Kathmandu. Not all reinsurers work the same way. There is a sophisticated system of contracts behind the financial protection that reinsurers provide to primary insurers. It’s called a treaty. These treaties determine exactly how risks, premiums, and losses are distributed between the two parties.
Understanding the structure of these arrangements is critical to understanding why reinsurance is such an indispensable tool for the global insurance industry. At the broad level, reinsurance agreements fall into two basic categories, voluntary and mandatory.
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Voluntary reinsurance, the oldest form of reinsurance business, operates on a risk-averse basis every time. The reinsurer is offered a different type of risk transfer each time. Suppose the reinsurer reserves the right to accept or reject the launch of a large industrial complex or a satellite. Similarly, the insurer is free to choose whether or not to re-insure that particular risk.
This flexibility makes automatic reinsurance well-suited for unique, complex or unusually large risks that require personal actuarial attention. Today it is often used as a supplement to the broader treaty regime. Includes risks that fall outside or above the scope of a permanent agreement.
Binding reinsurance is also known as treaty or automatic reinsurance. It works differently. Here, both the insurer and the reinsurer are bound by a permanent agreement. It commits to renouncing and accepting all risks that fall within the defined category. For example, a primary insurer agrees to transfer their entire motor insurance portfolio to the reinsurer. The reinsurer cannot rule out the risks of the insurance policy within that range. This automated nature makes treaty reinsurance highly efficient to manage.
It is the most widely used form of life and non-life insurance worldwide. Non-life treaties are usually renewed annually. On the other hand, some life reinsurance agreements for mortality businesses last up to 30 years.
The actual sharing of premiums and losses within both faculty and mandatory frameworks is governed by a further difference: proportional or non-proportional arrangements. In proportional reinsurance, the insured and the reinsurer share the premium and loss according to the pre-agreed ratio.
Reinsurance quota sharing
The simplest version is quota sharing. This includes a certain percentage of each insured (30 percent, for example) and each loss is assigned to the reinsurer. This facilitates quota allocation for uniform portfolios such as motor or domestic insurance (where the risks are similar).
A more subtle form is surplus reinsurance. This is the most common type of proportional risk allocation. In this, the insurer covers all the risks up to a defined limit, and the reinsurer only participates in the risk above that assumption.
Non-proportional reinsurance, which emerged as a significant market force in the 1970s, operates on an entirely different logic. Instead of splitting each loss from the first Re 1, the insurer bears all losses up to the agreed deductible. This is sometimes called prioritization or retention. The reinsurer has agreed to bear only losses that exceed that limit.
The most widely used form is high counter-risk loss. Which protects against big personal claims. The addition of catastrophic damage or catastrophe expands this argument to sum up the losses from a single event. For example, a storm that damages thousands of properties at the same time. A less common type, stop loss reinsurance, protects the insurer against total annual claims in excess of a specified proportion of its insured income. Effectively, any one year puts a limit on how bad it can be.
