Reinsurance is the terminology with which most insurers are familiar, but the general public may not be so well aware of it. If we look at it plainly, it is similar to insurance which an ordinary layman purchase. The only difference is that reinsurance is available to the insurance companies and not to ordinary customers. In insurance, the insured is the person who needs protection, and he buys protection by way of the insurance. Whereas the Loyal insurance companies who deal in different kinds of risks also need to protect themselves hence they have to buy insurance to protect themselves. Reinsurance is nothing but “insurance for the insurers”.
The insured is not a party to the reinsurance contract; the reinsurance contract is between the insurance company and the reinsurer. Let us look briefly into the forms and types of reinsurance.
There are two basic forms of reinsurance as below:
- Facultative reinsurance
- Treaty reinsurance
Facultative reinsurance
Facultative reinsurance is also known as case-by-case insurance or optional insurance. Facultative is a French word and was coined in the early 19thcentury, and means that occurs optionally. It is the oldest form of reinsurance. In this type of reinsurance, the reinsurers have an option to accept or decline risks that are offered to them, even the insurer also has a right to place or not to place risk. The insurer negotiates with each reinsurer separately and each risk is evaluated individually. It is a time-consuming process and does not guarantee placement of the risk.
Treaty insurance
Treaty insurance is also known as obligatory reinsurance and automatic insurance. Under treaty reinsurance, the reinsurer is obliged to accept cessions within the terms and conditions of the agreement, and the insurer is obliged to cede the risk. Under the treaty the reinsurer cannot refuse to accept the risk which is within the scope of the agreement, however, they have every right to deny any risk which is outside the scope of the treaty. Initially, the concept of reinsurance started with facultative insurance but as the complexity increased, the treaty became a more popular form of reinsurance.
There are two types of reinsurance as follows:
- Proportional reinsurance
- Non-proportional reinsurance
Proportional reinsurance
Proportional reinsurance means reinsurers take an agreed or stated percent share of each policy that the insurance company writes. The premiums, risks, and claims are shared in equal proportions.
Proportional reinsurance is usually done under the following heads:
- Facultative
- Facultative obligatory
- Quota share treaty
- Surplus treaty
- Open cover and pools
Non-proportional reinsurance
In Non-proportional reinsurance the premiums and loss (claims are not shared in proportion). Usually, in these types of contracts, the liability between the insurance company and the reinsurer is focused on the basis of loss occurring.
Arranging reinsurance program
Motor insurance is an attrition class of business. The car insurance claims are of three types, own damage claims, third-party claims, and miscellaneous claims. Under these claims, we find smaller claims which are of high frequency and large claims, which are of low frequency. The severity of low-frequency claims is high. Frequency refers to the number of times the claim is occurring. The severity refers to the very high value of the claims arising out of a single event. The insurance companies would want to go in for self-insurance of most of the motor risks. High-value cars are usually reinsured, the overall portfolio may also be reinsured to protect against a combination of losses including catastrophic losses.
Most of the insurance companies have to struggle with their Motor insurance portfolios. The best way to overcome this struggle with the portfolio is to have a robust underwriting and claims system in place; apart from it, they should also make sure that they have the right reinsurance program in place. To have the right reinsurance program the following basic steps need to be followed.
