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Definition .......................................................................................................1

Reinsurance needs .........................................................................................2Increasing underw

riting capacity ..........................................................2Risk capital im

provement and diversification .......................................3

Surplus relief ...........................................................................................4Catastrophic protection ..........................................................................4Expertise transfer ...................................................................................4Financing new business ..........................................................................5O

ther reinsurance needs and a word of warning ..................................5

Types of reinsurance agreements ................................................................6

Treaty reinsurance ..................................................................................6Facultative reinsurance ..........................................................................6

Forms of reinsurance ....................................................................................7

Proportional quota share reinsurance ...................................................7Surplus or excedent reinsurance ............................................................8Financing elem

ents .................................................................................9Pricing .....................................................................................................9Non-proportional reinsurance .............................................................10Excess of Loss reinsurance....................................................................10Stop loss reinsurance ............................................................................11Pricing ...................................................................................................13Reinsurance program

s ..........................................................................14

Participants of the reinsurance industry ..................................................15Reinsurance brokers .............................................................................15Captives ................................................................................................15Pools ......................................................................................................15O

ffshore reinsurance ............................................................................16Regulatory and supervisory issues .......................................................16

Accounting and control issues ...................................................................17

Understanding a reinsurance treaty ..........................................................17

Treaty format ........................................................................................17

Tax issues ..............................................................................................19

Concluding rem

arks ....................................................................................20

Further suggested reading ..........................................................................20

Annex I: Q

uota share slip ...........................................................................21

Annex II: Stop loss slip ...............................................................................22

Annex III: Reinsurance broker disclosure statem

ent .............................24

Annex IV: G

lossary of terms ......................................................................28

Figure 1. Difference betw

een reinsurance and coinsurance. .............2Figure 2. Risk capital im

provement ad diversification .......................3

Figure 3. Quota share reinsurance ........................................................7

Figure 4. Risk sharing in a surplus treaty. ............................................9Figure 5. Excess of loss .........................................................................11Figure 6. Stop loss. ................................................................................12Figure 7. Effect of a quote share and an excess of loss applied in a different order .................................................................................14

Reinsurance is a financial transaction by which risk is transferred

(ceded) from an insurance com

pany (cedant) to a reinsurance company

(reinsurer) in exchange of a payment (reinsurance prem

ium). Providers

of reinsurance are professional reinsurers which are entities exclusively

dedicated to the activity of reinsurance. Also in m

ost jurisdictions insurance com

panies are allowed to participate in reinsurance. Th

e term

s of a reinsurance transaction are defined in a reinsurance treaty. D

ue to the complexity of reinsurance treaties it is not uncom

mon that

the definitive treaties are only signed months after the risk transfer

took place. To document the acceptance of the risk, a short version of

a treaty call a slip containing the most im

portant terms of the agree-

ment is used instead. Slips are signed before the risk is transferred and

accepted by the reinsurer. Some jurisdictions are requiring signed trea-

ties before the risk is transferred. Reinsurance is to be differentiated from

coinsurance, where the

risk is shared and not transferred among several insurance com

pa-nies, each one of them

having a direct contractual relationship with

the insured for the portion of the risk accepted by that company. Th

us, reinsurance alw

ays involves legal entities and not individuals. In rein-surance, the contractual relationship is betw

een the cedant and the reinsurer. O

nly in special situations does the reinsurance treaty have a provision called the cut through clause that allow

s the insured to have a direct legal claim

to the reinsurer; for example in case the insurer

becomes insolvent.

Reinsurers can also transfer risks to other entities called retroces-sionaires by m

eans of a financial transaction similar to reinsurance

called retrocession. Professional retrocessionaires are expected to keep and not to transfer the assum

ed risk to other entities. In this manner

reinsurers and insurers that do accept risks not individually identi-fied can be sure that they w

ill never assume part of the risk they had

already transferred. How

ever, there have been situations in the past w

here retrocessionaires actually transferred further the assumed risks

resulting in unexpected over retention for the retrocedants. Proper retrocession treaty w

ording can help here. Figure 1 illustrates the contractual relationships in typical reinsur-

ance and coinsurance transactions.

There are several reasons for an insurance com

pany to use reinsurance. W

e will discuss here the m

ost important ones.

Insurance companies are often offered risks that m

ay surpass their financial strength. C

eding part of the risk may allow

them to accept

the full risk thus satisfying client’s needs. For this purpose insurance com

panies may also use coinsurance. H

owever in this case the insur-

ance company w

ill have to contact competitors to share part of the

risk which m

ight not be to its best interest, especially in a competitive

market. A

nother disadvantage to the use of coinsurance is the burden put on the insured that w

ill need to deal with each one of the partici-

pating insurance companies w

ith regard to premium

payments and

claim settlem

ents.

Insurance companies having a m

ore diversified portfolio of risks will

tend to have more stable financial results. U

sing reinsurance will allow

insurance com

panies to participate in a diversity of risks using the sam

e working capital by ceding part of the risk and keeping a sm

aller portion of each risk. Th

is reduction in the concentration on risk will

diminish the volatility of the annual results. Figure 2 illustrates this

reinsurance effect. Here, w

ithout reinsurance the company’s capital

comm

itment allow

s its participation in only one risk. Using reinsur-

ance, the same com

mitted capital allow

s the company to participate in

four different risks with a total higher sum

insured. 1

1. Th

e diversification effect lowers the total required risk capital.

The use of reinsurance allow

s insurance companies to partially transfer

risks off their balance sheet. While the ultim

ate responsibility to the policy holders still rem

ains with the insurance com

pany, most juris-

dictions recognize reinsurance as a risk managing tool that allow

s a reduction of statutory surplus requirem

ents. The guarantee im

plicit on a reinsurance contract to pay the reinsured claim

s is recognized in the capital requirem

ents for the cedant. Hence it is not uncom

mon to base

the prudential requirements on the insured prem

ium net of reinsurance.

Reinsurance thus removes a technical risk but it introduces a

counterparty risk since, as mentioned above, the ultim

ate responsi-bility to the policy holders still rem

ains with the insurance com

pany. To offset the counterparty risk additional surplus is usually required. Th

is additional capital will vary depending on the solvency rating of

the reinsurer. Also the am

ount of surplus relief granted will depend

on that rating.

Well run insurance com

panies accept risk exposure according to their financial strength. H

owever, the risks m

ay also be exposed to extreme

infrequent events, like earthquakes, floods, plane crashes and other m

ayor catastrophic events. Holding enough capital for those extrem

e events w

ould make the insurance operation econom

ically unvi-able or at least very expensive. Transferring this exposure to cata-strophic events to the reinsurers is a m

ore effective way to address very

infrequent events. Reinsures offer catastrophic protection in a more

economic feasible w

ay than insurance companies by participating in

catastrophic exposures through out the world and thus geographically

better diversifying the risk. Usually reinsurers are also m

ore capitalized than insurance com

panies. They also operate dedicated departm

ents that have gained substantial know

ledge of the physical characteris-tics and history of catastrophic events thus allow

ing them to price and

underwrite properly the exposure and accept those risks.

Through the reinsurance activity reinsurers acting in several m

arkets w

ith different insurance companies have the ability to acquire signifi-

cant knowledge of the different products, m

arkets and insurance tech-

niques like underwriting, adm

inistration of the policies and claims

assessment. Th

is is particularly important w

hen entering a new

market, a new

line of business or simply launching a new

product. Transferring the risk through reinsurance m

ay also include the shift of the underw

riting, administration, or other activity related to the

risk transferred to the reinsurer. Such a reinsurance agreement allow

s insurers to focus in their core business outsourcing to experts the non core activities.

As discussed in M

odule 1 a rapidly growing insurance activity can

require upfront financing. This is particularly true in the case of Life

Insurance business. Here the insurance com

pany has to finance the agents or broker’s com

missions that can be as high as the full first year’s

premium

as well as the underw

riting costs that may include m

edical exam

inations and financial assessments. Reinsuring part of the busi-

ness can provide a source of financing especially if the reinsurer agrees to advance the future expected profits of the business in the form

of reinsurance com

mission. Th

is source of financing of insurance busi-ness can be attractive com

pared to other sources such as bank loans or equity. Reinsurers, know

ing the business, will have low

er risk charges than non insurance financing sources. A

lso, in most reinsurance agree-

ments the pay back is contingent on the perform

ance of the reinsured business. i.e. the advancem

ent of future profits are only recovered by the reinsurer if the business actually generates those expected profits. If the payback of the reinsurance financing is totally contingent on the perform

ance of the reinsured business, in most jurisdictions no liability

needs to appear in the balance sheet of the cedant.

Insurance companies enter reinsurance agreem

ents for one or more of

the above mentioned reasons. Th

ere might be other special situations

where reinsurance is used as a valid financial and operational tool,

however if none of the above m

entioned needs is present, special scru-tiny of the transaction is required. Th

e great flexibility of reinsurance treaties that allow

s effective tailor-made solutions to m

eet individual insurance com

pany’s needs has been abused in the past to design tax avoidance, m

oney laundry and other illegal activities. A reinsurance

agreement that does not transfer any type of risk is alw

ays questionable.

Most reinsurance contracts are either autom

atic treaty or facultative. U

nder a treaty reinsurance arrangement all risks that are defined to

be object of the agreement are ceded autom

atically to the reinsurer, and the reinsurer agrees to accept all those risks. O

n a facultative treaty the cedant decides if a risk w

ill be offered to the reinsurer and the reinsurer w

ill decide on an individual basis if it will accept or not

the offered risk. There is a third less com

mon treaty structure called

facultative-obligatory reinsurance. Here, the offering of the risks to

the reinsurer is on a facultative basis but the acceptance of the risks is obligatory for the reinsurer.

Treaty reinsurance allows the cedant to act in an independent and

fast reacting way w

hen accepting risks that fall under the object of the reinsurance agreem

ent. In treaty reinsurance the acceptance of the risk by the reinsurer together w

ith all financial conditions has already been negotiated and agreed upon. Th

is characteristic of treaty reinsur-ance to offer “blind acceptance” of the risks to the cedant requires that the reinsurer know

and trust the cedant. Treaty reinsurance is there-fore only offered after the reinsurer has done proper due diligence on the insurance com

pany to determine the quality of the business that

would expect to reinsure. Th

e important aspects that a reinsurer w

ill pay attention to include: the expertise of the com

pany, its risk atti-tude, its track record, the expected am

ount of business to be reinsured and other technical aspects. Further, on a regular basis the reinsurer w

ill audit the cedant to ensure that the terms of the treaty are follow

ed: the underw

riting guidelines are respected, the types of accepted risk com

ply with the object of the treaty, all risks that needed to be ceded

have been ceded, proper accounting and administration w

as done, etc.

Insurance companies are offered from

time to tim

e the opportunity to insure risks that are very large or com

plex or simply unusual. In

these situations facultative reinsurance is the best alternative. Here the

reinsurer participates in the underwriting and assessm

ent of the risk. D

epending on the risk the reinsurer might or m

ight not accept the rein-surance. In case of acceptance the reinsurer w

ill provide the particular

terms, like prem

ium, exclusions, and so forth. Th

e already negotiated facultative treaty w

ill govern all other general terms of the agreem

ent.

Basically there are two form

s of reinsurance: proportional reinsur-ance and non-proportional reinsurance. A

s the names suggest, there

is or there is not a proportional sharing of premium

, claims, expenses,

and so forth. Proportional reinsurance creates a type of partnership betw

een the cedant and the reinsurer as they have a strong alignment

of interests in the performance of the underlying business. In non-

proportional reinsurance the interests are usually not aligned and can even be opposed w

ith respect to the performance of the business.

Under a Q

uota Share reinsurance treaty the cedant transfers the same

proportion or quota of each and every risk that falls under the object of the reinsurance agreem

ent to the reinsurer (See figure 3). The

premium

, expenses and claims are also shared in the sam

e propor-tion w

ith the reinsurer. The reinsurer pays the cedant a reinsurance

comm

ission to compensate it for the acquisition and adm

inistrative expenses of the business. A

lso, it is quite typical to include a profit sharing form

ula that allows for sharing profits of the reinsured busi-

ness with the cedant. Th

is is done to reward the cedant for the quality

of its underwriting and selection of the accepted business. Th

e propor-

tionality of the agreement also applies to any type of reserves that the

business may require. Th

e reinsurer is responsible for maintaining the

appropriate reserves for its share in the business. Some jurisdictions

require that certain reserves should be kept with the cedant or in a

trust. In these cases the reinsurer will send the necessary assets to the

cedant or the trust to build the reserve corresponding to the reinsured business. Th

e above indicated terms are usually first docum

ented in a reinsurance slip w

hen making a reinsurance offer. Th

e slip will then be

used to draft the definitive treaty. A slip containing the m

ost important

terms of a Q

uota Share agreement is attached in A

nnex 1.

This type of proportional reinsurance is basically a Q

uota Share agree-m

ent that assigns a different proportion to be reinsured to each risk (see figure 4). To determ

ine the proportion of the risk to be reinsured, the insurance com

pany fixes an amount called retention or surplus

line as the maxim

al sum insured that the com

pany will retain on ow

n account. A

ny amount above the retention and up to a given am

ount called capacity of the contract w

ill be reinsured. The capacity som

e-tim

es is given in number of surplus lines.

Surplus reinsurance allows the cedant to change the level of partici-

pation on any type of risk by choosing a given surplus line for that specific type of risk. A

s an illustration let us consider a treaty where the

retention is US$50 and the capacity U

S$200 or four surplus lines:

H

ere a particular risk that has a sum insured of U

S$100 will be

shared among the insurer and the reinsurer in a 50%

proportion (risk 1 in figure 4).

For a risk having a sum

insured of US$250, the proportion w

ill be 20%

for the insurer and 80% for the reinsurer (risk 2 in figure 4).

A

risk that has a sum insured low

er than the retention will not be

reinsured at all (risk 3 in figure 4).

Similarly risks w

ith a higher sum insured than the capacity w

ill not be part of the reinsurance agreem

ent (risk 4 in figure 4).

How

ever, note that there are different practices and in some

markets reinsurers w

ill accept risks having a sum insured higher

than the capacity to be reinsured up to the capacity of the surplus treaty (risk 5 in figure 4).

Proportional reinsurance creates a strong alignment of interest betw

een the insurer and the reinsurer since prem

ium, expenses and claim

s are shared in a proportional m

anner. The reinsurance prem

ium volum

e is high as com

pared to the non-proportional reinsurance because of the sharing of the expenses. A

high volume prem

ium m

ay allow the

reinsurer to finance substantial upfront costs in exchange of the future profits of the reinsured business.

The pricing or determ

ination of the amount of the reinsurance

premium

in proportional reinsurance is basically dictated by the underlying insurance prem

ium, as it usually is a percentage of that

premium

. Also the am

ount of reinsurance comm

ission should directly reflect the actual costs that the cedant undergoes in acquiring and adm

inistering the business. More involved calculations are needed

when determ

ining the profit sharing formula. H

ere sophisticated stochastic m

odels are used. Finally, when the reinsurance agreem

ent includes som

e sort of financing, for instance in the form of advancing

future profits, considerations of cost of capital, credit risk and risk of the business not perform

ing as expected have to be taken into consid-eration w

hen pricing the reinsurance allowance.

Insurance companies that are looking m

ainly to protect their portfolio from

adverse experience that could result from too m

any claims or too

high claims w

ill usually enter non-proportional reinsurance agree-m

ents. In non proportional reinsurance the protection is provided based on the actual loss the insurer suffers and not the sum

insured of the risk.

Surplus proportional reinsurance as describe above requires that the sum

insured of every individual risk is known to determ

ine the proportionality in sharing the risk. Th

ere are however several insurance

products where the sum

insured is not always know

n, such as MTPL

in the UK or com

mercial liability in the U

S, etc. In these cases when

individual differentiated risk protection is desired, non proportional reinsurance can be used.

The basic type of non proportional reinsurance is the excess of loss

reinsurance (XL). In an excess of loss agreement per risk the cedant w

ill pay in case of an event affecting a reinsured risk the claim

ed amount

up to a fixed chosen quantity called the priority of the agreement. Th

e reinsurer w

ill then pay any excess amount claim

ed above the priority up to the capacity of the contract.

As an exam

ple, consider in figure 5 an excess of loss agreement

where the priority is U

S$20 and the capacity is US$100 (U

S$100 XL U

S$20):

A

claim of U

S$50 will cost U

S$20 to the cedant and US$30 to the

reinsurer (see figure 5 risk 1).

A claim

of US$15 w

ill be totally paid by the cedant since the total am

ount is below the priority (see figure 5 risk 2).

A

claim of U

S$130 will cost U

S$20 +US$10=U

S$30 to the cedant and U

S$100 to the reinsurer. Here the full capacity of the treaty

has been exhausted leaving an additional US$10 uncovered

amount for the cedant (see figure 5 risk 3).

Note the im

portant difference to the surplus reinsurance that the excess reinsurance only covers actual losses above the priority, so that sm

all claims on the reinsured risk are not protected.

The reinsurance prem

ium for an excess of loss agreem

ent is not proportional to the direct prem

ium collected by the insurer and is

determined by the probability of having claim

s above the priority and attendant cost of capital. A

lso, as mentioned before there m

ight be a conflict of interests betw

een the cedant and the reinsurer: The financial

incentive of the cedant on settling the claim disappears the m

oment the

claimed am

ount is higher than the priority since beyond the priority the liability is transferred in full to the reinsurer up to the capacity of the treaty. To avoid these situations som

e agreements require either

that the reinsurer has to approve payments above the priority or that

the cedant retains a copayment of the liability above the priority.

An excess of loss agreem

ent on the whole portfolio is called a Stop Loss

coverage. The reinsurer w

ill protect the cedant only in case the priority is exceeded by adding up all claim

s paid during the period of coverage, usually one year. In a typical Stop Loss coverage the priority is expressed as a percentage of the insurance prem

ium and in m

ost cases a copaym

ent in excess of the priority is required. Annex 2 contains a

stop loss slip with the m

ain parameters.

To better understand figure 6 illustrates the way a stop loss coverage

works consider a stop loss agreem

ent that has as priority 80% of the

insurance premium

, 20% of the insurance prem

ium as capacity and a

copayment of 25%

above the priority.

In exam

ple 1 the total annual amount paid in claim

s is 70% of

the insurance premium

and hence it does not exceed the priority of 80%

. Here the reinsurer w

ill not participate in the payment of

claims.

In exam

ple 2 the total amount paid in claim

s is 100% of the

insurance premium

. The reinsurer pays an am

ount equal to 16%

of the insurance premium

. The cedant pays the full priority of

80% and a copaym

ent of 4% of the insurance prem

ium.

In exam

ple 3 the total amount paid in claim

s is 115% of the

premium

. The reinsurer pays an am

ount equal to the full capacity of 20%

of the insurance premium

. The cedant pays the

full priority of 80% and a copaym

ent of 6.67% of the insur-

ance premium

. The rem

aining amount of 8.33%

of the insured prem

ium is not reinsured and the cedant rem

ains responsible for that am

ount.

There is a third class of non proportional reinsurance form

called cata-strophic excess of loss reinsurance (Cat-XL). H

ere, in addition of the necessity to exceed the priority to have reinsurance protection also the catastrophic event has to have taken place. Catastrophic events can be for instance an earthquake, an explosion that has a toll of at least 3 lives, and so forth.

Catastrophic reinsurance does not cover every event. Typical

standard exclusions in a Cat-XL agreem

ent are the claims related to

nuclear or radioactive incidents. Terrorism is also a com

mon exclu-

sion. For these risks as well as other political risks, governm

ent or national industry pools have been established. W

e discuss pools later in the m

odule.

The pricing of non proportional reinsurance is an involved activity

that is done by experienced actuaries. Am

ong the methods used in

determining the cost of reinsurance are the burning cost evaluation,

scenario modeling and exposure pricing. Burning cost evaluation looks

at the past experience of the claims above the priority and below

the capacity w

ith adjustments m

ade for inflation, changes in conditions, etc. Th

e resulting cost is the necessary amount to pay expected claim

s or the so called risk prem

ium. Th

e reinsurance premium

is then the risk prem

ium loaded for expenses and profit. Th

e scenario modeling

uses mathem

atical models that utilize claim

distributions to simulate

the risk exposure of the reinsured portfolio. Several simulations are

run to determine the probable loss above the priority and below

the capacity of the treaty. A

gain this cost is loaded for expenses and profit to determ

ine the reinsurance premium

. Finally the exposure pricing looks at the existing reinsured portfolio and assigns em

pirical prob-abilities for claim

s to occur to every risk reinsured that could result in am

ounts above the priority.In non-proportional reinsurance the typical duration of an agree-

ment is annual since changes in the m

arket conditions, the economy

and the reinsured portfolio affect directly the reinsurance costs. A non

proportional agreement does not offer a profit sharing participation

that in case of the proportional reinsurance is used to compensate the

cedant for good underwritten business because of the different expo-

sure that the cedant and the reinsurer have here.

Reinsurance provides a flexible and effective tool to insurance compa-

nies for the managem

ent of the risks they are assuming. A

combination

of several reinsurance agreements is called a reinsurance program

. A

well structured reinsurance program

will provide im

portant competi-

tive advantage but can be quite complex.

Several reinsurers may participate in a reinsurance program

accepting different percentages of the program

. This structure is som

e-tim

e called a reinsurance pool. A

s a simple exam

ple consider the effect of combining a 50%

Quota

Share with a U

S$50 XL US$20 in different order. Figure 7 indicates the

participation of the cedant, the Quota Share reinsurer and the XL rein-

surer in case of a claim of U

S$100.

In exam

ple 1 the claim is first split 50%

between the cedant and

the Quota Share reinsurer. Th

en the XL coverage protects the share in the claim

of the cedant of US$50 paying U

S$30 in excess of U

S$20.

In example 2 the XL pays U

S$50 of the claim and the cedant

is left with a claim

of US$70. Th

en the Quota Share reinsurer

assumes half of that paym

ent.

As discussed above the m

ain participants in the reinsurance industry are the professional reinsurers, the retrocessionaires and the insurance com

panies. Reinsurance brokers also play a fundamental role in the

placement of reinsurance program

s, in particularly when dealing w

ith special program

s. Captives, Pools and Offshore Reinsurers com

plete the reinsurance industry.

For complex reinsurance program

s or when the reinsurance capacity

is scarce, insurance companies utilize the services of reinsurance

brokers. Reinsurance brokers are companies or professional individ-

uals that are licensed and supervised dedicated to provide professional advice to insurance com

panies on the placement of their reinsurance

programs. Reinsurance brokers are paid through reinsurance com

mis-

sions that are proportional to the placed reinsurance premium

. Reinsurance brokers also offer adm

inistrative services and product developm

ent. In most jurisdictions reinsurance brokers are required

to hold an error and omissions liability policy for the protection of the

insurance companies.

In recent years the press has reported on major financial scan-

dals related to the non transparency of the reinsurance comm

issions. Professional reinsurance brokers have reacted offering detailed disclo-sure of their com

missions. A

s an example w

e have attached in Annex 3

a disclosure comm

itment issued by G

uy Carpenter.

Large industrial conglomerates that are interested in keeping their

risks within the group usually operate w

ith a captive. A captive is a

legal entity, usually a stock insurance company ow

ned by the group that accepts and retains risks em

anating only from the sam

e indus-trial group.

Insurance companies m

ay want to insure an unusual or new

type of risk but fear they w

ill not have enough business of that type to benefit

from the law

of large numbers. In an insurance pool, several com

pa-nies agree to share all their risks of this type. Th

is will provide a large

enough sample to give m

ore predictable and consistent results from

year to year. The pool could be reinsured or the sharing of each policy

in the pool may be according to how

much business each com

pany puts into the pool or it could be a form

ula relating to how m

uch risk each com

pany would accept on any one case. Pooling w

as in fact the w

ay insurance of modern passenger airplanes began. Th

e World Bank

has been promoting pools to cover catastrophic risks like the Turkish

Catastrophic Insurance Pool (TCIP) and the Caribbean Catastrophic Risk Insurance Facility (CCRIF).

Offshore reinsurance com

panies are reinsurers which operate in

special geographic zones, often with less dem

anding regulatory and favorable tax environm

ents. A great deal of reinsurance is conducted

through these centers although much of the actual m

anagement

of these companies is done in the parents’ hom

e offices in Europe,

London and New

York. The purpose of offshore reinsurance has been

to optimize the use of capital and thus create com

petitive advantage. H

owever, special scrutiny is required w

hen offshore reinsurance is involved. Th

e lack of a strict regulation or the low capital requirem

ents in som

e offshore centers can lead to failing reinsurers in case of mayor

claims. A

lso money laundering activity has used this type of reinsur-

ance in the past.

The authorities in m

any countries are becoming concerned about the

quality of reinsurance purchased by domestic insurers. Th

e reinsurance credit that is granted to the cedants in the form

of a reserve or capital reduction can only be justified if the reinsurer is at least as solvent as the insurance com

pany. Minim

um security to operate as a reinsurer

is usually required and the amount of reinsurance credit granted w

ill depend on the quality of the security. In som

e jurisdictions additional risk capital is required w

hen using low rated reinsurers.

2. Th

e remaining sections of the m

odule were taken from

a course on reinsurance devel-oped by Rodney Lester and Serap O

rguz of the World Bank.

Virtually every insurance supervisor in the world has the right to

monitor reinsurance arrangem

ents for domestic insurers and to require

that they be strengthened. Regular information on the reinsurers can

be obtained from the supervisory authorities at their legal dom

icile.Professional reinsurers play an im

portant role somew

hat related to supervision. Reinsurers im

pose discipline on the reinsured companies

particularly in emerging m

arkets. It is the reinsurers who tell them

w

hat reserves to hold and what prem

iums to charge. In countries w

here there is little or no insurance regulation this an extrem

ely important

role played by the reinsurer.

Reinsurance accounting is very complex and only partly covered here.

A dedicated m

odule on accounting for insurance activities will be

published later in this series. Because of the im

portance of reinsurance in the impact of the

finances of the insurance companies, the governance structure of the

insurer should ensure that the boards take particular interest in this topic and the internal control system

s should ensure that the appro-priate reinsurance program

is in place.

A reinsurance treaty in very general term

s defines payments betw

een insurance com

panies. In diagram form

it looks like this:

In this diagram C

ompany 1 cedes business to the Reinsurer. Th

e treaty calls for C

ompany 1 to m

ake payments to or transfer funds to

the reinsurer. These paym

ents are usually called something like (1)

deposit premium

, (2) annual premium

s (3) investment incom

e, and (4) risk charge. N

ot all treaties will have all these item

s and some m

ay have m

ore.Th

e reinsurer must also m

ake payments or transfer funds to

Com

pany 1. These paym

ents will be called som

ething like (1) reinsur-ance com

missions, (2) expense allow

ance, (3) claims and (4) increase

in reserves. Again not all treaties w

ill have all these items and som

e m

ight have more.

The treaty m

ay also have a provision to share the profit with

Com

pany 1 and that share of the profit goes back under such names

as profit sharing, experience rating refund or profit charge or profit com

mission.

In most cases the paym

ents between the companies are netted so that

only one transfer of funds takes place. This is called the right of offset.

Each company has the right to offset w

hat it owes and what it is owed.

The flexibility in reinsurance is that each one of these term

s can be defined in m

any ways.

Some points to look for include:

W

ho is the reinsurer? Is it a strong reputable company?

W

hat is the definition of the business reinsured? The block of

business should be identified in a clear manner giving the date of

issue, the policy form used for the business, the type of business

and any information needed to identify the prem

iums, reserves

etc.

What is the risk actually reinsured? Is it all of the risk that the

direct writing com

pany has assumed? If it is not are the reserves

calculated accordingly? Are the reserves to be held by each side

actuarially correct?

Under w

hat conditions does the reinsurer have to pay? Is there liquidity in the treaty? W

ill the reinsurer have to pay cash imm

e-diately upon a claim

or will it be able to delay paym

ent?

Under w

hat conditions can the reinsurer cancel the contract? O

n cancellation what are the rem

aining responsibilities of the reinsurer?

H

ow long does the treaty run? Is it indefinite or for a fixed tim

e period? W

ill the reinsurer stop accepting new risks at a certain

time? D

oes it stop insuring the risks it has already accepted at that tim

e?

W

ho has responsibility for the claims run off tail on any business

that takes a long time to settle such as liability and m

arine?

Is there an arbitration clause to settle disputes?

