Reinsuring is the act of purchasing a reinsurance agreement.
Reinsurance is purchased by an insurance company who wishes to transfer part of the risk of loss from an issued policy or group of policies to another insurance carrier. This is done when the limit of insurance for a particular policy would exceed the capacity of an insurance carrier or a carrier needs reinsurance to increase the policy holder surplus required to maintain a sound financial position.
Their are two types of reinsurance, treaty reinsurance and facultative reinsurance. Treaty reinsurance is arranged usually in advance, for a group of policies meeting certain criteria. For example, a treaty reinsurance policy may cover $250,000 of property losses excess of $250,000 for all commercial building properties in a given state. This is called excess of loss treaty reinsurance. This would be used to address capacity issues that occur frequently.
Another type of treaty reinsurance is pro-rata reinsurance or share reinsurance. In pro-rata reinsurance, the reinsurer agrees to pay a percentage of all losses on the agreed upon policies. For example, a pro-rata treaty reinsurance policy may pay 50% of all losses of a group of policies. The premium for this type of reinsurance would be 50% of the earned premium for each of the policies covered minus a deduction for policy expense (underwriting and compensation to the agent). This type of treaty reinsurance is used to address a policyholder surplus need of the ceding insurer.
Facultative reinsurance is issued for one policy, not a group of policies, and is usually used to address large line capacity, especially in property coverage. Facultative is usually written on an excess of loss basis. For example, an insurance company may have secured treaty reinsurance to write properties of a certain type up to $150 million loss limit, but the insured is requesting $250 million. To write the insurance policy, the insurance company must secure facultative reinsurance in the amount of $100 million excess $150 million. This may be abrivated $100 million xs $150 million.
Mark Walters, ARM AAI
West Insurance Group
mwalters@westagy.com