icp 19: reinsurance case study - iaisweb.org · icp 19: reinsurance case study (teaching note) this...

�

ICP 19:Reinsurance Case Study

Advanced-level ModuleTeach�ng Note

A Core Curriculum for Insurance Supervisors

Copyright © 2006 International Association of Insurance Supervisors (IAIS).All rights reserved.

The material in this module is copyrighted. It may be used for training by competent organiza-tions with permission. Please contact the IAIS to seek permission.

Author Jeffrey Carmichael is chief executive officer of Promontory Australasia. Until recently a full-time consultant, he was previously chairman of the Australian Prudential Regulation Au-thority. His career also includes senior positions with the Reserve Bank of Australia, seven years as professor of finance at Bond University, and appointment to a number of government and private sector boards and inquiries, including the Wallis Inquiry into the Australian financial system. He has published in a number of the world’s top economics and finance journals, in-cluding the American Economic Review and Journal of Finance.

��

Contents

General comments on supervising reinsurance arrangements . . . . . . . . . . . . . . . . . . . . 1

Changes to clauses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

Related-party reinsurers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Unlicensed reinsurers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Appendix I. Round 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Appendix II. Round 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Appendix III. Round 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

�

ICP 19: Reinsurance Case Study(Teaching Note)

This case consists of two relatively long rounds and a short final round. After the com-pletion of each round, the instructor should bring the groups together to discuss the is-sues. The instructor should encourage active debate among the participants and should end each review session by bringing the debate together and adding any points that have been missed.

The main reference is the background note, which provides guidance as to the is-sues that supervisors need to review in relation to reinsurance purchasing, particularly in developing countries.

The issues raised by the contracts are included as comments in the contracts (ap-pendix I is the contract for ABC Insurance Limited from round 1, appendix II is the ABC contract from round 2, and appendix III concerns CSIC Insurance Limited).

Some more general guidance in relation to supervising reinsurance arrangements is provided below.

General comments on supervising reinsurance arrangements

Reinsurance is an important subject, but a difficult one for insurance supervisory au-thorities. First, few supervisors have the specialized expertise to evaluate reinsurance arrangements, particularly the complex ones. Second, many direct insurers also lack re-insurance expertise and tend to make decisions on the basis of past practice, high-level assumptions about the reinsurance arrangements they are offered, and verbal repre-sentations of the reinsurance brokers with whom they deal. The reinsurance managers of direct insurers rarely review the treaties that contain the detailed provisions of the

Insurance Superv�s�on Core Curr�culum

�

reinsurance arrangement they enter into, but instead rely on the slips that are issued after verbal agreement has been reached, which contain a brief summary of the ar-rangements. The slips often do not disclose material exclusions or coverage limitations found in the treaty documents.

Another reality of reinsurance that often surprises supervisors with a banking back-ground is that reinsurance obligations tend to be treated as something to be negotiated, not as a hard and fast obligation such as might arise from a derivatives contract. Thus, in addition to all the uncertainties of coverage that are discussed in detail in the back-ground note is the overriding uncertainty inherent in the negotiation process. This un-certainty should be taken into account when assessing the adequacy of provisioning.

The following provides some suggestions on how a supervisory authority can ef-fectively supervise this complex area:

• Create a reinsurance specialist group (or single position, in a smaller supervi-sory authority) to build expertise within the authority

• Regularly compare reinsurance practices across all direct insurers supervised (thematic cross-sector reviews can be helpful)

• Consult with the industry on best practices and issue “best practice” guides. These will help to upgrade practices in the industry and will provide an assess-ment template for supervisory staff

• Focus on processes and controls within the direct insurer. Look for depth of ex-pertise, escalation of key policy decisions to senior management and the board, documentation of key procedures, involvement of the appointed actuary in re-viewing key decisions, and use of internal audit to review compliance with poli-cies and procedures.

What should a supervisory authority’s objectives be in supervising the reinsurance area? Is the supervisory authority simply forming a view on the quality of a direct insurer’s reinsurance program, or should it be going further? It is suggested that the supervisory authority must go further. The ultimate objective is to form a view on the adequacy of the direct insurer’s provisioning, because reinsurance coverage is netted against an insurer’s gross provisions. If there are weaknesses in the reinsurance program, giving rise to material risks that expected reinsurance coverage may not be available when called upon, the insurer’s provisioning should reflect this.

Changes to clauses

In a number of instances, it is suggested in the background note that the direct insurer should not accept certain types of clauses, wordings, and exclusions in reinsurance trea-ties. Sometimes the direct insurer has limited bargaining power to address these clauses, such as when the following occurs:

ICP �9: Re�nsurance Case Study, Advanced-level Module (Teach�ng Note)

�

• The clause in question has become standard in the reinsurance industry• The direct insurer has limited bargaining power because of small size and/or

absence of financial strength • The direct insurer is part of an insurance group and is subject to the group’s

overall reinsurance program.

In these circumstances, the supervisor should be looking for reinsurance man-agement strategies employed by the direct insurer to minimize the chances of loss of reinsurance coverage and, as noted above, extra provisioning to address the risk of re-insurance coverage gaps. The supervisor should also encourage the direct insurer to amend policies wherever possible to mirror non-negotiable reinsurance exclusions in those policies.

Related-party reinsurers

Many direct insurers, particularly in the general insurance field, are members of insur-ance groups. In these groups, reinsurance coverage is decided at the head office, and subsidiaries in various countries buy their reinsurance as part of the global reinsur-ance program. Frequently, the insurance group has reinsurance subsidiaries located in jurisdictions such as Bermuda and Barbados, and the direct insurance subsidiaries or branches are required to place some of their reinsurance coverage with these related companies. This gives rises to transfer pricing issues (Is the direct insurer being over-charged, as a way of transferring profits within the group to lightly regulated, low- or zero-tax jurisdictions?) and quality of coverage issues. Even if a reinsurer within the group carries a high credit rating, should the supervisor give as much weight to the quality of reinsurance coverage provided by a related reinsurer as that provided by an arm’s-length reinsurer? There is clearly an additional element of risk in dealing with a related-party reinsurer because both the direct insurer and the reinsurer may be sub-ject to group-wide financial risks. The supervisor may consider limiting the amount of coverage provided by related-party reinsurers and limiting the amount of capital or solvency relief afforded by related-party insurance.

Unlicensed reinsurers

Another issue that arises in a number of countries is whether direct insurers should be restricted to dealing with reinsurers that are licensed to do business in that jurisdiction or whether the direct insurers can place at least some of their business with unlicensed reinsurers. Unlicensed reinsurers can be small companies with low credit ratings or highly rated international companies that choose not to seek a license in a particular jurisdiction. In some countries, incentives for dealing with licensed reinsurers are pro-


�

vided by setting limits on the amount of reinsurance that can be placed with unlicensed reinsurers or by limiting the capital or solvency relief arising from a contract with an unlicensed reinsurer.


�

Appendix I. Round 1

Reference: TN05123456 Reinsured:ABC Insurance LimitedType: Casualty Excess-of-Loss Program

ABC INSURANCE LIMITED

CASUALTY EXCESS-OF-LOSS PROGRAM

REINSURANCE CONTRACT

Reference number: TBA

All contractual agreements should carry a unique reference for future identification.

