A number of different types of reinsurance are available. The two main types are proportional reinsurance and nonproportional reinsurance.
Proportional reinsurance is an arrangement where the reinsurer takes a share of each loss the insurer incurs. This is also sometimes referred to as quota share reinsurance— the risk is allocated by a specified percentage that the ceding company and reinsurer will assume. The capital held by the insurer might only allow it to accept a risk with a value of $1 million but purchasing proportional reinsurance might allow it to, for example, double or triple its acceptance limit.
Four main categories of reinsurance arrangements are considered proportionate reinsurance:
1. Yearly Renewable Term (YRT) reinsurance – YRT
reinsurance permits the ceding company to transfer mortality risk, but leaves the ceding company entirely responsible for establishing reserves. The premium the ceding company pays to transfer the risk to the reinsurer varies each year with the net amount at risk and the ages of the insureds.
2. Coinsurance V – The ceding company transfers a proportionate share of all the policy risks and cash flows except the policy fee. Therefore, the reinsurer receives its proportionate share of premiums, pays its share of benefits, sets up its share of reserves, and pays an allowance to the ceding company. In contrast with YRT reinsurance, coinsurance helps to relieve the strain on the ceding company’s surplus because it is not entirely responsible for setting up the reserve.
3. Coinsurance with funds withheld – The ceding company keeps the premiums normally paid to the reinsurer and the reinsurer keeps the allowances normally paid to the ceding company, hereby limiting the cash flow between the companies.
4. Modified coinsurance – The reinsurer transfers its share of reserves back to the ceding company while the risk remains with the reinsurer. In return, the ceding company must pay interest to the reinsurer to compensate for what the reinsurer would have earned had it retained the reserves.
Both coinsurance with funds withheld and modified coinsurance permit a ceding company to take statutory credit for reserves in certain circumstances, reduce its credit risk, secure credit, and retain control over investments.
Nonproportional reinsurance only pays if the loss suffered by the insurer exceeds a certain amount. This type of arrangement, sometimes, called excess of retention reinsurance, allocates risk by amount. The ceding company sets a dollar amount on the level of risk it is willing to retain and cedes the excess to the reinsurer, up to what is called the reinsurer’s “retention limit.” The retention limit is the maximum amount the reinsurer is willing to assume. In many cases, the reinsurer will itself reinsure risks above its retention limit, thereby permitting the original ceding company to transfer all risks over the level it is willing to assume to the reinsurer who then handles the problem of reinsuring risks even beyond its retention level.
Nonproportionate plans include several different arrangements:
1. Stop loss – The reinsurer covers some or all of a ceding company’s aggregate claims above a predetermined dollar amount or above a percentage of premium during a specified period.
2. Catastrophe – The reinsurer covers losses exceeding a specified amount or number of insureds due to a single event resulting in more than one loss, such as from an airplane crash, train wreck, or natural disaster.
3. Excess of loss – In this form of reinsurance, the insurer is prepared to accept a loss of, say, $1 million for any loss that may occur and purchases a layer of reinsurance of, say, $5 million in excess of $1 million. If a loss of $3 million occurs, the insurer pays $1 million themselves and recovers $2 million from the reinsurer. In this example, the insurer will incur for their own account any loss exceeding $6 million unless they have purchased a further layer of reinsurance.
Companies often reinsure with reinsurance syndicates or groups, rather than with single company reinsurers. The reinsurer who sets the terms (premium and policy conditions) for the reinsurance program is called the lead reinsurer; the other companies subscribing to the program are called follow reinsurers.
The life, health, property reinsurance market is dominated by a small number of very large companies such as Munich Re, Swiss Re, and Berkshire Hathaway, who own several reinsurers including General Re and Faraday in London.
However, there is a wide range of smaller reinsurers who may lead reinsurance programs less frequently but who may often participate as a follow market. Most of the above reinsurance programs or treaties cover every risk accepted by the insurer of the type described in the reinsurance policy. However, companies may purchase reinsurance on a per-risk basis, in which case it is known as facultative reinsurance. The range of companies accepting facultative reinsurance is far wider than those underwriting treaty programs.
Reinsurance companies themselves also purchase reinsurance and this is typically known as retrocessional coverage.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM