular risk. If there remains a
balance after retention, he goes to facultative market with the request to make reinsures
interested in the risk. This request is usually made through a slip detailing the particulars
of the risk. It a reinsurer is interested in the risk then he initials the slip clearly indicating
the percentage or amount of risk he is willing to subscribe. In this way the insurer goes
from reinsurer to reinsurer unless 100% of the risk is absorved. It is only then that the
insurer is theoretically safe in issuing a cover to the insured for full amount.

MERITS/ADVANTAGES
I. This type of reinsurance is advantageous to ceding company since it can pick &
choose as to which risks are to be reinsured which risks are not.
II. It is advantageous to reinsurances because they can apply underwriting judgment
case by case and may accept or reject.

DEMERITS/DISADVANTAGE
I. The formality involved in obtaining cover is much more expensive in comparison to
treaty.
II. Lot of inconvenience is envisaged in the procedure involved.

2. Treaty reinsurance
Treaty reinsurance is a pre-arranged agreement whereby the direct insurer cedes and the
reinsurer(s) accepts cessions which a pre-determined limit. The important feature here is
that if cessions are made as per terms of the treaty, the reinsurer(s) cannot refuse to
accept.

TYPES OF TREATIES
Treaties are of various types and the important ones are:

(a) Quota share

This type of treaty requires the direct insurer to code a predetermined proportion
of all its business accepted in a certain class to the reinsurer(s), and the reinsure(s)
also agrees to accept that proportion in return for a corresponding proportion of
the premium.
(b) Surplus treaty
Under this method, the direct insurer agrees to reinsure only the surplus amount,
after its retention, and the reinsurers agree to accept such cession, usually up to a
predetermined upper limit. Surplus treaties are usually arranged in lines, each line
being equal to insurer’s own retention. This means that the insurer can automatically
make a gross acceptance of the risk to the extent of his own retention, plus, the
amount of retention multiplies by the number of lines for which treaty has been
made.
MERITS
I. Cover is automatic as opposed to facultative system.
II. It is less expensive in comparison to facultative.
III. Unlike quota system, the ceding company can retain whatever it likes and the
balance only is ceded.
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DEMERITS
I. It is not applicable for big liability insurance or for protection against losses
of catastrophe.
II. This method is not suitable for new insurance companies.

(c) Excess of loss

Under this system, unlike facultative, quota or surplus, the sum-insured does not
form any basis and it is not expressed in terms of proportion or percentage of the
sum-insured. Here, the insurer first decides as to how much amount of loss he can
bear on each and every loss under a particular class of business. The arrangement is
such that if a loss exceeds this predetermined amount then only reinsurers will bear
the balance amount of loss. Nothing is payable by the reinsurers if the amount of
loss falls below this selected amount. There may usually be an upper limit of liability
of the reinsurers beyond which they will not pay.

(d) Excess of loss ratio

This type of arrangement is also known as STOP LOSS reinsurance and is a bit
difference from the excess of loss arrangement, even though both basically base on
loss rather than sum-insured. Here, a relationship is usually drawn in between the
gross premium and the gross claim over a year in a particular class of business. The
ceding company decides a gross loss ratio up to which it can sustain. The
arrangement with the reinsurers is such that if at the year and it is found that the
total of all losses within the class has exceeded the predetermined loss ratio then
the reinsurers will pay the balance loss so as to keep the loss ratio of the ceding
company within the predetermined ratio. The treaty may contain an upper limit also.

ADVANTAGES OF TREATY METHOD OVER FACULTATIVE

1) The treaty-method provides obligatory and automatic nature of reinsurance
acceptances.
2) The risk commences simultaneously with that of the ceding insurer. Under the
facultative method, the reinsurance cover operates only from the time the reinsurer
accepts the risk.
3) The treaty method involves much less clerical work and costs as compared to the
costs involved in the facultative reinsurance.
4) The rights and obligation of each party are clearly defined in the treaty agreement
whereas in facultative, it has not been so easy.
5) The treaty-methods ensure a constant and regular flow of business.

3. POOL OR SYNDIOSTE METHOD

Under this method, a number of insurers agree to pool together all their business to a
leading office and the payment is made by this leading office. The profit of this association
is distributed amongst the insurers according to their shares to the business.
These pools usually operate in respect of especially hazardous classes of business
or where the market as a whole is weak to absorb the risk. Examples of risks may be crop
insurance, workmen’s compensation insurance act.
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FORMS OF REINSURANCE
Basically there are two forms of reinsurance, irrespective of the type or reinsurance
discussed so far. These are:

a) Participating or Pro-data
Where the proportion of amounts payable by the insurer and the reinsurers in respect of a
loss is determined and agreed beforehand, i.e., before a loss. Here the premium received by
the insurer is also distributed in between himself and the reinsurers in the same
proportions.
For example: facultative, quota share, surplus or pool.

b) Non-proportional
Where the reinsurance is on different terms and the reinsurers do not stand to be
proportionately liable for a loss. Therefore, premium received by the insurer is also not
required to be proportionately distributed to the reinsures.
Examples: Excess of loss treaty, stop loss treaty etc.

Created by, Russel (DIIT)

&
Composed by, Sojib (DIIT)
.