Some standard term

s of a reinsurance treaty include:

Parties to the agreem

ent are the ceding company and the rein-

surer. The policyholder is not involved and hence norm

ally has no claim

on the reinsurer. In most cases the policyholder w

ill not know

the policy is reinsured.

Reinsurance is usually an indemnity arrangem

ent. The reinsurer

indemnifies the ceding com

pany for what it pays in claim

s.

Both parties have the right to defend against a claim and if one

chooses not to it will pay its share to the other com

pany and leave the other to absorb all legal costs. If the defense is successful the one that did not join the defense does not get a refund.

Th

e reinsurer has the right to inspect the records of the ceding com

pany at any time.

A

choice of law w

ill be stated. In case of a dispute between the

parties there will be no tim

e wasted arguing w

hich law applies.

The clause w

ill say that the law of C

ountry X applies. The choice

will likely be the law

of the jurisdiction of the defendant.

The errors and om

issions clause says that unintentional clerical errors w

ill be set right in the next statement and are not cause to

cancel the contract.

An “actuarially equivalent” clause can save pages of form

ula for w

hat happens if the treaty is terminated at different tim

es. Th

e treaty may say that som

ething happens if termination is

Decem

ber 31 and if at other times the actuarially equivalent

adjustments w

ill be made.

Reinsurance sent outside the country is often subject to excise tax, usually from

1% to 3%

of reinsurance premium

s. Tax treaties between

countries sometim

es address the issue of excise tax and in some cases

exemptions are granted. For instance there is no U

S excise tax on reinsurance treaties w

ith the UK. Th

e path that reinsurance follows

is highly dependent on the tax treaties between nations. H

ence rein-surers w

ill have a good knowledge of these treaties as the tax of say 2%

of prem

iums is significant. A

nother consideration is the withholding

tax on dividends paid by reinsurance companies to their parents. Th

e absence of such w

ithholding tax or the exemption w

ithin a tax treaty also influences reinsurance activity.

The com

plexity of the reinsurance business has been treated in num

erous publications. Basically every professional reinsurer offers excellent learning m

aterial that go from basics into com

plex topics. H

ere we have aim

ed to pass enough information to the reader to

make her/him

familiar w

ith the basic concepts of reinsurance in a com

pressed manner. At the sam

e time w

e hope that the course will

allow and encourage the reader to reach out for further literature to

satisfy the individual needs of knowledge in the m

atter.For the convenience of the reader w

e have added a glossary of the m

ost important reinsurance term

s in annex 4 (adapted from http://

ww

w.captive.com).

Eliott, Michael W

., Bernard L. Webb, H

oward N

. Anderson, and Peter

R Kensicki. 1995. Principles of Reinsurance. Insurance Institute of A

merica: M

alvern, Pennsylvania.Pfeiffer, Christoph. 1980. Introduction to Reinsurance 4th ed. C

ologne Reinsurance C

o.: Cologne, G

ermany.

Heinz Stettler, Fritz Eugster, and M

ichael Kuhn et al. 2005. Reinsur-ance M

atters, A Manual of the Non Life Branches. Sw

iss reinsurance C

ompany: Zurich.

Gerathew

ohl, Klaus.1980. Reinsurance Principles and Practices, Vol. 1.

Verlag Versicherungswirtschaft.

Riley, Keith. 1997. The Nuts and Bolts of Reinsurance (Practical Insur-

ance Guides). Informa Finance: London.

Insurer A

Quota Share

Group of W

orkers

Term 5 year

Death from

any cause and accidental death

January 1 2002

Decem

ber 31, 2002

US$

US$1,000,000 per person and for benefit

20% w

ith a maxim

um of U

S$200,000

20%

1.75%o

1.216%o

10%

Policy exclusions

Monthly

Monthly

Insurer A

Stop Loss

Group policies issued

According to the documentation presented

Worldw

ide of the policies underwritten in the

domicile of the ceding com

pany

The priority lim

it for this cover will be 95%

of the original prem

ium net of taxes.

Capacity of the contract 30% of the original

premium

net of taxes corresponding to the risks covered. M

aximum

: US$30 m

illion.

The reinsurer w

ill pay 90% of all claim

s corre-sponding to the risks covered in excess of the priority. Th

e Ceding C

ompany w

ill run for ow

n account the resulting co-payment of the

10% loss.

January 1, 2005

Decem

ber 31, 2005

6% of the original prem

ium net of taxes corre-

sponding to the risks covered

US$3 m

illion

US$2 m

illion

Four installment payable at the beginning of

each quarter. First quarter as of February 1, 2005

Premium

s and losses will be calculated in

local currency. Settlement w

ill be in US dollars

based on the exchange rate at the time the

premium

is due

All losses on a quarterly basis

There is no profit sharing

The standard clauses of the reinsurer apply

In a letter to clients dated Decem

ber 1, 2004 announcing the new

policy, Guy Carpenter’s Chairm

an & CEO

, Salvatore D. Zaffi

no, noted there is a “need w

ithin the industry to address issues of full disclosure to clients w

ithin the reinsurance marketplace.”

“Guy Carpenter’s relationship w

ith its clients is built on longstanding trust and our ability to help our clients m

ake important decisions

in a difficult environm

ent. Transparency and full disclosure should strengthen the trust am

ong all parties to the reinsurance contract and foster better decision-m

aking. Since we announced our comm

itment to

transparency, the feedback from clients and reinsurance m

arkets world-w

ide has been overwhelm

ingly positive,” Zaffino said.

“The industry faces m

any challenges at the mom

ent, from ratings

downgrades and financial security to claim

s payment perform

ance and standards of practice around the w

orld. Guy Carpenter intends to

be a positive force in addressing these and other issues, individually w

ith our clients, and as an agent of change across the industry,” Zaffino

concluded.G

uy Carpenter’s “Disclosure D

octrine” addresses the firm’s varied

forms of com

pensation, including standard rates of brokerage for treaty placem

ents, fee for services and the firm’s history w

ith market agree-

ments, all of w

hich have expired or have been terminated.

As part of its “D

isclosure Doctrine” G

uy Carpenter has comm

itted to m

aking thefollowing disclosures on an ongoing basis:

W

hen a client appoints Guy Carpenter broker of record, w

e w

ill disclose to our client the compensation that w

e anticipate receiving for the services to be provided on the client’s behalf.

Prior to subsequent renew

als of reinsurance contracts, we w

ill review

with ourclient G

uy Carpenter’s expected compensation

based on standard comm

ission rates.

Guy Carpenter w

ill continue to strive for consistency in rates of brokerage to be earned by G

uy Carpenter within a layer and w

ill disclose any variation in rates to all parties w

ithin that layer.

Brokerage for each reinsurance transaction will be listed on the

Cover N

ote for all treaty business.

The above policy covers treaty placem

ents globally, which repre-

sent in excess of 90 percent of Guy Carpenter’s revenues, and w

ill be extended to include facultative placem

ents once a worldw

ide review of

current practices is completed.

In light of recent developments affecting the industry, G

uy Carpenter believes it is im

portant to address the issue of compensation in the

reinsurance broker marketplace and take this opportunity to reaffi

rm

our comm

itment to our clients in this regard. Th

erefore, Guy Carpenter

developed this Disclosure D

octrine, which identifies our procedures

with regard to the services w

e provide, the ethics we espouse, and

general manner in w

hich Guy Carpenter is com

pensated.