Reinsured: ABC Insurance Limited ABN 10 987 645 321, Sydney, Australia

Is this the only entity covered by this contract? If not, all branches and subsidiaries should be named.

Type of business: Casualty Excess-of-Loss Program

Period: Losses occurring during the 12-month-period commencing at 4:00 p.m. on June 30, 2005

Supervisors should be aware that there is no provision for runoff of the reinsurance contract, should cover not be available after this period.

This agreement consistsof three parts: • Contractual details • Contractual wording—provided in round 1 • Signing pages(s)— not provided


�


CONTRACTUAL WORDING

April 1, 2005


Period: Losses occurring during the 12-month period commencing at 4:00 p.m. on June 30, 2005

Type: Casualty excess-of-loss reinsurance

Territorial scope: Commonwealth of Australia

It is important to define this aspect. Does this refer to policies issued in Australia or losses occurring in Australia? If underlying policies grant cover in other territories, these should be reflected under the definition of territorial scope.

Class: Class 1—Domestic legal liability Class 2—General third-party liability Class 3—Worker’s compensation Class 4—Motor third-party property damage Class 5—Compulsory third-party liability

All of the above are poorly defined; for example, class 2 might include products liability, directors’ and officers’ liability, errors and omissions liability, and so forth. Greater detail should be included. Reference could be made to statutorily defined classes of business or to specific policy forms.

Limits

Layer 1: Classes 1–4 inclusive: AUD 5 million ultimate net loss each and every loss occurrence. Excess of AUD 5 million ultimate net loss each and every loss occurrence

Classes 3 and 5 (compulsory third-party liability and worker’s compensation): AUD 2.5 million ultimate net loss each and every loss occurrence. Excess of AUD 7.5 million ultimate net loss each and every loss occurrence

Layer 2: Class 1, 2, and 4 (domestic legal liability/general third-party li-ability/motor third-party property damage: to pay the difference


�

between AUD 20 million ultimate net loss each and every loss oc-currence

AND

AUD 10 million ultimate net loss each and every loss occurrence

Layer 3: Class 3—Worker’s compensation: AUD 80 million ultimate net loss each and every loss occurrence excess of AUD 20 million ulti-mate net loss each and every loss occurrence

Class 5—Compulsory third-party liability: to pay an unlimited amount each and every loss occurrence excess of AUD 20 million each and every loss occurrence

None of the above limits or deductibles states whether there is indexation to apply or whether legal costs are inclusive or exclusive of the limit of reinsurance. Assuming that legal costs form part of the ultimate net loss, it is important to establish how these are shared among the excess-of-loss layers.

There is no provision for costs in addition to the reinsurance limit, assuming cost-exclusive policies are issued.

It is not clear how a clash of two policies from the one event would be treated. Neither is there any provision for clash cover should two or more classes covered hereunder be involved in one event.

Reinstatements: Unlimited at nil additional premium

Specifying how reinstatements are to be calculated is important. Although in this example there is unlimited additional cover, this will not always be the case. Reinstatements that state, for example, “2 @100%” should be considered carefully, because it might not be clear whether the 100% applies to time, amount, or both. Also, in cases where no more reinstatements are available, an insurer might not seek a relatively small reinsurance recovery, in order to keep reinsurance coverage in force to meet potential large claims.

Supervisors should satisfy themselves of the adequacy of any alternative cover offered where limitations exist.

PREMIUM

Layer 1: Minimum and deposit premium: AUD

Payment dates must be clearly stated—that is, whether the minimum and deposit are to be paid in installments and the dates of such installments. The following is an example: “Payable in four


�

equal installments on July 1, 2005, October 1, 2005, January 1, 2006, and April 1, 2006, unless stated otherwise.”

Any reference to premium payment warranties (PPWs) as being a “condition prec-edent” should be analyzed carefully. The use of PPWs may lead to a reinsurance contract being voided for failing to meet payment terms, and the use of “condition precedent” intro-duces far more onerous conditions into the contract.

Class 1—Domestic legal liability: adjustable at percentage of reinsured’s gross net premium income written during the period

Many definitions of “premium” exist. The contractual wording must define clearly the in-come base to be used for adjustment purposes.

Class 2—General third-party liability: adjustable at per-centage of reinsured’s gross net premium income written during the period

Class 3—Workers’ compensation: adjustable at percentage of reinsured’s gross net premium income written during the period

Class 4—Motor third-party property damage (including CTP gap): adjustable at percentage of reinsured’s gross net premium income written during the period

Class 5—Compulsory third-party liability: adjustable at AUD per CTP-insured vehicle and calculated on the av-erage of the number of vehicles in force as of July 1, 2005, and June 30, 2006.

Particular classes of insurance lend themselves to adjustment on a basis other than in-come. Policy count or vehicle count are common, and supervisors should satisfy themselves that the reinsured has the appropriate systems to extract these data. A disadvantage of using measures other than income is that they are less likely to have been audited.

Layer 2: Minimum and deposit premium: AUD

Class 1—domestic legal liability: flat premium: AUD

Flat premiums are a common method of expressing premium payments. In this case, there are no details as to whether the premium is to be paid in installments or whether rein-surers expect it to be paid in advance.


9

Class 2—General third-party liability: adjustable at per-centage of reinsured’s gross net premium income written during the period

Class 3—Worker’s compensation: adjustable at percentage of reinsured’s gross net premium income written during the period

Class 4—Motor third-party property damage (including CTP gap): adjustable at percentage of reinsured’s gross net premium income written during the period

Class 5—Compulsory third-party liability: adjustable at AUD per CTP insured vehicle and calculated on the av-erage of the number of vehicles in force on July 1, 2005, and June 30, 2006

Layer 3: Minimum and deposit premium: AUD, payable in four equal installments on July 1, 2005, October 1, 2005, Jan-uary 1, 2006, and April 1, 2006, unless stated otherwise

Class 3—Worker’s compensation: adjustable at percentage of reinsured’s gross net premium income written during the period hereon

Class 5—Compulsory third-party liability: adjustable at AUD per CTP insured vehicle and calculated on the av-erage of the number of vehicles in force on July 1, 2005, and June 30, 2006

The basis of adjustment must be stated clearly, as this can be either an income-based adjustment or a policy count. It is important to define terms such as “gross net premium income” clearly within the body of the slip.

Taxes: As applicable

Taxes should always be addressed, even if these are stated as “nil.” Local conditions vary, and reinsurers should be made aware of all deductions from premium.

Applicable law and jurisdiction: Agreement and Arbitration Tribunals Law of New South

Wales in the Commonwealth of Australia; the Applicable


�0

Law and Jurisdiction Clause is as specified in the attached contractual wording

Seat of arbitration: Sydney, New South Wales

General conditions: As per expiring wording (including endorsements); new or amended clauses as follows:

• Special Termination Clause WRA2 • Indexation Clause: bodily injury losses only; base date

July 1, 2005, to apply where stated

All of the above general conditions are specified in full in the attached contractual wording.

Best practice demands that all clauses be included in full within the body of the contract. Wording that is “to be agreed” creates contractual uncertainty and substantially increases the probability of disputes arising. There are many versions of seemingly standard clauses, and mere reference to a clause will create future issues.

