reinsurance project

CHAPTER – 1

INTRODUCTION TO REINSURANCE

IntroductionReinsurance holds a greater role in the realm of insurance as primary insurers can latch on to the business of insurance in an unshackled way as the risks they are exposed to, constantly make them to look back with caution. Reinsurance provides them cushion through risk transfer and a source to share their liability and increases their ability to undertake huge risk exposures and undertake claims. Without reinsurance cover, it is obvious that large claims might jeopardize the viability of individual insurers or even the entire insurance system.

Reinsurance is an insurance of insured risk where the insurer retains a part and cedes the balance of a risk to the reinsurer. This is done to facilitate a greater spread and reduce liability on the part of the insurer. In other words, reinsurance is insurance of insured risk taken by insurance companies to protect their liability commitments beyond their net capacity. It is the foundation on which the whole edifice of insurance rests.This is a widely used risk transfer mechanism and provides the backbone to insurance industry. Reinsurance is one of the major risk and capital management tools available to primary insurance companies.

The progress in science and technology brought in its wake many revolutions the way in

which the companies operate today, thus making insurers to face more complex risks, with

substantial values at single locations and demanding special types of cover. The

stakes involved are considerable and in money terms very huge. The changing legal system and the increasing court awards, the increasing number of potential liabilities and the depreciation of the money are affecting in a cumulative fashion the cost of claims today. Reinsurers help the industry to provide protection for wide range of risks.

HISTORY OF REINSURANCEIn the early days of insurance, as there is no facility of reinsurance, an insurer accepted only those risks that could be entirely handled by him. The origin of reinsurance dates back to the fourteenth Century when the Lombardians began to develop the concept of reinsurance. The need for reinsurance was first felt in marine business, where there was a concentrated risk with a recognized catastrophe hazard. The oldest known contract with the legal characteristics of a reinsurance contract occurred in Genoa in 1370. Soon marine insurance developed rapidly and became a common practice throughout Europe. The earliest statutory reference to reinsurance was an Ordinance of Louis XIV in 1681, when it was promulgated that “it shall be lawful to the insurers to make reassurance with other men of those effects which they had themselves previously insured”. Marine reinsurance was permitted by British legislation only when the insurer died or became insolvent or went bankrupt. This prohibition continued until 1864. Fire reinsurance appears to have developed much later. The first fire reinsurance was found in a royal concession granted to the Royal Chartered Fire Insurance Company of Copenhagen in 1778. One of the earliest recorded fire reinsurance transactions took place in 1813 when the Eagle Fire Insurance Company of New York assumed all of the outstanding risks of the Union Insurance Company, but it was never really executed, as the insurer did not avail this facility. However, in the year 1821 a fire reinsurance treaty was executed between the National Assurance Company, Paris (the reinsurer) and the United Proprietors of Belgium. It is the Supreme Court of New York, in the year 1837 that provided real boost to reinsurance by upholding the contract of reinsurance in the case of New York Browery Insurance Company, the cedent and the New York Fire Insurance company, the reinsurer.

One of the earliest reinsurance companies are the Cologne Reinsurance Company established in 1846 and started operations six years later. The Company is still in existence and is thus the oldest professional reinsurance company. The SwissReinsurance company which started its business in 1863 is the first reinsurance company to be founded in Switzerland. The Munich Reinsurance company was formed in 1880. The disruption of the two world wars resulted in London developing into a substantial reinsurance market. The development was further aided by Lloyds’ increased involvement in reinsurance and the spread of excess of loss covers which were predominantly written by Lloyds. Of the total business written at Lloyds now, reinsurance constitutes a significant proportion.

Now reinsurance has spread all over the world especially for offshore risks, wide bodied

jets, satellite, and petrochemical risks. Development of reinsurance exchanges in the

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USA, and tax concessions in Bermuda, Panama, Honkong and Singapore have also helped in the development of reinsurance.

In the beginning, reinsurance was done mostly in the area of facultative transactions. With the progress of industry and commerce in 19th Century the innovative forms of coverage came into operation, giving rise to automatic forms of reinsurance known as treaties, which became an indispensable part of a company’s operations today. By the time of World War-I, proportional treaties became the main vehicle replacing facultative reinsurance that proved costly to administer and slow to operate besides being inflexible. The invention and technique of excess of loss cover was the most significant development in reinsurance in the past 100 years. This form of reinsurance filled a real gap for property policies which were extended to cover catastrophe hazards.

By 1850 there were already 306 insurance companies in 14 countries. In 1900, this number reached 1272 in 26 countries and in 1910, 2540 in 29 countries. Today more than 10,000 insurance companies are working in over 100 countries in addition to some 2600 agencies.

CONCEPT OF REINSURANCEReinsurance may be defined as a contractual arrangement under which one insurer, known as the primary insurer, transfers to another insurer, known as the reinsurer, some or all of the losses to be incurred by the primary insurer under insurance contracts it has issued or will issue in the future. Reinsurance is a contract of indemnity, even in life insurance and personal accident insurance.

The primary insurer is sometimes referred to as the ceding insurer, ceding company, cedent, or reinsured.

Reinsurers also may reinsure some of the loss exposures they assume under reinsurance contracts. Such a transaction is known as retrocession. The insurer or reinsurer to which the exposure is transferred is known as a retrocessionaire and the reinsurer transferring the exposure is called the retrocedent.

Retrocession agreements do not differ greatly in detail from reinsurance agreements.

In almost all cases, the reinsurer does not assume all of the liability of the primary insurer. The reinsurance agreement usually requires the primary insurer to keep or retain a portion of the liability. This is known as the insurer’s retention and may be expressed as a percentage of the original sum insured or a specified quantum.

In other words, reinsurance is insurance of the insured risk taken by insurance companies to protect their liability commitments beyond their limit.

Under ideal conditions, the contractual relationship between a reinsured and its reinsurer

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is a long-term, mutually beneficial relationship. The mutual obligations found in the reinsurance contract are derived from the principles of fairness and good faith, which culminate in the standard of ‘utmost good faith’ between the reinsured and reinsurer. Indeed, reinsurance agreements are often referred to as ‘honorable engagements’, generally intended to be viewed as statements of industry custom and understanding, and concerned above all with perceived intention of the parties rather than the strict interpretation of contract provisions.

Adverse Selection: conscious and deliberate submission by a reinsured company to a reinsurer of those risks, segments of risks, or coverage that appear less attractive for retention by the reinsured.

Primary: In reinsurance, this term is applied to the nouns: insurer, insured, policy and insurance and means respectively:

1. The insurance company which initially originates the business – the ceding company;

2. The policy holder insured by the primary insurer;

3. The initial policy issued by the primary insurer to the primary insured;

4. The insurance covered under the primary policy issued by the primary insurer to the primary insured (sometimes called ‘underlying insurance’).

Reinsurance premium: Consideration paid by a ceding company to a reinsurer for the coverage provided by the reinsurer.

Treaty: A reinsurance contract under which the reinsured company agrees to cede and the reinsurer agrees to assume a particular class or classes Insurance business automatically.

FUNCTIONS OF REINSURANCE

1. Stabilization of Loss Experience The primary insurer, despite the best forecast of losses, may yet find the loss ratios to be erratic, in the sense that there will be some years when the losses are least, but in other years the losses may be substantial. Such an inconsistent trend may make the insurance business risks and rather unprofitable. Profits are necessary to attract and retain capital and to increase the capital and surplus.

When a primary insurer purchases reinsurance, its losses are limited to retention. With reinsurance, whenever the loss exceeds retention, the primary insurer does not have to bear the excess loss as it is already reinsured and mathematically the primary insurer’s loss level will stabilize at the planned level.

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The following table illustrates how reinsurance provides the primary insurer stability in its underwriting results through reinsurance.

Table 8.1

Stabilization of Loss Experience of a Primary Insurer Loss Experience of a Primary Insurer Loss Experience of a

Primary Insurer for a Line of BusinessYears Actual Loss Amount reinsured Stabilized Loss level

(Rs. in thousands) (Rs. in thousands) (Rs. in thousands)

1 200 - 200

2 450 50 400

3 260 - 260

4 160 - 160

5 820 420 400

6 740 340 400

7 330 - 330

8 185 - 185

9 120 - 120

10 215 - 215

Average Annual Losses Rs. 3,48,000.

The aggregate loss over a ten-year period is Rs. 34,80,000 or an average of Rs. 3,48,000 each year. If a reinsurance agreement were in place to cap losses to Rs. 4,00,000, the primary insurer’s loss experience would be limited to the amounts shown in the ‘stabilized loss level’ column.

2. Large-line CapacityLarge line capacity refers to an insurer’s ability to provide a higher limit of insurance on a single loss exposure. In the commercial and industrial world, there are many items of property, which are of high value, say exceeding Rs. 100 cores. Instances are: a high rise building, a ship, an aircraft and so on.

Individually, many primary insurers would be unable to retain such a large amount of insurance on a single loss exposure without reinsurance. Besides, governments regulate the capacity of insurance and put a cap on the amount of insurance an individual insurer can write on a single loss exposure.

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In practice, the limit varies, but it may be stated that generally state regulators in the US prohibit a primary insurer from writing an amount of insurance in excess of 10 percent of its policy holder’s surplus on any one loss exposure.

However, when the primary insurer has the reinsurance facility, he can write a large line, keeping his retention within his stipulated maximum in relation to its capital and surplus and reinsuring the balance of the risk.

3. Financing Surplus ReliefIn practice, as if by convention, most insurers limit the amount of premiums they can write, making it a function of the policyholders’ surplus. For example, if the net written premiums, after deducting premiums on reinsurance ceded, exceed the policyholders’ surplus by a ratio of more than 3 to 1, it means the insurers have exceeded their capacity. In other words, a ratio below 3 to 1 is favorable.

In the case of the insurer with growth targets, the premium to surplus ratio will tend to go over 3 to 11. This is because there will be shrinkage of the surplus resulting from the prepaid expense portion of the unearned premium as agent’s commission is charged against surplus.

According to insurance regulations in force, every insurer is required to establish an initial unearned premium reserve equal to the total premium for the policy and then recognize the income over the life of the policy. The insurer has to charge the expenses immediately against income and does not amortize them throughout the policy period since most of these expenses are incurred at the inception of the policy. Since the insurer has not yet earned any income, initial expenses are paid out of surplus. This is referred to as the surplus drain as a result of growth in written premium.

The financing function of insurance is called surplus relief because of the reduction of the surplus drain, by using reinsurance.

4. Catastrophe ProtectionCatastrophe is a large loss to the community, resulting from such natural disasters as earthquakes, hurricanes, plane crashes, industrial explosions, terrorist attacks etc. This is a fundamental risk spread over the community. The September 11 attack in New York in USA is a case in point. Total industry losses usually reach several crores of rupees for one such catastrophe and, without reinsurance support, the primary insurer cannot write large amounts of catastrophe insurance. Since catastrophes are major causes of the instability of losses, one may say that this purpose of reinsurance is closely related to the purpose of stabilizing loss experience.

5. Underwriting AssistanceIn general, reinsurers have good expertise in underwriting different classes of insurance all

over the world. This expert knowledge available with the reinsurer can be beneficially

shared with many small and medium sized primary insurers. This service of reinsurers is

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very important in all fields of insurance. Reinsurers must be careful in offering advisory services and have to ensure that they do not reveal proprietary information obtained through confidential relationships with other primary insurers.

6. Withdrawal from a territory or class of businessMany a time, a primary insurer will be under pressure to withdraw from a region or class of business. There are strategic disadvantages in pulling out of a territory, as this is likely to affect its future business.

That is why in the modern day, primary insurers, in spite of pulling out of a region try to place 100% reinsurance. This process of reinsuring all losses for an entire class, territory or book of business is known as portfolio reinsurance.

BASICS OF A VALID REINSURANCE CONTRACTa) Contract of Reinsurance is a contract of insurance.

b) It is a separate contract distinct from original contract of insurance. The persons or firms insured by the primary insurer are not parties to the contract and usually have no rights under the reinsurance contract.

c) It is a contract of indemnity on the same risk as the original contract of insurance.

d) Both contracts are in existence at the same time.

e) There must be transfer of risk from one party to another.

f) Reinsurance must be between two insurance entities.

g) The insurance operators are recognized by regulators.

h) All the transactions between a ceding company and a reinsurer must be conducted on the principle of ‘utmost good faith’.

The availability of reinsurance makes it possible for policyholders to obtain all of their insurance from one insurer instead of buying it in bits and pieces from several insurers.This simplifies the problems of buying insurance. The availability of reinsurance helps to maintain the solvency of primary insurers with obvious advantages to policyholders. Reinsurance makes it possible for small insurers to compete effectively against larger ones, thus increasing the options available to buyers of insurance.

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? Questions

1. “Reinsurance holds a greater role in the realm of insurance”-Discuss.

2. Briefly trace the history of reinsurance.

3. Explain the concept of reinsurance and outline the roles of primary insurer and reinsurer.

4. Discuss the main functions of reinsurance.

5. What are the requirements of a valid reinsurance contract? Explain.

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CHAPTER – 2

REINSURANCE THEORY

OUTLINE OF THE CHAPTERl Reinsurance Theory

l Types/Methods of Reinsurance

l Proportional and Non Proportional

l Difference between Coinsurance and Reinsurance

LEARNING OBJECTIVESl Understanding the operations of reinsurance

l Distinguishing between various types of Reinsurance

- Proportional and Non-Proportional

- Facultative or Treaty

l To get to know the Magnitude of coverage and period of coverage

l To understand Premium sharing and claim liability under different varieties

l To know the meanings of Common terms in reinsurance

Introduction“Although the primary purpose of reinsurance is to avoid too large a risk concentration within one company, it may be used to take advantage of the underwriting judgment of the reinsurer, to transfer all or certain classes of substandard business to reduce the strain on surplus caused by writing new business, to stabilize the overall mortality or morbidity experience of the ceding company or in the case of newly organized small companies, to obtain advice and counsel on underwriting procedures, rates and forms.”…Dr. Skipper. Jr.

Reinsurance business operations require considerable skill and expertise. With competition among reinsurers growing, it is all the more challenging. From the cedent company point of view certain aspects need consideration.

a) Historic relationships: Cedent companies often prefer a reinsurance company which is reputed and financially sound with a large customer base spread over a wide geographical area. It is assumed that such companies can serve customers well. However, there are cases wherein the small companies also carried on the business successfully with exponential growth in their business.

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b) Security: The cedent company, like a typical policyholder, is equally concerned

with the security and therefore it chooses a standard and established reinsurer.

c) Quality of service: The quality of service offered by a reinsurer also matters a lot. The insurers and reinsurers have a duty to their respective shareholders to show profits. Therefore, they are equally concerned with risk they undertake and its financial consequences.

d) Pricing of the deal: The business offered to a reinsurer depends on the pricing deal negotiated and settled. Reinsurance comes at a cost to the primary insurer and a prudent analysis must be undertaken to see that the benefits and costs involved in taking a reinsurance policy provide protection to the reinsured.

The reinsurers should, at the same time, think in terms of their business prospects and not ending up in losses. Therefore, they may prefer a retrocession policy to cover up their risk. A retrocession is placed to afford additional capacity to the original reinsurer’s risk. Reinsurers should have strong focus and consider the industry’s competition and dynamics to meet the requirements of their customers.

TYPES OF REINSURANCE BUSINESSThere are two approaches that reinsurers adopt for securing business:

1. Direct writing

2. Through Brokers

Reinsurance companies solicit reinsurance business directly through their employees as well as through reinsurance broking companies.

Similarities and differences between insurance and reinsurance:

Similarities differences

1. Principle of utmost good faith 1. Liability of reinsurers isseveral, not joint.

2. Principle of indemnity 2. Broad scope of reinsuranceagreements.

3. Conditional contracts 3. ‘Follow the fortunes’ principle.

4. Not a contract of adhesion.

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TYPES OF REINSURANCEThere is no single kind of reinsurance that effectively serves all purposes. Several kinds of reinsurance have developed to serve the various functions listed in the preceding chapter.

While reinsurance contracts can be categorized in several ways, one basic categorization is between facultative reinsurance and treaty reinsurance. In facultative reinsurance, the primary insurer and reinsurer negotiate reinsurance contract for each risk separately. There is no compulsion for the primary insurer that it should purchase reinsurance on a policy that it does not wish to insure. Likewise, there is no obligation on the part of the reinsurer to reinsure proposals submitted to it. The reinsurer has the option of either accepting or declining a proposal. Facultative reinsurance may be either proportional or non-proportional.

Facultative reinsurance is now widely used for reinsuring hazardous risks not covered by treaty arrangements, for the purpose of reducing the insurance in certain area, for reducing the treaty reinsurers’ liability, to augment risk capacity and to get advice of the reinsurer on risks that are considered new and complicated.

In the treaty reinsurance there is a prior agreement between the primary insurer and reinsurer whereby the former reinsures certain lines of business in accordance with the terms and conditions of the treaty and the latter agrees to accept the business that falls within the scope of the agreement. An obligation is imposed that all policies that come within the terms of the treaty are required to be placed with the reinsurer. Similarly, the reinsurer can not decline risks that come within the terms of the treaty.

Given that the treaty reinsurance guarantees a definite amount of reinsurance protection on every risk which the primary insurer accepts, treaty reinsurance works out to the cheaper than the facultative reinsurance.

Though there seems to be a clear distinction between facultative and treaty reinsurance, there are some insurance contracts, called facultative treaties, which are hybrid in nature. The Reinsurance Association of America defines a facultative treaty as “a reinsurance contract under which the ceding company has the option to cede and the reinsurer has the option to accept or decline classified risks of a specific business line. The contract merely reflects how individual facultative reinsurance shall be handled”.

Sometimes a facultative treaty is referred to as facultative obligatory treaty or automatic facultative treaty. Under this, the primary insurer may submit risks within a specified class which the reinsurer is obligated to accept, if ceded. As this type of reinsurance provides plenty of opportunities for adverse selection, reinsurers exercise abundant caution in selecting primary insurers.

The Facultative Obligatory Treaty which is not very common is a combination of facultative and treaty forms of reinsurance.

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Proportional and Non-proportional ReinsuranceAnother system of classifying reinsurance is dependent upon the way in which the obligations under a reinsurance contract are divided between the reinsurer and the primary insurer. Prorata reinsurance or proportional reinsurance and excess of loss or non-proportional reinsurance are the two approaches for sharing losses.

Under Pro-rata or proportional reinsurance (also called participating reinsurance) the premium as well as the losses are shared between the primary insurer and reinsurer in the agreed proportions. For instance, if the reinsurer covers 25 per cent of the risk under a given policy, he also receives 25 per cent of the premium and has to pay 25 per cent of each loss under the policy, irrespective of the size of the loss. Under prorata insurance treaties, the primary insurer receives from the reinsurer a ceding commission in order to cover his expenses and possibly an allowance for profit.

Excess of Loss Reinsurance or Non-proprotional ReinsuranceUnder this, no amount of insurance is ceded. This reinsurance arrangement will not come into effect until the primary insurer has sustained a loss exceeding his retention under the contract and is covered by the excess of loss agreement.

It is to be noted that both facultative reinsurance and treaty reinsurance can be written as a pro rata or excess of loss or a combination of the two.

Fig. 2.1 depicts the various ways of classifying reinsurance.

CATEGORIES OF REINSURANCEExcess of loss reinsurance written on a facultative basis is always per risk or per policy

excess basis. Per occurrence and aggregate excess of loss reinsurance relate to a

Reinsurance

Treaty Facultative Financial

Pro-Rata Excess of Loss Pro-Rata Excess of Loss

Quota Surplus Per Risk Per Occurrence AggregateShare Share (Per policy) (Catastrophe) Excess

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class of business, a territory, or the primary insurer’s entire book of business rather than a specific policy or a specific loss exposure. A financial reinsurance agreement can be written for any of the above types of reinsurance.

Adopted from Micheal W. Elliott, Bernard L.Webb, Howard N.Anderson, and Peter R Kensicki, Principles of Reinsurance Vol.1 (Malvern, PA: Insurance Institute of America, 1955), pp. 5, 148

SOURCE: Webb. B.L; et.al., Insurance Operations, Vol. 2, Second Edition, American

Institute for Chartered Property Casualty Underwriters, Malvern, PA., 1997

Treaty ReinsuranceTreaty reinsurance has become popular with primary insurers because of its several advantages over facultative reinsurance. As the reinsurer has to necessarily accept all business that falls within the terms of the treaty, the primary insurer, with no prior consultation with the reinsurer, can underwrite, accept and reinsure such business on each application submitted to him. Because of the absence of prior negotiations with the reinsurer, the transaction cost on each policy is lower under treaty reinsurance than under facultative reinsurance.

As shown in Fig. 2.1 Treaty Reinsurance is subdivided into

(i) Pro Rata or Proportional Reinsurance Treaties and

(ii) Excess of Loss Reinsurance Treaties

Pro-rata reinsurance whether belonging to property or liability reinsurance involves sharing of agreed proportion of original premium and the claims. The excess of loss reinsurance is considered loss effective in this regard. The greater effectiveness of pro-rata treaties lies in two directions.

(i) The practice of paying ceding commission which is not common under excess of loss treaties.

(ii) The premium for a pro-rata treaty is likely to be a larger percentage of the of the original premium that in the case of an excess of loss treaty

There are two kinds of treaties in the pro rata category; namely

a) Quota Share Treaty Reinsurance and

b) Surplus Share Treaty Reinsurance

Similarly there are three general classes of excess of loss treaties (sometimes referred to as non-proportional treaties). They are

a) Per risk excess treaty or per policy excess treaty

b) Per occurrence of loss treaty

c) Aggregate excess treaty

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Quota Share Treaty

In Quota share contracts the cedant binds himself to retain and cede a fixed proportions of all the business it underwrites up to a fixed amount within the class or classes subject to the treaty. Even the smallest risks are reinsured.

For example, if the Ceding Company shall retain for own account 40% of all burglary business, with an underwriting limit of Rs. 50,000 per risk, the Cedant shall reinsure with the Reinsurer, who agrees to accept a 60% share of all burglary business. The reinsurer receives the same percentage of the premium less the ceding commission as it does of the amount of insurance and pays the same percentage of each loss. In the U.S. Quota Share treaties are much more common with property coverages than liability coverages.

The advantages of the system are particularly appropriate in the following cases:

1. When a company commences business in a line of business for which no statistics exist; here the Reinsurer participates in the underwriting of each policy, large and small, and pays in the same proportion its share of the losses.

2. To simplify administrative work and reduce cost.

3. If the loss ratio is uncertain and cannot be corrected immediately quota share reinsurance provides relief for a limited period of time.

An example of quota share treaty is given below:

Assume that ABC Insurance Company has purchased from XYZ Reinsurance Company a quota share treaty a retention of 30 percent and a cession of 70 percent with a limit of Rs. 8,00,000. Policy No.1 insures a building for Rs. 2,00,000 for a premium of Rs. 800. A loss of Rs. 50,000 is reported. Policy No.2 insures a building for Rs. 3,00,000 for a premium of Rs. 1,500. A loss of Rs. 80,000 is reported. Policy No.3 insures a building for Rs. 4,00,000 for a premium of Rs. 1,700. A loss of Rs. 90,000 is reported. Show how the insurance, premiums, and losses under these policies will be divided between the primary insurer and reinsurer.

