“Pass on the liability from one to another and so onâ€¦.. That is the trick of Reinsurance”
With this understanding Reinsurance is defined in simple insurance parlance. As “Reinsurance is the insurance of the risk assumed by the insurer”. With the advancements in science and technology, various risk factors emerged, which are more complex in nature with substantial high values at a single location affecting the major properties and liabilities leading to catastrophe and disasters.
These risk factors compel the insurers to reinsure their liabilities with various reinsurers to minimize their financial burden and avoiding such steps can render them into bankruptcy state and they may run out of the business. Reinsurance has gained more importance in the recent years.
The basic functions of Reinsurance are increasing the insurers capacity to handle larger risks by passing to the reinsurer that part of the exposure which the insurer would not normally bear due to constraints of financial capacity.
ï¬ï¬Â Â Â Â Â enhancing ability to accept larger lines than the capital allows.
ï¬ï¬Â Â Â Â Â stabilizing the operating results from year to year with the reinsurer absorbing larger claims or catastrophe losses.
ï¬ï¬Â Â Â Â Â increasing the chances of making a profit by reinforcing the underwriters attempt to establish an account which is homogenous in both size and quality of risks.
ï¬ï¬Â Â Â Â Â ability to write untested and new risk exposures
ï¬ï¬ Â Â Â Â protection of solvency margin of the insurer
Reinsurance becomes effective only if the risks are spread geographically in many countries across many classes. It also help to absorb new risk exposure arising from:
1)Â Â Economic changes
2)Â Â Social changes
3)Â Â Changes in insurance methods
4)Â Â Changes caused by scientific development.
Reinsurance provides a means of communication between the reinsurer and insurer of different market and frequently acts as a catalyst by
ï®Â Â Propagating new forms of insurance,
ï®Â Â Communicating internal experience;
ï®Â Â Suggesting technical restrictions.
They have to decide as to how much retention they should laid down and the same should be reviewed periodically. Reinsurance therefore follows the approved method for a decision and ceded through an approved form of reinsurance.
Various forms of Reinsurance are enumerated below to understand the methods of reinsurance.
1)Â Â Facultative Reinsurance:
This is a method of reinsuring risks on an individual basis where the insurer has no obligation to cede a risk from an original insured and reinsurer has the option of accepting or declining each proposal. Facultative reinsurance may be transacted on proportional or non proportional basis when reinsuring facultative, the insurer may obtained reinsurance coverage before accepting to insure a client for two reasons.
a)Â Â to ensure that the reinsurance terms do not exceed those applying to the direct insurance, and
b)Â Â to backup the judgement of the original underwriter at the insurer’s office who will often benefit from the reinsurer’s knowledge of a particular risk or class of risk.
In the initial stage, all reinsurance were transacted facultative but because of high administrative costs this method had largely been replaced by treaty insurance. Its flexibility has resulted in an increase in its use to reinsure hazardous risks not protected by treaty arrangements, to reduce the liability to treaty reinsurer on certain risks, to reduce the insurer’s liability on a certain area, to provide extra capacity and to obtain the reinsurer’s advice on doubtful risks.
This method consists of an arrangement between the original insurer and reinsurer whereby the reinsurer automatically accept a certain liability for all risks falling within the scope of the agreement. This is an obligatory contract in which each party foregoes certain rights. The reinsurer may not decline risks falling within the scope of the agreement. The insurer must allow all risks coming within the scope to be covered.
This treaty specifies monetary limits, mode of operation, classes of business to be covered, the territorial scope, the risks excluded, calculate and payment of premium and claims and the period of agreement. Being automatic cover, the insurer is guaranteed a definite amount of protection every risk which the reinsurer accepts. Even the administrative costs are also much lower than applicable to facultative reinsurance. This treaty arrangement is now well known and spread all over the world covering various risks at various locations.
Some reinsurers are hesitant to adopt treaty reinsurance and hence they evolved a different form of reinsurance by way of facultative obligatory treaty.
Facultative obligatory treaty:
This form is a combination of facultative and treaty forms,whereby the ceding insurer may cede risks of any agreed class of insurance which the reinsurer must accept if ceded. This form is rarely invoked during weak reinsurance market conditions and is therefore insecure. Ceding commission is also very meager because of lack of premium to loss exposure balance and spread of portfolio.
This form is generally used to facilitate writing of high value exposure or to deal with high accumulation and generally adopted after exhausting existing automatic arrangement for reinsurance cessions. The most popular and widely adopted form of reinsurance are proportional treaties in the form of
i)Â Â Â Surplus and
ii)Â Â Quota share
Under a surplus treaty, the ceding insurer decides the limit of liability which the ceding insurer wishes to retain on any one risk or class of risks. This limit i.e. the ceding company’s retention will be the maximum to retain but may also actually retainÂ lesser amount as commensurate to risk exposure. The surplus over and above the retention will be allotted to one or more reinsurer normally expressed in the number of ‘lines’ it contains. A line is equal to the ceding company’s retention, for e.g. if a ceding insurer has a ten lines surplus treaty on the basis of maximum retention over and above each line, surplus treaty will take care of the liabilities of the ceding insurer. In this form of reinsurance, limits of surplus can be determined on the basis of (1) Sum Insured and (2) PML.