Specific conditions: Applicable to class 2—General third-party liability: ex-ports to the United States and/or Canada shall be covered up to a maximum of 25 percent of total turnover or AUD 50 million, whichever is the lesser

Applicable to class 3—Worker’s compensation: occupa-tional disease clause ACOD/A; acts-in-force clause

Applicable to class 5—Compulsory third-party liability: acts-in-force clause

All of the above specific conditions are specified in full in the attached contractual wording

Special acceptances: Special acceptances to be agreed

Supervisors should require evidence that a system exists for referring original risks that fall outside treaty terms and conditions.

For many treaties, several reinsurers are involved. In such cases, one reinsurer—usu-ally the one taking the largest share of the risk—is typically designated as the lead rein-


��

surer. An issue to be considered is whether the insurer has to get a special acceptance from each reinsurer or whether “following reinsurers” are bound by the decision of the lead reinsurer. For some treaties, such as those with 10 or more reinsurers, it is not practical to get a special acceptance from each reinsurer. It is important to examine the original stamps of reinsurers to ensure that the acceptance conditions on the stamp are consistent with the way in which special acceptances are treated.

Finally, supervisors should be comfortable with the way in which a special acceptance agreed in one treaty year is to be treated subsequently. In certain cases, special acceptances are deemed to be agreed for all subsequent treaty years subject to no “material” change. The definition of material should be considered.

It may also be the case that new reinsurers are brought onto the panel who have never seen, and therefore never had the opportunity to agree to, previous special acceptances.

Exclusions: As stated in the attached contractual wording

Currency: All settlements (premiums and claims) to be converted to or paid in Australian dollars

Treaty documentation needs to address explicitly the way in which claims settled in a cur-rency other than the one in which the treaty is denominated are converted.


��

Appendix II. Round 2


ABC INSURANCE LIMITED

CASUALTY EXCESS-OF-LOSS PROGRAM

REINSURANCE CONTRACT

Agreement number: TBA


Type of business: Casualty Excess-of-Loss Program

Period: Losses occurring during the 12-month-period commencing at 4:00 p.m. on June 30, 2005

Contract details: • Contractual wording—provided in round 1 • Signing pages(s)— not provided


��

CONTRACTUAL WORDING

Casualty excess-of-loss reinsurance

between

the reinsured

as specified in the attached contractual details

and

insurance companies, certain reinsurers, and underwriting members of Lloyds whose names and proportions are the signed percentage lines allocated to the reinsurers, each for their own part and not one for another (the “reinsurer”).


��

CONTRACTUAL WORDING

PREAMBLE

The reinsured desires to reinsure its net retention in respect of classes of business specified in attached Contractual Details no. TN05123456 (the “contractual details”).

ARTICLE 1Reinsuring Clause

In consideration of the payment of premium as stated in the contractual details, and subject to the provisions of Article 11 and to the other conditions, the reinsurer shall indemnify the reinsured for that portion of the liability attached to the reinsured under the business specified in the contractual details, which represents the limits as stated in the contractual details of ulti-mate net loss in respect of each and every loss occurrence.

ARTICLE 2Territorial Scope

Policies issued or renewed in the territory or territories specified under territorial scope in the contractual details.

ARTICLE 3Exclusions

This reinsurance shall not apply to any classes of business or risks specified in the exclusion list, which is attached as appendix 1, or to any loss or liability excluded by the following:

1. War and Civil War Exclusion Clause: Loss or damage directly or indirectly occasioned by, happening through, or in consequence of war, invasion, acts of foreign enemies, hos-tilities (whether war be declared or not), civil war, rebellion, revolution, insurrection, military or usurped power, or confiscation or nationalization or requisition or destruc-tion of or damage to property by or under the order of any government or public or local authority.

This is of no particular concern, although supervisors should be satisfied that this form of wording is used in underlying original policy documentation.

2. Reinsured’s liability for loss arising from fire, flood, and explosion

Such clauses should be avoided at all costs. This is a classic peril-based exclusion. However, these clauses are becoming more prevalent in both direct insurance and reinsurance. The supervisor’s


��

efforts may be better directed at ensuring that the direct insurer incorporates similar exclusions in the policies that it issues.

3. Liability incurred under any pooling agreement

The acceptability of this clause will be determined largely by the nature of the marketplace where the reinsured operates.

4. Obligatory reinsurance

5. Excess-of-loss reinsurance

6. (a) Excess-of-loss insurance (b) Umbrella liability

The reinsured must be clear as to what reinsurers deem to be excess-of-loss insurance placements. In today’s market, many original insureds hold large self-insured deductibles, and there may be dispute as to definitions.

7. Terrorism Exclusion Clause—NMA 2930B: Notwithstanding any provision to the con-trary within this reinsurance agreement or any endorsement thereto, it is agreed that this reinsurance agreement excludes death, injury, illness, loss, damage, cost, or expense directly or indirectly caused by, contributed to by, resulting from, or arising out of or in connection with any act of terrorism, as defined herein, regardless of any other cause or event contributing concurrently or in any other sequence to the loss.

An act of terrorism includes any act, or preparation in respect of action, or threat of action designed to influence the government de jure or de facto of any nation or any political division thereof, or in pursuit of political, religious, ideological, or similar purposes to intimidate the public or a section of the public of any nation by any person or group(s) of persons, whether acting alone or on behalf of or in connection with any organization(s) or government(s) de jure or de facto, and which:

a) Involves violence against one or more persons orb) Involves damage to property orc) Endangers life other than that of the person committing the action ord) Creates a risk to health or safety of the public or a section of the public ore) Is designed to interfere with or to disrupt an electronic system.

This reinsurance agreement also excludes death, injury, illness, loss, damage, cost, or expense directly or indirectly caused by, contributed to by, resulting from, or arising out of or in connection with any action in controlling, preventing, suppressing, retaliating against, or responding to any act of terrorism.


��

Notwithstanding the above and subject otherwise to the terms, conditions, and limi-tations of this reinsurance agreement in respect only of personal lines, this reinsurance agreement will pay actual loss or damage caused by any act of terrorism provided such act is not directly or indirectly caused by, contributed to by, resulting from, or arising out of or in connection with biological, chemical, or nuclear pollution or contamina-tion.

For the purposes of this agreement, personal lines shall be defined as domestic motor third-party property damage (including CTP gap cover) business and householders’ do-mestic legal liability business (including strata title policies where the original risk has a sum insured of less than AUD 10 million).

This was a new clause for this contract, yet there is no effective date from which it should apply. This will create a run of issues for unexpired underlying risks.

8. Nuclear Energy Risks Exclusion Clause—Applicable to classes 1, 2 and 3 only: Nuclear energy risks being operations employing the process of nuclear fission or fusion or han-dling of radio-active material which operations include but are not limited to:

a) The use of nuclear reactors such as atomic piles, particle, particle accelerators or generators, or similar devices or

b) The use, handling, or transportation of radioactive materials orc) The use, handling, or transportation of any weapon of war or explosive device em-

ploying nuclear fission or fusion.

This exclusion shall not apply to insurances of occupational risks arising from radio-isotopes or radium or radium compounds when used away from the place where such are made or produced and when used exclusively incidental to ordinary industrial, edu-cational, medical, or research pursuits.