The follow

ing outlines the manner in w

hich Guy Carpenter receives

payment for treaty placem

ent services rendered as a reinsurance inter-m

ediary:

Guy Carpenter’s longstanding practice is to conform

to rates of brokerage in accordance w

ith industry custom and usage. W

e also

continue to support consistency of rates within a placem

ent and disclo-sure of brokerage rates. To that end, G

uy Carpenter sets forth below

the rates of brokerage that would apply to the m

ajority of business w

e place. These rates are guidelines and are generally standard in the

marketplace but can vary depending on the specifics of a particular

placement:

-m

ents of between 1%

and 2.5% of gross prem

ium. Th

ere are some

placements w

here brokerage is greater than 2.5%.

brokerage of 10% of contract prem

ium.

market, an additional 5%

brokerage is charged and retained by the London correspondent broker. A

Guy Carpenter affi

liated London broker is often used on these placem

ents.

In some m

arkets, Guy Carpenter receives brokerage of up to 5%

on reinstatem

ent premium

s.

such cases, Guy Carpenter generally receives 20%

of the margin.

In addition to our traditional reinsurance intermediary role, G

uy Carpenter also provides other “nontraditional” reinsurance related services for w

hich we receive fees. Revenue from

these activities repre-sents a sm

all portion of Guy Carpenter’s annual revenue. Currently, the

two prim

ary examples of these services are:

Reinsurance Solutions International, LLC is a Guy Carpenter

subsidiary that receives fees for providing unbundled services such as policy adm

inistration, claims adm

inistration, premium

/reinsurance collections, statutory/G

AA

P accounting, regulatory com

pliance and auditing. In addition, RSI provides specialized consulting services focusing on process reengineering, bench-m

arking, and performance m

anagement m

etrics and measures.

Guy Carpenter &

Com

pany, Inc., of Pennsylvania is a subsidiary of G

uy Carpenter and is a licensed reinsurance manager over-

seeing a reinsurance underwriting facility for certain reinsurers.

This underw

riting facility assumes business from

smaller regional

and mutual com

panies.

In the past, Guy Carpenter entered into a lim

ited number of agree-

ments w

ith certain reinsurers that provided payments to G

uy Carpenter. Th

ese agreements, in the aggregate and in any one year,

represented a very small percentage of G

uy Carpenter’s total revenue. A

ll of such agreements have either expired or have been term

inated.

Guy Carpenter believes that the reinsurance m

arketplace would

benefit from m

ore transparencies with the clients w

ith regard to broker com

pensation. In order to promote this objective, G

uy Carpenter will

implem

ent the following steps effective on January 1, 2005:

When a client appoints G

uy Carpenter broker of record, we

will disclose to our client the com

pensation that we anticipate

receiving for the services to be provided on the client’s behalf.Prior to subsequent renew

als of reinsurance contracts, we w

ill review

with our client G

uy Carpenter’s expected compensation

based on standard comm

ission rates.G

uy Carpenter will continue to strive for consistency in rates of

brokerage to be earned by Guy Carpenter w

ithin a layer and will

disclose any variation in rates to all parties within that layer.

Brokerage for each reinsurance transaction will be listed on the

Cover N

ote for all treaty business.

—A

company is “adm

itted” when it has been

licensed and accepted by appropriate insurance governmental authori-

ties of a state or country. In determining its financial condition a ceding

insurer is allowed to take credit for the unearned prem

iums and unpaid

claims on the risks reinsured if the reinsurance is placed in an adm

itted reinsurance com

pany.

—Language providing a m

eans of resolving differ-ences betw

een the reinsurer and the reinsured without litigation.

Usually, each party appoints an arbiter. Th

e two thus appointed select a

third arbiter, or umpire, and a m

ajority decision of the three becomes

binding on the parties to the arbitration proceedings.

(plural )—

A form

providing premium

or loss data w

ith respect to identified specific risks which is furnished the rein-

surer by the reinsured.

—

A term

most frequently used in spread loss property

reinsurance to express pure loss cost or more specifically the ratio

of incurred losses within a specified am

ount in excess of the ceding com

pany’s retention to its gross premium

s over a stipulated number

of years.

* Adapted from w

ww.captive.com

.

—(a) Run-off basis m

eans that the liability of the rein-surer under policies, w

hich became effective under the treaty prior to

the cancellation date of such treaty, shall continue until the expira-tion date of each policy; (b) Cut-off basis m

eans that the liability of the reinsurer under policies, w

hich became effective under the treaty

prior to the cancellation date of such treaty, shall cease with respect

to losses resulting from accidents taking place on and after said

cancellation date. Usually the reinsurer w

ill return to the company

the unearned premium

portfolio, unless the treaty is written on an

earned premium

basis.

—Th

e percentage of surplus or the dollar amount of expo-

sure that an insurer or reinsurer is willing to place at risk. Capacity m

ay apply to a single risk, a program

, a line of business, or an entire book of business.

—

A form

of reinsurance that indemnifies the

ceding company for the accum

ulation of losses in excess of a stipulated sum

arising from a catastrophic event such as conflagration, earth-

quake or windstorm

. Catastrophe loss generally refers to the total loss of an insurance com

pany arising out of a single catastrophic event.

—W

hen a company reinsures its liability w

ith another, it “cedes” business.

—Th

e cedant’s acquisition costs and overhead expenses, taxes, licenses and fees, plus a fee representing a share of expected profits—

sometim

es expressed as a percentage of the gross reinsurance prem

ium.

—

The original or prim

ary insurer; the insurance com

pany which purchases reinsurance.

—A

form of reinsurance under w

hich the date of the claim

report is deemed to be the date of the loss event. Claim

s reported during the term

of the reinsurance agreement are therefore

covered, regardless of when they occurred. A

claims m

ade agreement

is said to “cut off the tail” on liability business by not covering claims

reported after the term of the reinsurance agreem

ent—unless extended

by special agreement. See

.

—In reinsurance, the prim

ary insurance company usually

pays the reinsurer its proportion of the gross premium

it receives on a

risk. The reinsurer then allow

s the company a ceding or direct com

mis-

sion allowance on such gross prem

ium received, large enough to reim

-burse the com

pany for the comm

ission paid to its agents, plus taxes and its overhead. Th

e amount of such allow

ance frequently determines

profit or loss to the reinsurer.

—

A clause in a reinsurance agreem

ent, which

provides for estimation, paym

ent and complete discharge of all future

obligations for reinsurance losses incurred regardless of the continuing nature of certain losses such as unlim

ited medical and lifetim

e benefits for W

orkers’ Com

pensation. (or )—

An allow

ance payable to the ceding com

pany in addition to the normal ceding

comm

ission allowance. It is a pre-determ

ined percentage of the rein-surer’s net profits after a charge for the reinsurer’s overhead, derived from

the subject treaty.

—W

here there is more than one reinsurer sharing

a line of insurance on a risk in excess of a specified retention, each such reinsurer shall contribute tow

ards any excess loss in proportion to his original participation in such risk. Exam

ple: Retention US$100,000,

Reinsurer A accepts one-half contributing share part of U

S$1,000,000 in excess of said U

S$100,000. Reinsurer B accepts remaining one-half

contribution share part of US$1,000,000.