PML limit adds efficiency to retention which means Probable Maximum Loss. This in turn has a direct bearing to the sum insured under the policy. The facilities extended to this form of reinsurance viz. high commission including profit, overriding commission, wider reinsurance cover including provision in the treaty for large claims and catastrophe even to the extent of immediate cash loss settlement.
This treaty is an automatic reinsurance arrangement whereby the ceding insurer is bound to part with a fixed percentage of every risk written by it. The same percentage is applied to every risk to determine cession in the class of insurance as reinsured, irrespective of whether risk is good or bad, sum insured small or large.
In this form percentage of reinsurance is fixed and not varying as in case of surplus. This form also attract a higher rate of commission and adopted only for short term specialized requirements. Hence, the ceding insurers prefer a combination of quota share and surplus, which is beneficial to both ceding insurer as well as reinsurers.
Another forms of reinsurance are non proportional treaties, namely
i)Â Â Â Excess of loss
ii)Â Â Excess of loss ratio (Stop loss)
Excess of loss:
Under this form of reinsurance, the reinsurer is not liable until a loss is admitted by the insurer and it exceeds his retention limit. Over and above retention, the reinsurer pays the amount in excess of retention upto the limit of treaty. Balance of loss over and above the total retention and treaty reverts to the ceding insurer. It means ultimate net loss is accepted by the reinsurer. The fixing of the limit will also depend on what type of excess of loss cover is required working or per risk covers and catastrophe cover.
Per risk cover is also known as working excess of loss cover to reduce the insurer’s loss in respect of a single risk.
Under this type of excess of loss protects the insurer against unknown accumulation arising out of one event. The retention under this type of excess of loss it is normally more than the amount retained under each individual risk.
The reinsurer may quote a flat rate as a percentage applied to the gross premium income of the insurer. However, under this treaty, due to erratic claims experience the burning cost basis is gaining in popularity especially in the liability classes. Even loading is intended to provide margin for worsening claim experience, management expenses and reinsurer’s profit.
The rating basis is subject to a minimum rate to safeguard the reinsurer and a maximum rate to safeguard the insurer. Excess of loss reinsurance is designed primarily to protect the insurer against large losses. This stabilizes the operating results by spreading the heavy losses over a number of years.
Stop loss (excess of loss ratio)
Under this reinsurance, the reinsurance covers losses incurred by an insurer in a particular class of insurance business when the insurer’s annual loss exceeds an agreed percentage of the earned premium income for that class. The insurer’s losses are totaled and any loss, no matter, how small over and above the agreed loss ratio is paid. The reinsurance limits and the insurer’s retention expressed as percentage by Way of monetary limit.
This treaty is designed to protect an insurer from an aggregation of small losses or in those classes of business where it is difficult to establish losses as being due to one or more causes. Generally, Agriculture classes of insurance are commonly protected by this form of cover. This treaty is an consideration in establishing the retention to maintain the insurer’s average expense ratio although it does not guarantee profit.
This treaty applied to one particular risk since certain risks because of their size and/or nature may be excluded from the scope of an insurer’s automatic reinsurance facilities. In such cases, facultative reinsurance is invoked to retain a fixed loss and this may be arrange don an excess of loss basis.
With the privatization of insurance, the General Insurance Corporation of India, which was a parent body controlling the reinsurance arrangements of its subsidiaries was isolated and established as a separate entity to handle reinsurance business. GIC-Re was renamed as National-Re to underwrite and carryout reinsurance business in India.
IRDA (Insurance Regulatory and Development Authority) was established in 1999 to control and monitor the insurance business activities in India. Reinsurance regulations were passed and notified in the official gazette in 2000 and thus IRDA (Life Insurance-Reinsurance) Regulation, 2000 came into force to regulate the reinsurance business in India.
The regulation laid down the following procedure for reinsurance arrangements :
1)Â Â The Reinsurance Programme shall continue to be guided by the following objectives to :
a)Â Â maximize retention within the country;
b)Â Â develop adequate capacity;
c)Â Â secure the best possible protection for the reinsurance costs incurred;
d)Â Â simplify the administration of business.
2)Â Â Every insurer shall maintain the maximum possible retention commensurate with its financial strength and volume of business. The authority may require an insurer to justify its retention policy and may give such directions as considered necessary in order to ensure that the Indian Insurer is not merely fronting for a foreign insurer.
3)Â Â Every insurer shall cede such percentage of the sum assured on each policy for different classes of insurance written in India to the Indian reinsurer as may be specified by the authority in accordance with the provisions of the Insurance Act, 1938.
4)Â Â The reinsurance programme of every insurer shall commence from the beginning of every financial year and every insurer shall submit to the Authority his reinsurance programmes for the forthcoming year, 45 days before the commencement of the financial year.