9. Asbestos Exclusion Clause, Absolute Asbestos Exclusion: This reinsurance does not cover any liability for:

a) Personal injury arising directly or indirectly, out of or caused by, through or in con-nection with the inhalation of (including the fear of inhalation of, or exposure to) asbestos, asbestos fibers, or derivatives of asbestos

b) Property damage, or loss of use or diminution in value of property, arising directly or indirectly, out of or caused by, through, or in connection with asbestos, asbestos fibers, or derivatives of asbestos

c) The cost of cleaning up, removing, treating, controlling, storing, or disposing of as-bestos, asbestos fibers, or derivatives of asbestos.


��

Again, this is a new clause with no effective date, which creates a gap in cover for unexpired orig-inal policies without such an exclusion or where there is a difference in the wording.

10. E-Commerce Exclusion Clause: This reinsurance does not apply to personal injury or property damage arising directly or indirectly out of or caused by, through, or in connection with:

a) The total or partial destruction, distortion, erasure, corruption, alteration, misuse, misinterpretation, misappropriation, or use of computer equipment

b) Any error in creating, amending, entering, directing, deleting, or using computer equipment or

c) The total or partial inability or failure to receive, send, access, or use computer equip-ment.

“Computer equipment” means data or part of data, computer hardware, operating system, com-puter network, web sites, servers, extranet, internet, mail systems, software applications, soft-ware, computer chip including microprocessor chip and coded instruction, as well as any new technology, product, or service replacing computer equipment.

This is a classic example of a situation in which the reinsured needs to align the original policy language with the reinsurance language.

11. Information Technology Hazards Exclusion Clause: This reinsurance does not apply to any losses (bodily injury, property damage, or any other loss covered under policies reinsured hereunder) arising, directly or indirectly, out of, or in any way involving an original insured’s “internet operations.”

This exclusion does not apply to bodily injury or property damage arising out of any material which is already in print by the manufacturer in support of its product, in-cluding but not limited to product use and safety instructions or warnings, and which is also reproduced on its site. Coverage does not include bodily injury or property damage arising out of any other advice or information located on the site that is used for the purpose of attracting customers.

“Internet operations” means the following:

a) Use of electronic mail systems by the insured’s employees, including part-time and temporary staff, and others within the insured’s organization

b) Access through the insured’s network to the world wide web or a public internet site by the insured’s employees, including part-time and temporary staff, and others within the insured’s organization

c) Access to the insured’s intranet (meaning internal company information and com-puting resources) which is made available through the world wide web for the in-sured’s customers or others outside the insured’s organization and


��

d) The operation and maintenance of the insured’s web site.

Nothing in this exclusion shall be construed to extend coverage under this contract to any li-ability which would not have been covered in the absence of this exclusion.

The issue is how this clause is different from the preceding clause and whether both are imported into original policies.

ARTICLE 4Period

This reinsurance shall apply to all losses occurring during the period specified in the contrac-tual details. The reinsurance shall follow local time at the location of any loss.

Maximum original policy period: 12 months plus odd time not exceeding 18 months in all.

Although multiyear policies are not excluded, the period clause effectively introduces a further stipulation that may give rise to a special acceptance. Exclusions hidden in other areas of the con-tract need careful attention.

The loss trigger requires particular attention. Some insurers will issue occurrence-based poli-cies and policies with a claims-made trigger. This creates significant potential for a mismatch be-tween the date of loss for treaty purposes and the date of loss under the original policy.

A straight losses-occurring treaty offers no run of protection. This contract contains no provi-sion for reinsurers to renew in the event that the reinsured ceases underwriting. If the reinsured is unable to renew the contract due to an inability to agree to acceptable terms or the absence of a viable reinsurance market, the underlying direct portfolio would be unreinsured as it runs off. This would not be the case if the reinsurance were placed on a “risks- or policies-attaching” basis, as the reinsurance attached to each policy written would be for the full duration of those policies.

The “location” of a loss is not always clear. Property-based risks rarely present a problem, al-though certain casualty classes do not lend themselves to identifying a location.

ARTICLE 5Definition of “Loss Occurrence”

The term “loss occurrence” shall mean each and every loss or series of losses arising out of any one accident or event.

It is important that the definition of loss occurrence mirror as closely as possible the form of words used in the underlying policy. This is not a guarantee of back-to-back coverage, as the original and reinsurance contracts are distinct, but it does reduce the propensity for a mismatch.


�9

Reinstatement

In the event of the whole or any portion of the indemnity as stated in the contractual details being exhausted by loss, and if so specified in the contractual details, the amount so exhausted shall be reinstated to its full amount from the time of the occurrence of such loss or losses to the expiry hereof, in consideration for which the reinsured shall pay to the reinsurer when such loss or losses are settled an additional premium calculated at the rate as specified under reinstate-ment in the attached contractual details. In the event of any loss or losses requiring payment of reinstatement premium being settled prior to the final adjustment of premium being made, the reinstatement premium shall be provisionally calculated on the deposit premium and adjusted subsequently as may be necessary.

The term “pro rata” shall mean pro rata as to the fraction of the limit of indemnity rein-stated.

Nevertheless, the reinsurer shall never be liable for more than the limit of indemnity stated in the contractual details in respect of each loss occurrence, nor more than the limit in all, as stated in the attached contractual details.

ARTICLE 6Ultimate Net Loss

The term “ultimate net loss” shall mean the sum actually paid by the reinsured in settlement of losses or liability after making deductions for all recoveries all salvages and all claims on other reinsurances, whether collected or not, and shall include all adjustment expenses including costs of litigation, if any, and all other loss expenses of the reinsured, including those where the reinsured engages its own insurance surveyors and assessors, arising from the settlement of claims other than the salaries of employees and office expenses of the reinsured.

All recoveries or payments recovered or received subsequent to a loss settlement under this reinsurance shall be applied as if recovered or received prior to the settlement, and all necessary adjustments shall be made by the parties.

Nothing in this article shall be construed to mean that losses under this reinsurance are not recoverable until the ultimate net loss of the reinsured has been ascertained.

In the event of a loss occurrence giving rise to a claim under this reinsurance from more than one constituents of the reinsured, the limits shall be applied to the aggregate of all such losses.

ARTICLE 7Benefit of Underlying Reinsurances

Notwithstanding anything to the contrary, it is understood and agreed that recoveries under all underlying excess reinsurance treaties and/or contracts (as far as applicable) are for the sole benefit of the reinsured and shall not be taken into account in computing the ultimate net loss


�0

or losses in excess of which this reinsurance attaches, nor in any way prejudice the reinsured’s right of recovery.

ARTICLE 8Net Retained Lines

This reinsurance applies only to that portion of any insurance or reinsurance which the rein-sured retain net for their own account and, in calculating the amount of any loss and also in computing the amount in excess of which this reinsurance attaches, only loss or losses in re-spect of that portion of any insurance or reinsurance that the reinsured retain net for their own account shall be included.

The amount of the reinsurer’s liability in respect of any loss or losses shall not be increased by reason of the inability of the reinsured to collect from any other reinsurers (whether specific or general) any amounts that may have become due from them whether such inability arises from the insolvency of such other reinsurers or otherwise.

