Reinsuring Mutual Insurance Companies
Risk Excess of Loss Reinsurance
Risk Excess of Loss Reinsurance is normally preferred by mutual insurance companies with established portfolios but who need to reduce the impact of any one loss above a certain level. With the benefit of actual experience, the mutual is better able to predict overall loss ratios. Individual risks which are either too large or which fall outside the treaty parameters can be reinsured on a facultative (case by case) excess of loss basis following the same approach as a risk excess of loss treaty.
Risk Excess of Loss insures a mutual's exposure on any one individual risk event excess of a predetermined amount known as an excess.
Unlike quota share arrangements, a risk excess reinsurer only pays when the loss exceeds a pre-agreed amount which is retained by the mutual, known as a net retention. As the payments of losses are not split proportionately, reinsurers charge a percentage rate of the total premium. This can increase or decrease as negotiated by the reinsurance intermediary at each renewal. By reducing the amount to which the mutual is exposed from any one loss to a level commensurate with the mutual's capital base, the mutual does not face financial ruin in the event of a large individual loss.
Risk Excess reinsurance can usually be secured on a risks attaching basis which protects all risks underwritten by the captive during the underwriting year until expiry or renewal, or alternatively on a losses occurring basis which protects losses happening during the underwriter year, regardless of when the original policies incepted.
Individual risks which are either too large or which fall outside the treaty parameters can be reinsured on a facultative (case by case) excess of loss basis following the same approach as a risk excess of loss treaty.
Quota Share reinsurance is ideal for start-up portfolios where the experience is less predictable or for programs which have a higher degree of volatility but which over a period of time are profitable.
Using the quota share method, a mutual cedes a pre-agreed percentage of its premium to a reinsurer who in turn agrees to pay the same percentage of claims.
The costs of acquiring and handling the business, known as ceding commission, are deducted from the premium passed to the reinsurer who normally also agrees to pay an additional commission based on the profits of the treaty.
By reducing the amount to which the mutual is exposed from any one loss to a level commensurate with the mutual's capital base or surplus, the captive does not face financial ruin in the event of a large individual loss.
A 75.00% Quota Share Treaty describes an arrangement whereby a reinsurer pays 75.00% of all losses and is paid 75.00% of all premiums after commissions and expenses. If a 75.00% quota share is secured the captive is left with 25.00% of the risk. Whilst it the mutual may lose out on retained profits, its financial downside will be limited.
If a fronting company is needed that requires collateral then that collateral requirement will be reduced assuming that the quota share reinsurer’s security is acceptable to the fronting company.
Quota share reinsurance contracts protect policies which start or renew during a specific period until expiry or renewal, regardless of when losses occur.
Whilst quota share and risk excess reinsurance respond to individual losses, there is always the risk that a loss ratio may be impacted by an accumulation of losses. Catastrophe reinsurance provides protection for such an eventuality which arises from a single event or occurrence.
Examples of such exposures are the potential effect of acts of God such as windstorms to property portfolios or having a number of policyholders affected by a single occurrence under a liability portfolio.
Liability reinsurance policies are generally known as clash covers and often include coverage for run-away costs arising from any individual risk as well as an individual loss involving a number of insureds.
Catastrophe reinsurance always has a finite recovery amount and the emphasis is on the mutual and its advisors to ensure that sufficient coverage is purchased for any accumulations of risk after the impact of any quota share or risk excess reinsurance.
Catastrophe reinsurance is normally secured on a losses occurring basis which protects losses happening during the underwriting year, regardless of when the original policies incepted.
Once a net retention has been established, either by risk excess of loss or quota share reinsurance, depending on the class of business, a mutual may still have a potential exposure to an unexpected series of losses for its net retention.
Aggregate reinsurance can protect a mutual once losses to its net retention exceed a percentage of its net retained income (the residual premium after reinsurance premium and taxes). Normally the trigger point will be in the region of 120% of net retained income to ensure that the mutual is not guaranteed to profit from poor underwriting.
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