5)Â Â Within 30 days of the commencement of the financial year, every insurer shall file with the Authority a photocopy of every reinsurance treaty slip and excess of loss cover in respect of that year together with the list of reinsurers and their shares in the reinsurance arrangement.
6)Â Â The authority may call for further information or explanation in respect of the reinsurance programme of an insurer and may issue such direction as it considers necessary;
7)Â Â Insurers shall place their reinsurance business outside India with only those reinsurers who have over a period of the past five years counting from the year preceding for which the business has to be placed, enjoyed a rating of at least BBB (with Standard & Poor) or equivalent rating of any other international rating agency. Placements with other reinsurers shall require the approval of the Authority. Insurers may also place reinsurances with Lloyd’s syndicates taking care to limit placements with individual syndicates to such shares as are commensurate with the capacity of the syndicate.
8)Â Â The Indian Reinsurer shall organize domestic pools for reinsurance surpluses in Fire, marine hull and other classes in consultation with all insurer on basis, limits and terms which are fair to all insurer and assist in maintaining the retention of Business within India as close to the level achieved for the year 1999-2000 as possible. The arrangement so made shall be submitted to the Authority within three months of these regulations comingÂ into force, for approval.
9)Â Â Surplus over and above the domestic reinsurance arrangements class wise can be placed by the insurer independently with any of the reinsurers complying with sub-regulation  subject to a limit of 10% of the total reinsurance premium ceded outside India being placed with any one reinsurer. Where it is necessary in respect of specialized insurance to cede a share exceeding such limit to any particular reinsurer, the insurer may seek the specific approval of the Authority giving reasons for such cession.
10) Every insurer shall offer an opportunity to other Indian insurers including the Indian insurers including the Indian Reinsurer to participate in its facultative and treat surpluses before placement of such cessions outside India.
11) The Indian Reinsurer shall retrocede at least 50% of the obligatory cessions received by it to the ceding insurers after protecting the portfolio by suitable excess of loss covers. Such retrocession shall be at original terms plus an over-riding commission to the Indian reinsurer not exceeding 2.5%. The retrocession to each ceding insurer shall be in proportion to its cession to the Indian Reinsurer.
12) Every insurer shall be required to submit to the Authority statistics relating to its Reinsurance transaction in such forms as the Authority may specify, together with its annual accounts.
It is now essential to ascertain reinsurance position pre and post privatization of General Insurance.
With the IRDA commencing its regulation of reinsurance, all the insurers have been empowered to exercise their discretion for placement of their insurance business for reinsurance. Reinsurance was arranged by the insurers depending on their financial capacity. However, it is obligatory on the part of all the insurers to place at lease 10% of their aggregate insurance business with the General Insurance Corporation of India for Reinsurance.
IRDA has prescribed maximum retention up to Rs.300 crores liabilities per risk/policy with the ceding insurer. With the Detariffing of insurance premium rats have been reduced to a great extent, as a result, reputed and well-known reinsurers viz. Swiss-Re, Munich-Re lost their interest in Indian General Insurance market. Insurers in India sought the assistance of small time reinsurance brokers for reinsurance.
It is needless to state that if a major catastrophe destruction arise, it will be difficult for the insurers in India to get full-fledged support from reinsurers IRDA as a controlling body have not stipulated any strict guidelines for reinsurance. However certain risks viz Terrorism, Motor Third party liability are reinsured with Indian pool.
With the establishment of IRDA, IRDA took up the task of controlling and regulating reinsurance market in India. It continued to issue more and more licence to the brokers and composite brokers to transact reinsurance business in India. This lead to cutthroat, stiff and unhealthy competition in the reinsurance market. Ignoring the risks factors involved, reinsurance brokers started grabbing reinsurance business. This certainly will have a disastrous effect in the long run, which may put the insurers in crisis.
All said and done, the effect of reinsurance will be reflected only in the long run. Unless insurance market is streamlined, it will be difficult to survive in such situation.
Prior to privatization of General insurance, General Insurance Corporation of India was playing a key role in reinsurance arrangement, although, public sector insurers were given freedom to arrange treaty reinsurance in certain classes of business. With the Tariff Advisory Committee, premium, rates were controlled and tariffed.
Reputed and well known foreign reinsurers were showing keen interest in the reinsurance business of Indian market. Public Sector insurers during nationalization were doing the reinsurance as per the guidelines laid down by the General Insurance Corporation of India.
The only fallacy during the nationalization more than 70% of the aggregate total business were reinsured by the GIC and its subsidiaries. Had they retained at least 50% with them, their financial position would have brightened and prospered.
Dependents depending on the depending bodies Should be strong and capableÂ To shoulder the responsibilities of the dependents And if the head fall – the entire dependents collapse.
By : P. V. Sethu, Dy. Manager, New India Assurance Co. Ltd. , Grievance cell, H.O., Published in The Insurance Times, February, 2011Â