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TABLE 2.2

DIVISION OF INSURANCE, PREMIUM AND LOSSES UNDER QUOTA SHARE TREATY

ABC Insurance Co. XYZ Reinsurance Company Total

(30 percent) (Rs.) (70 percent) (Rs. ) (Rs.)Policy No.1Insurance 60,000 1,40,000 2,00,000Premium 240 560 800

Loss 15,000 35,000 50,000Policy No.2Insurance 90,000 2,10,000 3,00,000Premium 450 1,050 1,500

Loss 24,000 56,000 80,000Policy No.3Insurance 1,20,000 2,80,000 4,00,000Premium 510 1,190 1,700

Loss 27,000 63,000 90,000

It is seen that the share of the primary insurer and the reinsurer in insurance, premium and loss remains the same in each policy, the rupee amount of retention by the primary insurer increases as the amount of insurance increases.

The Quota Share Treaty has the main disadvantage of ceding by primary insurer of a large share of presumably profitable business. Another disadvantage is it is not effective in stabilizing underwriting results as it does not influence the primary insurer’s loss ratio.

Surplus Share Treaty

Surplus share treaty is also a pro-rata or proportional reinsurance. Under a surplus treaty, the ceding company decides the limit of liability (rupee amount) which it wishes to retain on any one risk or risks and reinsures only the surplus over and above its own net retention. If the sum insured under the policy is within the net retention of the company, there will be no cession to the reinsurer. Thus, the company will be able to retain for its own account such risks.

It is usually arranged in terms of number of lines of retention. The amount retained by the ceding company for its own account is called the net retention or a line. Thus a surplus treaty may be of ten or twenty lines capacity, which means that the ceding company can assume cover on risks with sums insured ten or twenty times its own retained line.

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The following illustrative example is helpful for our understanding:

ABC insurance company has purchased from XYZ Reinsurance company a surplus treaty with a retention of Rs. 2,00,000 and a limit of Rs. 20,00,000. This is referred to as a ten-line surplus treaty. The primary insurer (ABC Insurance Company) will cede coverage upto ten times the retention amount. The given below illustrate how the surplus share treaty would apply to the same three policies shown in Table 9.2

TABLE 3.3

DIVISION OF INSURANCE, PREMIUM AND LOSSESUNDER SURPLUS SHARE TREATY

ABC Insurance XYZ Reinsurance TotalCo. (percent) (Percentage ceded) (Rs.)

(Rs.) (Rs. )Policy No.1Insurance 2,00,000 (100%) 0 (0%) 2,00,000Premium 800 0 800

Loss 50,000 0 50,000Policy No.2Insurance 2,00,000 (66.67%) 1,00,000 (33.3%) 3,00,000Premium 1,000 500 1,500

Loss 53,333 26,667 80,000Policy No.3Insurance 2,00,000 (50%) 2,00,000 (50%) 4,00,000Premium 850 850 1,700

Loss 45,000 45,000 90,000

As is seen in case of Policy No.1, there is no ceding as the amount of insurance is equal to Rs. 2,00,000 retention. For Policy No.2, the proportion in which premium and losses are shared between ABC Company and XYZ company is determined by retention divided by the insurance amount. Similarly with Policy No. 3.

It is again seen that under a surplus share treaty for insurance amounts above the retention, the rupee amount of retention remains constant while the percentage retention decreases as the amount of insurance increases.

The main advantage to the primary insurer of the surplus share treaty is the avoidance of ceding insurance on small loss exposures as he can afford to retain them. The primary disadvantage in comparison with quota share treaty to the increased administrative expense.

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Characteristics of Surplus Share Treaty and Quota ShareTreaty

Surplus share treaty Quota share treaty

1. Often property only. 1. Both property and casualty.

2. Sharing of percentage is 2. Sharing of percentage isvariable. fixed.

3. Individual cessions. 3. No individual cessions.

4. Reinsurer’s premium is the 4. Reinsurer’s premium is thepercentage of the original percentage of the originalpremium less a negotiated premium less a negotiatedceding commission. ceding commission.

5. Provides large line capacity. 5. Provides a limited line capacity.

6. Premiums and losses are 6. Premium and losses aresettled by account. settled by account.

Given below is an example on calculation of premium in a surplus share treaty.

Munich insurance company entered into two surplus treaty contracts with the reinsurers.The first surplus treaty consisted 10 lines with a maximum liability of Rs. 30,00,000.The

second surplus treaty consists of 20 lines with a maximum liability of Rs. 50,00,000.

Risk Gross Sum Retention

Insured (Rs.) Applicable (Rs.)1 2,00,000 2,00,000

2 3,00,000 1,00,000

3 12,00,000 2,00,000

4 30,00,000 4,00,000

5 65,00,000 2,00,000

Calculate the cessions to first surplus treaty.

Calculate the cessions to second surplus treaty.

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Solution:Risk Gross sum Retention Cessions to Cessions to

insured [Rs.] [Rs.] 1st surplus 2nd surplus

treaty [Rs.] treaty [Rs.]1 2,00,000 2,00,000 Nil

2 3,00,000 1,00,000 2,00,000 Nil

3 12,00,000 2,00,000 10,00,000 Nil

4 30,00,000 4,00,000 26,00,000 Nil

5 65,00,000 2,00,000 20,00,000 40,00,000

Balance of Rs. 3,00,000 has to be arranged facultatively.

Excess of loss or non-proportional Treaties

Non-proportional reinsurance arrangements are characterized by a distribution of liability between the cedant and the reinsurer on the basis of losses rather than sums insured, as in case of proportional arrangements. In fact, no insurance amount is ceded under excess of loss treaties; what is ceded is losses and premiums.

As compensation for the cover granted, the Reinsurer receives part of the original premiums and not part of the premium corresponding to the sum reinsured as in proportional reinsurance.

The following common characteristics differentiate them from proportional treaties.

1. The size of cession is not determined case by case.

2. Administrative costs are substantially reduced.

3. Usually there is no profit commission.

4. Reinsurance premium is worked out on the basis of exposure and past loss experience.

There are three general classes of excess of loss treaties.

(i) Per risk or per policy excess

(ii) Per occurrence excess or per loss excess, and

(iii) Aggregate excess

A per risk excess treaty is applicable to property insurance; the retention and limit apply separately to each risk insured by the primary insurer. A per policy excess treaty applies to liability insurance; the retention and limit apply separately to each policy sold by the primary insurer. The retention under each of these policies is specified as a

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rupee amount of loss. Further, the reinsurer is obligated for all or part of a loss to any

single exposure in excess of the retention and up to the accepted reinsurance limit.

Per occurrence excess of loss reinsurance gives indemnity against loss sustained in excess of the net retention of the primary insurer, subject to the reinsurance limit, irrespective of the number of risks involved in respect of one accident, event or occurrence. This kind of reinsurance when applied to property coverage is called catastrophe excess and when applied to liability coverage is called clash cover.

Aggregate excess treaties, also called excess of loss ratio or stop loss treaties are not common. They are used generally in crop hail insurance and for small insurers in other lines.

Characteristics of Pro-rata and Excess of Loss Reinsurance:

Pro- rata excess of loss

1. Liability is based on 1. Liability is in excess of thepredetermined percentage. cedant’s loss retention.

2. It is a proportional treaty. 2. It is a non-proportional treaty.

3. There is sharing of risks. 3. Risks that are above retentionare not covered.

4. This treaty focuses on the 4. This treaty focuses on the sizesize of the risk. of the loss.

5. Premium is shared as the 5. Premium is charged as apercent of original premium percentage on retainedless the ceding commission. premium.

6. Premiums and losses are 6. Settlement of premiums bysettled by account or account and the settlement ofbordereau. losses individually.

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Characteristics of Non-proportional Treaties:

Per Risk Per Occurrence Aggregate (stop loss)

1. It is negotiated on rate 1. It is negotiated on rate 1. It is negotiated on Rateexposure basis and exposure basis and there exposure basis andthere is no commission. is no commission. there is no commission.

2. Premiums are 2.Premiums are 2. Premiums aresettled by annual settled by annual settled by annualadjustment of adjustment of adjustment ofdeposit premium. deposit premium. deposit premium.

3. Premium is minimum. 3.Premium is minimum. 3. Premium is minimum.

4. Losses are settled 4.Losses settled by 4. Losses are settledindividually. catastrophe or event. annually.

5. Retention is for each risk 5.Retention is usually 5. Retention and the limitor building or location. above a minimum of two are stated as a loss ratio.

6. It has per occurrence Full-losses. 6. It has a co-insurancelimitation. 6. It has a co-insurance provision when the

provision when the reinsured shares the lossreinsured shares the loss above retention.above retention.

RATING FOR EXCESS OF LOSS COVERSOne concept which is frequently used in calculation of rate for excess of loss covers (either per risk or per policy) is BURNING COST. The burning cost is computed by the ratio of actual past losses over some time period, say, five years, to their corresponding premium (written or earned) for the same period. This ratio is used in assessing a portfolio of business and in determining rate of premium for renewal. This can also be termed as experience rating. The burning cost will give the rate of premium, which is just sufficient to cover the losses suffered by the reinsurers. This is then loaded by the underwriter for a reserve in case of worsening of loss experience, catastrophic element, acquisition costs and profit margin. The loading factor normally used is 100/70 or 100/80. An example of burning cost calculation will clarify the concept better.

(GNPI – Gross Net Premium Income; the usual rating base for excess of loss reinsurance. It represents the earned premium of the primary insurance company for the lines of business covered net, meaning after cancellation, refunds, and premiums paid for any reinsurance protecting the cover being rated and gross meaning before deducting the premium for the cover being rated.)

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In an excess of loss cover the rate of premium is 100/70th of the average burning cost

of incurred claims for the current and previous years. Rate to be applied to GNPI.

Year gnPI Incurred losses

1980 1,000,000 8,000

1981 1,200,000 20,000

1982 1,500,000 40,000

1983 1,800,000 50,000

Minimum rate of premium is 3%. Calculate premium for the year 1983.

SolutionYear gnPI Incurred losses to XL loaded BC

cover Paid+o/s losses with 100/70(1) (2) (3) (4) (5)

(3)/(2)*100

1980 1000000 8000 0.8 1.1143

1981 1200000 20000 1.667 2.381

1982 1500000 40000 2.667 3.810

1983 1800000 50000 2.778 3.969

TOTAL 5500000 118000 2.145 3.064

Hence the rate of premium would be 3.064 and amount of

premium 1,800,000 x 3.064 = Rs. 55,152

Per Occurrence Loss Cover-72 Hour Clause

“Loss Occurrence” means all individual losses arising out of and directly occasioned by one catastrophe. This will be limited to:72 consecutive hours as regards a hurricane, a typhoon, windstorm, rainstorm, hailstorm and or tornado72 consecutive hours as regards earthquake, seaquake, tidal wave, and or volcanic eruption168 consecutive hours and within the limits of any one State as regards riots, civil commotions and malicious damage168 consecutive hours for any other catastrophe of whatever nature and no individual loss from whatever insured peril which occurs outside these period or areas, shall be included in that “loss occurrence”

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An example will help to clarify this further:

Shilpa insurance company has taken an excess of loss cover for Rs. 20,00,000 in excess of Rs. 10,00,000 per event with two reinstatements. A hurricane causes a loss of Rs. 90,00,000 in a period of 10 days. If there is no hour’s clause, then the whole occurrence will be treated as one event and the recovery from excess of loss reinsurers will be limited to Rs. 20,00,000. In all such events it will become extremely important to determine the exact date of loss. So, assuming the dates, which are fixed by the surveyors are correct the position may be as under:

1. First period of 72 hours 30,00,000

2. Second period of 72 hours 35,00,000

3. Third period of 72 hours 20,00,000

4. Fourth period of 24 hours 5,00,000

Calculate reinsurance payment

Solution:1. Rs.30,00,000 – 10,00,000 = Rs. 20,00,000

2. R s . 3 5 , 0 0 , 0 0 0 – R s . 1 0 , 0 0 , 0 0 0 = R s . 2 5 , 0 0 , 0 0 0 b u t o n l y Rs. 20,00,000 payable since it is the maximum liability per event.

3. Rs. 20,00,000 – Rs. 10,00,000 = Rs. 10,00,000

4. Loss is borne by the company since it is within the deductible.

Thus, the total recovery is Rs. 50,00,000 by treating each 72 hours period as one event.

Working Excess of Loss CoverThe aim of this cover is to relieve the insurer of losses, which surpass the amount he has decided to retain for own account on any accepted risk.

ExampleThe company has decided to retain Rs.1,00,000 on all textile factories in its portfolio (i.e. Rs.1,00,000 on the sum of the risks which make up each factory – Furniture, Machines, Raw Materials, Semi Finished and Finished products). It protects its retention with an excess of loss cover of Rs.60,000 excess Rs.40,000, which means that the reinsurer pays up to Rs.60,000 after the cedant has paid at least Rs.40,000. If a loss of Rs.75,000 occurred in a factory, the cedant would pay its share, i.e. Rs.40,000 and the reinsurer would reimburse him Rs.35,000.

The working of excess loss cover is most commonly used in the fire (and allied perils) branch as well as marine cargo.

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Cover per event (catastrophe excess of loss)It offers the insurer protection against the accumulations resulting from numerous losses caused by the same event (cyclone, earthquake). In general, it protects the retention against catastrophes.

ExampleStorm causes Rs. 1,000 losses of Rs.3,000 on policies covering private houses, which are all retained within the companies’ retention. The company having concluded an excess of loss reinsurance cover on its retention for an amount of Rs.20,00,000 excess Rs.5,00,000. In other words the reinsurer has to bear Rs.20,00,000. The total loss would be distributed in the following manner:

Rs.

Total Loss 30,00,000

Cedants loss retention 5,00,000

Reinsurance cover 20,00,000

Balance Non reinsured (amt.- borne by the cedant 500,000

DIFFERENCE BETWEEN COINSURANCE ANDREINSURANCECoinsurance, a form of reinsurance, is a system whereby reinsurer shares direct responsibility for a risk with one or more insurance companies. The Cedent’s liability is limited to the amount it underwrites on the original policy.

The system is used especially for covering big industrial risks and certainly has many advantages. However, to apply it to the underwriting of thousands of medium and small risks would only mean high administrative costs and inconvenience.

In co-insurance the relationships are between the primary insured and each insurance company separately. If one company/insurer fails to pay its share of a claim, the others are not liable to pay more than their share of claims. In other words, their liability is limited to extent of share accepted by them individually.

Reinsurance is basically passing on the risk to some other insurer and therefore it does not absolve the insurance company from making payment irrespective of receipt of payment from reinsurer. In reinsurance the reinsured has a contractual relationship with the reinsurers. The insurer must pay valid claims, even if he fails to recover from his reinsurers.

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PML UNDERWRITINGWe have discussed about retention and retention limits of the insurance companies in terms of Sum Insured.

The degree of hazard in respect of fire risk of a first class residential building is less compared to fire risk in a cotton ware house. Further the frequency of fire losses in the case of cotton ware houses is much greater than in a residential building. If we follow “Sum Insured” basis of underwriting the primary insurer will retain the same volume of sum insured for a superior risk and a hazardous risk. However it will be advantageous for the primary insurer to retain more on a superior risk where the chances of total loss is smaller and retain less of hazardous risk.

Therefore, a way has been evolved by companies over a period to relate the retention to probable maximum loss (PML) estimates rather than to the sum insured. The main advantage of this basis is that risks are evaluated in terms of their loss potential. Usually PML assessment will be made by risk engineer after inspection of the various steps involved in the process and accumulation of risk in an industrial unit.

The advantages of PML underwriting to the primary insurance companies are

1. It gives them greater capacity to handle large risks.

2. It helps them to retain a lot more premium for net account than would be possible otherwise.

However this method of underwriting on PML basis suffers from following defects:

1. In respect of mega industrial risk, it is very difficult to have an objective evaluation of the process involved and its impact on PML assessment.

2. Primary insurers will have a tendency to depress the PML estimate so as to accommodate the values within the automatic reinsurance arrangements.

3. If the evaluation is haphazard or unscientific, it will result in the company having to carry a liability much in excess of its intention and this may have serious repercussions on reinsurers as well.

PML underwriting is normally practiced in the case of major fire, Industrial All Risk and project insurance policies.

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COMMON TERMSIt is essential at the outset to understand the meanings of some common terms in reinsurance.

Bordereau: a report furnished periodically to the reinsurer by the reinsured providing details of risks, premium and/or losses.

Cede: to give away or transfer all or part of risk to another company or companies.

Line: the amount of retention of the direct insurer; Reinsurer may accept one or more lines or fraction of a line

Overriding Commission: commission payable to the ceding company in addition to the original commission to take care of overhead expenses and often including a profit margin.

Profit commission: an additional commission payable by the reinsurers to the ceding company as a percentage of profits derived from the business.

Portfolio: the liability of an insurer for the unexpired portion of the policies in force or outstanding losses or both for a particular segment of the insurer’s business.

Treaty: an agreement made between the ceding company and the reinsurer under which the former agrees to cede a portion of risks up to the agreed limit to the reinsurer who in turn agrees to accept such cessions.

Reinstatement: A provision in an excess of loss reinsurance contract, (specially catastrophe and clash covers) that stipulates for a reinstatement of a limit that is reduced by the occurrence of a loss/losses.

Reserves: the portion of premiums/losses retained by the insurer for the due performance of the obligations of the reinsurer under the treaty.

Retention: the amount of liability the ceding company keeps for its account of a risk.

Retrocession: when a reinsurer (retrocedent) cedes all or part of the reinsurance risk it has assumed to another reinsurer (retrocessionaire).

Slip: a document showing details of reinsurance proposed to be offered which is circulated to the reinsurers by the brokers/ceding company.

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? Questions

1. ”Reinsurance requires lot of skill and expertise to operate and take it to logical business ends.” – Discuss.

2. What are the similarities and differences between insurance and reinsurance?

3. What is a proportional reinsurance treaty? Discuss various methods of proportional reinsurance contracts.

4. Discuss various types of non-proportional treaties.

5. Bring out the difference between coinsurance and reinsurance.

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CHAPTER – 3

SPECIAL AREAS OF REINSURANCE

OUTLINE OF THE CHAPTERl Special Areas of Reinsurance

l Property and Casualty Reinsurance

l Marine and Aviation Reinsurance

l Accident and Liability Reinsurance

l Life Reinsurance

LEARNING OBJECTIVESl Having a closer look at Property and Casualty Reinsurance

l Better knowledge of Accident and Liability Reinsurance including

- Motor,

- Personal Accident,

- Burglary,

- Jewelers block,

- Legal exposures to third parties and public,

- From products sold etc.

l Understanding of the Life Reinsurance

Property insurance is the business of operational contracts of insurance against risk of loss of or damage to material property like damage to machinery, buildings, stock, personal belongings or household goods, money etc.,

The types of property risks amenable to reinsurance are:

l Money insurance – all risks

l Goods in transit – damages/loss

l Business Interruption – effects on turnover/profits

l Engineering – risks of collapse of machinery

l Fire and Material damages – ‘All Risks’, riot, earthquake etc.

l Theft of Property – Burglary risk

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Special Areas of Reinsurance

IntroductionProperty reinsurance principally deals with many classes of original insurance business. The reinsurance contracts cover normally all those aspects which are covered in the original policy which may be physical loss or damage to real and personal property and the financial consequences arising out of losses/damages in respect of various areas outlined above.

Under the provisions of the Insurance Act 1938, a fixed percentage of each and every risk underwritten in India should be reinsured with GIC of India. This is called ‘Statutory Cessions’ and currently it is 10%. After meeting this mandatory requirement any surplus is ceded to others. The net retention of each company, after statutory cessions, is protected by Excess of Loss cover arrangements made by each company.

Certain important areas are explained here.

ENGINEERING REINSURANCEThe engineering insurance normally covers the machinery – erection to operation. The protection of insurance is provided at construction stage and operational stage.

Construction Stage1. Contractors’ All Risk insurance (CAR)

2. Erection All Risk insurance (EAR)

3. Marine Cum Erection insurance (MCE)

4. Contracts Works insurance (CW)

5. Advance Loss of Profits (ALOP)/Delay in Start Up (DSU) insurance

The construction stage policies are issued for the period of the project and they are all one-time policies.

Operational Stage1. Machinery Insurance (MI)/Machinery Breakdown Insurance (MB)

2. Boiler and Pressure Plant (BPP) insurance

3. Machinery Loss of Profits (MLOP) insurance

4. Contractors’ Plant and Machinery (CPM) insurance

5. Civil Engineering Completed Risks (CECR) insurance

6. Electronic Equipment (EE) insurance

7. Deterioration of Stocks (DOS) insurance

The operational stage policies are annual policies renewable at expiry.

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In engineering insurance even though claims are small there is a risk of catastrophe. There could be claims following accidents to plant and machinery, damage to property, interruption in production on account of many factors involving machinery. Fire or floods can also cause damage to machinery. Mumbai floods (2005) is an example, which affected many factories in Raighad district of Maharashtra.

The usual reinsurance methods adopted for engineering reinsurance are Facultative reinsurance, Treaty reinsurance (Quota Share treaty and Surplus Treaty) and Excess of Loss reinsurance. The highly exposed risks should be covered under Facultative reinsurance and the most frequent method is the surplus – quota share or surplus.

The ceding company has to basically think about its retention strategy for reinsurance program. The factors that need consideration to draw out a proper retention strategy are – size of the portfolio, probability of loss, size of loss, capital, reserves and rate of return, premium rates, cost of reinsurance and investment policy. By evaluating the types of risks underwritten and the hazard in their locations, a ceding company sets different retentions according to the degree of exposure to loss involved. Evaluating risks in this manner is called setting up a table of limits.

Usually the reinsurer provides the policy wordings and rating guidelines with the corresponding underwriting instructions. If an insurer wants to accept any risk outside the scope of the rating principles, the insurer should obtain the reinsurer’s approval. The reinsurer may also reserve the right to take part in the claims settlement.

FIRE REINSURANCEThe Proportional Treaty agreement is well suited for fire reinsurance in view of the large number of risks involved. For ceding company the result net of reinsurance remains stable over a period of time. The net retained business can be appropriately covered. In an year of higher than average losses in large risks, a larger recovery can be made from reinsurers.

l Fire insurance risk business is vulnerable to losses arising on a single large risk from natural perils and to an abnormal increase in aggregate losses during a particular period. Therefore, it would be necessary for an insurer to avail of any of the main forms of excess of loss covers as follows:

l Facultative excess of loss to limit commitment on a single risk.

l A working ‘risk’ excess of loss treaty as an alternative to proportional treaty.

l A catastrophe excess of loss cover to protect against accumulation of losses from one event on net account.

ALL RISKS PROPERTY PACKAGE REINSURANCEThis is normally obtained to cover a range of diverse activities. It deals with multi-line/

multi-location/ multi-occupancy exposures which is otherwise reinsurable under

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different departments. It is a package cover. It is not a spread of risks of similar nature but a combination of various exposures, which are competitively priced. This is normally available under facultative arrangement. The insurer has to select a combination of facultative and excess of loss covers while ensuring that the net retention is not unduly burdensome.