It is further noted and agreed that amounts ceded to any quota share reinsurances shall be considered as being retained net by the reinsured for the purposes of this agreement.

ARTICLE 9Premium

A premium, as specified in the contractual details, shall be paid by the reinsured in the manner specified in the contractual details.

Where applicable, as soon as possible after the expiry of this reinsurance, the above pre-mium shall be adjusted as specified in the contractual details subject, however, to a minimum premium, if any, of the amount specified in the contractual details.

The term “gross net premium income” shall mean gross premiums as charged by the rein-sured to its insureds in each respective territory for the respective classes of business covered for the period, less only cancellations, returns, and premiums on reinsurances that inure to the benefit of this reinsurance.

Statements of actual gross net premium income and number of applicable vehicles in force shall be submitted within three months of the respective dates specified in the contractual de-tails, for the purpose of premium adjustment between the parties hereto. Any balances due to the reinsurer beyond the deposit premiums paid shall be remitted concurrently therewith.

ARTICLE 10Goods and Services Tax (GST)

a. Payments: Any amount shown as payable under this reinsurance does not include GST and, where applicable, will be calculated with reference to the GST-exclusive premiums payable to the reinsured by its insureds. In addition to any amount shown as payable,


��

wherever the supplier (whether the reinsurer or the reinsured) is liable for GST on that amount, the supplier shall be paid an amount equal to that GST.

b. Claims: The ultimate net loss will be calculated after accounting for any adjustment under the GST legislation to which the reinsured is entitled on settlement of claims to its insureds or on recoveries from any third parties, and any input tax credit to which they are entitled on acquiring goods or services for the purpose of settlement of a claim.

This reinsurance does not cover any liability that the reinsured has for GST on any claim payment under this reinsurance arising from the reinsured’s failure to disclose correctly to the reinsurer its entitlement to an input tax credit for the premium.

Changes to Legislation

If the effect of this article is changed as a result of any new amendment, enactment, interpreta-tion, or application of any law, the parties hereto must as soon as possible and in the utmost good faith negotiate an appropriate amendment to this reinsurance.

Withholding Tax

If Australian nonresident withholding tax applies in respect of any payments under this re-insurance, the amount of that tax will be deducted prior to payment by the paying party, as required by law.

ARTICLE 11Index Clause: Bodily Injury Only

It is the intention of this reinsurance that, where applicable, the retention of the reinsured and the limit of liability of the reinsurer shall retain their values relative to those which exist at the date specified in the contractual details.

At the time of payment of any claim, the change in relative monetary value shall be ascer-tained from the table of average weekly earnings (all male employees)—Australia, as published by the Australian Bureau of Statistics, Canberra, Catalogue number 6302.0.

The retention of the reinsured and the limit of liability of the reinsurer shall be increased or decreased in proportion to the difference between the average weekly earnings figure at the date stated above and that at the date of payment by the reinsured of any claim. The average weekly earnings figure at the date of payment of the claim by the reinsured shall be that for the quarter immediately preceding that during which the claim payment is made.

The retention of the reinsured and the limit of liability of the reinsurer, where applicable, shall be calculated as follows:


��

a) Claims payments are adjusted on the basis:

b) All actual payments and adjusted payment values shall be separately totaled, and the re-tention of the reinsured and the limit of liability of the reinsurer, where applicable, shall then each be multiplied by the fraction:

to indicate the indexed retention and the limit of liability where applicable. The date of payment of any claim for the purpose of this reinsurance shall be deemed

to be as follows:

i) Except where an award is made by a court, the actual date on which payment is made by the reinsured

ii) The date an award is made by a court, if no appeal is made, or if the appeal court reduces or leaves unchanged the original award

iii) The date an award is made by the appeal court if this increases the award made by the original court

iv) In the event of the appeal court not making an award, the date of the final award made by the court to which the case has been returned, if such final award is in ex-cess of the original award

v) In the event of a loss being settled in more than one payment, any advance payment, being a payment that is deducted from the total damages when they are finally as-sessed in respect of any claimant, shall be added to the final or any subsequent pay-ment to that claimant, and the average weekly earnings figure used at the time of the final settlement shall be that employed to ascertain the adjusted value of all advance payments to that claimant.

ARTICLE 12Claims-Reporting Clause

It is a condition precedent that the reinsured shall advise the reinsurer as soon as possible of any occurrence where the sum claimed or the potential loss may reasonably be considered as likely to give rise to a claim under this reinsurance or alternatively is likely to exceed 50% (fifty percent) of the amount shown as the deductible.

Actualamount of xpayment

AdjustedpaymentvalueAverage weekly earnings

figure at date of payment

Average weekly earningsfigure at base date

=

Total of adjusted payment values

Total of actual payments


��

The use of the term “condition precedent” is highly undesirable. Undesirable as this condition precedent may be from the point of view of the direct

insurer, such provisions are not uncommon and, from the reinsurer’s point of view, may not be unreasonable. The supervisor should direct his efforts to ensuring that the direct insurer has an effective claims-reporting process in place.

The reinsured shall, on request, furnish the reinsurer with all information in the rein-sured’s possession regarding such claim or claims.

In addition, the reinsured shall report those cases where it has made or expects to make regular payments for a period of two years or more, irrespective of the amount of such regular payments or the estimated total.

ARTICLE 13Claims Cooperation Clause

Solely for the purpose of reporting claims or accidents, the reinsured shall, in all in-stances, consider to be themselves legally liable for such injuries and/or damage.

The course to be adopted by the reinsured in connection with the defense or settle-ment of any claim or claims falling within the reporting conditions of this reinsurance shall be determined between the reinsured and the reinsurer or their representatives, and the reinsured’s litigation, if any, of such claim/s shall be after consultation and con-sent of the reinsurer or its representative.

There are numerous versions of claims cooperation clauses. MANY ARE EXTREMELY ONEROUS, and supervisors should consider them carefully. Failure to comply with the exact wording of the clause may exacerbate the grounds for dispute.

ARTICLE 14Payment of Losses

All loss settlements made by the reinsured, provided they are within the terms and con-ditions of the original acceptances and fall within the terms and conditions of this rein-surance, shall be unconditionally binding on the reinsurer, and the reinsurer’s portion of such losses shall be payable by it as soon as possible after receipt from the reinsured of the necessary papers proving the loss, always provided that the reinsurer shall have the right to deduct from such payments any sums due to it from the reinsured in respect of premiums due hereunder or under any contract(s) renewing this reinsurance.

ARTICLE 15Errors and Omissions

Any inadvertent error or omission on the part of either the reinsured or the reinsurer shall not relieve the other party from any liability that would have attached under this


��

reinsurance, provided that such error or omission is rectified immediately on discovery and shall not impose any greater liability on the reinsurer than would have attached if the error or omission had not occurred.

ARTICLE 16Books and Records

The books and records of the reinsured, insofar as they relate to business falling within the scope of this reinsurance, shall be open to the inspection of an authorized represen-tative of the reinsurer at any reasonable time.

ARTICLE 17Confidential Nature

The reinsured and the reinsurer shall regard the transactions under this reinsurance and any policies, records, or documents obtained, as strictly confidential.