—(1) Th

at part of the premium

applicable to the expired part of the policy period, including the short-rate prem

ium

on cancellation, the entire premium

on the amount of loss paid under

some contracts, and the entire prem

ium on the contract on the expira-

tion of the policy. (2) That portion of the reinsurance prem

ium calcu-

lated on a monthly, quarterly or annual basis w

hich is to be retained by the reinsurer should there cession be canceled. (3) W

hen a premium

is paid in advance for a certain tim

e, the company is said to “earn” the

premium

as the time advances. For exam

ple, a policy written for three

years and paid for in advance would be one-third “earned” at the end of

the first year.

—A

provision in reinsurance agreements

which is intended to neutralize any change in liability or benefits as a

result of an inadvertent error by either party.

—A

form of reinsurance under w

hich recoveries are available w

hen a given loss exceeds the cedant’s retention defined in the agreem

ent.

—A

payment m

ade for which the com

pany is not liable under the term

s of its policy. Usually m

ade in lieu of incurring greater legal expenses in defending a claim

. Rarely encountered in rein-surance as the reinsurer by custom

and for practical reasons follows the

fortunes of the ceding company.

—Th

e percentage of premium

used to pay all the costs of acquiring, w

riting and servicing insurance and reinsurance.

—(1) Th

e loss record of an insured or of a class of coverage. (2) Classified statistics of events connected w

ith insurance, of outgo, or of incom

e, actual or estimated. (3) W

hat figures show to have

happened in the past.Experience m

ay be compiled on different bases to provide various

means of appraisal, nam

ely Accident Year, Calendar Year, or Policy Year, but, for underw

riting purposes, should always com

pare earned prem

ium w

ith incurred losses after the latter have been modified by an

allowance for loss developm

ent and incurred but not reported losses (I.B.N

.R.).

—A

generic term that, w

hen used in reinsurance agreem

ents, refers to damages aw

arded by a court against an insurer w

hich are outside the provisions of the insurance policy, due to the insurer’s bad faith, fraud, or gross negligence in the handling of a claim

. Examples are punitive dam

ages and losses in excess of policy lim

its.

—Facultative reinsurance m

eans reinsurance of individual risks by offer and acceptance w

herein the reinsurer retains the “faculty” to accept or reject each risk offered.

—A

form of reinsurance w

hich considers the tim

e value of money and has loss containm

ent provisions. One of its

objectives is the enhancement of the cedant’s financial statem

ents or operating ratios, for exam

ple, the combined ratio; loss portfolio transfers;

and financial quota shares are examples.

—In reinsurance, a percentage rate applied to a ceding com

pa-ny’s prem

ium w

ritings for the classes of business reinsured to deter-m

ine the reinsurance premium

s to be paid the reinsurer.

—Th

e clause stipulating that once a risk has been ceded by the reinsured, the reinsurer is bound by the sam

e fate thereon as experienced by the ceding com

pany.

—Th

e percentage of losses incurred to premium

s earned. (See Experience.)

—A

loading to provide for increased medical costs and

loss payments in the future due to inflation.

—A

third party in the design, negotiation, and admin-

istration of a reinsurance agreement. Interm

ediaries recomm

end to cedants the type and am

ount of reinsurance to be purchased and nego-tiate the placem

ent of coverage with reinsurers.

—A

provision in reinsurance agreements w

hich identifies the interm

ediary negotiating the agreement. M

ost interme-

diary clauses shift all credit risk to reinsurers by providing that:

1. the cedant’s payments to the interm

ediary are deemed paym

ents to the reinsurer; and

2. the reinsurer’s payments to the interm

ediary are not payments to

the cedant until actually received by the cedant.

This clause is m

andatory in some states.

—A

horizontal segment of the liability insured, for exam

ple, the second U

S$100,000 of a $500,000 liability is the first layer if the cedant retains U

S$100,000 but a higher layer if it retains a lesser amount.

—Th

e reinsurer who negotiates the term

s, condi-tions, and prem

ium rates and first signs on to the slip; reinsurers w

ho subsequently sign on to the slip under those term

s and conditions are considered follow

ing reinsurers.

—A

financial guaranty issued by a bank that permits

the party to which it is issued to draw

funds from the bank in the event

of a valid unpaid claim against the other party; in reinsurance, typically

used to permit reserve credit to be taken w

ith respect to non-admitted

reinsurance; and alternative to funds withheld and m

odified coinsurance.

—A

ll expenditures of an insurer associated w

ith its adjustment, recording, and settlem

ent of claims, other than the

claim paym

ent itself. The term

encompasses both allocated loss adjust-

ment expenses (A

LAE) w

hich are loss adjustment expenses identi-

fied by a claim file in the insurer’s records, such as attorney’s fees; and

unallocated loss adjustment expenses (U

LAE), w

hich are operating expenses not identified by claim

file, but functionally associated with

settling losses, such as salaries of claims departm

ent.

—Th

e difference between the original loss as origi-

nally reported to the reinsurer and its subsequent evaluation at a later date or at the tim

e of its final disposal. A serious problem

to reinsurers w

ho, being involved in the more serious cases, m

ust frequently wait

many years for the final disposition of a loss.

—Th

e total losses to the ceding company or to the reinsurer

resulting from a single cause such as a w

indstorm.

—Proportionate relationship of incurred losses to earned

premium

s expressed as a percentage.

—A

Com

pany is “non-admitted” w

hen it has not been licensed and thereby recognized by appropriate insurance governm

ental authority of a state or country. Reinsur-ance is “non-adm

itted” when placed in a non-adm

itted company and

therefore may not be treated as an asset against reinsured losses or

unearned premium

reserves for insurance company accounting and

statement purposes.

—A

n adverse contingent accident or event neither expected nor intended from

the point of view of the insured. W

ith regard to lim

its on occurrences, property catastrophe reinsurance agreem

ents frequently define adverse events having a comm

on cause and som

etimes w

ithin a specified time fram

e, for example 72 hours, as

being one occurrence. This definition prevents m

ultiple retentions and reinsurance lim

its from being exposed in a single catastrophe loss.

—A

provision in reinsurance agreements w

hich permits

each party to net amounts due against those payable before m

aking

payment; especially im

portant in the event of insolvency of one party w

hich ceases to remit am

ounts due to the other.

—Includes Q

uota Share, First Surplus, Second Surplus, and all other sharing form

s of reinsurance w

here under the reinsurer participates pro rata in all losses and in all prem

iums.

—Th

is term refers to the causes of possible loss in the property

field—for instance: Fire, W

indstorm, C

ollision, Hail, and so on. In the

casualty field the term “H

azard” is more frequently used.

—Retention and am

ount of reinsurance apply “per risk” rather than on a per accident or event or aggregate basis.

—Th

e year comm

encing with the effective date of the policy

or with an anniversary of that date.

—A

n organization of insurers or reinsurers through which

particular types of risks are underwritten w

ith premium

s, losses, and expenses shared in agreed ratios.

—In transactions of reinsurance, it refers to all

the risks of the reinsurance transaction. For example, if one com

pany reinsures all of another’s outstanding Autom

obile business, the rein-suring com

pany is said to assume the “portfolio” of Autom

obile busi-ness and it is paid the total of the unearned prem

ium on all the risks so

reinsured (less some agreed com

mission).