CASUALTY REINSURANCECasualty insurance is a broad field of insurance and covers whatever is not covered by fire, marine and life insurers. It includes automobile, liability burglary and theft, workers compensation, glass and health insurance. It is basically US way of looking at general insurance and is used synonymous to liability insurance. It covers the indemnification of the first party – the insured party; in the event that it is legally liable to pay compensation to a third party. The different considerations of underwriting that are applicable in the case of property reinsurance are equally applicable to casualty reinsurance.

MARINE REINSURANCEThe marine risks were one of the earliest known risks, which were covered under reinsurance. Marine insurance can be done in two ways – cargo and hull; the former covers the merchandise and the later the body of ship, its machinery etc., reinsurance is available separately for each.

In India, section 9 of the Marine Insurance Act, 1963 states that an insurer under a contract of marine insurance has an insurable interest in his risk and may reinsure in respect of it. Reinsurance is effected with the objective of:

l Reduction of an underwriter’s line on any particular risk to a desirable amount that he can retain on his own account;

l To offload all or part of an undesirable risk;

l To protect against catastrophe loss;

l To increase market capacity by spreading the risk over the international market and creating reciprocity – an exchange of business for comparable business from another insurer;

l To provide an underwriting capacity, which can also mean ability to participate in risks which are not otherwise available;

l To stabilize the underwriting results of a company.

The marine insurance is typical in the sense that the items to be covered under insurance

are mobile and in some cases travel at high speed. Two cargo vessels may be moving in

opposite direction somewhere in the world and in a short time come closer almost bordering

on collision. A marine underwriter may not see the goods / ships that he is

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insuring and only good faith forms the bedrock of their business to avoid frauds etc., The range of values and items requiring marine insurance is enormous and amounts may at times be colossal. The vessels and cargoes can be totally lost and the insurer, unless he goes for reinsurance, can land in bankruptcy after a major loss.

The better way for a reinsurer to reduce the impact of war risks is to reinsure on a proportional basis and protect the retained amount by seeking protection under an aggregate excess loss cover relating to all losses taking place during a particular year.Sometimes it is difficult to get claims settled easily, on account of administrative and legal hassles. And to tackle such situations tonners have come into existence. They were developed in the reinsurance market as a means of purchasing reinsurance exceeding an aggregate value of insurance or a certain tonnage. However tonners could not survive on account of legal problems.

CARGO REINSURANCECargo risks are normally covered from initial warehouse to the final destination and the risk exposure is less if an event occurs outside the coverage. The reinsurer should be able to pinpoint the actual cargo and the risks insured. The cargo business is normally covered by Marine open Covers. The insurer would automatically accept from his assured all shipments falling within the scope of the Open Cover up to an agreed amount per vessel/conveyance. It is quite possible that, when a number of open covers are issued, several clients may be shipping full lines perhaps by the same vessel, and an insurer may not know the full extent of his cargo commitments on a vessel before the risk commences. Often the name of the carrying vessel may not be known, or known only after completion of the voyage. Therefore, problems arise in accumulation control.

While containerization with several high limits can be aggregated on a single ship, and thus reduce the incidence of theft, there are instances where the whole container along with the cargo have been robbed thereby leading to more complicated problems like major claims. The combination of cargo and hull insurance values are, at times, so fabulous that it becomes impossible for a single reinsurer to assume the total loss and hence go for sharing or retrocession.

It is not possible for an underwriter with general cargo account to protect himself against unduly large commitments on any particular vessel by means of facultative reinsurance alone. Facultative reinsurance is effected only in special cases for specific risks, while general protection is obtained by treaty reinsurance arrangements. The underwriting of cargo insurance calls for care in choosing the retention limits considering the premium income for the year. It should bear a reasonable ratio to the total income so as to protect against the company’s profit being wiped off with a single loss. Alternatively,Quota Share arrangements can be sought when there is a need to create reciprocal

treaties. For valuable items like diamonds and gold, it is usual to reinsure these risks

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separately under Surplus and other treaties and facultatively when the treaty limits are exceeded.

In recent times, non-proportional reinsurance gained popularity as there is increasing use of Excess of Loss treaty under which a company can fix a limit up to which it can absorb all the risks. Only when the net loss exceeds this pre-determined retention limit does the reinsurer’s role comes into play. On the other hand, an Excess of Loss Treaty may protect the ceding company’s gross lines/net lines after cessions to Surplus/Quota Share. Normally, the Excess of Loss reinsurance is placed in layers. It protects the ceding company’s net retained account where the ceding company’s basic reinsurance arrangements are on proportional basis, to reduce the impact of accumulations and catastrophe exposures.

HULL REINSURANCEHull risks cover the body of a ship, its machinery, docks and also others like vessels, coasters, barges and yachts etc. However it mainly deals with items relating to body of a ship. Hull insurance broadly falls into two categories viz., ocean-going vessels, including bulk carriers, and tankers and local crafts such as barges, lighters, launches, tugs, dredgers, trawlers etc., Marine cargo business in most of the countries around the world is ocean transit and air-transit but in India the inland transit like rail, road or water ways constitute a substantial portion.In hull insurance, the insurer is certain of his commitments as the value of each vessel or fleet can be clearly estimated as a result of which open covers ( as in cargo insurance) can be avoided. In case of total loss the demand is for facultative reinsurance in hull reinsurance. Depending on the gradation of the vessel, the cedent should determine his retention limits, taking into account the various aspects of the vessel like age, performance, sea-worthiness etc. Above the net retention limit, excess of loss facility should be obtained to reinsure the risk. As with cargo interests, the present trend is away from proportional treaties towards excess of loss methods of protection. However, even though Quota Share and Surplus treaties are encouraged, the emphasis is growlingly on excess of loss arrangements, particularly for ‘catastrophe’ covers. Wherever the excess of loss is the selected method of protection, the agreement is to pay the excess of an ultimate net loss to the ceding company in respect of each and every loss or series of losses arising out of the same ‘loss occurrence’.It is suggested that the hull insurer should take care to obtain reasonably high reinsurance limits since the hull policy may cover liability risks in addition to physical damage to the vessel. He should endeavor to obtain most extensive coverage at a cost which leaves him scope for making profits on his retained portion.

AVIATION REINSURANCEAs the capital required in aviation is high, very few private entrepreneurs enter this area

and it is dominated by government undertakings. Insurance in the aviation faces

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peculiar challenges because of fabulous amounts involved and the loss of human life adding to the monetary commitment under accepted policies. The aviation insurance market is truly international as risks are placed in all countries through exchange of reinsurance. This makes for a competitive and free market on worldwide basis. In order to limit their risks insurers have always shown a tendency to spread risks as widely as possible. Even though initially London was the nerve center of aviation insurance, slowly it is giving way to countries in Europe like France, Germany and Switzerland. Reinsurance plays a major part in aviation insurance, as around 80 per cent of any aircraft will be reinsured.

According to Economic Times, Dec. 14, 2001 - the year 2001 turned out to be the worst in aviation insurance history. The aviation insurance business has received claims amounting to $ 4.8 billion during the calendar year, which has been enough to wipe out at least four years of average premium income. Hull claims which represent claims on account of damages to the aircraft, account for less than half a billion dollars. Most of the claims ($4.3 bn) are on account of liability claims, which mostly include compensation to relatives of passengers killed in air crashes. Airline losses have not stopped with the September 11, 2001 incident. After the terrorist attacks in US there have been five major incidents inNovember 2001 itself. Indian Airlines, which renewed its policy after the attacks, had to pay a renewal premium of $17 million, which is $3 million higher than the rates for the previous year.

Aviation insurance encompasses three areas – Hull, Liability and Personal accidents. Broadly it covers loss of/or damage to the aircraft, third party liability and passenger liability. In aviation insurance, facultative covers are normally sought because of the changes in aircraft sizes and passenger liability. The reinsurer often places certain clauses under the facultative cover:

l To control claims negotiation and settlements;

l To determine the details of the original policy wordings;

l To discover the original policy rates or premiums.

A reinsurer involved in airlines business faces the problems of accumulation of risk.This occurs in two ways. The first is the risk of two or more aircraft being at the same place. Whether on ground, at airports or while flying along the air corridors, there is a risk of collision. The second type of accumulation arises from insurance policies, particularly those for airline hull and liability and aviation products liability. These accumulations are severe and unquantifiable and only an actual loss evidences the potential. This calls for maintenance of detailed records in a comprehensive manner so that sufficient levels of excess of loss or other suitable cover may be put in place.The underwriting of aviation insurance needs a closer scrutiny due to high values in insurance and reinsurance.

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The main forms of coverage for airline risks are placed on a policy for the operator’s whole fleet. There used to be separate policies for hulls and liabilities but over the years combined hull and liability policies came into vogue to save on administrative costs. Hull war risks are normally covered under a separate insurance policy where the values are the same as under the Hull All Risks. This coverage can also be provided on the Hull All Risks policy as a separate section. In many insurance markets, aviation business is pooled. These pools are formed by local companies to unite their efforts to solve technical and capacity problems.

Normally the reinsurers exclude the following under the policies:

l Hull war is not generally acceptable under treaties. It is protected under a separate reinsurance program

l Policies exceeding a period of twelve months

l Inward Treaties

l Tonners

l Brokers, binders and Line Slips: except line slips where risk are rated by a leading London underwriter

l Profit commission. Good Experience Return or Deductible Insurances

ACCIDENT AND LIABILITY REINSURANCEAn accident is an event, which is wholly unexpected, not intended or designed. It does not include the cumulative result of a series of small incidents. It may be noted that while suicide and murder or homicide following grave provocation are not accidents, homicide or murder without provocation, frostbite, snakebite and drowning are accidents. The purpose of personal accident insurance is to pay a fixed compensation for death or disability resulting from accidental bodily injury. The basic coverage of the policy is, if at any time during the currency of this policy, the insured shall sustain any bodily injury resulting solely and directly from accident caused by external violent and visible means, then the insurance company shall pay to the insured or his legal personal representative(s), as the case may be, the sum or sums set forth in the policy, if resulting in specified contingencies such as death, permanent disablement etc.

The purpose of Liability Insurance is to provide indemnity to the insured in respect of financial consequences of a legal liability. Whenever liability arises under Civil Law, compensation becomes payable. Besides there may be legal costs awarded against the insured and also legal costs of defense of the claim incurred by the insured. Civil liability may arise under a) Law of Tort e.g. negligence and b) Statutory Law (Public Liability Insurance). Liability Insurance comprises the following policies:

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l Policies under Public Liability Insurance Act, 1991.

l Public Liability for Industrial and Non-Industrial risks.

l Products Liability.

l Professional Indemnities for Doctors, Chartered Accountants, Solicitors etc.

l Employer’s Liability (Workmen’s Compensation Policy).

l Directors and Officers Liability policy.

l Vendors of Software Liability.

l Stock Exchanges, Banks and Financial Institutions Liability etc.

The form of reinsurance, in these cases, normally adopted is mostly the Quota Share in conjunction with a working excess of loss. Personal accident requires reinsurance for high net worth individuals and for accumulation as in a single aircraft. These are addressed through a combination of working and catastrophe excess of loss reinsurances. In India, it is not the practice to include personal accident insurance for excess of loss covers and these risks were entirely retained by the local insurers.Catastrophes like Gujarat earthquakes, Mumbai floods and terrorist attacks on WTC made insurers to reconsider this approach.

Experience of other insurances differs from country to country. The risk of burglary exposure, for example, is attended to differently within a country and between countries. At one extreme a simple guard provides security and considered as adequate and at the other extreme there is electronic surveillance, frisking and restricted access as can be observed in software companies. The Law and Order situation differs depending upon the seriousness and extent of attention by political leadership and government. The values involved and size of assets involved are material to consideration given these variations.

In case of software exports, particularly to USA, for example a different situation arises wherein the overseas vendor requires insurance protection for a fabulous amount. Indian market requires reinsurance to support the transaction. Reinsurers will provide protection if they have investigated the proposal and found the risk as reinsurable. The risk is evaluated on the basis of reliability of Indian exporters and the jurisdiction of USA, litigious country. Detailed proposals are required to be completed for all professional, public and product liability covers. The information as provided is scrutinized for vulnerable risk exposures. The cover is negotiated with appropriate restrictions and rating.

LIFE REINSURANCELife reinsurance differs from other classes of reinsurance. The nature of risks assumed

by the life insurance has necessitated the development of various forms of reinsurance.

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The proportion of total life insurance premiums reinsured is small in comparison with most of the non-life insurance classes. The demand for life reinsurance arises on account of a) difference in the number of deaths and b) death strain. Life insurer’s mortality risks arises on account of uncertain calculations of death claims made by him with the help of mortality tables. However in practice, the actual number may differ resulting in wide dispersion. Such divergence will have impact on the earnings of a Life Insurance Company.

The cost to a life insurance company in case of a claim is the sum assured plus bonus, if allowed. Cost minus reserves applicable to the policy gives the amount of ‘Death Strain’. This results in creating an impact on operating results. Life insurers generally seek reinsurance to reduce the impact of such death strain on operating results of the company.

Three life reinsurance plans are in general use under both facultative and automatic agreements.

Coinsurance Plan: The reinsurer assumes a proportionate share of the risk according to the terms that govern the original policy. The reinsurer is liable for an amount determined by the size of the insurance assumed in relation to the original insurance amount. Thus, if the reinsurer has accepted one -half of the original insurance, it becomes liable for one-half of any loss. In return for this guarantee, the reinsurer receives a pro-rata share of the original premium less a ceding commission and allowance. These payments reimburse the direct-writing company for an appropriate share of the agent’s commissions, premium taxes paid, and a portion of the other expenses attributable to the reinsured policy. Also, the reinsurer reimburses for a proportionate share of any dividends paid. In general, the reinsurance contract is a duplicate of that entered into between the direct-writing company and the policy owner. The ceding company and the reinsurer share the risk (premiums and claims) according to agreed proportions; with the reinsurance rates derived from the original rates charged the policy owner.

Yearly Renewable Term Plan: Under this the reinsurer assumes the reinsured policy’s net amount at risk in excess of the ceding company’s retention. The ceding company pays premium on a yearly renewable term basis. This plan is particularly appropriate for smaller ceding companies because it results in larger assets for these companies and is simpler to administer than coinsurance plan. Thus, for policies with declining net amounts at risk, decreasing amount reinsurance is purchased every year. If a loss occurs, the reinsurer is liable for the amount that it assumed that year and the ceding insurer is liable for its retention plus the full reserve on the reinsured portion of the policy. Premium rates for yearly renewable term reinsurance are established independently of the premium charged to the policyholder.

Modified Coinsurance Plan: In the interest of permitting a company to retain control

over the funds arising out of its own policies, a modified coinsurance plan has

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been developed. Under this arrangement, the ceding company pays the reinsurer a proportionate part of the gross premium, as under the conventional coinsurance plan, less commissions and other allowances, premium taxes and overhead allocable to reinsured policies. At the end of each policy year, the reinsurer pays to the ceding company a reserve adjustment that is equal to the net increase in the reserve during the year, less one year’s interest on the total reserve held at the beginning of the year. The net effect of the plan is to return to the ceding company the bulk of the funds developed by its policies. Modified coinsurance can be considered as yearly renewable term on a calendar year basis because the reinsurer, after paying the reserve adjustment, cash surrender values, and commissions and allowances, is left with only the risk premium.

Aside from the reserve adjustment, the modified coinsurance plan follows that of the regular coinsurance plan.

A key element, under life reinsurance, is in assessing the true value of assets recoverable from a reinsurer. A direct insurer who relies too heavily on one reinsurer faces a substantial risk of default. A life insurer who totally depends on reinsurance and retains a small percentage of his total portfolio is generally considered to be an increased risk to the insuring public. Very little reinsurance is affected by Life Insurance Corporation of India. Its reinsurance is a surplus treaty, which takes sum insured exposures on individuals in excess of US $ 100,000. The substantial part of LIC’s business is not reinsured. Key man insurance, and accumulation are two risk exposures of significance to a life insurer for arranging his reinsurance.

Key man insurance protects business debts of a firm, which is dependant on a key individual for continuing its business. In view of which the sum insured would not be related to the value of a person but the value of loss to his firm in case of his leaving the company and the premium is paid by the firm is treated as business expense.This has become a big controversy in India and IRDA suspended operation of this policy for some time.

Accumulation is when several people are affected by a loss and there is an accumulation of insured persons; also, where several policies arranged in respect of one and the same individual are affected, one speaks of a policy accumulation. Accumulation control is therefore essential to determine need for reinsuring.

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? Questions

1. What are the special areas of insurance? Highlight their treatment.

2. Explain engineering reinsurance at (i) construction stage, and (ii) operations stage.

3. Write short notes on a) fire reinsurance, and b) casualty reinsurance.

4. “Marine insurance can be done in two ways – cargo and hull”. Explain them.

5. “The aviation insurance market is truly international as risks are placed in all countries through exchange of reinsurance”. Outline the procedure in aviation insurance.

6. “The proportion of total life insurance premiums reinsured is small in comparison with most of the non-life insurance classes”. Why reinsurance of life insurance is not popular? Trace out reasons and explain the process of reinsurance of life insurance.

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CHAPTER – 4

REINSURANCE REGULATIONSAND LAW IN INDIA

OUTLINE OF THE CHAPTERl Reinsurance Regulations and Law in India

l Reinsurance Contracts Treaties

l Treaty Wordings

l Arbitration and Mediation

LEARNING OBJECTIVESl Getting acquainted with Reinsurance Regulations in India

l Knowing IRDA Regulations

l Understanding Principal contract related strategies

l Appreciating Salient features of Arbitration

l Understanding Treaty Wordings

REINSURANCE REGULATIONS AND LAW IN INDIAThe law of reinsurance is based primarily on the law of contract. In India, IRDA has prescribed regulations for the reinsurance sector for general as well as life insurance. The principal contract related statutes and regulations govern the insolvency, offset and intermediary clauses, which appear in both treaties and facultative certificates.Treaty wordings are reinsurance agreements entered into in writing between the ceding insurer and his reinsurer and embody the terms and conditions of the treaty.Until recently, reinsurers were not subject to the extent of regulations generally imposed on the insurers, that is, until a few scandals involving some reinsurers and reinsurance brokers rocked the industry. The reasons that have resulted in regulating insurers chiefly were to protect insured from unfair trade practices of some insurers and also possible insolvency of insurers, apart from unreasonable premium rates.

However, recently many countries have felt the need to impose some regulations on reinsurers for the overall health of the insurance industry.For instance, in the U.K., the Department of Trade requires the primary insurers to annually report on the following:

a) The names and addresses of all reinsurers to whom business has been ceded during the year;

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Reinsurance regulations and law in india

b) Any connection (other than the reported reinsurance) between the primary insurer and any of its reinsurers;

c) The amount of premium payable to each reinsurer; and

d) Any indebtedness of a reinsurer to the primary insurer at the end of the year.

The reinsurance rules relating to the Indian context are discussed separately in the next section.

In the United States, reinsurers as well as licensed alien reinsurers have to keep solvency margin almost along the lines prescribed for primary insurers and must follow reserves, investment, capital and surplus requirements and annually or sometimes every quarter file financial statements with State regulatory authorities.

Pricing is not directly regulated though the regulation of primary insurer’s rates could affect the reinsurance pricing.

Another important regulation relates to a contingency when a primary insurer goes bankrupt. The regulation by means of an insolvency clause provides that the insolvency of the primary insurer will not affect the liability of the reinsurer for losses under the reinsurance contract: the reinsurer will make payment to the liquidator or the receiver of the insolvent primary insurer for the benefit of their creditors, namely the insured.

Another important regulation is through an intermediary clause whereby the risk of insolvency of the reinsurance broker is passed on to the reinsurer so any default by the reinsurance broker either to transmit the reinsurance premium to the reinsurer or pass on reinsurance claims payments to the primary insurer will be made good by the reinsurer since it is now established that the reinsurance broker is an agent of the reinsurer and not the primary insurer.

Reinsurance brokers are regulated much less in the U.S. However, some States, notably, New York, have required reinsurance brokers to be licensed. According to New York Regulation 98, the following regulations apply to the reinsurance brokers:

l Reinsurance intermediaries act in a fiduciary capacity for all funds received in their professional capacity and must not mix them with other funds without the consent of the insurers and reinsurers they represent;

l Reinsurance intermediaries shall have written authorization from the insurers and reinsurers they represent, spelling out the extent and limitations of their authority;

l The written authority above must be made available to the primary insurers or reinsurers with which the intermediary deals;

l No licensed intermediary shall procure reinsurance from an unlicensed reinsurer unless the reinsurer has appointed an agent for the service of process in New York;

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l The intermediary must make full written disclosure

of: Any control over the broker by a reinsurer,

Any control of a reinsurer by the intermediary,

Any retrocession of the subject business placed by the intermediary,

andCommissions earned or to be earned on the business.

l Records of all transactions must be retained for at least ten years after the expiration

of all reinsurance contracts.

REINSURANCE REGULATIONS IN INDIAIn India, the Insurance Regulatory and Development Authority (IRDA) has prescribed regulations for the reinsurance sector for general as well as life insurance and we summarize below these regulations. (The test of the Regulations is reproduced in Annexure I to the Chapter)

The IRDA (General Insurance-Reinsurance) Regulations, 2000 are as follows.

l The first chapter defines such special terms as cession, facultative, Indian reinsurer, pool, retrocession, retention, and treaty.

l The second chapter describes the procedure to be followed for reinsurance arrangements:

i) Clause 3-1 states the objectives of a reinsurance program as;

■ To maximize retention within the country;

■ Develop adequate capacity;

■ Secure the best possible protection for the reinsurance costs incurred;

■ Simplify the administration of business.

ii) Clause 3-2: Every insurer shall maintain the maximum possible retention

commensurate with its financial strength and volume of business. The Authority may

require an insurer to justify its retention policy and may give necessary directions to

ensure that the Indian insurer is not merely fronting for a foreign insurer.

iii) Clause 3-3: Every insurer shall cede such percentage of the sum insured on each policy for different classes of insurance written in India to the Indian reinsurer as may be specified by the Authority in accordance with the Insurance Act, 1938 in this regard.

iv) Clause 3-4: The reinsurance program of every insurer shall commence from the beginning of every financial year and every insurer shall submit to the Authority, his reinsurance programs for the forthcoming year, 45 days before the commencement of the financial year.

