The types of Reinsurance

Reinsurance is insurance for insurance companies. In this article we will focus on the conventional and most-used types of reinsurance.

In our previous article we covered the concept of reinsurance and its different uses. Overall, reinsurance is insurance for insurance companies. You might wonder — is there a different type of reinsurance for each need? Yes, almost! In this article we will focus on the conventional and most-used types of reinsurance.

Facultative Reinsurance vs Treaty Reinsurance

The first recorded reinsurance contract (circa 1370) was about insuring a cargo ship during its “voyage”. An underwriter decided to ask another party to reinsure part of the journey between two specific locations. This highlights the concept of facultative reinsurance: a reinsurer accepts (or not) an individual risk laid out by an insurer. As it covers large individual risks (gas plants, offshore energy platforms, etc.), facultative reinsurance is tailor-made and the structure is adapted to it. In some cases, it can also be a defined package of risks.

The second type of reinsurance is treaty reinsurance. For this type of reinsurance, the insurer transfers the entire book of a business line (e.g. all motor risks). The reinsurer cannot decline any policies from the transferred book — it must accept all of them or none! The cover period of a treaty often lasts for one year and is renewed every year. Usually, non-life insurers have one treaty for each of the following risks: motor, fire and CAT.

Proportional vs. Non-proportional Structures

Because of different needs, the way how risks are transferred to reinsurers varies between different contracts. Fortunately, for reinsurance structures, there are two categories: proportional and non-proportional.

1. Proportional: proportionally shared losses and premiums

The most common type of proportional treaty is called quota-share. This treaty is a type of pro-rata reinsurance where the insurer cedes, in the same proportion, premium and losses to reinsurers. In return for the administrative tasks and acquisition costs of the insurer, the reinsurers pay a reinsurance commission to the insurer. An annual loss limit paid by each reinsurer may be specified.

A quota-share treaty is mainly used to launch new lines of business (or new insurance companies!) or to satisfy solvency requirements. For example, insurtech company Lemonade, underwrites quota-share treaties to “retain a limited share of exposure”.

Proportional treaties are not always as simple as quota-share treaties. Another common proportional treaty is: surplus. The proportional rate is estimated in excess of a retention line and depends on the risk sum insured.

This type of treaty allows the insurer to write larger risks and diversify its portfolio without fully retaining the risk.

2. Non-proportional: providing covers against specific events

The second main category is: non-proportional treaties. There is no proportionality between the premium paid by the insurer and the losses ceded. The first type of non-proportional treaty is excess of loss. It shares similarities with the surplus, but the ceded losses and premium are not related. The reinsurer compensates losses of the insurer exceeding and in deduction of a retention amount. There is also a limit for which the exceeding amount will be once again charged to the insurer. Hence, the reinsurer pays a loss between a threshold and a limit. This type of treaty is mainly defined “per risk” (fire, motor, etc.) or “per event” (windstorm, hail, etc.). Such treaties are used by insurers to protect themselves against major events, such as natural catastrophes.

Last but not least: stop-loss treaties. The difference with excess of loss lies in the loss aggregation. Stop-loss is what we call an annual treaty as it aggregates all the losses for a given line of business (or multiple lines of business) during a year. Also, deductibles and limits are given in percentage of loss ratio (ratio between losses and premium). The stop-loss allows insurers to be protected in the event of a poor year in terms of event frequency and/or intensity. For example a multi-line stop-loss treaty will be used to cover all losses negatively impacting the loss ratio from a given percentage.

Conclusion

As the need for reinsurance can greatly vary for every insurer and line of business, different types of reinsurance have been created to protect against event intensity or frequency, per risk or annually, etc. Insurers usually combine different types of reinsurance to be efficiently covered against unexpected events.

Bifröst supports all types of structures to enable our clients to efficiently manage their reinsurance treaties all in one place! If you want to know more about our platform and discover all the features, you can book a slot to get a demo of Bifröst.

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