ARTICLE 18

The importance of reinsurance recoverable assets demands that supervisors pay particular attention to the form of security used for any placement and the mechanism by which re-insurers may be replaced should they fall below a certain financial strength rating.

Many downgrade clauses are available with varying “trigger” points. It is important that the clause be explicit in the way in which a reinsurer may be removed, the timing of such removal, and the way in which premiums and future claims are to be treated subse-quent to removal.

Special Termination Clause WRA2

Section 1 (Rating)

a) It is a condition on each subscribing reinsurer that participates in this agree-ment that such individual subscribing reinsurer shall at all times during the pe-riod of this agreement maintain an insurer financial strength (IFS) rating from Standard & Poor’s Rating Group of 1221 Avenue of the Americas, New York, New York 10020, USA (S&P) equal to or greater than “A minus.”

b) In the event of an explicit downgrading of any individual subscribing reinsurer by S&P to an IFS rating inferior to “A minus,” then, at the sole option of the rein-sured, the reinsured may elect to terminate the participation of that subscribing reinsurer by giving notice to that reinsurer. The effective date of such termina-tion shall be determined at the sole discretion of the reinsured provided the date so determined shall not be earlier than the date on which the relevant down-


��

grading by S&P was announced in New York, USA, nor earlier than the date the reinsurer is advised that the reinsured intends to invoke its downgrading rights.

c) Any individual subscribing reinsurer that does not have an IFS rating from S&P but maintains during the period of this agreement a rating from A. M. Best Company of A. M. Best Road, Oldwick, New Jersey 08858-0700 USA (Bests) shall also be considered as falling within the terms of this article. Any explicit downgrading of such an individual subscribing reinsurer by Bests to a rating less than “A minus” shall give the reinsured the same right of termination as set out in (b) above.

d) In the event that a rating should be given to an individual subscribing reinsurer by both S&P and Bests, then the rating of S&P shall prevail.

e) For the avoidance of doubt, the status of CreditWatch as defined by S&P or a rating modifier of “u” (under review) applied to a rated company as defined by Bests shall not, of itself, be construed as a downgrading for the purposes of this agreement.

f) With regard to any Lloyd’s Underwriters participating hereunder, the rating ap-plicable to each individual Lloyd’s Underwriter shall be the S&P IFS rating ap-plicable to the Lloyd’s insurance market as a whole.

Section 2 (Termination)

Furthermore, either party shall have the right to terminate this Agreement immediately by giving the other party notice:

a) If the performance of the whole or any part of this agreement be prohibited or rendered impossible, de jure or de facto, in particular and without prejudice to the generality of the preceding words in consequence of any law or regulation that is or shall be in force in any country or territory or if any law or regulation shall prevent directly or indirectly the remittance of any payments due to or from either party

b) If the other party has become insolvent or unable to pay its debts or has lost the whole or any part of its paid-up capital or has had any authority to transact any class of insurance or reinsurance withdrawn, suspended, or made conditional

Clause b could lead to a withdrawal of coverage in the event the supervisor suspends the insurer’s right to write new business or puts the insurer into runoff. (In this case, the rein-surer could terminate the agreement and would probably do so if the experience was bad. After termination, coverage would remain on the existing claims, and unearned premium would be refunded.) It could tie the supervisor’s hands and result in a loss of coverage at a time when it is needed most. If such clauses cannot be altered, the supervisor may have to


��

factor in the possibility of the withdrawal of reinsurance coverage before taking otherwise neces-sary supervisory action.

c) If there is any material change in the management or control of the other partyd) If the country or territory in which the other party resides or has its head office or is

incorporated shall be involved in armed hostilities with any other country whether war be declared or not or is partly or wholly occupied by another power, or be in a state of civil war

e) If the other party shall have failed to comply with any of the terms and conditions of this agreement.

Section 3 (Effect)

a) After the date of termination, under either sections 1 or 2 above, the liability of the reinsurer hereunder shall cease outright other than in respect of losses falling to the reinsurer.

b) All notices of termination served in accordance with any of the provisions of sections 1 or 2 above shall be by telex, telefax, or any other means of instantaneous communica-tion that provides a permanent record of such communication and shall be deemed to be served on dispatch or where communications between the parties are interrupted on attempted dispatch.

c) All notices of termination served in accordance with any of the provisions of sections 1 or 2 above shall be addressed to the party concerned at its head office or at any other address previously designated by that party.

d) In the event of termination in accordance with the provisions of sections 1 or 2 above, the exact premium payable hereunder shall be calculated on the premium income of the reinsured up to the date of termination or pro rata temporis of the minimum premium, whichever is the greater.

e) In the event of termination in accordance with the provisions of Sections 1 or 2 above, reinstatement premiums (if any) payable in respect of losses falling to reinsurers car-rying exposure prior to the date of termination shall be payable in full to those re-insurers carrying the exposure. Likewise, reinstatement premiums (if any) payable in respect of losses falling to reinsurers carrying exposure after the date of termination shall be payable in full to those reinsurers carrying the exposure.

ARTICLE 19Legal Interpretation

This reinsurance shall be governed by the law and jurisdiction of the territory specified in the contractual details.


��

ARTICLE 20Specific Conditions

This reinsurance shall be subject to the specific conditions as specified in the contractual de-tails.

ARTICLE 21Arbitration

Any dispute or difference whatsoever arising in connection with this reinsurance shall be re-ferred to the arbitration of three arbitrators. One arbitrator shall be chosen by each party, and the third arbitrator, who shall act as chairman, shall be a nominee of the president, for the time being, of the Institute of Arbitrators, Australia.

The chairman shall have the deciding vote in the absence of a majority decision. The arbi-trators may determine any question that arises for determination in the course of proceedings by reference to considerations of general justice and fairness. The arbitration shall be held in the place specified in the contractual details in accordance with and subject to the provisions of the relevant Commercial Arbitration Act.

This agreement has been drawn up and exchanged between the parties.

Signed in this day of 2003

for and on behalf of the reinsured

and signed in the attached signing page(s) for and on behalf of the subscribing reinsurers whose obligations under contracts of reinsurance to which they subscribe are several and not joint and are limited solely to the extent of their individual subscriptions. The subscribing reinsurers are not responsible for the subscription of any co-subscribing reinsurer that for any reason does not satisfy all or part of its obligations.

APPENDIX I. SPECIFIC EXCLUSIONS

All exclusions should be listed in their entirety even if they are market standards.

EXCLUSION LIST—CLASS 2: GENERAL THIRD-PARTY LIABILITY

Supervisors need to investigate the control mechanism that ensures that excluded risks are either not written or that reinsurance is arranged via a separate facultative placement.

Wherever possible, occupations should be defined as precisely as possible. Supervisors must be satisfied that, if there is any doubt regarding an original insured’s occupation, particularly for


��

incidental work carried out, a rigorous internal sign-off procedure is in place in addition to the mechanism for a special acceptance request.