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v) Clause 3-5: Within 30 days of the commencement of the financial year, every insurer shall file with the Authority a photocopy of every reinsurance treaty slip and excess of loss cover note in respect of that year together with the list of reinsurers and their shares in the reinsurance arrangement.

vi) Clause 3-6: The Authority may call for further information or explanations in respect of the reinsurance program of an insurer and may issue necessary directions.

vii) Clause 3-7: Insurers shall place their reinsurance business outside India with only those reinsurers who have over a period of the past five years counting from the year preceding for which the business has to be placed, enjoyed a rating of at least BBB (with Standard & Poor) or equivalent rating of any other international rating agency. Placements with other reinsurers shall require the approval of the Authority. Insurers may also place reinsurances with Lloyd’s syndicates taking care to limit placements with individual syndicates to such shares as are commensurate with the capacity of the syndicate.

viii) Clause 3-8: The Indian reinsurer shall organize domestic pools for reinsurance surpluses in fire, marine hull and other classes in consultation with all insurers on basis, limits, and terms, which are fair to all insurers and assist in maintaining the retention of business within India as close to the level achieved for the year 1999-2000 as possible.

ix) Clause 3-9: Surplus over the domestic reinsurance arrangements class wise can be placed by the insurer independently with any of the reinsurers complying with sub regulation (7) subject to a limit of 10% of the total reinsurance premium ceded outside India being placed with any one reinsurer. Where it is necessary in respect of specialized insurance to cede a share exceeding such limit to any particular reinsurer, the insurer may seek the specific approval of the Authority giving reasons for such cession.

x) Clause 3-10: Every insurer shall offer an opportunity to other Indian insurers including the Indian reinsurer to participate in its facultative and treaty surpluses before placement of such cessions outside India.

xi) Clause 3-11: The Indian reinsurer shall retrocede at least 50% of the obligatory cessions received by it to the ceding insurers after protecting the portfolio by suitable excess of loss covers. Such retrocession shall be at original terms plus an overriding commission to the Indian reinsurer not exceeding 2.5%. The retrocession to each ceding insurer shall be in proportion to its cessions to the Indian reinsurer.

xii) Clause 3-12: Every insurer shall be required to submit to the Authority statistics relating to its reinsurance transactions in specified forms together with its annual accounts.

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xiii) Clause 4: Inward Reinsurance Business: Every insurer wanting to write inward reinsurance business shall have a well-defined underwriting policy for underwriting inward reinsurance business. The insurer shall ensure that persons with necessary knowledge and experience make decisions on acceptance of reinsurance business. The insurer shall file with the Authority a note on its underwriting policy stating the classes of business, geographical scope, underwriting limits, and profit objective. Any change in underwriting policy shall also be filed.

xiv) Clause 5: Outstanding Loss Provisioning: Every insurer shall make outstanding claims provisions for every reinsurance arrangement accepted on the basis of loss information advices received from Brokers/Cedants and where such advices are not received, on an actuarial estimation basis.

In addition, every insurer shall make an appropriate provision for incurred but not reported

(IBNR) claims on its reinsurance-accepted portfolio on actuarial estimation basis.

It is interesting to note that the IRDA’s rules for reinsurance of life business are almost wholly along the lines of its regulations in the matter of general insurance business.In other words, the general prescription seems to be that there will be maximum retention within the country and overseas placements of reinsurance will be based on satisfactory rating of those reinsurers, either according to Standard & Poor or other reputed rating agencies.

IRDA has issued fresh guidelines on Insurance and Reinsurance of General Insruance Risks in September 2006 in the context of impending abolition of tariffs. The guidelines are given as Annexure – II to the Chapter.

Reinsurance Contracts and TreatiesAn insurance is a transfer, a business and a contract: a transfer of risks from the insured to the insurer, a business, meaning a commercial activity with profit as the goal, and a contract, meaning an agreement enforceable at law. Written agreements are more easily enforceable than verbal ones and so every insurance contract is written, satisfying all the legal principles on which insurance is founded and the points of law to satisfy the definition of a legal contract. These legal features of a contract are:

l There must be consensus ad idem, namely, that there must be identity of views between the contracting parties.

l The parties to the contract must not have any legal disabilities, that is, say, they must not be minors.

l There must be consideration for the contract as a contract without consideration is void ab initio (from the beginning).

l There must be an offer from one party that must be accepted by the other party to result into a contract.

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Reinsurance is similar to an insurance contract and hence it is important that the wordings of the reinsurance agreement are agreed between the cedant and the reinsurer before hand. The contract may relate to one particular reinsurance and be expressed in a reinsurance policy, or as was often called in fire insurance, a guarantee policy but nowadays is more commonly called as facultative reinsurance. Or it may provide for the reinsurance of a number of risks and be expressed in the form of a treaty. The insured under the direct policy has no interest in or right over the reinsurer since he has no privy of contract. The reinsurer is certainly liable in respect of his share of any claim made by the insured, but his liability is to the insurer and to the insurer only. The insured may have an interest indirectly in knowing that his insurer is supported by sound reinsurers.

In recent years the increasing complexities in reinsurance has demanded for a greater degree of attention to the problems of disclosure and materiality. The ordinary rule as to disclosure of material facts operates only up to the time the contract is concluded but under a treaty something more may be required.

Other than facultative reinsurances, all other agreements between the ceding primary insurer and the reinsurer are by means of written and agreed treaties and therefore, the treaty wordings have come to occupy an important place in the study of reinsurance. However, it is recognized that the treaty wordings are not standardized and different countries and reinsurers have adopted their own typical wordings for treaties. At the same time, the general conditions are fairly uniform for all treaties but the special conditions are distinct exercises depending on particular needs of the contracting parties and also the individual classes of insurance. Again, the proportional and non-proportional treaties have separate distinct wordings, which have some special features characteristic of the type of treaty. One other interesting feature of all treaty wordings is that they include agreements on the follow-up accounting procedures, which actually make implementation of the treaty much easier.

We give below the treaty wordings generally followed by the insurers in India.

PROPORTIONAL TREATY WORDINGS

1. Operative Clause“The Company binds itself obligatorily to cede and the Reinsurer binds itself obligatorily to accept by way of reinsurance a percentage stated in the schedule of the first surplus over and above the amount retained by the Company for its own account on all insurances and /or facultative reinsurances written in the Fire Department of the Company and emanating from all parts of the world except the United States of America and Canada. Within the scope of this Agreement, the Company may cede hereunder on any one risk up to ……… times its net retention and not exceeding an amount equivalent to Rs…………

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The Company shall be the sole judge of what constitutes one risk and unless otherwise hereafter provided shall fix its net retention without reference to the Reinsurer in accordance with the usual net retentions of the Company.”

2. “Attachment of Cessions” Clause“The liability of the Reinsurer in respect of reinsurance allotted hereunder shall commence

simultaneously with that of the Company as soon as the retention of the Company on any

one risk as defined by its limits, records, practice or instructions is exceeded.”

3. “Follow the Fortunes” Clause“All acceptances hereunder shall be at the same gross rates, terms and conditions as the ceding company and to follow the settlement of the Company, and the Reinsurer shall follow the fortunes of the Company in regard to the cessions in which the Reinsurer by virtue of this Agreement takes part.”

4. “Exclusions” Clause“In no event shall this Agreement protect the Company in respect of: War and Civil War Obligatory Reinsurances.

Any loss or liability accruing to the Company, directly or indirectly and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy risks.”

5. Accounting Clause“Accounts embodying all transactions under this Agreement shall be rendered quarterly by the Company to the Reinsurer as soon as possible after the close of each quarter which shall be deemed to close on the 31st March, 30th June, 30th September and 31st December respectively.

The Reinsurer shall confirm the accounts within fifteen days of receipt and the balances

on either side shall be paid within fifteen days after receipt of such confirmation.”

6. Commission and Profit CommissionThe Reinsurer shall pay to the Company a commission as specified in the Schedule upon the net premiums (gross premiums less returns and cancellations) together with an additional commission, as specified in the Schedule, on the profits derived from thisAgreement and computed at the 31st December in each year as follows:

Income

1. Premium reserve for previous year

2. Losses outstanding for previous year

3. Net premiums for the current year

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Outgo

l Premium reserve of 40% of the net premium for the current year.

l Commission, taxes, fire brigade charges etc.

l Losses paid during the year.

l Reinsurers’ expenses being 5% of item 3 of “Income”.

l Losses outstanding at the end of the current year.

l Deficit, if any, from the previous year’s profit commission statement.

The excess, if any, of Income over Outgo shall be deemed the net profit of the Reinsurer and profit commission shall be calculated thereon.

In the event of termination, profit commission on the net profit in respect of the year in which such termination takes place shall be calculated in like manner. Thereafter, when the whole of the liabilities hereunder have been liquidated a final profit commission statement shall be rendered to include all transactions subsequent to the date of termination and the profit commission share on the preceding account shall be adjusted accordingly.”

7. Loss Advices and Accounting of LossesPreliminary loss advices shall be sent by the Company to the Reinsurer in respect of all losses where the proportion of the reinsurers sharing in the Agreement is estimated to exceed the amount stated in the Schedule. Furthermore, the Company shall furnish the Reinsurer an estimate of outstanding losses as at 31st December of each year.

When the proportion of a loss and/or expenses falling upon all the reinsurers sharing in this Agreement amounts to or exceeds the amount specified in the Schedule, the reinsurers shall be liable to pay their proportions within 21 days of demand. The Company shall debit all other losses and/or loss expenses in the accounts of the quarters in which the losses and/or loss expenses are settled.Any loss or claim or compromise thereof and all expenses including fire extinguishing expenses shall be settled by the Company without reference to the reinsurer and such settlements including ex-gratia payments shall in all cases be unconditionally binding upon the reinsurer. The Company at its sole discretion may commence, continue, defend, compromise, settle or withdraw from any actions, suits and prosecutions and generally do all such matters relating to any loss or claim which in its judgment may be advantageous and the payment of all expenses and allowances in connection therewith shall be shared by the reinsurer in proportion to its participation.

The Reinsurer shall share in proportion to its participation in all amounts which may be recovered by the Company in respect of any loss or claim.”

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8. Reserves Clause“The Company shall be entitled to retain Premium Reserve at the percentages specified in the Schedule as security for the due performance of the obligations of the Reinsurer under this Agreement. The Premium Reserve shall be retained at the percentage specified in the Schedule in each quarterly account and shall be based upon the net premiums of the relative quarter and of the three preceding quarters after deduction of the reserve of the corresponding quarter of the previous year.

The Company shall pay to the Reinsurer interest on premium reserve at the rate specified in the Schedule less tax, such interest to accrue from the date on which the respective amounts are credited to the premium reserve.”

9. Premium and Loss Portfolios“The Company may at its option require the Reinsurer to assume liability for its proportion of risks current at the date of this Agreement in consideration for which theCompany shall credit the Reinsurer with an amount equal to a percentage as specified in the annexed Schedule of the net premiums without deduction of commission appearing in the four quarterly accounts immediately preceding the date on which this Agreement commences.

In the event of the Company exercising the aforementioned option, the Reinsurer shall also be credited with the proportion of 90% of the estimated losses outstanding as at the date of inception for which the Reinsurer shall assume liability for all settlements of such losses outstanding. Should the total payments in respect of such losses differ materially from the amount credited to the Reinsurer in accordance herewith, the Company shall have the right to effect the appropriate adjustment.

The term ‘net premium’ in the aforementioned paragraph is understood to mean original gross premiums less only return premiums. The provisions of this Article may also be applied in the event of any increase or decrease of the Reinsurer’s proportion under this Agreement.”

10. Commencements and Termination Clause“This Agreement shall incept on the date stated in the Schedule and shall remain in force indefinitely, but either party shall be at liberty to terminate it as at 31st December in any year by giving not less than 90 days ‘previous notice in writing. Unless the parties otherwise agree, the Reinsurers will remain liable for all reinsurances ceded under this agreement until their natural expiry.

In the event of war (whether declared or not) arising between India and the country in which the Reinsurers reside or carry on business or are incorporated, this Agreement shall be automatically terminated forthwith.

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l If during the period of this Agreement, postal and/or telegraphic communications should be rendered impossible as a consequence of war, warlike operations, blockade, revolution, civil war or other similar event for a period exceeding thirty (30) days, the Company shall be entitled to terminate this Agreement forthwith without giving notice.

Either party shall have the right to terminate this Agreement immediately by giving the other party notice:

l 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 which 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 or all or any part of the balance or payments due to or from either party.

l 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 withdrawn or cancelled or suspended or made conditional.

l If there is any material change in the ownership or control of the other party.

l If the country or the territory in which the other party resides 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.

l If the other party shall have failed to comply with any of the terms and conditions of this Agreement.

During the term of a notice of cancellation and until its expiry the reinsurers shall accept new cessions and renew existing cessions in the same manner and in all respects as if no such notice has been given.”

Non-Proportional Contract ClausesSome typical wordings are given below:

1. Terms of Agreement“This Agreement shall apply only to losses occurring during the period commencing on the date stated in item … of the Schedule and expiring on the date stated in item ….. of the Schedule, both days inclusive.

If the Agreement should expire or be terminated while a loss occurrence covered hereunder is in progress it is understood and agreed that, subject to the other conditions of this Agreement, the Reinsurers hereon are responsible as if the entire loss or damage has occurred prior to the expiration of this Agreement, provided that no part of that loss occurrence is claimed against any renewal of this Agreement.

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In the event of this Agreement not being renewed, this Agreement, at the option of the Company (provided it is exercised on or before the expiry date hereof and provided there is prior agreement of both parties to the additional premium payable), shall be extended to apply to any loss occurrence or loss occurrences:

Which are covered by any policy or policies of insurance or insurances, the inception date or dates of which fall prior to the expiry date of this Agreement.

And which take place during the twelve months period immediately following the expiry date of this Agreement.”

2. Insuring Clause“The Reinsurers hereby agree to indemnify the Company for that part of the ultimate net loss which exceeds the amount stated in item … of the Schedule on account of each and every loss occurrence and the sum recoverable under this Agreement shall be up to but not exceeding the amount stated in item … of the Schedule, ultimate net loss on account of each and every loss occurrence.

The underlying loss stated in item … of the Schedule shall be retained net by theReinsured subject only to underlying excess catastrophe reinsurances as specified in item … of the Schedule.”

3. Definition of loss occurrence has been dealt with earlier.

4. The term ‘ultimate net loss’ shall mean the sum actually paid by the Company in respect of any loss occurrence including expenses of litigation, if any, and all other loss expenses of the Company (excluding, however, office expenses and salaries of the company) but salvages and recoveries, including recoveries from other retrocession, other than underlying reinsurances provided for herein, shall be first deducted from such loss to arrive at the amount of liability, if any attaching hereunder.

5. Net Retained Lines “This Agreement shall only protect that portion of any insurance or reinsurance which the Company retains net for its own account combined with cessions made by them to their Quota Share Reinsurers. Reinsurer’s liability hereunder shall not be increased due to the inability of the Company to collect from any other Reinsurers (other than the aforesaid Quota share Reinsurers) any amounts which may have become due from them whether such inability arises from the insolvency of such other Reinsurers or otherwise.”

6. Premium clause“The Company shall pay a Deposit Premium of the amount stated in item … of the Schedule and same shall be paid in the manner prescribed in item … of the Schedule.

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As soon as possible after the expiry of this Agreement, the above Deposit Premium shall be adjusted to an amount equal to the rate stated in item … of the Schedule applied to the Company’s premium income, as defined hereunder, subject, however, to a Minimum Premium of the amount stated in item … of the Schedule. The payment of any adjustment due between the parties shall be made at once.”

7. Reinstatement Clause“In the event of any portion of the indemnity given hereunder being exhausted, the amount exhausted shall be automatically reinstated from the time of commencement of any loss occurrence to the expiry of this Agreement and a pro rata additional premium calculated on the premium hereunder in the manner stated in item … of the Schedule shall be paid by the Company upon the amount of such loss reinstated, but nevertheless the Reinsurer’s liability shall never be more than the limit of liability as stated in item … of the Schedule in respect of any one loss occurrence not more than the amount as stated in item … of the Schedule, in all, during the term of this Agreement.”

8. Inspection Clause“The Reinsurers may at any time during normal working hours inspect and take copies of such of the Company’s records and documents which relate to business covered under this Agreement. It is agreed that the Reinsurers’ right of inspection shall continue as long as either party has a claim against the other arising out of this Agreement.”

10. Errors and Omissions Clause“No error or inadvertent omission on the part of the Company shall relieve the reinsurer of liability in respect of losses hereunder provided that such errors and/or omissions are rectified as soon after discovery as possible.”

11. Alterations Clause“This Agreement may be altered at any time by mutual consent of the parties by Addendum and such addendum shall be binding on the parties and be deemed to be an integral part of this Agreement.”

12. Set-off Clause“If during the currency of this Agreement any balances under any other treaty or treaties between the Company and the Reinsurer remain unpaid by one party, the other shall be entitled either to: Retain the balance due hereunder until full payment has been made under the other treaty or treaties; or Set off such balance against the amount due from the other party.”

13. Underwriting Policy Clause“The Company undertakes not to introduce any change in its established acceptance

and underwriting policy in respect of the classes of business to which this Agreement

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applies without prior approval of the Reinsurers and any reinsurance arrangements relating thereto shall be maintained or be deemed to be maintained unaltered for the purpose of this Agreement.”

14. Intermediaries Clause“All correspondence and settlement of accounts pertaining to this Agreement shall be through the intermediaries specified in item … of the Schedule.”

15. Arbitration clause for disputes“Incase of any disputes between the company and the reinsurers regarding the interpretation of the agreement or the rights with respect to any transaction involved either before or after the termination, disputes as such shall be dealt with the single arbitrator appointed in writing by both the parties. If incase of any failure to agree upon the single arbitrator it can be referred to two arbitrators of which one is appointed in writing by each of the parties. Incase of any disagreement between the two arbitrators an umpire is appointed by the arbitrators.

These arbitrators or the umpire are required to be appointed in 30 days after such a requisition of arbitrators made by the parties. These are appointed in writing by the chairman of the Bombay Regional Committee of the tariff advisory committee. Such appointed arbitrators or umpires are required to interpret their agreement as an honorable engagement and make their award and serve the purpose.

The decision of these arbitrators or the umpires is final and binding as the case may be inclusive of allocation of costs on both the parties. This clause is present in every treaty.

Arbitration and Mediation

Arbitration means the reference of a matter in disputes to the judgment of a person selected by the parties to the dispute. Arbitration is thus a private process of resolution of disputes and it is commonly resorted to because it is less formal, less expensive and less time consuming than proceedings in law. More commonly, the arbitration process has employed private bodies to settle controversies in which the decision reached is final and binding. In spite of the best care taken to prepare the contract documents certain disputes may arise leading to unnecessary litigation. To address such problems normally arbitration clause is incorporated in the contract. The companies involved in reinsurance business may prefer independent arbitration to avoid impact on reputation and public gaze.

The salient features of arbitration:

l No difference shall be referable to arbitration if the company has disputed or not accepted liability under the policy.

l The arbitrators are normally experts in the practice area of dispute.

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l A sole arbitrator may be agreed to by the parties in writing; if not agreed, each party can approach an arbitrator after receipt of written notice of the other party.

l The place and time of the arbitration can be arranged to suit the parties.

l Any disagreement between the two arbitrators shall be referred to an umpire and such umpire is generally appointed before entering in to the agreement.

l The agreement cannot extend to disputes between the parties for which some other contractual mechanism is established to resolve such disputes.

The Arbitration Clause

It should be well drafted considering all the matters and its ramifications. It should contain, inter alia, the manner of appointment of arbitrator, his qualifications and experience, the period for which the appointment has to be made, and the cost of arbitration, which will be at the discretion of arbitrator (s).Arbitration is governed by law which is known as Arbitration Act 1940 which was subsequently repealed by the Arbitration and Conciliation Act, 1996 which is ‘ an Act to consolidate and amend the law relating to domestic arbitration, international commercial arbitration and enforcement of foreign arbitral awards as also to define the law relating to conciliation and for matters connected therewith or incidental thereto’.

Unless otherwise agreed, the arbitration tribunal shall consist of persons with no less than ten years experience in insurance or reinsurance field.The tribunal shall have all powers to make orders in respect of pleadings, discovery, inspection of the documents, examination of witnesses etc., All costs of arbitration shall be fixed by the tribunal and it will also decide by whom it is to be paid.

The award of arbitration tribunal shall be in writing and binding upon the parties who agree to carry out the same. If any of the parties fails to carry out any award the other party may apply for its enforcement to a court of competent jurisdiction.Majority of the reinsurance contracts/treaties contain arbitration clauses so that disputes can be avoided at a later date and settled amicably and privately. When interpreting reinsurance contracts, the starting point, should be to look at the tribunal, which will resolve any disputes between the parties and the law, which will be applied.

The arbitration law may vary from country to country and therefore parties must be clear as to which law they are applying.

Finally it is to be stated that at times some arbitration can become as complex and rigid in its formality and costs, as any proceedings in a court of law. It is a matter of dispute whether to go court or seek arbitration as the best forum to resolve disputes.During the enforcement there are difficulties that some people challenge an arbitration award. There are those who plead that the courts have wider coercive powers and that litigation makes for greater certainty. The general criticism against arbitration is that it

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is fraught with complexity, costs and delay. The competent man constituting arbitration

tribunal is more important in case of reinsurance as it has universal dimensions.

Mediation

The mediation process involves the use of an impartial third party to encourage a satisfactory compromise to the dispute. The mediator, typically an experienced trial attorney or retired judge, who has no binding authority, uses his/her skills to diffuse the dispute or find alternative solutions. Mediation is fast developing method in the resolution of reinsurance disputes, particularly in the London Market. In the last 20 years the number of reinsurance disputes going to litigation/arbitration have been growing phenomenally. Therefore, an alternative and quick method was evolved. There are very few issues, which are unsuitable for mediation. Most of the mediations involve rights of avoidance, issues of coverage, construction issues and issues as to the conduct of intermediaries.

As the mediation is another successful mode to operate, the ceding companies and reinsurers are likely to consider the inclusion of ‘mediation clause’ in their wordings. However mediation process itself is not cheap, as perceived by some, but its speed is the key to achieving cost advantage. The mediation can succeed provided that certain precautions are taken and where the parties engage in the process in good faith the results are reassuring.

? Questions

1. Explain the role of IRDA in regulating insurance industry in India. Do you find it effective? If not, suggest the areas that need to be reexamined and strengthened.

2. What are the legal features underlying insurance contracts?

3. Explain important treaty wordings.

4. Explain arbitration and mediation. Which one do you prefer and why?

5. Write short notes:

(i) Attachment of Cessions clause

(ii) Follow the Fortunes clause

(iii) Exclusions clause

(iv) Commission and profit commission

(v) Reserves clause

(vi) Commencement and Termination clause.

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CHAPTER – 5

REINSURANCE ACCOUNTINGAND FINANCIALS

OUTLINE OF THE CHAPTERl Reinsurance

Accounting and Financials

l Special Nature of Reinsurance Accounts

l Main Types of Reinsurance Arrangements

l Closing of Annual Accounts

LEARNING OBJECTIVESl To understand the

primary Objective of the reinsurance accounting

l To come to know Reinsurance accounting as concerned with

- technical

- financial

- legal and

- underwriting aspects

introductionThe objective of the reinsurance accounting is to record the business, control the funds and maintain proper books and records for the benefit and information of all stakeholders both internal and external. Special nature of Reinsurance Accounting is concerned with technical, financial, legal and underwriting aspects of reinsurance.

Premiums, expenses and losses will have effects on both sides of a treaty but these have to be considered on all overall basis of reinsureds and reinsurers. It is imperative for reinsurance firm to have proper accounting and financial management so that it can safely settle accounts and create confidence with regulators. The insurance regulators in countries all over the world, including India, have prescribed regulations for insurance and reinsurance accounts and methods of treating certain assets and liabilities. In this connection, IRDA regulations relating to various items need to be examined.