—Th

e opposite of Return of Portfolio—perm

itting prem

iums and losses in respect of in-force business to run to their

normal expiration upon term

ination of a reinsurance treaty.

—W

hen the terms of a policy provide that the final

earned premium

be determined at som

e time after the policy itself has

been written, com

panies may require tentative or “deposit” prem

iums

at the beginning which are readjusted w

hen the actual earned charge has been later determ

ined.

—Th

e portion of the premium

calculated to enable the insurer to pay losses and, in som

e cases, allocated claim expenses or

the premium

arrived at by dividing losses by exposure and in which no

loading has been added for comm

ission, taxes, and expenses.

—W

ritten premium

is premium

registered on the books of an insurer or reinsurer at the tim

e a policy is issued and paid for. Prem

ium for a future exposure period is said

to be unearned premium

for an individual policy, written prem

ium

minus unearned prem

ium equals earned prem

ium. Earned prem

ium

is income for the accounting period, w

hile unearned premium

will be

income in a future accounting period.

—A

term used to designate a com

pany whose

business is confined solely to reinsurance and the peripheral services offered by a reinsurer to its custom

ers as opposed to primary insurers

who exchange reinsurance or operate reinsurance departm

ents as adjuncts to their basic business of prim

ary insurance. The m

ajority of professional reinsurers provide com

plete reinsurance and service at one source directly to the ceding com

pany.

—A

provision found in some reinsurance agree-

ments w

hich provides for profit sharing. Parties agree to a formula for

calculating profit, an allowance for the reinsurer’s expenses, and the

cedant’s share of such profit after expenses.

—Th

e basic form of participating treaty w

hereby the reinsurer accepts a stated percentage of each and every risk w

ithin a defined category of business on a pro rata basis. Participation in each risk is fixed and certain.—

When the am

ount of reinsurance coverage provided under a treaty is reduced by the paym

ent of a reinsurance loss as the result of one catastrophe, the reinsurance cover is autom

atically reinstated usually by the paym

ent of a reinstatement prem

ium.

—A

pro rata reinsurance premium

is charged for the reinstatem

ent of the amount of reinsurance coverage that w

as reduced as the result of a reinsurance loss paym

ent under a catastrophe cover.

—Th

e practice whereby one party called the Reinsurer in

consideration of a premium

paid to him agrees to indem

nify another party, called the Reinsured, for part or all of the liability assum

ed by the latter party under a policy or policies of insurance w

hich it has issued.

The reinsured m

ay be referred to as the Original or Prim

ary Insurer, or D

irect Writing C

ompany, or the C

eding Com

pany.

—A

n insurer or reinsurer assuming the risk of another under

contract.

—Th

e net amount of risk w

hich the ceding company or the

reinsurer keeps for its own account or that of specified others.

—A

reinsurance of reinsurance. Example: C

ompany

“B” has accepted reinsurance from C

ompany “A”, and then obtains

for itself, on such business assumed, reinsurance from

Com

pany “C”.

This secondary reinsurance is called a Retrocession. Th

e transaction w

hereby a reinsurer cedes to another reinsurer all or part of the rein-surance it has previously assum

ed.

—A

plan or method w

hich permits adjustm

ent of the final reinsurance ceding com

mission or prem

ium on the basis of

the actual loss experience under the subject reinsurance treaty—subject

to minim

um and m

aximum

limits.

—A

term used to denote the physical units of property at risk or

the object of insurance protection and not Perils or Hazard. Reinsur-

ance by tradition permits each insurance com

pany to frame its ow

n rules for defining units of Risks. Th

e word is also defined as chance of

loss or uncertainty of loss.—Th

ose rights of the insured which, under

the terms of the policy, autom

atically transfer to the insurer upon settlem

ent of a loss. Salvage applies to any proceeds from the repaired,

recovered, or scrapped property. Subrogation refers to the proceeds of negotiations or legal actions against negligent third parties and m

ay apply to either property or casualty coverage.

—Setting aside of funds by an individual or organiza-

tion to meet his or its losses, and to absorb fluctuations in the am

ount of loss, the losses being charged against the funds so set aside or accu-m

ulated.

—A

ceding comm

ission which varies

inversely with the loss ratio under the reinsurance agreem

ent. the scales are not alw

ays one to one: for example, as the loss ratio decreases by 1%

, the ceding com

mission m

ight increase only 5%.

—A

binder often including more than one reinsurer. At Lloyd’s

of London, the slip is carried from underw

riter to underwriter for

initialing and subscribing to a specific share of the risk.

—Th

e facultative extension of a reinsurance treaty to em

brace a risk not automatically included w

ithin its terms.

—A

form of reinsurance under w

hich premium

s are paid during good years to build up a fund from

which losses are recovered

in bad years. This reinsurance has the effect of stabilizing a cedant’s loss

ratio over an extended period of time.

—A

form of reinsurance under w

hich the reinsurer pays som

e or all of a cedant’s aggregate retained losses in excess of a prede-term

ined dollar amount or in excess of a percentage of prem

ium.

—A

cedant’s premium

s (written or earned) to w

hich the reinsurance prem

ium rate is applied to calculate the reinsur-

ance premium

. Often, subject prem

ium is gross/net w

ritten premium

incom

e (GN

WPI) or gross/net earned prem

ium incom

e (GN

EPI), w

here the term “gross/net” m

eans gross before deducting reinsurance prem

iums for the reinsurance agreem

ent under consideration, ;but net after all other adjustm

ents, for example, cancellations, refunds, or other

reinsurance. Norm

ally, subject premium

refers to premium

on subject business. A

lso known as base prem

ium.

—Th

e excess of assets over liabilities. Statutory surplus is an insurer’s or reinsurer’s capital as determ

ined under statutory accounting rules. Surplus determ

ines an insurer’s or reinsurer’s capacity to write

business.

—A

form of proportional reinsurance w

here the rein-surer assum

es pro rata responsibility for only that portion of any risk w

hich exceeds the company’s established retentions.

—A

general reinsurance agreement w

hich is obligatory between

the ceding company and the reinsurer containing the contractual term

s applying to the reinsurance of som

e class or classes of business, in contrast to a reinsurance agreem

ent covering an individual risk.

—Th

is term usually m

eans the total sum w

hich the assured, or any com

pany as his insurer, or both, become obli-

gated to pay either through adjudication or comprom

ise, and usually

includes hospital, medical and funeral charges and all sum

s paid as salaries, w

ages, compensation, fees, charges and law

costs, premium

s on attachm

ent or appeal bonds, interest, expenses for doctors, lawyers,

nurses, and investigators and other persons, and for litigation, settle-m

ent, adjustment and investigation of claim

s and suits which are paid

as a consequence of the insured loss, excluding only the salaries of the assured’s or of any underlying insurer’s perm

anent employees.

—Th

at portion of the original premium

that applies to the unexpired portion of risk. A

fire or casualty insurer or reinsurer m

ust carry a reserve against all unearned premium

s as a liability in its financial statem

ent, for if the policy should be canceled, the com

pany would have to pay back the unearned part of the original

premium

.

—Th

e first layer above the cedant’s retention wherein

moderate to heavy loss activity is expected by the cedant and reinsurer.

Working layer reinsurance agreem

ents often include adjustable features to reflect actual underw

riting results.