Reinsurance in property and liability insurance
There are two essential ways in which risk is shared under reinsurance agreements in the field of property and liabity insurance.
The reinsurance agreements may repuire the reinsurer to share in every loss that occurs to a reinsureed risk,or it may require the reisurer to pay only after a loss reaches a certain size.
Quota share treaties and surplus treaties fall in the first category,while excess-loss treaties comprise the second.
•HEADING A
Under a quota share treaty,the direct-writing company and the reinsurance company agree to share the amount of each risk on some percentage basis.
Thus,the ABC Mutual Insurance Company(the direct writer)may have a 50% quota share treaty with the DEF Reinsurance Company(reinsurer).
Under such an agreement,the DEF Reinsurance Company will pay 50% of any losses arising from those risks subject to the reinsurance treaty.
In return the ABC Mutual Insurance Company will pay the DEF Reinsurance Company 50% of the premiums it receives from the insureds.
(with a reasonable allowance made to ABC for the agent's*commission and expenses connected with putting the business on the books).
•HEADING B
Under a surplus treaty,the reinsurer agrees to accept some amount of insurance on each risk in excess of a specified net retention.
Normally,the amount the reinsurer is obligated to accept is referred to as a number of "lines" and is expressed as some multiple of the retention.
A given treaty might spectify a net retention of $10,000,with five "lines."
Under such a treaty,if the direct writer writes a $10,000 policy,no reinsurance is involved,
but the reinsurer will accept the excess of policies over $10,000 up to $50,000.
These treaties may be "first-surplus treaties","second-surplus",and so on.
A second-surplus treaty fits over a first-surplus treaty,assuming any excess of the first treaty,and so on for a third or fourth treaty.
To illustrate,let us assume that the ABC Mutual Insurance Company,
has a first-surplus treaty with a $10,000 net retention and five lines with the DEF Reinsurance Company and a second-surplus treaty with the GHI Reinsurance Company,also with five lines.
If ABC sells a $100,000 policy,it must,under the terms of both agreements,retain $10,000.
The DEF Reinsurance Company will then assume $50,000 and GHI will assume $40,000:
ABC Mutual Insurance Company $10,000
DEF Reinsurance Company 50,000
GHI Reinsurance Company 40,000
Any loss under this policy would be shared on the basis of the amount of total insurance each company carries.
Thus,ABC would pay 10% of any loss,DEF would pay 50%,and GHI would pay 40%.
The premium would be divided in the same proportion,
again with a reasonable allowance from the reinsurers to the direct writer for the expense of putting the policy on the books.
•HEADING C
Under an excess-loss treaty,the reinsurer is bound to pay only when a loss exceeds a certain amount.
In essence,an excess-loss treaty is simply an insurance policy that has a large deductible taken out by the direct writer.
The excess-loss treaty may be written to cover a specific risk or to cover many risks suffering loss from a single occurrence.
Such a treaty might,for example,require the reinsurer to pay after the direct-writing company had sustained a loss of $10,000 on a specific piece of property,
or it might require payment by the reinsurer if the direct writer suffered loss in excess of $50,000 from any one occurrence.
There is,of course,a designated maximum limit of liability for the reinsurer.
Insurers get that sinking feeling
WHETHER insurers have hearts is debatable.
But if they do,the date of August 24th 1992 is surely etched indelibly upon them.
That was the day that Hurricane Andrew blew its way through Florida and Louisiana and into the record books,
leaving insurers with a repair bill of over $15 billion.
Reinsurers-sellers of insurance to insurers-ended up footing much of that bill.
As a result,they swore that they would introduce discipline into an industry notorious for relying on gut instinct rather than actuarial tables.
Notably,there would be a re-think of traditional underwriting methods.
Two years on,however,little has changed.
At first,the hurricane provoked a minirevolution.The price of catastrophe insurance soared:
rates in the end-1992 renewal season were anywhere from 50% to 200% higher than those a year earlier.
Retentions,which show the potential losses to which primary insurers opt to stay exposed rather than buying reinsurance,also rose sharply.
Why?One reason was that the market's capacity to cover losses had shrunk.
Hurricane Andrew followed several years of heavy losses.
For several smaller reinsurers,it proved the last straw;they quit the industry.
Even the world's two biggest reinsurance firms,Munich Re and Swiss Re,
which had previously competed for market share,said that they would turn down business that did not meet tough underwriting criteria.
At the same time,capacity at Lloyd's,London's troubled insurance market,
was squeezed as "names"-the individuals whose capital supports the market-resigned in droves.
Another reason that rates rose was that Hurricane Andrew had caused firms to revise their forecasts of future catastrophes.
Munich Re,in particular,talked gloomily about global warming and the fear that it would lead to many more violent storms.
To cover the increased probability of higher pay-outs,reinsurers began to charge more for their services.
Recently,these trends have gone into reverse,for several reasons.
First,1993 turned out to be a much better year for reinsurers than anyone had expected,with claims totalling a mere $12 billion.
(The bulk of the cost of that year's biggest disaster,the floods in America's Mid-west,fell on the government,not the insurance industry).
As reinsurers turned in bumper results,talk of global warming faded.
Second,reinsurance capacity began to rise again.
Lloyd's of London was boosted by the prospect of an injection of capital from newly authorised corporate investors.
And Bermuda,hitherto known only as a base for captive insurers(subsidiaries set up to allow industrial firms to insure themselves),suddenly became a force to be reckoned with.
The creation of several new firms since November 1992 has boosted the capacity of the island's reinsurers from almost nothing to around $7 billion.
New capacity has not stopped talk of an insurance crisis in Florida and,since January's earthquake in Los Angeles(the second-biggest insured loss ever),in California.
Reinsurers have realised that potential catastrophic losses in those states are now so huge that it might never make sense to provide full coverage,
reckons Peter Kellogg of A.M. Best,an American firm of insurance analysts.
If thousands of homes are now to be left without cover,the government might have to step in.
One way it could do so is by selling reinsurance,as proposed by the National Disaster Coalition,a lobby group.