SPECIAL NATURE

OF REINSURANCE ACCOUNTSReinsurance accounting is comprehensively connected with technical, financial, legal and underwriting aspects of reinsurance. The significance of accounting for

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reinsurance techniques must be understood and appreciated with reference to the class of business, the type or combination of types of reinsurance methods used and the forms of arrangements as placed directly or through brokers. Legal issues and tax matters are significant to reinsurance accounting. Mind-blowing perils like natural perils such as devastating floods, chilling windstorms and life shattering earthquakes became insurable because of sharing of risk through reinsurance. It is not profit or earnings that can count in these risks since one loss in 25 to 30 years can wipe out the entire profits accumulated over a period of time. It is reinsurance that is so special to motivate insurers to venture into these kinds of businesses.

A long-standing relationship with the reinsurer can be maintained only if proper accounts are rendered by the ceding company. The actual must be reconciled with past trends for renewal of the reinsurance business.

MAIN TYPES OF REINSURANCE ARRANGEMENTS

Proportional Treaty AccountsMost of the present day treaties are ‘blind’ – meaning thereby that the ceding company supplies no details of individual cessions to the reinsurer. The reinsurer receives quarterly or periodical accounts that give details about the premium, claims etc., There is no standard format of the treaty contract. A specimen is given below:

The first step in reinsurance accounts is preparation of treaty accounts.

Ceding Company : ABC insurance Company

Treaty : First Surplus Fire Treaty

Period : 1st Quarter 2008

Reinsurer : XYZ Reinsurance Ltd.

Reinsurer’s share : 1% Currency US$

100% account Debit Credit

Premiums 60000

Portfolio premium entry at 1-1-2008 70000

Portfolio loss entry at 1-1-2008 24000

Commission at 45% 27000

Taxes and Charges 1800

Excess of loss premium 450

for common account @ .75%

Claims paid 35000

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Reinsurance Accounting and financials

Common account excess of

Loss recoveries 0

Premium reserve retained @40% 24000

Premium reserve released 0

Interest on reserve released 0

Tax deducted on interest 0

Credit for cash loss paid 2000

Balance due to reinsurers 67750

Total 156000 156000

Balance due to XYZ Reinsurance Co. Ltd. @1% 677.50

Some ceding insurers divide the account into two parts- the first part called the technical account showing items relating to the reinsurer’s share of the technical result for the period and the second part called the financial account which include the balance brought forward from previous account, premium and loss reserves and interest thereon, loss settlements made, cash loss credit and the final balance which is due for settlement. It is not necessary that all the items appearing in the above specimen should appear in the account for each accounting period. For example, portfolio premium and loss entries will appear in the first quarter’s account and portfolio premium and loss withdrawals in the last quarter account.

Premiums

The premium may change according to local practice, the terms of contract or the class of business. In some markets gross premium may be subject to deduction of such items as license fees, fire brigade charges, local taxes etc., while in some other cases it may be separately accounted. With marine and aviation business, it is usual for premiums to be accounted net of original acquisition costs and therefore only subject to a relatively low reinsurance overriding commission. Provision is made for payment of a minimum and deposit premium based upon an estimated total net premium and the deposit premium will be subject to an adjustment premium when the ceding insurer’s final premium income becomes known. The deposit premium is usually paid in quarterly installments. It can also be paid annually in advance.

Brokerage

Where a reinsurer receives a share of a treaty through a broker, he will normally agree to pay brokerage. The broker will either include his brokerage in the actual statement of account for the business or render a separate statement for brokerage due. The percentage of brokerage payable is applied to the premiums written on a gross, net or partial net basis and this must be clearly stipulated in the treaty agreement.

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Non-proportional Treaty AccountsThe requirements for preparation of accounts under non-proportional treaties vary from proportional treaties and simple in nature. Losses are usually dealt with on a cash loss basis and are payable by individual reinsurers upon the rendering of appropriate information by the ceding insurer. Therefore accounts under non-proportional treaties are substantially in respect of premiums. They are not subject to premium or claim reserves or profit commission.

Premium

The premiums to be paid by cedent to reinsurer is based on the rate specified in the contract and the rate will be applied to the ceding insurer’s total net premium after ceding to proportional reinsurances.

Example:From: Broker

Reassured: ABC Insurance Co.

Ltd. Fire Excess of Loss Cover

2004 10,000,000 XS 5,000,000

The following premium will be credited in your books. Please make necessary entries in your books.

Currency: U.S. $

Minimum & Deposit Premium 2007 300,000

Less: Brokerage @10% 30,000

270,000

Payable in 4 Equal installments of 67,500

On 1st January, 2007

On 1st April, 2007

On 1st July, 2007

On 1st October, 2007

Your 10% share amounts to 6750

Payable in 4 equal installments of 1687.50

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Foreign Exchange

Normally the unit of currency expressed in treaty agreements is the domestic currency of the ceding company concerned. For the purpose of conversion of various foreign currencies, companies adopt rates of exchange at the average rates for each quarter for compliance with AS-11. This is used at the time of transfer of their share of premium or recovery of claims from the reinsurer.

Calculation of Profit CommissionWe have read about commission in the first chapter on reinsurance. Commission is received when the primary insurer cedes premium to reinsurers. Over and above this commission some treaties also allow for profit commission. This commission is based on the profits of the treaty. Profit commission is an additional percentage payable to a ceding insurer on profitable treaties in accordance with an agreed formula. It is therefore an incentive for ceding insurers to produce profitable business. Profit commission will be worked out on accounting year basis in the case of clean cut treaties (Fire and Accident Proportional treaties) and on underwriting year basis in the case of others.

Accounting Year basis

A profit commission on an ‘Accounting Year’ basis requires all transactions for the same treaty period, without reference to underwriting year, to be included in the same profit commission statement. Items to include on debit side – commissions, claims, Miscellaneous charges, premium reserve carried forward, loss reserve carried forward, allowance for reinsurer’s expenses and profit for the year and credit side– premium reserve brought forward, loss reserve brought forward and premiums. A profit commission on accounting year basis would not be adjusted in subsequent years as long as the treaty continues without cancellation.

Underwriting Year basis

A profit commission on an ‘underwriting year’ basis requires all transactions of an underwriting year, without reference to accounting year, to be accounted to the same year for the purpose of determining the profit of that underwriting year. Given below is an example on calculation of profit commission (PC), which will help in understanding the concept better.

ABC INSURANCE LTD.

MARKET FIRE POOL Rs.

Profit as at 31/03/2004 207,161,000

Premium 767,898,000

PC Terms 15% Pc on Profit Up to 10% of Premium& 75% of balance

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Calculate Profit Commission

Answer

15% PC up to 10% on Premium

10% on Premium 76,789,800

@15% on above 11,518,470 (A)

75% of Balance

Profit 207,161,000

Less 10% Premium 76,789,800

Balance 130,371,200

@75% on Balance 97,778,400 (B)

Commission (A+B) 109,296,870

FORMAT OF ANNUAL ACCOUNTSThe format to be followed by the respective reinsurer for preparing revenue accounts at the end of year published reports in different countries is prescribed by the local insurance laws. In India, Revenue Account as well as Balance Sheet should be prepared as per Insurance Act and IRDA Regulations. The Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2000 covers the whole gamut of preparation of final accounts of, not only insurance companies, but also reinsurance companies. There is a provision for audit of annual accounts and specified number of copies to be furnished to the IRDA.

The ceding company’s accounting year may differ from that of the reinsurer because of the time required to transfer information for a given period of cover. For reinsurers wishing to calculate their results more rapidly, estimates are made for the accounts of ceding companies for the last sum received by the insurer or reinsurer as a consideration for covering risk.

The reinsurance companies are required to maintain the following records, inter alia, others.

a) Record of insurance companies with which common and facultative reinsurance arrangements of reinsurance treaties are entered into.

b) Record of facultative reinsurance ceded and accepted.

c) Information on security level of reinsurers is to be monitored and maintained.

d) Total placement to each reinsurer is required to be monitored and reported to IRDA.

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Closing Proportional Treaty AccountsA reinsurer finds a major problem with preparation and rendering of proportional treaty accounts by insurers to reinsurer. It consequently leads to problems of ascertainment of profit or loss on each of its acceptances at the end of the financial year. Certain classes of business such as marine, motor and other liability business with a long tail present problems in estimating outstanding provisions for claims. Thus only two quarters premiums and claims may be advised and accounted for in the books of reinsurer for a particular year and the remaining two quarters would get accounted in the following year. Therefore, it may not be possible to match the accounted figures with the treaty year results. But over a period, these two sets of figures should match with each other, unless outstanding claims provisions made in the books of the reinsurer are substantially different from the actual outstanding claims.

Closing Non-proportional Treaty AccountsThe treaty year is the same as the reinsurer’s accounting year in case of non-proportional accounts. The main problem with this is the long duration of claims reporting with eventual cost of claims not being known for many years. Many reinsurers overseas operate their non–proportional account on funded basis to overcome the above problem. Each year the fund is examined to ensure its adequacy with regard to outstanding claims.Any deficit arising in the fund must be replaced by a transfer from revenue reserves.In assessing surplus, each treaty year would normally be assessed after three years, and any surplus arising then would be transferred to revenue reserves. A surplus is not normally removed from a fund until three years after the year to which it relates, since there would be inadequate information available before the expiration of three years.

Closing of Annual AccountsEvery insurance company while closing its annual accounts at the end of the year examines all claims outstanding with respect to inward treaties in the books in order to make a reasonable estimate for provisions to be made in the revenue account so that it can present as accurate as possible. Based on the estimates made for gross claims, the company will work out the outstanding claims position in respect of its various outgoing treaties, which will be included in the annual accounts as well as advise to the respective reinsurers.

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? Questions

1. What is the objective of reinsurance accounting? In what way is it different from other accounting?

2. Explain proportional treaty accounting, giving example.

3. With the help of a hypothetical example, explain non-proportional treaty accounting.

4. Explain the different methods of calculation of profit commission.

5. Which agency prescribes the format of Annual Accounts for reinsurance companies and what are its special features?

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CHAPTER – 6

REINSURANCE ADMINISTRATION

OUTLINE OF THE CHAPTERl Reinsurance

Administration

l Claims Settlement

l Claims Reporting and Claim Reserving

l Claim Developmental Analysis

LEARNING OBJECTIVESl Understanding Claim

settlement, claims reporting and claim reserving

l To get acquainted with Inspections and auditing by Reinsurers

introductionReinsurance administration deals with the routine details of handling a case from the stage the ceding company seeks reinsurance. Ceding company and reinsurer have several mutual obligations and

expectations in the administration of the reinsurance business. There is expectation of the other to conduct business in an orderly and ethical manner, to establish and maintain a clear, accurate exchange of information, and not fail to provide all those services, which are contractually arranged.

For the success of a reinsurance program, both the primary insurer and the reinsurer must make joint efforts. They both have duties as well as rights under the treaties or let us say, reinsurance contracts.

Role of the primary insurerThe primary insurer must conduct his underwriting operations satisfactorily within the guidelines and expectations of the treaty so that the reinsurer has no surprises coming in the form of large losses. Moreover, the primary insurer must notify promptly all large losses and the reinsurer must be given the opportunity to participate in investigation of such losses.

The primary insurer has the freedom to underwrite individual risks and adjust individual claims once clear cut underwriting

policies are contemplated under a treaty. We conventionally use a phrase “FOLLOW THE FORTUNES”, it means the reinsurer is normally bound by the primary insurer’s actions in the underwriting and claims matters.

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The primary insurer must have a good or well designed information system to be able to furnish all necessary information in time for the reinsurer to be able to control losses wherever possible and to discharge their obligations under the treaty professionally. The more important data that should be capable of being made available from a good information system used by the primary insurer will include the following:

l Direct premium data to calculate the reinsurance premium payable to the reinsurers;

l Data for individual losses needed to apply treaty limits and excess retentions;

l Codes for catastrophe losses;

l Codes for identifying occurrences under casualty ‘clash’ coverage;

l Data to determine the portion of policy(ies) ceded to each surplus share reinsurer;

l Separate data on retention, limits, rates, and the reinsurer involved for each facultative placement;

l Information on risks included in the treaty but not ceded for preserving profitability of the treaty;

l Data on risks excluded under the treaty but underwritten by the primary insurer so as not to include the same in the reinsurance bordereau.

An accurate and efficient information system helps the credibility of the primary insurer and helps the renewal of treaties. The primary insurer must make available his books of account for inspection if required by the reinsurer.

The primary insurer must send quarterly bordereaux to the reinsurers, which contain detailed statistics of premium, commission and losses paid and outstanding as at the end of each quarter. However, in the modern day, most primary insurers send a current account statement to the reinsurers, giving details of premiums ceded, ceding commission, net premiums ceded, losses paid, loss expenses paid and losses outstanding and also a summary from which the amount due to the reinsurer will be evident.

A final point in the matter of dispute resolution is that whereas in former times, disputes between the primary insurers and reinsurers were generally resolved through direct negotiations or arbitration, nowadays, both the parties are not averse to go to courts to resolve disputes.

Role of the reinsurerOne would think that the reinsurers have very little to do except collecting reinsurance premium, and paying claims and brokerage commission to brokers and ceding commission to the primary insurer. Maybe this is so when the treaty relationship is

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Reinsurance Administration

smooth. In fact, some reinsurers minimize their work by preferring large retentions with the possibility of no claims being presented at all.

On the contrary, the reinsurers may be engaged in auditing the underwriting and claims practices of the primary insurer so as to ensure that these are done satisfactorily and as expected. Again, whenever the losses are large, the reinsurers may like to participate in the in the claims settlement process. Normally reinsurers incorporate claims –control or claims cooperation clause in the facultative contracts for claims the exceeding prescribed limit (major claims). Many a time, the primary insurers, both on underwriting and claims issues, openly consult the reinsurers.

We have already seen how the reinsurers, not only help in stabilizing loss exposures but also positively assist the primary underwriters in underwriting by sharing their expertise.

CHAIN OF ACTIVITIESThe chain of activities in administration would include:

l Negotiating and drafting treaties:- the product features must be properly understood at the time of negotiation so that treaties signed are free from disputes subsequently.

l Underwriting cases:- wherever there are any special terms & conditions in underwriting they should be brought to the notice of reinsurer, particularly in case of automatic reinsurance.

l Paying premiums:- the agreed premiums need to be properly calculated and paid to reinsurer.

l Modifying policies:- whenever there are changes in policies both insurer and reinsurers should maintain reinsurance in force on mutually agreed and fair terms.

l Paying Claims:- the reinsurer will pay his share of claim to the ceding company in a single amount or as per agreement provided that all conditions are properly complied with.

l Recapturing Coverages:- whenever a ceding company raises its retention limit, the insurer should inform a reinsurer of his intention to recapture ceded business if the insurer intends to that. If the insurer fails to inform reinsurer the insurer will forfeit its right to recapture the reinsured coverage.

l Evaluating in-force reinsurance:- periodical review of reinsurance is required to see that every thing is moving according to agreed treaty provisions.

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CLAIM SETTLEMENTA broker or the cedent notifies the claim to reinsurer on a daily basis, by post or electronically. The procedure differs from treaty to treaty based on individual agreements. If it is a pro-rata treaty, the primary insurer sends monthly bordereau to the reinsurer, detailing the premiums due to the reinsurer and claims due from the reinsurer. The primary insurer will remit the difference to the reinsurer when the premiums exceed the losses and if the losses exceed the premiums, the reinsurer remits the difference to the primary insurer. If at any time, there are some exceptionally large losses, then it is the convention for the reinsurer to remit the losses to the primary insurer before the end of the reporting period.

In the case of excess loss treaties, as soon as losses exceed the retention, intimation is given and the reinsurer pays on being given proof of settlement, which is simply a statement of losses paid by the primary insurer, together with estimates of current reserves.

In the case of aggregate excess loss treaties, the reinsurers are known to make initial

payments say sixty days after the end of the accounting year. If it is clear that the losses will

exceed the retention, then payments may be made before the end of the year.

CLAIMS REPORTINGClaims administration presupposes the primary reinsurer to maintain proper claim records so that it can estimate its liabilities on individual contracts . In order to properly monitor recording of claims information is made in proper format. At times it may so happen, due to poor maintenance of records, lot of time may pass between the date of loss occurrence and date of claim notification to the reinsurer. Proper recording facilitates determination of funds, which will be needed to meet the company’s obligations. Claims administrator will be able to cull out all the information like – cedent, broker, peril class of business, location of cedent, period of cover, sum insured, limit, and reinsurance arrangements – from records whenever a claim is received. The data required can be obtained in coded format to avoid inconsistencies. There could be cases where lot of supplementary information is required, particularly in respect of serious and large claims. Here the objective is to collect more information on those cases that materially have an effect on the overall results of the treaty. By providing comprehensive information the insurer can avoid possible points of difference and confusion with reinsurer. If the reinsurer has his own proportional retrocession treaties, then accounting information relating to claims can be built up as a part of processing retrocession accounts. However, where the reinsurer has his own excess of loss protection covering a specific class of business or the whole account, then he is concerned with aggregations of specific claims arising from several treaties, proportional or non-proportional. In such cases it will have to maintain a record of all claim advices from specific claims.

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Reinsurance Administration

CLAIM RESERVINGThe reserves are meant to meet claims in future and the reserves need to be maintained by cedent company and reinsurer. Every insured risk needs to be supported by maintenance of reserves. They have to be maintained on an ongoing basis and when risks are reinsured, the reinsurer also agrees to establish reserves for its proportionate share of each risk. Reserves are calculated basing on estimates of expenditure in case of likely claims. The insurance company sets reserves to meet indemnity costs. In addition to such reserves, reserves for defense and loss adjustment expenses are also posted by the insurance company. The reinsurer sets reserves for the economic damage posted by the ceding carrier. The ceding carrier normally settles the claims and reinsurer helps him to do this job efficiently. The ceding carrier should settle the entire claim in fairness to his reinsurers. The total reserve exists at all times in the books of the ceding carrier. Normally reinsurers do not set reserves below the amount reported by the cedent. If the reinsurer wants to post a larger amount, the excess amount is considered as an additional case reserve and such reserve is in the reinsurer’s books but not posted in the cedent’s books.

Incurred But Not Reported (IBNR)It denotes the liability for future payments on losses, which have already occurred but have not yet been reported in the reinsurer’s records. This definition may be extended to include expected future development on claims already reported. Thus, technicallyIBNR covers the field from:

a) those individual losses that have occurred but have not been reported to the insurer or reinsuerer.

b) That amount of loss that may arise from a known loss which has been reported as an event but which has not been recorded in full to its ultimate loss value (known as loss development).

Sometimes, reinsurers may end up with overpayment of claims. Such payments can be avoided by addressing senior management focus and initiating proper claims handling methods.

? Questions

1. What is the role of primary insurer and reinsurer in case of reinsurance administration?

2. Explain the chain of activities involved in reinsurance

administration.3.Explainclaimsettlement and claim reporting activities.

CHAPTER – 7

REINSURANCE MARKET

OUTLINE OF THE CHAPTERl Reinsurance Markets

l Reinsurance Brokers

l Global Reinsurance Markets

l Regional Reinsurance Corporation

l Indian Reinsurance Market

l Role of Captives

LEARNING OBJECTIVESl To get to know the Reinsurance market all over the world

l To understand Reinsurance brokers and their functions

l To understand Global Reinsurance Markets

introductionReinsurance Market is spread all over the world with major reinsurers being concentrated in Europe and West. Reinsurance Brokers are intermediaries between insurers and reinsurers and they operate on a large scale and present in all developing markets. Players like Munich Re, Swiss Re and Berkshire Hathaway, the leading players in the world, dominate global Reinsurance Markets.

Market is a place where buyers and sellers interact with each other or an arrangement which facilitates interaction between buyers and sellers to do the business, which includes exchange of goods and services for money. A strong insurance and reinsurance market is an essential element of economic progress as industry can take calculated risks with a backup support of insurance. The global insurance industry is being shaped by a number of external drivers of change.

Reinsurance is sold by a reinsurance Company and bought by ceding company.

It is difficult to define the boundaries of reinsurance market in a geographical sense but the reinsurance is spread over the different parts of the world. Since it is usual that reinsurance acceptances may not be completed within the local market, the world reinsurance market must be used. Presently, clients are not contended with only

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Reinsurance Market

traditional reinsurance solutions. Some of them wish to take a more far reaching and all-embracing view of risk management.

REINSURANCE BROKERSJust as there may be brokers for primary insurers who act as intermediaries between the insured and the insurer, there are reinsurance brokers who are go-betweens to primary and reinsurers. The percentage commission paid by the reinsurers to the reinsurance brokers is relatively small, compared to the commission paid to the insurance brokers and is sometimes as low as one percent of the reinsurance premium.

When there are reinsurance brokers, the premium payments and loss payments as well as premium refunds pass through them. When primary insurers do not have expertise to place reinsurance directly, they need the services of the reinsurance brokers. Large reinsurers also use reinsurance brokers as a matter of course. However, if primary insurers go direct to reinsurers, they may be able to reduce the reinsurance cost to some extent.

Although reinsurance brokers obtain their commission from the reinsurers, they have a duty to observe the principle of utmost good faith, which means they must reveal to the reinsurers all material facts concerning the risks, which they obtained from the primary insurers. The market share of the reinsurers combined in the United States is estimated at 75%, which shows the predominance of the reinsurance brokers in the reinsurance market. Generally, reinsurance brokers handle treaty reinsurances in preference to facultative reinsurance.

Reinsurance Pool: A reinsurance pool (or syndicate or association) is an association of reinsurers banded together to underwrite reinsurance jointly. Some pools write reinsurance for only members. Some others write for non-members as well. Industrial insurers may form a pool to write specific risks that require large capacity. Specialized pools are also formed for energy insurance and the like.

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GLOBAL REINSURANCE MARKETSNow the reinsurance markets are able to penetrate much faster across the world and new markets are emerging with the advancement of technology and availability of Internet. In fact even the US insurers buy more than half of their reinsurance requirements from non-admitted alien reinsurers, who are located in many countries of the world, including Russia and China. However, Britain, Bermuda and Switzerland together account for the largest share. The reinsurance industry all over the world generates approximately $150 billion in ceded premiums. More than 75 percent of the ceded premiums originate from North America and Western Europe. The North American market represents the largest single source providing more than 50 percent of the total. Asian market is a follower of trends and attitudes developed in advanced countries. Regional integration worked well in Europe. However, integration has yet to take shape in Asia.

Almost all global and regional reinsures of the west got impacted on account of WTC attack losses, which were estimated at around $ 80 billion.

In the world of reinsurance, it would be interesting to observe at global level, two reinsurance companies namely Munich Re (Germany based) and Swiss Re (Switzerland based), which have more than a century of history of operations to their credit, have developed phenomenally.

MUNICH RE: The business generated by this company is dependant on the domestic insurance sector and most of its business is generated internally from the German market. The focus has slowly shifted to outside markets after exploiting the German markets to the full extent.

SWISS RE: It occupies a prominent position in the Swiss insurance market and is very popular name in the world of insurance. It is one of the oldest reinsurance firms in the world. Since the Swiss market is of small size, the business generated by this company depends to a certain extent on the domestic markets and the rest is generated from the international markets. As an international player it has withstood the intense competition in the field and expanded across the global markets.