1. Asbestos Exclusion Clause2. E-Commerce Exclusion Clause (only in respect of business classified as not-for-

profit organizations)3. Information Technology Hazards Exclusion Clause (other than in respect of

business classified as not-for-profit organizations)4. LGT 397 (1994) North American Operations Exclusion Clause5. LGT 398 (1994) North American Exports Costs Inclusive Clause6. LGT 399 (1994) Worldwide Punitive Damages Clause7. LGT 400 (1994) Claims-Made-Basis Clause8. LMC1 (A) Gradual Environmental Impairment Clause9. LMC2 North American Absolute Environmental Impairment Clause

Public and Products Liability

a) Space and/or satellite risksb) Tobacco producers and manufacturers of tobacco productsc) Toxic waste disposal, contractors, and land site owners and operatorsd) Liability arising from the delegation of underwritinge) Retroactive cover for known loss occurrences and/or known incidents/circum-

stancesf) Liability arising from loss portfolio transfers of any kindg) Offshore platforms, offshore rigsh) Products liability policies not carrying an annual aggregate limiti) Products guarantee and/or product recall coversj) Decennial liability risksk) Financial guarantee, insolvency, trade credit risks, and life businessl) All forms of legal liability arising out of the operation or navigation of ships or

vessels over fifteen (15) meters in lengthm) Subaqueous work and liability in respect of the construction, ownership, opera-

tion, maintenance, or modification of operational dams and Cofer dams with a capacity greater than 5,000 mega liters other than losses arising out of recre-ational use

n) Pure financial/pecuniary loss coverso) Claims arising directly or indirectly from the use of human organs, transplants,

blood, cells, secretions of any kind, and derivatives therefromp) Claims arising directly or indirectly from clinical trialsq) Tire manufacturers and retreaders


�9

r) Municipal and council authorities. This exclusion does not apply to liabilities arising from lease agreements for the use of properties owned by municipal and council authorities

s) Liability arising from the ownership or operation of oil wells and oil or petro-leum refineries. In respect of contractors’ exposure, this exclusion shall not apply where the total contract value is less than AUD 100,000

t) Liability in respect of the ownership, operation, construction, or maintenance of underground mines

u) Defamation, libel, or slander arising from publishing, advertising, or broad-casting activities unless incidental to normal activities

v) Operation, supervision, and maintenance of amusement rides and commercial operators of amusement parks

w) Original insureds exclusively employed in building demolitionx) Sports meetings involving motor-propelled vehicles as competitors.

Products Liability

For the purpose of exclusions a, b, c, and d below, the term “manufacturers” shall not include the liability of retailers deemed as manufacturers under any consumer legisla-tion.

a) Product liability of manufacturers of (a) aircraft, (b) aircraft component parts comprising aircraft fuselage, wings, and all structural, landing gear, tires, en-gines and engine components, propellers, fuel systems, electronic and electrical equipment, hydraulic equipment, aircraft instruments

b) Manufacturers of inorganic pharmaceutical products; however, this exclusion shall not apply to cosmetics, hair care products, externally applied antiseptic creams and lotions, skin care and skin treatment products

c) Manufacturers, importers, suppliers, or distributors of:

i) Chemical/petrochemicals of an explosive, toxic, or noxious nature, chemi-cals, cleaning agents, detergents, fumigants, and disinfectants. Provided this exclusion shall not apply to retailers or wholesalers with annual turnover less than AUD 50 million of such products intended solely for domestic use

ii) Fertilizers, pesticides, insecticides, fungicides, herbicides, defoliants, or crop sprays

iii) Stock feed or poultry feed where the stock feed or poultry feed includes an-imal rudiment products, the addition of vitamins, minerals, amino acids, enzymes, hormones/synthetic hormones and/or growth hormones, phar-maceuticals or any drug, including a distributor, manufacturer, or direct im-porter of any of these components.


�0

Provided that, this exclusion shall not apply when such distribution, import, or manu-facture is added to an original insured’s trade or business during the policy period. This exclusion also does not apply to original insureds who trade principally as retailers.

d) Shipbuilders and repairers and manufacturers of machinery and/or components with marine applications. In respect of components, this exclusion shall not apply unless the components are considered critical to the navigation of a vessel.

Provided that, this exclusion shall not apply to the repair and maintenance of water-craft up to 8 meters in length used in Australian inland and coastal waters.

Public Liability

a) Aerodrome and/or airport operations and aircraft refueling risks and airline or aircraft liability

b) Ownership, occupancy, or control of any property or structure used as a commercial airport or landing area

c) Railway authorities and/or companies and tramway authoritiesd) Manufacture, storage, sales, fitting, filling, breaking down, or transport of explosives

(including fireworks, ammunition, fuses, cartridges, powder nitroglycerin, or any ex-plosive) or high-pressure gases in containers; fireworks displays are also excluded

e) Prospecting, extraction, production, storage, and distribution or sale of natural gas, pe-troleum products, and/or highly inflammable gases or spirits other than contractors engaged in initial surveying or core sampling

f) Gas, water, and electricity supply utilities/authoritiesg) Port authorities and risks connected with docks and wharvesh) Liability arising from shipbuilding, ship repair of and the ownership, operation, or

loading or unloading of commercial cargo-carrying vesselsi) Trolley buses or motor vehicles.

EXCLUSION LIST—CLASS 3: WORKER’S COMPENSATION

In many jurisdictions, worker’s compensation/employer’s liability risks are statutory classes. The relevant legislation defines the boundaries of cover, and generally few, if any, exclusions exist. Where the reinsured is obligated to quote on all policies offered, occupation-based exclusions in the reinsurance wording are problematic and therefore undesirable. The reinsured should seek a way of automatically writing and reinsuring higher hazard risks, even if this requires payment on a specifically agreed additional premium.

1. Underground mining2. Drilling and/or refining of liquid or gaseous fuels3. Crews of ships or vessels and offshore risks4. Crews of aircraft.


��

EXCLUSION LIST—CLASS 4: MOTOR THIRD-PARTY PROPERTY DAMAGE (IN-CLUDING CTP GAP COVER)

1. Excess of loss2. Tramways or motor vehicles of any kind running on rails3. Insurance for any vehicle not designed to run on terra firma.

EXCLUSION LIST—CLASS 5: COMPULSORY THIRD-PARTY LIABILITY

1. Radioactive Contamination and Explosive Nuclear Assemblies Exclusion Clause NMA 1622.

APPENDIX II. ANNEXURE OF CLAUSES

EMPLOYER’S LIABILITY/WORKER’S COMPENSATION: DEFINITION OF OCCUPA-TIONAL DISEASE COVER (ACOD A)

The provisions of this article shall override any provisions of any other article contained herein that may conflict.

Insofar as liability is incurred by the reinsured under an employer’s liability policy and/or worker’s compensation policy in respect of legal liability for occupational disease or physical impairment attributable to a gradually operating cause that does not arise from a sudden and identifiable accident or event, this reinsurance shall provide cover on the basis that any one claim in respect of any one employee of an original insured shall be considered individually as one event for the purpose of recovery hereunder.

(100%) of all such policies. The result, expressed as a percentage, shall be used to calculate the limit of liability of the reinsurer and the retention of the reinsured under this reinsurance.

ACTS IN FORCE

Such clauses should be resisted if at all possible, although they are common in most reinsurance contracts.

In the event of any change in law by which the reinsurers’ liability hereunder is materially in-creased or extended, the parties hereto agree to take up for immediate discussion a suitable revision in the terms of this reinsurance. Failing agreement on a revision, this reinsurance shall operate from the effective date of a change in law as if the change had not occurred.


