RiskWhat is Risk? Risk describes the uncertainty of the future outcome of a current decision or situation. We have learned to cope with this uncertainty through different means. There are certain risks for which market offers no insurance cover. A risk is only insurable if:
- the loss is accidental
- the law of large numbers applies
- there is no moral hazard
- the cover is allowed by law
Need for ReinsuranceReinsurance is about transferring risk from a primary insurer to a reinsurer. Reinsurance which is contractual arrangement that transfers some or all of the potential costs of insured losses from policies written by one insurer to another insurer. The insurer that transfers the loss exposures is the primary insurer and the insurer that accepts the loss exposures is the reinsurer. Some reinsurers are companies or organizations that specialize in the reinsurance business. Other reinsurers are also primary insurers that enter into reinsurance arrangements with other insurers. A primary insurer might buy reinsurance for a variety of reasons. One of the most important reasons is that reinsurance permits the primary insurer to share its exposures with the reinsurer. For example, an insurer that writes a large amount of property insurance in the seismic prone area can use reinsurance to reduce its exposure to claims from its insured arising from earthquake damage to their property. Reinsurance also enables a small insurer to provide insurance for large accounts, whose insurance needs would otherwise exceed the insurer’s capacity. For example, suppose a primary insurer writes a commercial liability policy for a large company that manufactures hazardous chemicals. Since the potential for heavy liability losses resulting from injuries caused by leakage of this chemical is great, the primary insurer might arrange with a reinsurer to cover all of its liability losses for this insured over a certain amount, such as INR 1 million. Therefore, the primary insurer and the reinsurer are sharing the liability loss exposures for this insured.
Purpose of Reinsurance
- A mechanism of spreading losses
- Increasing capacity to handle larger risks
- Stabilizing operating results from year to year with reinsurer absorbing larger / catastrophic losses
- Increasing the chances of making profit by reinforcing the underwriters attempts to establish an account which is homogenous in both size and quality of risk
- Ability to write untested and new risk exposures
Arranging ReinsuranceWith reinsurance the reinsurer receives a portion of the premiums from the primary insurers’ policies and assumes some of the losses on those policies. The primary insurer usually retains portion of the premium and pays that insured losses on reinsured policies and is then reimbursed by the reinsurer for losses for which the reinsurer is contractually responsible. If reinsurance is readily available, insurance companies can increase the number of new policies they write by transferring some of the premium and loss exposures to reinsurers. Thus, the availability of reinsurance can affect an insurance company’s capacity to write business. There are two broad categories of reinsurance: treaty reinsurance and facultative reinsurance: Treaty reinsurance is an arrangement whereby a reinsurer agrees to reinsure automatically a portion of all eligible insurance of the primary insurer. It is blind – risk wise details not revealed. The treaty is a contract that defines the eligible insurance. The primary insurer is required to reinsure, and the reinsurer must accept, all business covered by the treaty. There is no individual selection of policies. Primary insurers and reinsurers periodically renegotiate the agreement on which treaty reinsurance is based. Before entering into a treaty and agreeing on pricing arrangements, the reinsurer carefully evaluates the primary insurer’s past performance and expected future underwriting results. Because the treaty is based on all eligible insurance written by the primary insurer, the reinsurer is more concerned with the group of insured as a whole that with individual accounts that compose that group. Facultative reinsurance is not automatic but involves a separate transition for each reinsured policy. That is, the reinsurer evaluates each policy it is asked to reinsure. Underwriters for the primary insurer decide which policies to submit for reinsurance, and underwriters for the reinsurance company decide which policies to reinsure. Pricing terms and condition of each policy are individually negotiated.
Proportional & Non-Proportion Treaty
- Proportional Treaties are based on sharing of risks which is defined either in ‘%’ or ‘lines”. Proportional treaties protect risk exposure. Premiums and losses are shared in the proportion that the reinsured’s retention and the reinsurer’s share bear to the sum insured of the risk.
- Quota Share Treaty is an automatic reinsurance whereby the reinsured cedes a fixed percentage of every risk.
- Surplus Treaty is an automatic reinsurance whereby the reinsured cedes the surplus over and above its retention on every risk and limit of cession to the treaty as number of ‘lines’.
- Non-proportional Treaties are based on sharing of losses. Non-proportional treaties protect loss exposure as incurred by reinsured. Insurer does not cede risks, but seeks protection against actual losses on risks as and when they may occur. Reinsured agrees to retain a loss up to a certain amount and the Reinsurer agrees to pay the excess loss, up to a certain specified amount. Types of non–proportional arrangements are Risk Excess of Loss, Event Excess of Loss (CAT Losses), Stop Loss.
Implementation of claims handling proceduresWhat do well-designed claims handling procedure look like? No matters that sort of claim we are considering, there are certain features that all claims handling operations must incorporate. They must be able to:
- Accepts claim notifications;
- Verify policy liability
- Record claims details on the insurer’s IT system;
- Accurately reserve in respect of claims notifications;
- Pay valid claims quickly; and
- Pursue recoveries (including reinsurance recoveries)
Reinsurance Claims proceduresReinsurance Claims Procedure should include a process incorporating communication with reinsurance underwriters. It is essential that reinsurance claims are handled efficiently and adequately in order to:
- Restrict claim payments to those that are properly due under the terms and condition of the particular reinsurance contract at issue and any relevant legal requirements
- Confine claim payment to those which are correctly presented, such as technical accuracy, adequate loss detail, and any required supporting evidence.
- Maintain accurate and representative statistical records of the losses advised settled and reserved in order to meet internal and external reporting requirements, and
- Ensure that all possible recoveries are made from the appropriate retrocessional protections.
Reinsurer’s Claims departmentThe claims department receives its daily claim advices either from a broker or directly from the cedant. A quarterly account is generally used to advise of losses arising from a proportional treaty. As noted above, the nature of a proportional treaty means that if a reinsurer was to pay its share of every loss at the time of settlement with the original insured, the administrative burden of the treaty would be too great. However, certain larger losses, which exceed contractually stipulated amounts, and which reinsurers are generally requested to settle immediately, are notified to reinsurers outside of normal quarterly reporting procedures. The minimum value of a cash loss should be set at a level that avoids the need for reinsurers to make a large number of individual payments, but is not so high as to cause the financial strain for the ceding company. The quarterly account also provides outstanding loss information. Non-proportional or excess of loss treaties generally provide for all losses to be payable by the reinsurers upon receipt of a statement of the settlement of the original loss or within a specified period thereafter. The information provided is of a more specific nature, including individual loss information with applicable outstanding losses. In general terms, the primary responsibility for the handling of losses rests with the ceding company. Reinsurers need prompt advice of losses that may involve them in a significant liability. With regard to proportional treaties, they require sufficient information to enable them to:
- understand the nature of the loss and form a view of liability
- assess the probable cost and
- keep their own retrocessionaires informed about large losses.
ConclusionReinsurance is not merely getting rid of the portion of risk that cannot be retained, rather it is optimization of retention and designing of reinsurance programme, aligning it with the available best practices of the market is a challenge. Reinsurance helps primary insurers in many diversified ways viz., transferring of risks, protection of the balance sheet, underwriting complex and untested risks, providing additional underwriting capacity and many more.
RAVINDRANATH M NAYAK
Faculty & Research Associate National Insurance Academy, Pune