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Reinsurance Market

The following exhibit shows the world’s 20 largest reinsurers, ranked by consolidated gross premium written in 2006.

Insurance Company Company at Domicile

Swiss Re Switzerland

Munich Re Germany

Berkshire Hathaway Group United States

Hannover Re Germany

Lloyds of London United Kingdom

RGA Reinsurance Co. United States

Everest Re Group United States

Transatlantic Hlds Inc Group United States

Scor Group France

Partner Re Group France

XL Capital United States

Korean Reinsurance Co. Korea

London Reinsurance Co. United Kingdom

Assicurazioni Generali SpA Italy

Odyssey Re Group United States

Scottish Re Bermuda

Mapfre Spain

Aegon Netherlands

Converium Group Switzerland

Renaisance Re Bermuda

From this exhibit, it is obvious that there is a certain geographic diversity in top reinsurers, with 5 headquartered in the United States, 2 each in Germany, UK, and Switzerland and France and the rest in other parts of the world.Reciprocity: There is a practice of reciprocal reinsurance among primary insurers, whereby two or possibly more primary insurers enter into an agreement under which each cedes to the other an agreed percentage of its business. In most reciprocal reinsurance arrangements, similarity of business is a prime consideration. Again normally, they do not compete in the same market area. In the modern day, reciprocal reinsurance is not widely practiced.

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The London MarketThe reinsurance market in London consists of the Lloyd’s, other reinsurers in London, Direct insurers accepting inward reinsurance business, underwriting agents and brokers writing reinsurance on behalf of other insurers, and contact offices writing business for overseas insurers for placement in the London market.

Of late, there has been a marked trend in the formation and development of Regional and State Reinsurance Corporations such as Caisse Centrale De Reassurance in France, the Instituto Nationale de Assicurazioni in Italy and the Asian Re in Bangkok.

CONSTITUENTS OF A REINSURANCE MARKET1. Insurers (Reinsured)

2. Reinsurance Brokers

3. Reinsurers – Reinsurance Reinsurer (Retrocedant)

4. Reinsurer of Reinsurer (Retrocessoionaire) – Retrocession

5. The Arbitration Factor

6. Infrastructure Facilities

7. Domestic Markets

8. The Location Advantage

9. The Role of Foreign Reinsurers

Several factors characterize advanced reinsurance markets in the world. Let us discuss some of the main features:

Stability factorThe performance of reinsurers depends on many factors such as economic, social and political stability. If the economy is turbulent, then there will be an adverse affect on the performance of reinsurance companies. There should also be a consistency not only in regulatory environment but also in legal environment so that it would be helpful for the augmentation of the reinsurance market.

As reinsurance is not a daily business, both the parties to the reinsurance contract should be sure that the market remains stable and they are not affected by the changes in the market.

Availability of Knowledge CapitalFor the reinsurance market to be thriving, there should be personnel with widespread knowledge about the industry. Tasks, like underwriting which the reinsurer has to take on, depend upon the proficient knowledge of the staff possess.

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Matured Financial MarketsThe scope for the reinsurers to raise the required resources depends upon the maturity of the country’s financial markets. If the financial markets are matured, then reinsurance markets will be very much benefited. The reinsurers can easily access the market and can maintain their business.

The Role of EconomyThe economies, which have high inflation, are not favored as it adversely affects the reinsurer’s costs like staffing cost etc. Reinsurers are prone to setting up their shops in a steady market.

The Arbitration FactorIn reinsurance if any dispute arises then it is referred to arbitration. If the market provides good arbitration facilities with appropriate legal framework, then the disputes between the parties can be settled easily. Hence, arbitration plays a very significant role in the development of reinsurance industry.

Infrastructure FacilitiesAs reinsurance is a global industry and reinsurance players are from developed countries, the markets should have excellent infrastructure facilities.

Domestic MarketsIf the insurance players generate good business in the domestic market reinsurers will be interested in expanding their operation. And domestic insurers will get competitive terms for their placement. Professional reinsurers are normally interested in developing insurance in underdeveloped countries if the legal system and regulatory environment is not adverse.

Locational AdvantageLocation plays a very important role in case of reinsurance business. If the country has well-developed reinsurance market, then reinsurance business can be expanded to the countries that are less developed.

Role of Foreign ReinsurersIf there are foreign players in the reinsurance market then it would be helpful for the domestic players in that they would have better knowledge of various techniques like underwriting, marketing etc. of the foreign players. This would lead to the development of the domestic reinsurance industry.

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REGIONAL REINSURANCE CORPORATIONTo take care of domestic needs, two reinsurance corporations were formed in the country, which would be helpful for the growth of the domestic reinsurance industry. They are:

1. State Reinsurance Corporation

2. Regional Reinsurance Corporation

The setting up of a Regional Reinsurance Corporation is equally important as setting up of a State Reinsurance Corporation, since the regional Reinsurance Corporation is set up based on the geographical factor. Generally, a regional reinsurance corporation caters to the needs arising among a group of neighboring countries. These corporations were proposed to be set up across the different developing nations of the world. For example one such corporation is the Asian Reinsurance Corporation, set up in Bangkok. The major participants of this corporation are India, China, Bhutan, Thailand, Philippines, Afghanistan, South Korea, Bangladesh and Sri Lanka.

The setting up of a regional reinsurance corporation mainly depends on certain common features, which the member countries must have due to the binding proximity with or to each other. The common features of these countries are as follows:

1. Common physical boundaries among the member countries.

2. Well-developed communication between member countries.

3. Well-developed economic trade ties between member countries, leading to free flow of trade.

4. Common customs, ethnic identity and language.

The regional reinsurance corporations have the liberty to choose their own market place to locate their headquarters. The setting up of headquarters depends largely on factors such as well-developed accessibility, excellent communication facilities, well-established commercial backup etc. The backing of good banking system will enable the corporation to have smooth functioning.

The regional reinsurance corporations end up with a good business in hand by involving compulsory cessions from its members. On the other hand, the corporations can get exposed to risks arising from member nations. In order to avoid such happenings they get protection through retrocession covers from other markets. The regional reinsurance corporations manage their portfolio, which is spread over different countries through various retrocession covers, which are:

l Proportional covers

l Non-proportional covers

l By trading outward covers through traders and generating inward covers.

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l Non-reciprocal inward reinsurance accounts, a part of which may be retroceded back to the member nations.

Under the regional reinsurance corporations reinsurance cover may be issued to the domestic company too.

Characteristics of a regional reinsurance corporationThe two main characteristics of a regional reinsurance corporation are:

1. The company is owned through a non-insurance business group with common interest. The interest may be of a single – parent shareholder or a group of shareholders.

2. As the name goes all the risks written are ‘captive’. The risks are somehow related to

the shareholders or to the third party risk which the shareholders control.

INDIAN REINSURANCE MARKETIn India prior to nationalization, there were 44 foreign insurers and 63 domestic companies operating. As there was no reinsurance market in India they used to access the international reinsurance industry for their reinsurance needs.

After nationalization of the insurance industry, five companies started taking care of the general insurance needs. They are:

1. General Insurance Corporation of India

2. National Insurance Company Limited

3. The New India Assurance Company Limited

4. Oriental Insurance Company Limited

5. United India insurance company Limited

General Insurance Corporation of India (GIC) (with its subsidiaries) has been the erstwhile monarch of non-life insurance for almost three decades. After the change in the role as ‘national reinsurer (National Re), the GIC delinked its subsidiaries and entry of foreign players through joint ventures have changed the outlook of the whole general insurance industry in India.

Prior to nationalization, there were 55 non-life domestic insurers and each company had its own reinsurance arrangement. After nationalization, all these companies were brought under the aegis of GIC and four subsidiaries were formed, with GIC as holding company. There was a huge jump in the Indian reinsurance market and GIC became the ‘National Reinsurer’.

GIC undertakes both domestic reinsurance and international reinsurance. Domestic reinsurance is provided to the direct general insurance companies in the domestic

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market. GIC, as per IRDA statute, receives cession of 10% on each policy. As per IRDA regulation GIC will retrocede at least 50% of the obligatory cessions received to the ceding insurers after protecting the portfolio by suitable excess of loss covers. Such retrocession will be at original terms plus an overriding commission to National Re not exceeding 2.5%. The retrocession to each ceding insurer will be in proportion to his cessions to National Re. It leads many of domestic companies’ treaty programs and facultative placements. GIC is also emerging as an international player in the reinsurance market by providing reinsurance facilities to companies in Afro-Asian region – SAARC countries, South East Asia, Middle East and Africa.

Following are excerpts from IRDA Annual ReportThe reinsurance program of each non-life insurer is required to be guided by the basic tenets of maximizing retention within the country; developing adequate reinsurance capacity; securing the best possible protection for the reinsurance costs incurred; and simplifying the administration of business. Every life insurer is required to draw a program of reinsurance in respect of lives covered by it. The profile of the reinsurance program, duly certified by the Appointed Actuary, is required to be filed with the IRDA, giving details of the reinsurer(s)with whom the insurer proposes to place business. Every insurer is required to furnish the reinsurance program to the IRDA at least forty-five days before the commencement of each financial year. In addition, every insurer is required to file copies of the treaty slips and cover notes, furnishing details of the proportionate share of the reinsurers, within 30 days of the commencement of the year. The Authority reserves the right to seek any clarifications and if necessary, give directions.

The Authority is particularly concerned that insurers while ceding abroad do so only after utilization of the national capacity and on competitive international terms. Also, the business placed with any one re-insurer should not be excessive. Thus, every insurer is required to offer an opportunity to other Indian insurers, including the Indian reinsurer to participate in its facultative and treaty surpluses before placing such cessions outside India. Insurers are also required to place their reinsurance business outside India with only those re-insurers who have over a period of past five years counting from the year preceding for which the business has to be placed, enjoyed a rating of at least BBB (with Standard & Poor) or equivalent rating of any other international rating agency. Placement with any other reinsurer requires approval of the Authority. Surplus over and above the domestic class-wise reinsurance arrangements can be placed by the insurer independently subject to a limit of 10 percent of total reinsurance premium ceded outside India being placed with any one reinsurer. Where it is necessary to cede a share exceeding such limits to any particular reinsurer, the insurer needs to seek the specific approval of the Authority.

Introduction of brokers has helped the direct insurers to secure facultative placements abroad,

especially in aviation, energy and petrochemical risks. GIC, the national re-insurer, extends

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the additional facilities to insurers besides managing obligatory cessions by participating in a) companies surplus treaties; b) market surplus treaties; and c) facultative acceptances protecting their net account through excess of loss arrangements. GIC as a member of the Federation of Asian Insurers and Reinsurers (FAIR) Pool is able to extend additional facilities in the Indian market.

CAPTIVE INSURANCE COMPANIESCaptive insurers operate from such tax havens as Bermuda, catering to the reinsurance

requirements of parent companies situated in Europe, America and elsewhere.

The insurance companies formed by large commercial or industrial establishments, essentially to take care of their own insurance needs, are called captives. These captives play a major role in fulfilling the insurance needs of the parent companies and help the money flow inside the periphery of the business group. The captives form their bases in places where the investors are given tax concessions by the local governments. There are over 4000 captive insurers operating world-wide with nearly 35% of them located in tax havens like Bermuda, Luxembourg, Guernsey, Cayman Islands, Bahamas, Hawaii, Isle of Man, Barbados, Dublin, Vermont, Singapore and other locations.

The captives were established since 1960’s but there was good development since a decade ago.

A captive insurance company normally provides coverage at a lower cost compared to the companies in insurance industry generally. The stocks controlled by the company depend on either one interest or a group of interests covered related to the business operations. The captive insurance company can be a non-resident, non-admitted or a foreign insurer.

Types of captivesThe various kinds of captives can be branched out as follows:

Single Parent Captives

Single parent captives are also called ‘pure’ captives. These provide coverage to single owners who hold the company. A risk manager or finance officer at the parent company monitors them.

Association captives

An established association generally forms this kind of captive. The coverage is provided to its members. In this the ownership vests with the association or the individual members. The financial expert at the association level looks after the operation or this responsibility is outsourced to a management company, consultant or a broker.

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Industry captives

An industry captive is owned by industries with similar specific insurance problem.The shareholders to whom the company is required to report appoint a board of directors.

Agency captives

An agent or group of agents owns this type of company. These are formed such that their clients can participate in the programs.

Rent-A-Captives

The risks of the members are insured by this type of captive. The investment income and underwriting profits are returned to the insureds. Certain companies rent their surplus to institutions in order to establish a self-insurance program but not their own captive.

Protected cell companies

These are special category of rent-a-captives. They shield their capital and surplus from

other renters in the captive as long as the rent-a-captive ‘s owner remains solvent.

Benefits of captivesThe corporations and groups who want to take financial control and manage risks by underwriting their own insurance than paying premiums to the third-party insurers can opt for captives. Captive is nothing but a tool to such organizations.

The benefits of captives are as follows:

l Provides insurance for certain exposures, which other insurance companies might not provide.

l Enables retention of the premiums within the group by the parent company.

l Operating costs are reduced.

l There is an improved cash flow.

l There is an increase in coverage and capacity.

l Better investment as well as investment income.

l There is a direct reach to wholesale reinsurance markets.

l There is flexibility in underwriting and funding.

l There is a greater control over claims.

l Availability of smaller deductibles for operating units.

l There is an additional negotiating leverage with underwriters.

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l Availability of incentives for loss control.

The captives adopt their own methods in order to protect their business exposures.

l They generally retain smaller losses in their own account and they reach out for excess of loss exposure in cases of larger loss exposures.

l In order to spread their portfolio in a better way, they write inward reinsurance business.

l There is a reinsurance pool organized for their clients.

l There is also a reciprocal and non-reciprocal reinsurance arrangement.

? Questions

1. “Reinsurance Market is spread all over the world with major reinsurers being concentrated in Europe and West”. Explain global reinsurance market.

2. What is Regional Reinsurance Corporation? Explain its features.

3. Explain the main features of Indian reinsurance market.

4. What do you understand by term ‘captives’? Discuss briefly various types of captives.

5. Outline the benefits of captives.

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CHAPTER – 8

INWARD REINSURANCE

OUTLINE OF THE CHAPTERl Inward Reinsurance

l Objectives

l Business Strategy

l Retrocession Arrangements

l Reciprocal Trading

LEARNING OBJECTIVESl To understand the features Inward Reinsurance business

l To get familiarized with Retrocession Arrangements

l Understanding the essentials of Reciprocal Trading

introductionIn recent times, the trend of direct insurers undertaking inward business is on the rise as it results in increase of gross premium and net retained premium. Inward reinsurance business is defined as “the insurance business taken up by a direct insurer or reinsurer from the cedent in turn for share in the premium volume generated by the cedent or on a fee basis”. The growing reinsurance market kindled new hopes for many insurance companies, which traditionally carry insurance business, to undertake inward reinsurance business along with their main line of business. In a retrocession arrangement a reinsurer (the retrocedent) cedes all or part of the reinsurance risk it has assumed to another reinsurer (the retrocessionaire).

As the market for inward reinsurance is yielding attractive returns, many kinds of companies all over the globe are jumping into the fray of inward reinsurance.

However, the company taking up inward reinsurance should look at its competence in terms of market knowledge, research facilities, sound actuarial practices and knowledge of changing risk profiles in the market.

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OBJECTIVES of inward reinsuranceAny reinsurance company would, in addition to ceding their business, also accept some reinsurance business. Some of the reasons why companies go for inward reinsurance are as follows:

l To increase the gross premium and net retained premium

l To achieve a lower expense ratio by maintaining the volume of premium income as ceding reduces the premium income

l To obtain a better and wider spread of business

l To counteract the drain of foreign exchange caused by ceding of premium

l To earn an investment income which may be derived from the cash flow.

After examining all the pros and cons a company has to devise an appropriate corporate strategy for its underwriting policy. It can write lines for its net account or it can write larger shares and create a retrocession treaty to take care of the surplus over its net retention.

Some considerations the company should keep in mind while finalizing its inward insurance programme for the year are as follows:

l Treaty or facultative: Facultative involves more administrative work as each offer will be scrutinized. Treaty is less expensive but it requires a thorough knowledge of the market and treaty clauses.

l Territorial scope: If the company wants a greater geographical spread then it should underwrite foreign business keeping in view the political and economic conditions of the country.

l Direct or brokers: If the company has experienced staff direct business can be solicited. However, this will involve travel expenses to procure business. So initially it is better to place business through a broker.

l Class of business: The company should decide whether it wants to underwrite property business, which is on an annual basis, or casualty business.

l Acceptance limits: Keeping in mind the financial standing and premium income of the company, the acceptance limit should be large enough to make it attractive for the brokers and ceding companies to offer business.

l Finally, IRDA has brought in certain norms for acceptance of inward business, which have to be adhered to while designing the inward programme.

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BUSINESS STRATEGYA business strategy is required to support any insurer or reinsurer to transact reinsurance business and all logistical help should be available to carry out the task. Intimate knowledge of the international markets, skills in reinsurance area are basically essential in restricting or excluding acceptances.

The reinsurer should study the market conditions with due focus on expected spread of risks and volume of business. There has been dramatic changes in the methods and forms of reinsurance at international level compared to traditional methods of doing business. The reinsurance capacity has undergone rapid changes and the capacity is also available from capital markets.

Reinsurer should aim at writing a large line to attract business with quality and to keep his costs of acceptance economical. Nearly 90 percent of global reinsurers depend on some form of retrocessional protection as a means both to cede a portion of their risk and to stabilize their earnings. The reinsurer has to cope with financial problems like delayed remittances and exchange of losses. Besides the tool of credit rating, gathering information first hand would assist for diligence in writing inward reinsurance.

Some important dimensions in business strategy are as follows:

1. The companies should have clarity on the basis of underwriting – should it be reciprocal or non-reciprocal?

2. An insurer or reinsurer accepting reinsurance business has two options open to him – gross or net lines. He can write such shares as can be retained by him without retrocession or he can write larger shares and create a retrocession treaty to take care of the surplus over his net retention.

3. Undertaking facultative reinsurance business involves more administrative work and the amount of premium is relatively small and the insurer needs to have thorough knowledge of tariffs and other market conditions. In treaty reinsurance business the premium volumes can be built up.

4. Insurers need to be clear on how much will be proportional and what amount will be non-proportional. Reinsurance companies should exercise the choice carefully.

5. Opting for wider geographical areas and spread will result in growing volumes and at the same time bring new types of business. Therefore, the market conditions will certainly impact the profitability of the reinsurer.

6. Reinsurer can procure business from various sources. It can be by granting an underwriting or binding authority to another company or agency to write business. It may accept business through brokers.

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7. The acceptance limit should be sufficiently large to make it more attractive for the ceding companies and brokers to offer business. Companies need to stay within their financial limits to avert any kind of financial crisis subsequently.

8. The company should lay down guidelines for accepting business.

RETROCESSION ARRANGEMENTSA retrocession is both the unit of insurance that a reinsurance company cedes to a retrocessionaire and the document used to record the transfer of risk from a reinsurer to a retrocessionaire. After making acceptance, decision, underwriting decision has to be taken. The accepting insurer or reinsurer may retain it wholly for his net account or retrocede a part of the acceptance to a retrocession arrangement, if any, or even arrange a specific retrocession on an individual acceptance with another reinsurer.Retrocession is required by a leads underwriter who lead quotes on a reinsurance proposal. The larger is his acceptances, the higher is the confidence of his underwriters.Retrocession is also required to support reinsurance offers, which may otherwise be scarce in the absence of retrocession. When there is excess capacity, lead underwriters yield to broker pressure to offer lower and retrocession support is in offing.

RECIPROCAL TRADINGThe mutual exchanging of reinsurance, often in equal amounts, from one party to

another, the object of which is to stabilize overall results, is the essence of reciprocity.

Ceding insurers tend to protect the experience of the treaty by not fully utilizing the treaty capacity for more serious risks or arranging an excess of loss cover to protect the treaty portfolio to take the benefit of reciprocal reinsurance trading. These parties are ready to offer adjustments in commission, profits and reciprocity terms to keep the treaty exchanges balanced.

The benefits that accrue from reciprocal exchange are:

a) it enables the ceding insurer to add to his net premiums and net profits;

b) it provides a wider spread for the net retained portfolio of the insurer with an improved balance thus ensuring greater stability in profits.

The reciprocal reinsurance trading is very much prevalent in fire insurance and it is not that much evident in cargo business, barring a few instances. Reciprocal reinsurance tends to take place in the same area of both the insurers.

One can think of more than 100 percent premium reciprocity to balance the exchange of profits when dealing with markets of lower average profitability. It can be said that a ceding insurer with a treaty carrying an average 10 per cent profitability can expect to receive 200 percent premium reciprocity from a reinsurer whose treaty has an average profitability of 5 percent. However, the reciprocating insurer has a much better balance for his treaty and is able to conclude short of 100 percent profit reciprocity

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in consideration for the steady results. Profit is normally subject to fluctuations and therefore, accepting a large premium reciprocity from a treaty may be fraught with danger. It is preferable to increase profit commission to reduce the net profit ceded.A large premium reciprocity adds to the net premium of the ceding insurer and has other advantages flowing from it such as creation of larger reserves and reduction of tax on profits consequently.

Finally one should consider the impact of brokerage cost on the result of reciprocal profit from the inward treaty when examining the terms of any treaty exchange through intermediary.

REGULATIONSIRDA regulations state that all life and non-life insurers in India can write inward reinsurance business from other domestic insurers and from overseas, provided that they have a well-defined underwriting policy. The insurer shall ensure that decisions on reinsurance business are exercised by persons with necessary knowledge and experience. The insurer shall file with the IRDA a note on his underwriting policy stating the classes of business, geographical scope, underwriting limits and profit objective. The insurer is also required to file any changes to the note as and when a change in underwriting policy is made.

?Questions

1. What is inward reinsurance? Explain its objectives?

2. What considerations an insurance company should keep in mind while finalizing its inward insurance programme?

3. Explain the role of business strategy in case of inward reinsurance.

4. Outline the concept of Reciprocal Trading.

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CHAPTER – 9

REINSURANCE PRACTICE

OUTLINE OF THE CHAPTERl Reinsurance Practice

l Setting Retention

l Setting Reinsurance Limits

l Cost of Reinsurance

l Reinsurance Negotiations

l Reinsurance Commissions

l Designing and Arranging of a Reinsurance Program

LEARNING OBJECTIVESl Fixing the goals of

reinsurance

l Factors determining the reinsurance needs of a primary insurer

l Choice of retention

l Setting the reinsurance limits

l Determining the reinsurance cost

l Information required in reinsurance

negotiations

l Examining typical questions to consider in assessing the underwriting policy of a primary insurer

l Understanding the kinds of commission involved in reinsurance transactions

l Underwriting factors that a reinsurance underwriter must consider

l Designing of and arranging a reinsurance program

l Understanding Indian Reinsurance Program

introductionIn practice, there cannot be a specific type of reinsurance that tackles the impact of loss frequency. The factors determining the reinsurance needs of a primary insurer are many. In practice, most of the primary insurers try to be specific in fixing their goals and therefore negotiate on limits, commissions and work on cost of reinsurance.