��

SUBSCRIPTION AGREEMENT BETWEEN THE BROKER AND THE INSURERS/REIN-SURERS THAT WILL NOT FORM PART OF THIS AGREEMENT FOR DOCUMENTA-TION PURPOSES

Slip leader/leading reinsurer:

Brokerage: 10% (ten percent)—nil on reinstatements

Basis of agreement to contract changes: As per expiring as far as applicable

Signing/document provisions: Reinsurers’ acceptance of a share in this agreement, whether by

direct signature of the attached signing page(s) (whether attached hereto or otherwise), or by correspondence, shall constitute their formal signature of the agreement, and no further documentation shall be issued.

Reinsurers agree to allow XYZ Reinsurance Australia Limited, without further authorization, to sign written lines disproportion-ately. Signing-down estimations given at time of placement are for indication only and are not warranted.

Currency: All settlements (premiums and claims) to be converted to or paid in Australian dollars.


��

Appendix III. Round 3

The following extract from the CSIC’s contractual details gives a broad overview of the coverage provided by reinsurers.

CSIC INSURANCE LIMITEDSUMMARY OF CONTRACTUAL DETAILS WITH REINSURER

The main relevant contractual details are the following:

Reinsured: The Casualty Specialist Insurance Company (CSIC)

Period: Losses occurring and/or losses discovered and/or claims made during the 12-month period from January 1, 2001, to December 31, 2001, both days inclusive

Class: All casualty insurances written by the Reinsured, including but not limited to motor, general third-party liability, employer’s liability, and professional indemnity

Limits: AUS 1 million ultimate net loss each and every loss or series of losses arising out of one event

EXCESS OF

AUS 1 million ultimate net loss each and every loss or series of losses arising out of one event

The contractual wording clarified the exact reinsurance period with the following language:

As regards losses arising under policies and/or contracts covering on a “losses discovered” or “claims made” basis, that is to say policies and/or contracts in which the date of discovery of the loss or the date the claim is made determines under which policy and/or contract the loss is collectible, such losses are covered hereunder, and the date such loss is discovered or claim made shall be deemed to be the date of the loss occurring for the purpose of this agreement provided that the date the loss is discovered or the claim made falls within the period of this agreement.

The original policy wording, in the case of a significant portion of CSIC’s business, specified (words in bold refer to specific policy definitions) the following:


��

The insurer shall pay, on behalf of the insured, loss resulting from claims first made against the insured during the policy period in respect of any civil liability for wrongful acts.

Notwithstanding CSIC’s policy wording concerning the definition of date of loss (a loss resulting from claims first made against the insured during the policy period), CSIC in fact administered claims as though the date of loss was determined by the date at which the claim was notified to the insurer.

The policies issued by CSIC were, perhaps, professional indemnity policies, under which a claim is first made against the professional, who then reports the claim to the insurer. If these two events happen in different years, then the insurer might not report the claim correctly to the reinsurer. This differs from many other forms of casualty insurance, in which an event leads im-mediately to a claim by the insured against the insurer.

The difficulty in this case arose in the administration within CSIC. From the very first point in time when claims under this policy wording were made against CSIC, the claims department had fallen into the practice of noting that the date of loss was the date on which the claim was first made against the CSIC. (Note that claims are made against CSIC, not against the original insured.) From then on, nobody at CSIC sought to change this practice. Perhaps nobody even con-sidered that something might be wrong. As a consequence, however, more than a decade passed, with successive reinsurance renewal proposals being completed and a substantial portion of the claims reported to reinsurers each year being designated as having loss date allocations that were incorrect.

This of itself did not necessarily cause trouble. As long as nobody checked the finer details of CSIC’s claims practices, there was no problem. Both direct and reinsurance claims were adminis-tered smoothly.

However, one of CSIC’s reinsurers (we might call them the ZHA Re), which was only involved in the 2001 treaty year, found itself in an adverse economic position. It adopted a policy of checking client practices to a high level of detail, uncovered CSIC’s errors in allocating claim dates, and pointed out that a number of claims that had been notified to ZHA Re’s treaty year should have been notified to the previous treaty year.

In theory, of course, this too might not have caused problems. CSIC could have found as many claims in 2002 (as entered in CSIC’s books) that should have belonged to 2001 as there were in 2001 (in CSIC’s books) that, according to ZHA (correctly, of course), belonged to 2000. Indeed, it might have suited CSIC to adopt ZHA’s analysis across all years, because this would have had the effect of transferring many losses to earlier treaty years. This, in turn, most probably would have improved CSIC’s overall recoveries from reinsurers, given that CSIC’s treaty deductibles had risen as time passed, and the process of transferring claims to earlier treaty years would have reduced CSIC’s retention.

Naturally, the longer-term reinsurers would have resisted such a procedure, and CSIC would have been prejudiced, had it tried this approach, by the fact that the annual proposal that it had completed used on its own (erroneous) date allocation procedure. Reinsurers might also have caused trouble in the event of a substantial initiative to reallocate claims to earlier years, in that


��

they could have argued that many of the claims thus reallocated would have been late-notified to the treaty years concerned.

Accordingly, it would not have been practical for CSIC to attempt to reallocate claims across all its past, even if it had had the time and inclination to embark on such a process from an admin-istrative standpoint. There was a further practical problem in that the 2002 treaty year had very few claims that could have been reallocated to 2001 (on the ZHA approach). This undermined any argument that ZHA should pay 2001 as presented because it would “lose on the swings what it gained on the roundabouts.” ZHA took care to ask whether there were claims from 2002 and soon established that it stood to gain from insisting on the correct application of the treaty conditions.

The inevitable outcome was that ZHA achieved a considerable saving on what otherwise would have been its treaty responsibilities.

Fortunately, ZHA’s treaty shares were very modest in size, and thus the damage to CSIC’s bal-ance sheet was quite limited in the larger context.

The text of the treaty required CSIC to operate treaty recoveries on a basis that deemed certain dates of loss to be applicable. Thus even if CSIC had conformed its practice to the original policy wordings, this might not have been sufficient to ensure adherence from the perspective of its rein-surers. It so happened that the original policy wording requirements were more or less the same as the treaty requirements, and this further concern need not have arisen.

Thus it is a sobering reminder that, despite all appearing to be well with CSIC’s reinsurance program for quite a number of years, the underlying treaty provisions were at odds with CSIC’s day-to-day practice, and this was sufficient to cause CSIC material economic loss.

The CSIC case might afford a useful discussion of the claims administration process, which the supervisor should examine closely. The type of coverage offered by CSIC is complex and potentially problematic. It requires disciplined procedures that call for immediate notification by the insureds of all possible claims (not just actual claims), immediate estimate of claims exposure, confirma-tion of claims when a possible claim becomes an actual claim, notification by the direct insurer to the reinsurer when required under the reinsurance policy, maintenance of comprehensive claims files and regular reviews to update claims exposure estimates, management of claims against the insureds to minimize losses, including exercising rights to encourage settlement or allow a claim to be litigated, and prompt filing of reinsurance claims.

icp 19: reinsurance case study - iaisweb.org · icp 19: reinsurance case study (teaching note) this...

Documents