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The primary insurers benefit from a well-planned and well-executed reinsurance program in more ways than one. Reinsurance helps stabilize loss experience, provide capacity and provide surplus for growth. Reinsurance is especially useful in financing catastrophic losses. A good reinsurance program can only be executed with assistance from reinsurers, brokers and consultants. A reinsurance plan must take into account the primary insurer’s needs and be based on a thorough understanding of the reinsurance market. By the primary insurer’s needs, we mean how much large line capacity is desired, how much stability of losses is expected, or in other words, what is the variance in expected losses and how much surplus relief is needed. There are two considerations to be taken:

l Firstly, the primary insurers must continue to be solvent, and

l Secondly, primary insurers must be able to pursue the future growth plans.

The management’s attitude to the stability of losses must be considered. For example, in the case of mutual insurers, the policyholders may be prepared to accept lower short-term profits and hence greater loss ratio volatility than stock insurers. While the reinsurers look at the underwriting profit, the primary insurer must also consider the stability of investment profit when designing the reinsurance program since that would make variations in underwriting results more acceptable.

In practice, most primary insurers try to be specific in fixing their goals. Such goals might include, say,

l Not allowing increase in the net loss ratio to exceed five percentage points on account of catastrophic losses:

l Providing a single risk capacity of at least Rs.10 billion for commercial property insurance and Rs.5 billion for commercial liability insurance, and

l Automatic treaties or increase the surplus by Rs.5 billion.

The factors determining the reinsurance needs of a primary insurer are many. But the more important of them are the following:

l Kinds of Insurance written

l Exposures subject to catastrophic loss

l Volume of Insurance written

l Available Financial Resources

l Stability and Liquidity of Investment Portfolio, and

l Growth Plans

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Kinds of Insurance WrittenBased on the insurance written by the primary insurer, it is possible to gauge the stability of loss frequency and of loss severity. In practice, there cannot be a specific type of reinsurance that tackles the impact of loss frequency. On the other hand, having an aggregate excess treaty (since it puts a cap on the primary insurer’s loss ratio) can reduce the impact of severe losses. However for large individual losses, both surplus and per risk excess treaties are effective.

Exposures subject to catastrophic loss: The primary insurer must assess the history of catastrophic losses both in terms of individual natural disasters and in terms of geographical distribution of its insured properties. Usually, however, reinsurers themselves have such historical records and are in a better position to price reinsurance for different primary insurers.

Volume of Insurance written: If the primary insurer has written a large volume of business, then the Probable Maximum Loss (PML) is predictable with some accuracy since the law of large numbers will operate. However, this is a gamble since the law of large numbers is inapplicable in the case of catastrophes.

Available Financial Resources: There are two possible scenarios. In the first, the primary insurer with a weak surplus position needs a highly stable net loss ratio and might require the use of pro-rata reinsurance to provide surplus relief. On the contrary, the primary insurer with a very strong surplus position can risk a more volatile net loss ratio. However, the quality of the surplus as indicated by the invested assets is also important.

Stability and Liquidity of Investment Portfolio: This is an every day investment consideration since investment of funds must also consider the need for liquidity at short notice; that means, investment must be in readily marketable securities. Besides, since return is not a more important consideration than liquidity, investment must not be in shares or stocks with wide fluctuations in the short term.

Growth Plans: A rapidly growing insurer needs surplus relief more than an insurer with less rapid growth. In this process, many profitable lines will be ceded to reinsurer in the short run but that is a strategy for surviving in the long run while achieving the growth potential.

SETTING RETENTIONSThe choice of retention depends on the type of treaty, which, in turn, depends on the needs of the primary insurer. The setting of retention varies depending on the type of treaty. In other words, the basic reason for choosing one type of treaty in preference to another is supported by the following example. For example, if the primary insurer prefers a pro-rata treaty when compared to an excess treaty the reason could be that a pro-rata treaty provides surplus relief. Therefore, the important factor in the setting of retention must be the amount of relief needed.

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The amount of surplus relief received will be a function of the percentage of premiums ceded and the percentage ceding commission received.

On the other hand, the principal purpose of an excess of loss treaty is to stabilize loss exposures, besides providing large-line capacity. It may be seen readily that providing large-line capacity is a function of treaty limit rather than the retention. Therefore, the true consideration in setting the retention of an excess of loss treaty is the size of loss the primary insurer can absorb without affecting the policyholder’s surplus or the net loss ratio. That amount, in turn, is a function of the premium volume and the policyholder’s surplus of the primary insurers. It is logical that the primary insurer should retain that part of its aggregate losses that is reasonably stable and predictable and should cede that part that is not reasonably stable. Losses are stable and predictable when the maximum probable variation is not likely to affect the insurer’s loss ratio or surplus beyond expectations and hence unacceptable to the management. Hence, retention is related first to the frequency of losses and secondly to the probability of a very large loss occurring. In all these calculations, the cost of reinsurance and the role of reinsurers in setting retentions cannot also be overlooked. For example, reinsurers sometimes insist on a lower retention than what is designed by the primary insurer. Retention also depends on the number of treaties the primary insurer may carry.

SETTING REINSURANCE LIMITSThere should be fairly high limits to cover a good majority of the loss exposures and the limits must be considered along with retention. Large limits are sought especially in pro-rata and per risk or per policy excess treaties. Setting the reinsurance limits depends on cost considerations since reinsurance costs increase in direct proportion to reinsurance limits, keeping the retention constant. However, the treaty reinsurance costs must be weighed against other recurring costs in facultative placements such as the premium, administrative expense and inconvenience and uncertainty associated with facultative reinsurance. However, while setting the reinsurance limits only the volume of the premium is considered and not the premium loading.

Limit Setting for a Catastrophe treaty is even more difficult in practice since one cannot predict a large loss merely based on historical records. Therefore, in reinsuring catastrophes, concentration of loss exposures must be carefully analyzed.

In the case of aggregate excess treaty, the reinsurance limit must be set at an amount adequate to cover the higher loss ratio that the primary insurer may expect to sustain, but the reinsurance premium for such a limit must be acceptable.

To estimate a large loss in future is not easy. However, there will be greater variation in loss ratios for a property insurer than for a liability insurer and it is clear that the variance in the loss ratios is, in part, a function of the lines of insurance written.

It is also understood that there will be greater variation in loss ratios for a similar

insurance with a lower premium volume. Similarly, a primary insurer who is having a

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business in major parts of the country will be less vulnerable to loss ratio fluctuation than a regional insurer.

In the exercise of setting the reinsurance limit, the terms of several treaties must be compared and the limits kept flexible. For example, the limit for an aggregate excess treaty can be lowered if adequate catastrophe reinsurance is carried. Again the limit of a catastrophe can be lower if it applies only to the retention of the primary insurer after recoveries from pro - rata reinsurance, rather than to the direct losses.

COST OF REINSURANCEThe reinsurance cost includes the premium paid to the reinsurer and losses recovered or to be recovered under the reinsurance agreement. A primary insurer should pay its own losses and the reinsurer’s expenses and profit under any treaty, if the treaty is continued over a fairly long period. That is why the amount included in the premium for the reinsurer’s expenses and profit is an important factor in assessing the reinsurance cost.There is a certain loss of investment income to the primary insurer, since reinsurance involves transfer of some loss reserves and unearned premiums from the primary insurer to the reinsurer. Consequently, the assets offsetting these reserves are invested. And such a transfer of assets results in loss of investment income to the primary insurer. Such a loss of investment income may be greater under a pro-rata treaty than under the excess treaty since the reinsurance premium for a pro-rata treaty is usually greater. Thus, the loss of investment income may also become an additional cost of reinsurance. The cost of administering the reinsurance program varies depending upon the type of reinsurance. For instance, since facultative placements are individual and separate, the cost of administration in these cases is greater than in the case of treaties. Like-wise, pro - rata treaties cost more to administer than excess treaties.

Finally, the profit or loss on insurance assumed under reciprocal arrangement must also form part of the reinsurance cost.

REINSURANCE NEGOTIATIONSNegotiations depend on several factors but chiefly the nature of the primary insurer and the reinsurer and the kind of reinsurance transacted.

Information needed: The primary insurer must first compile some basic necessary information. The favorable reinsurance terms and rates depend on the thoroughness of the data compiled by the primary insurer.

The information required in reinsurance negotiations is different for treaties and for facultative reinsurance. In treaties, the reinsurer will look for information concerning the management and underwriting operations of the primary insurer. But in facultative reinsurance negotiations, the details of individual loss exposures are more important than the general operations of the primary insurers.

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Before signing a reinsurance treaty, the reinsurer must be satisfied about the integrity of the primary insurer, his management characteristics, underwriting policies, underwriting results and financial condition. The moral hazard of the primary insurer must be considered since numerous frauds have occurred.

The underwriting staff of the primary insurer must have demonstrated capability and experience. In the event of the primary insurer becoming insolvent, depending on the cut through endorsements in place, the policy holders will have direct access to the reinsurers and if in the meanwhile, the courts have given awards, compelling the reinsurers to deposit their share of loss, the reinsurers will be facing double liability and this could injure their financial interests. Besides, a reinsurance treaty signifies a long-term relationship and the primary insurer’s bankruptcy may lead to disastrous situation.

The underwriting policies and underwriting results of the primary insurer are important considerations in every reinsurance negotiation. Here are some typical questions to consider in assessing the underwriting policy of a primary insurer.

1. What are the classes of business the primary insurer is writing?

2. Is the primary insurer basically concentrating on personal lines, commercial, industrial or others?

3. What is his geographic area of operation?

4. How satisfactory are the primary insurer’s underwriting guidelines?

5. Are there gross line limits and net line limits in keeping with his financial strength?

6. Are the primary insurer’s loss control and loss adjustment practices adequate for the classes of business written?

7. Have the primary insurer’s underwriting results been satisfactory in the lines covered by the proposed reinsurance treaty?

8. Does the primary insurer anticipate any substantial changes in his management, marketing or underwriting practices?

9. Are the primary insurer’s rates adequate for the risks covered under the treaty?

Reinsurers are also interested in ascertaining the terms of other reinsurances the primary insurer is having. The idea is to find out if reinsurance is sought only for the benefit of the primary insurer or if it also protects the interests of the reinsurer.

Again, the most recent loss experience of the primary insurer is to be considered as that will reflect the underwriting policy, that tells of the selection of risks, rating and commission terms. It is not the level of the loss ratio that is important but the reinsurer is interested in knowing about its stability or volatility over time. Distribution of both

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losses and amounts of insurance by size must also be considered, especially for arranging a per risk or per policy excess treaty.

Since reinsurance negotiations are two-sided, even the primary insurer must collect enough information, concerning the solvency of the reinsurer, his satisfactory claims practices, the competitiveness of rates and also the licensing in the territory where the primary insurer operates.

REINSURANCE COMMISSIONSThere are two kinds of commission involved in reinsurance transactions, namely:

l Ceding commissions paid by the reinsurer to the primary insurer, and

l Brokerage commissions paid by the reinsurer to the reinsurance broker.

Ceding commissions are said to compensate to some extent the initial costs of acquisition of the primary insurer as well as the cost of servicing the business. The negotiation of the ceding commission depends on the administrative expenses of the primary insurer as well as the reinsurer’s estimate of the premium volume and the loss experience expected under the treaty being negotiated and also in practice the market situation of demand for and supply of reinsurance. Treaties also provide for retrospective adjustment of the ceding commission based on a variance of the loss ratio from expected loss.

Brokerage commission varies between 2% and 5% of the reinsurance premium for pro rata treaties and 5% and 10% for Excess of Loss (EOL) treaties.

DESIGNING A REINSURANCE PROGRAMMEUnderwriting factors that a reinsurance underwriter must consider:

The reinsurance underwriter must assess the loss exposures that are covered by the ceding company and he must also assess the explicit terms of that coverage.

The following are the underwriting factors to be considered by the reinsurance underwriter about the primary insurer:

1. Financial status

2. Loss exposure

3. Coverage

4. Risk retained

5. Premium pricing

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DESIGNING OF AND ARRANGING A REINSURANCE PROGRAMBoth the parties to the contract should have a proper understanding regarding underwriting

of business. The insurer needs thorough knowledge about the reinsurance and also the

insurer should design a reinsurance plan for his business. Therefore, the insurer as well the

reinsurer while considering large business, should know the following:

1. Sources of business.

2. Different classes of reinsurance or insurance.

3. Geographical distribution of business.

4. Identification of exposures.

1. Sources of Business

A reinsurer should identify the areas where he can get business. Reinsurer can acquire his business from different sources such as

1. Domestic Direct Insurance Companies

2. Foreign Direct Insurance Companies

In case of domestic direct insurance business, foreign exchange will not have any effect on the business. Acquisition costs are low in this type of company .It can also be easily manageable.

In case of foreign direct insurance business acquisition costs are high; maintenance costs are also high. It is difficult to adapt to different market situations prevailing in different countries.

2. Classes of Reinsurance

As the characteristics of different classes of reinsurance vary, necessary study must be done. The type of reinsurance required for the insurer depends upon the exposures involved. The reinsurance program should be prearranged for each class of insurance separately.

3. Geographical distribution of business

Since the risk factors affecting the loss experience vary for every region. The results will be more stable if the portfolio is distributed broadly. There will be growth in business if the economy is growing steadily.

4. Identification of Exposures

While designing a reinsurance program, risks that are involved in a portfolio should be

studied. This helps the reinsurer in building risk profile. The major factor in deciding

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retention is the underwriting criteria, which are applicable to a particular class of business.

The company should protect its retained portfolio of business so that the underwriter can distribute his acceptances to the company’s reinsurance protection.

REVIEWING A PROGRAMReinsurance companies should review their reinsurance program to approve changes in the type of business, inflation, regulation, loss experience etc.

Review program for non-proportional contracts are generally done annually.

In case of proportional contracts, review or renewal starts earlier and should consider the following while reviewing its reinsurance business.

1. When to change a reinsurer?

2. Changes in underwriting the policy and its business.

To decide whether to continue with the existing reinsurer the following should be given utmost importance:

l Technical competence

l Reputation

l Financial strength

l Long-term relationship with the company (can be obtained by continuing with one reinsurer)

l Adequate reinsurance protection must be given by the company

Indian Reinsurance ProgramAs outlined earlier, following are the objectives of the common reinsurance program, which was in effect from 1973:

1. Maximize retention within the country.

2. Develop adequate capacity.

3. Secure the best possible protection for the reinsurance costs incurred.

4. Simplify the administration of business.

Both the parties should take into account all the above factors while designing a reinsurance programme.

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Given below is a case study of a small insurance company.

Name: Mumbai Insurance Co. Ltd.

Authorised Capital: Rs. 100 crores

Paid up Capital: Rs. 25 crores

Commencement of Operations : 1st April, 2001

Business operations : Initially the company wants to write Fire businessonly in Mumbai. Later on it plans to expand itsoperations to other classes and other areas ofMaharashtra.

Underwriting guidelines:

Fire: Type of Business accepted – private dwellings,office premises, retail outlets, wholesale outletsand non-hazardous mfg business.

Sum Insured : not more than Rs.10 crores.

Construction, coverage & rates as per Indian tariff.

Projected Gross premium Income

Year Premium Rs. (crores)

2001-02 17.50

2002-03 40.00

2003-04 60.00

2004-05 80.00

2005-06 100.00

Design a reinsurance programme for the company for the year 2001.

Solution: This involves:

1. Fixing the net retention per policy/risk for the company.

2. Choosing the right method of insurance for the company and fixing the limits.

1. Net Retention Maximum net retention per risk is normally not more than 5% of the paid up capital and free reserves in the case if fire business. However the loss retention per event should not be more than 1% (paid up capital+reserve). In the case of small companies whose portfolios are still unbalanced have to fix retentions related to their financial capacity: They may be forced to put at risk a proportionately more significant portion of their capital than the larger companies i.e. up to 5% of capital and free reserves.

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Keeping this in mind, the net retention per risk for this company is fixed at 4% of its paid up capital and loss retention at 1%.

Paid up Capital - Rs. 25 crores

Net Retention per Risk - Rs. 1 crore (@ 4%)

Net loss retention per event Rs. 25,00,000

2. Reinsurance ProtectionSince this is a newly formed company with no previous underwriting experience, it is advised that the company should initially arrange a Quota Share Treaty (with 10 lines).

Net Retention = Rs. 1 crore

Obligatory cession to GIC – 10% (Statutory)

Maximum surplus Reinsurance acceptance limit = Rs. 10 crores.

The total automatic capacity available for the company would be Rs.12.22 crores as detailed below:

Obligatory Cession - 10.00% 1.22 Cr

Net retention - 8.18% 1.00 Cr

Quota share treaty - 81.82% 10.00 Cr----------- ------------100.00% 12.22 Cr

Premium for QS Treaty (2001-02) = Rs. 14.3185 crores(81.82% of Rs.17.50 crores)

Premium for Net Retained A/C = Rs. 1.4315 crores (8.18% of Rs.17.50)

When the company’s income increases in the following years, it may review net retention limit. Later on the company may decide to switch over to a surplus treaty. The company should also protect its net retained account (premium Rs.1.35 crores) under an excess of loss arrangements against catastrophic losses such as earthquake, hurricane, windstorm, rainstorm, riot, civil commotion, malicious damage etc.

The company may avail excess of loss cover for a limit of Rs.10 crores with a loss deductible of Rs. 25 lakhs.

Thus one must review the Reinsurance programme every year with actual losses incurred especially catastrophe losses, regulations, inflation, changes in type of business etc.

One should also decide when to change a reinsurer keeping in mind the changes in its underwriting policies

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? Questions

1. The factors determining the reinsurance needs of a primary insurer are many. Explain the important of them.

2. “The setting of retention varies depending on the type of treaty” Explain.

3. Explain the concept of Reinsurance Negotiations and its implications.

4. Outline the process involved in designing a reinsurance program.

5. Discuss the objectives of Indian reinsurance program.

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CHAPTER – 10

Illustrations on reinsurance

1. A primary insurer – Prose covers an insurance risk of Rs. 500 lakh. Prose retains 10% of the risk to retention and cedes the balance 90% to X Reinsurers and X in turn retrocedes 50% of his acceptance (45% of 100%) to Y. Calculate the net claim of each assuming that a claim has been reported for Rs. 50 lakhs.

Solution:

Prose:

Total claims : 50,00,000

Less: recoverable from reinsurer : 45,00,000--------------

Net claim 5,00,000---------------

X Reinsurer:

Share of claim from Prose : 45,00,000

Less: recoverable from retrocessionaire : 22,50,000

--------------22,50,000--------------

Y Retrocessionaire:

Share of loss from X : 22,50,000

2. A pru life company

keeps the first Rs.

2,00,000 of each

claim and cedes the

next 5,00,000 to the

reinsurer.

l Calculate the

cedent’s retention

and ceding

amount on a

policy of Rs.

4,00,000.

l Calculate the

retention and ceding

amounts on a Rs.

5,00,000 policy. Solution:

l On the policy amounting Rs.4,00,000, the cedent keeps 2/4 i.e. ½ of the claim. i.e. Rs. 2,00,000 and the reinsurer has ½ i.e. Rs. 2,00,000.

l On the policy amounting Rs. 5,00,000 the cedent keeps 2/5 of the claim. i.e. Rs.2,00,000 and the reinsurer has 3/5 i.e. Rs. 3,00,000.

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3. Prudential insurance was reinsured by swarn reinsurance. The contract consisted of five surplus lines of each Rs. 2 million. The retention of prudential insurance is Rs. 2 million. The risk written and the sum insured by prudential insurance were as follows:

Risk sum insured

1 Rs.15,000,000

2 Rs.12,000,000

3 Rs.30,000,000

4 Rs.18,000,000

5 Rs.25,000,000

Calculate the shares of both the prudential insurance and swarn

reinsurance. Solution:

Risk Sum insured Retention Percentage Reinsurers Percentage

amount [%] amount [%]

1 Rs.15,000,000 Rs. 2,000,000 13.33 Rs.13,000,000 86.67

2 Rs.12,000,000 Rs. 2,000,000 16.67 Rs. 10,000,000 83.33

3 Rs.30,000,000 Rs. 2,000,000 6.67 Rs. 28,000,000 93.33

4 Rs.18,000,000 Rs. 2,000,000 11.11 Rs.16,000,000 88.89

5 Rs.25,000,000 Rs. 2,000,000 8 Rs.23,000,000 92

4. Shah insurance entered into a contract with the Brit Reinsurance Company. The reinsurance arranged was for Rs. 13,00,000 in excess of Rs. 3,00,000 per risk. The claims received were as follows:

Claim Amount of claim

1 Rs. 3,00,000

2 Rs.10,00,000

3 Rs.14,00,000

4 Rs.11,00,000

Calculate the retention by shah insurance company.

Calculate the recovery from Brit Reinsurance Company.

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Solution:

Claim Payment to Retention Recovery from Brit

insured [Rs.] amount [Rs.] reinsurance [Rs.]

1 3,00,000 3,00,000 Nil

2 10,00,000 3,00,000 7,00,000

3 14,00,000 3,00,000 11,00,000

4 11,00,000 3,00,000 8,00,000

5. The Stag insurance company entered into a reinsurance contract with the Delite Reinsurance Company regarding the commercial property reinsurance. The insurer enters into a ten-line surplus treaty. The company also retains up to the following:

Offices Rs. 5,00,000

Retail outlets Rs. 6,00,000

Warehouses Rs. 7,00,000

Factories Rs. 4,00,000

Miscellaneous Rs. 3,00,000

Calculate the maximum coverage under the

reinsurance. Solution:

The maximum coverage under the treaty is as follows:

Particulars Retention [Rs.] Ten-line surplus limit. [Rs.]Offices 5,00,000 50,00,000

Retail outlet 6,00,000 60,00,000

Warehouses 7,00,000 70,00,000

Factories 4,00,000 40,00,000

Miscellaneous 3,00,000 30,00,000

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6. The ‘Time’ insurers are retaining the following amounts in commercial property account and enter a five-line first surplus treaty and six-line second surplus treaty. The company’s retention is Rs. 2,00,00,000 on any risk. The sum insured is given as follows:

Risk sum insured [Rs.]

1 8,00,00,000

2 7,00,00,000

3 10,00,00,000

4 15,00,00,000

5 12,00,00,000

Solution:

Risk Sum insured Company’s First surplus Second surplus

[Rs.] retention [Rs.] treaty share [Rs.] treaty share [Rs.]

1 8,00,00,000 2,00,00,000 60000000 Nil

2 7,00,00,000 2,00,00,000 50000000 Nil

3 10,00,00,000 2,00,00,000 80000000

4 15,00,00,000 2,00,00,000 100000000 30000000

5 12,00,00,000 2,00,00,000 100000000 Nil

7. The people’s insurance company underwrites its fire business on PML basis. Find how a risk with the sum insured of Rs. 1100 crores is placed on the following reinsurance facilities. The risk engineers have assessed the PML of the risk as Rs.110 crores (10%). Maximum retention Rs.3 crores regardless of the risk

First surplus treaty 20 lines with a maximum limit of 30 crore PML

Second surplus treaty 40 lines of Rs. 50 crores PML

Third surplus treaty 10 lines with a limit of 10 crore PML

Solution:

PML = Rs. 110 crores

Net retention = Rs. 3 crores PML

First surplus treaty = Rs. 30 crores PML

Second surplus treaty = Rs. 50 crores PML

Third surplus treaty = Rs. 10 crore PML

The balance i.e. the facultative reinsurance = Rs. 17 crores PML

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8. The Stump insurance company has a gross retention of Rs. 50,00,000 including 50% of quota share treaty and a 10 line surplus treaty. The balance will be placed on facultative terms. Assuming that the company has accepted a risk of Rs.10,00,00,000 and the risk suffered a loss of Rs.1,20,00,000, allocate the loss to the reinsurer.

Solution:

Reinsurance distribution:

(Rs.)

Net retention - (2.50%) - 25,00,000

QST - (2.50%) - 25,00,000

Surplus Treaty - 10 lines (25%) - 2,50,00,000

FAC (70%) - 7,00,00,000-----------------10,00,00,000

Allocation of Loss:

Loss amount – Rs.1,20,00,000

(Rs.)

Net retention - (2.50%) - 3,00,000

QST - (2.50%) - 3,00,000

Surplus Treaty - (25.00%) - 30,00,000

Facultative - (70.00%) - 84,00,000------------------

1,20,00,000------------------

9. Pallavi insurance company has taken an excess of loss cover from Ram reinsurance company paying 30,00,000 excess of 20,00,000 with a provision for two reinstatements at 60% of final earned premium. A loss occurred and the cover should entail a recovery of 100,000. Calculate the reinstatement premium payable to the reinsurers. Earned premium is 80000 for the year.

Solution:

100,000——————— * 80,000 * 60/100 = 1,600

30,00,000

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10. Suresh insurance company writes fire business consisting of simple risks. The Insurance Company is ready to bear any claim up to Rs. 1,00,000. So, the company arranges an excess of loss arrangement treaty to meet the balance of any claim in excess of Rs. 1,00,000 per risk up to further 2,00,000. The following are the details of the claims:

Claim Payment to Retained by Recovery frominsured ceding company excess of

loss Reinsurers

1 1,00,000 1,00,000 nil

2 2,00,000 1,00,000 1,00,000

3 3,30,000 1,00,000 + 30,000 2,00,000

Will the reinsurer pay for all the claims, if claims payment is -100000, 200000,

330000?

Solution:

As the recovery from the reinsurers is limited to Rs. 2,00,000 per risk, so for claim 3 the ceding company will retain the balance 30,000. So the ceding company’s net retained loss will be Rs. 1,30,000 in case of claim 3.

In this case there is inadequate protection due to incorrect estimation of the exposure per event.

11. In an excess of loss cover, the rate is 100/60th of the average burning cost of incurred claims for the current and previous years, subject to a minimum rate of 3% and a maximum rate of 7%. Rate to be applied on GNPI. Calculate the premium for the year 1991.

Year gnPI Incurred losses to cover

1989 4,00,000 20,000

1990 8,00,000 30,000

1991 10,00,000 15,000

22,00,000 55,000

Solution:

55,000Burning cost = ——————— * 100 = 2.5%

22,00,000

Rate = 2.5 * 100/60 = 4.167%

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Excess of Loss Premium payable for year 1991 = 4.167% *

10,00,000 = 41670

12. In an excess of loss cover, the rate is 100/80th of average burning cost of incurred claims for the following years, subject to a minimum rate of 2% and a maximum rate of 5%. The claims incurred are as follows:

Year gnPI Incurred losses to cover

1980 4,00,000 25,000

1981 12,00,000 12,000

1982 15,00,000 10,000

31,00,000 47,000

Calculate the premium for the year

1981? Solution:

47,000Burning cost = ———————— *100 = 1.51%

31,00,000Rate = 1.51% * 100/80 = 1.89%

Since the rate obtained is less than the minimum rate i.e. 2%, therefore minimum rate will apply.

14. Consider an excess of loss cover paying 30,00,000 excess of 20,00,000 with provision of two reinstatements at 60% of final earned premium. The contract period is 1-1-1991 to 31-12-1991 and the loss has occurred on 31-4-1991. A loss of 60,000 should be recovered. Calculate the reinstatement premium payable to the reinsurer? Earned premium is 80000 for the year.

Solution:

60,000 (Loss recovery)—————————————— * 80,000 * 60/100 = 960 30,00,000 (Cover limit)

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Annexure - 1

INSURANCE REGULATORY AND DEVELOPMENT AUTHORITY (GENERAL

INSURANCE - REINSURANCE) REGULATIONS, 2000In exercise of the powers conferred by section 114A of the Insurance Act, 1938, sections 14 and 26 of the Insurance Regulatory and Development Authority Act, 1999, the Authority, in consultation with the Insurance Advisory Committee, hereby makes the following regulations, namely:-

CHAPTER – I

PRELIMINARY

Short title and commencement

1. (1) These regulations may be called the Insurance Regulatory and Development

Authority (General Insurance - Reinsurance) Regulations, 2000.

(2)They shall come into force on the date of their notification in the Official Gazette.

Definitions

2. In these regulations, unless the context otherwise requires:—

(a)‘Act’ means the Insurance Regulatory and Development Authority Act, 1999 (41 of 1999);

(b)‘Authority’ means the Insurance Regulatory and Development Authority established under sub-section (1) of section 3 of the Act;

(c) ‘cession’ means the unit of insurance passed to a reinsurer by the insurer which issued a policy to the original insured and, accordingly, a cession may be the whole or a portion of single risks, defined policies or defined divisions of business, as agreed in the reinsurance contract;

(d) ‘facultative’ means the reinsurance of a part or all of a single policy in which cession is negotiated separately and that the reinsurer and the insurer have the option of accepting or declining each individual submission;

(e)‘Indian re-insurer’ means an insurer who carries on exclusively reinsurance business and is approved in this behalf by the Central Government;

(f) ‘Pool’ means any joint underwriting operation of insurance or reinsurance in which the participants assume a predetermined and fixed interest in all business written;

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annexure - I

(g)‘Retrocession’ means the transaction whereby a reinsurer cedes to another insurer or reinsurer all or part of the reinsurance it has previously assumed;

(h) ‘Retention’ means the amount which an insurer assumes for his own account. In proportionate contracts, the retention may be a percentage of the policy limit. In excess of loss contracts, the retention is an amount of loss;

(i) ‘treaty’ means a reinsurance arrangement between the insurer and the reinsurer, usually for one year or longer, which stipulates the technical particulars and financial terms applicable to the reinsurance of some class or classes of business;

(j) Words and expressions used and not defined in these regulations but defined in the Insurance Act, 1938 (4 of 1938) or the General Insurance Business Nationalisation Act, 1972 (57 of 1972) or Insurance Regulatory and Development Authority Act, 1999 (41 of 1999), rules made thereunder shall have the meanings respectively assigned to them in those Acts or rules as the case may be.

CHAPTER – IIProcedure to be followed for reinsurance arrangements

(1) The Reinsurance Programme shall continue to be guided by the following objectives to;

a) maximise retention within the country;

b) develop adequate capacity;

c) secure the best possible protection for the reinsurance costs incurred;

d) simplify the administration of business.

(2) Every insurer shall maintain the maximum possible retention commensurate with its financial strength and volume of business. The Authority may require an insurer to justify its retention policy and may give such directions as considered necessary in order to ensure that the Indian insurer is not merely ponting for a foreign insurer.

(3) Every insurer shall cede such percentage of the sum assured on each policy or different classes of insurance written in India to the Indian reinsurer as may be specified by the Authority in accordance with the provisions of Part 1VA of the Insurance Act, 1938.

(4) The reinsurance programme of every insurer shall commence from the beginning of every financial year and every insurer shall submit to the Authority, this reinsurance programmes for the forthcoming year, 45 days before the commencement of the financial year;

241


(5) Within 30 days of the commencement of the financial year, every insurer shall file with the Authority a photocopy of every reinsurance treaty slip and excess of loss cover covernote in respect of that year together with the list of reinsurers and their shares in the reinsurance arrangement;

(6) The Authority may call for further information or explanations in respect of the reinsurance programme of an insurer and may issue such direction, as it considers necessary;

(7) Insurers shall place their reinsurance business outside India with only those reinsurers who have over a period of the past five years counting from the year preceding for which the business has to be placed, enjoyed a rating of at least BBB (with Standard & Poor) or equivalent rating of any other international rating agency. Placements with other reinsurers shall require the approval the Authority. Insurers may also place reinsurances with Lloyd’s syndicates taking care to limit placements with individual syndicates to such shares as are commensurate with the capacity of the syndicate.

(8) The lndian Reinsurer shall organise domestic pools for reinsurance surpluses in fire, marine hull and other classes in consultation with all insurers on basis, limits and terms which are fair to all insurers and assist in maintaining the retention of business within India as close to the level achieved for the year 1999-2000 as possible. The arrangements so made shall be submitted to the Authority within three months of these regulations coming into force, for approval.

(9) Surplus over and above the domestic reinsurance arrangements class wise can be placed by the insurer independently with any of the reinsurers complying with sub-regulation (7) subject to a limit of 10% of the total reinsurance premium ceded outside India being placed with any one reinsurer. Where it is necessary in respect of specialised insurance to cede a share exceeding such limit to any particular reinsurer, the insurer may seek the specific approval of the Authority giving reasons for such cession.

(10) Every insurer shall offer an opportunity to other Indian insurers including the Indian Reinsurer to participate in its facultative and treaty surpluses before placement of such cessions outside India.

(11) The Indian Reinsurer shall retrocede at least 50% of the obligatory cessions received by it to the ceding insurers after protecting the portfolio by suitable excess of loss covers. Such retrocession shall be at original terms plus an over riding commission to the Indian Reinsurer not exceeding 2.5%. The retrocession to each ceding insurer shall be in proportion to its cessions in the Indian Reinsurer.

(12) Every insurer shall be required to submit to the Authority statistics relating to its reinsurance transactions in such forms as the Authority may specify together with its annual accounts.

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annexure - I

Inward Reinsurance Business

4. Every insurer wanting to write inward reinsurance business shall have a well-defined underwriting policy for underwriting inward reinsurance business. The insurer shall ensure that decisions on acceptance of reinsurance business are made by persons with necessary knowledge and experience. The insurer shall file with the Authority a note on its underwriting policy stating the process of business, geographical scope, underwriting limits and profit objective the insurer shall also file any changes to the note as and when a change in underwriting policy is made.

Understanding Loss Provisioning

(1) Every insurer shall make outstanding claims provisions for every reinsurance arrangement accepted on the basis of loss information advices received from Brokers/ Cedants and where such advices are not received on an material estimation basis.

(2) In addition, every insurer shall make an appropriate provision for incurred not reported (IBNR) claims on its reinsurance accepted portfolio on actuarial nation basis.

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ANNEXURE – II

020/NL/IRDA/06 15th Sep

`06. To

CEOs of All Insurance Companies &

The Principal Officers of All Broking Companies

GUIDELINES ON INSURANCE AND

REINSURANCE OF GENERAL INSURANCE RISKSWith the abolition of tariffs in the near future, competition will extend not only to service matters but also to pricing of products. In order to ensure that the business is transacted along proper lines, it is important to set out the rules of conduct that should be followed by both insurers and brokers in the matter of insurance and reinsurance of general insurance risks, especially those with high sums insured.

Insurers are advised to ensure that the procedures as set out in these guidelines note are followed in their competition for business.

Attention of all licensed brokers is invited to the Code of Conduct specified in ScheduleIII of the IRDA (Insurance Brokers) Regulations 2002 and in particular, para 1 of the Code of Conduct. All brokers are hereby required to ensure strict adherence to the practice stated in this guidelines note and in the Code of Conduct. Prior approval of IRDA should be obtained by application supported by valid reasons for any variations from the practice stated here.

1. Where a client invites more than one broker to submit terms for its

insurance requirement:

(a) A broker shall not block capacity with one or more insurers in anticipation of being invited to quote terms for insurance requirements of a client, where the client has not yet decided as to which brokers should be invited to quote terms.

(b) Once the client has selected the brokers who should be invited to quote terms, all other brokers should withdraw from the market. They should also immediately advise any insurers with whom they have been in touch to propose terms, about their not being invited to quote terms.

(c) Brokers who are invited to quote terms should obtain a written appointment letter to develop terms. Where the client has given oral instructions to quote, the broker should record the fact of its being invited to quote terms, in a letter to the client. (Refer paras 2(f) and 2(h) of Code of Conduct).

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annexure - II

(d) Every broker invited to quote terms should fully comply with para 4 of the Code of Conduct. The broker should clearly distinguish between information provided by the client and information provided by the broker based on its own study of the risk.

(e) Where the client has specified the terms of the insurance cover required by it, the broker shall develop terms on the basis specified by the client and not any other basis (which may be patched up without the knowledge of the client) to provide the required cover. However, it is open to the broker to discuss with the client and agree with the client to develop terms on any other basis.

(f) It is open to the broker to ask more than one insurer to quote terms. The broker shall furnish full information on a common basis to all the insurers. This does not prevent the broker from providing supplementary information to an insurer in response to questions raised by that insurer.

(g) Where an insurer is asked to quote terms by more than one broker in respect of the same risk, the insurer shall quote the same terms to all the brokers. However, if a broker seeks quotes from the insurer on a different basis, the insurer shall be free to quote terms on the basis requested by that broker without having to advise those terms to all the other brokers.

(h) Where an insurer is approached by a broker to quote terms for a particular account, the insurer should not approach the client directly to quote terms and eliminate the broker.

(i) Where a client has also asked an insurer to quote terms directly to it, the insurer may quote terms directly to the client and if any broker approaches it for terms, the insurer should inform the broker that it is quoting directly to the client.

(j) Where terms are developed on a “net rate” basis, the broker shall advise the client the full facts, namely, the net rate and the addition made for brokerage.

(k) Where the insurer needs to develop terms from the reinsurance markets before quoting its terms to the client, the insurer shall be free to use the services of any reinsurance broker of its choice.

(l) A composite broker shall not go to the reinsurance markets to develop terms in respect of cases referred to in (k) above, without the written prior authorization of the insurer invited to quote terms for the insurance. Paras 2(i) and 2(j) of the Code of Conduct are relevant in this connection. It is important to emphasize that placement of reinsurance is entirely within the purview of the insurer and neither the direct broker nor the client can direct the insurer where to place reinsurance and how much to reinsure. This does not prevent the client or the

245


broker from enquiring about the insurer’s own retention on the risk and the reinsurances that it will place and the security rating of reinsurers to be used, as a part of its examination whether to accept the insurer for its insurance requirements.

(m) Where reinsurance terms are developed as part of the process of quoting terms for direct insurance, the broker who is instructed to develop terms shall truthfully communicate to the insurer on whose behalf the reinsurance terms are developed, the basis of the quotation, the rates and terms and the list of reinsurers with written lines and the extent of likely support at those terms.

(n) A composite broker or reinsurance broker shall not put conditions of minimum percentage of reinsurance placement as part of the quotation or allow such terms to be put in by the client or foreign co-broker or reinsurers. This does not prevent a lead reinsurer quoting terms subject to his being offered a minimum stated line on the risk. It shall be open to the insurer to instruct the broker not to offer the risk to a particular reinsurer or to specified reinsurer’s specified markets.

(o) A broker shall not put up terms developed within its own office (desk quotes) but not received from an insurer, as insurance premium terms. If a broker is responding to an enquiry about the likely insurance cost, it should make it clear when indicating the premium cost that it is not a quotation but only a non-binding indication of the likely cost.

2. Where a client retains one broker to develop terms from several insurers: (a) The broker shall select the insurers to be invited to quote terms, entirely

from the point of view of the client and in the best interests of the client. (b) The broker shall provide information on a common basis to all insurers

invited to quote. However, it may provide further clarifications or additional information in response to queries of an insurer that is invited to quote.

(c) The broker shall not first develop terms from foreign markets and then go round locating insurers willing to front the business at those terms.

(d) The broker shall not go round looking for insurers to be invited to quote terms, on the basis of a minimum reinsurance order as a condition of giving an opportunity to the insurer to write a share of the risk.

(e) The terms put up to the client by the broker should include the original letters of quotation from the insurers and the recommendation of the broker should be properly documented with reasons in support of the recommendation.

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3. Documentation and post-insurance servicing of the direct insurance client: (a) Once the direct insurance client gives orders to bind the cover, the

broker should obtain a letter of cover or cover note or insurance policy from the insurer or insurers concerned and submit them to the client before commencement of risk.

(b) The broker should ensure payment of premium in a timely manner in compliance with Sec 64VB of the Insurance Act. The broker should explain to the client, the importance of compliance with policy conditions and warranties by the client during the policy period. Where the insurer issues only a cover note or letter of cover, the broker should follow up for issue of the formal policy document without delay. The broker should scrutinize all these documents to ensure that they are in conformity with the terms and conditions quoted and accepted by the client. Likewise, the broker should ensure timely payment of reinsurance premium on any reinsurance placed through it and follow up for the formal reinsurance document in a timely manner.

4. Placement of facultative reinsurance:

(a) A composite insurance broker or reinsurance broker shall not enter the

reinsurance markets either to develop terms for reinsurance cover or to place

reinsurance on any risk without the specific written authorization of the insurer

insuring the risk or insurer who has been asked to quote terms for the risk.

(b) A reinsurance broker or a composite broker shall not block reinsurance capacity in anticipation of securing an order to place reinsurance.

(c) The broker shall provide to the insurer, a true and complete copy of the reinsurance placement slip to be used, before entering the market. The broker shall incorporate any modifications or corrections proposed by the insurer in the placement slip.

(d) The broker shall put up to the insurer, all the terms (including the reinsurance commission and brokerage allowed) obtained by it from various reinsurers and indicate the share the lead reinsurer is willing to write at those terms and the expectation of the broker about placement of the required reinsurance at the terms quoted, with acceptable reinsurance security.

(e) The broker shall furnish to the insurer, a true copy of the placement slip signed by the lead reinsurer quoting terms, indicating thereon, the signed line of the reinsurer.

(f) Where reinsurance on a risk is proposed to be placed with different reinsurers at different terms, the fact that terms for all reinsurers are not uniform, shall be disclosed to reinsurers suitably.

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(g) Once the insurer has accepted the reinsurance terms quoted, the broker shall place the required reinsurance cover and shall keep the insurer informed about the progress of placement from time to time. In selecting the reinsurers to whom the risk is offered, the broker shall be mindful of the need to use only such reinsurers who are rated BBB or higher by a recognized credit rating agency, as required by Regulation 3(7) of IRDA (General insurance – reinsurance) Regulations 2000. Where the reinsurance is over-placed, the signing down shall be done in consultation with the insurer in a manner consistent with good market practice. The ceding insurer shall have the right to tell the broker not to use a specific market or reinsurer or reinsurers.

(h) Immediately after completion of placement of reinsurance, the broker shall issue a broker’s cover note giving the terms of cover and the names of reinsurers and the shares placed with each of them. The cover note shall contain a listing of all important clauses and conditions applicable to the reinsurance and where the wordings of clauses are not market standard, the wordings to be used in the reinsurance contract shall be attached to the broker’s cover note.

(i) The broker shall follow up the cover note by a formal signed reinsurance policy document or other acceptable evidence of the reinsurance contract signed by the reinsurers concerned, within one month of receipt of reinsurance premium.

(j) The broker shall have a security screening procedure in-house or follow credit ratings given by recognized credit rating agencies and answer without any delay, any questions raised by the insurer about the credit rating of one or more reinsurers. Where the insurer declines to accept a particular reinsurer for whatever reason and asks the broker to replace the security before commencement of risk, the broker shall do so promptly and advise the insurer of the new reinsurer brought on the cover.

5. Placement of Treaty or Excess of Loss Reinsurance:

(a) A composite insurance broker or reinsurance broker invited to place a proportional treaty shall prepare the treaty offer slip and supporting information with the cooperation of the insurer and secure the insurer’s concurrence to the slip and information before entering the market.

(b) Where a reinsurance treaty is placed at different terms with different reinsurers, the fact that such is the practice shall be made known to all the reinsurers suitably.

(c) Where a reinsurer accepts a share in a treaty subject to any condition, the conditions shall be made known to the ceding insurer and its agreement obtained before binding the placement.

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(d) The broker shall advise the progress of placement of the treaty from time to time. Immediately after completion of placement, the broker shall issue a cover note setting out the treaty terms and conditions and list of reinsurers with their shares. Where a treaty is over-placed, the broker shall sign down the shares in consultation with the insurer in a manner consistent with good market practice.

(e) The broker shall secure signature of formal treaty wordings or other formal reinsurance contract documentation within three months of completion of placement.

(f) The broker shall have a security screening procedure in-house or follow credit ratings given by recognized credit rating agencies and answer without any delay, any questions raised by the ceding insurer about the credit rating of one or more reinsurers. Where the insurer declines to accept a particular reinsurer for whatever reason and asks the broker to replace the security before commencement of the reinsurance period, the broker shall do so promptly and advise the insurer of the new reinsurer brought on the cover.

6. Handling of reinsurance monies:

Every broker shall abide by the provisions of Regulation 23 of the IRDA (Insurance Brokers) Regulations 2002.

7. Co-broking:

(a) It is open to a client to appoint more than one broker to jointly handle the broking of its insurance requirements depending on the skills that the brokers may bring to the activity and to decide the manner in which the brokerage payable on the business may be shared among them. However, it is not permitted for one broker to appoint another broker to handle the broking of an account that has been given to that broker to handle by the client.

(b) Each of the direct insurance co-brokers shall be brokers who are licensed to broke the class of business concerned and each co-broker shall be responsible to ensure that these guidelines are complied with.

(c) The manner in which the brokerage is shared among the co-brokers shall be disclosed to the insurer on request. The insurer will be guided by the instructions of the client with regard to payment of brokerage to each co-broker for his share or to the lead co-broker who will then be responsible to pay the other co-brokers.

(d) Each of the co-brokers on a reinsurance placement shall also be responsible to ensure that these guidelines are complied with by themselves and any foreign brokers used by them.

(e) Where a reinsurance placement is co-broked with a foreign reinsurance broker, the licensed broker in India shall only use reinsurance co-brokers

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who agree to comply with the requirements of these guidelines and shall be responsible to secure compliance with these guidelines to the extent applicable, by the foreign reinsurance co-broker. The name and other particulars of the foreign reinsurance co-broker shall be disclosed to the insurer.

8. Reinsurance brokerage:

(a) Where the brokerage charged for a particular case exceeds the normal level of brokerage for such transaction, the fact should be disclosed to the insurer before binding cover. For this purpose, the normal level of brokerage shall be taken to be 2.5% on reciprocal proportional treaties, 5% on non-reciprocal proportional treaties, 10% on excess of loss covers and 5% on facultative placements.

(b) For the purpose of sub-para (a) above, payments of all nature in respect of the particular account, such as risk inspection fees or risk management fees or administration charges, etc., shall be aggregated.

9. Insurer’s right to develop business directly:

Nothing contained in these guidelines shall be interpreted as prohibiting an insurer from approaching a client directly to service its insurance requirements. However, an insurer shall not go to a client who has already decided to use a broker for its insurance placement and has appointed a broker and such broker has approached the insurer for terms.

10. Effective date

These guidelines shall come into effect from 1st October, 2006 and shall apply to any insurances where the process of placing insurance or negotiating terms of insurance is initiated after that date, including renewals in respect of insurances expiring after that date.