REINSURANCE

TOPICS OF THE DAY

REINSURANCE WHY REINSURANCE PORTFOLIO INSURANCE RETROCESSION PROCESS OF REINSURANCE PRINCIPLES OF REINSURANCE TYPES OF REINSURANCE REGULATING REINSURANCE

WHAT IS REINSURANCE??
What is reinsurance, what does it do, why is it important to me? These are questions that many of you have asked at one time or another. Today I am going to remove the mystery and mystique surrounding reinsurance. It is simple, really! Reinsurance is insurance for insurance companies. Everyone knows what insurance is. Indeed, everyone buys insurance in some form or another to protect their possessions and their loved-ones in case of accident, harm, or disaster.

 Take your home for example. All of you purchase homeowners insurance to protect yourself if your house catches fire or is destroyed or damaged by windstorm, hurricane, or other similar peril. You are the insured, a company such as GIC or ICICI is your insurer For some of the very same reasons you buy homeowners coverage to insure your possessions, nearly every insurance company in the world buys coverage to reinsure its portfolio of business from accident, harm, or disaster.

Why Reinsurance?
Usually an insurance company will buy reinsurance for one or more of the following reasons: 1. Market Capacity. 2. Stabilization of Result. 3. Catastrophe Protection. 4. Strengthening of its Financial Structure. 5.The reinsurance safeguards capital and reinforces stability

PORTFOLIO REINSURANCE
Reinsurance provides more diversification when risks are accepted on a worldwide basis and not just in a specific region or country. The reinsurer can also help an insurance company withdraw from a particular geographical territory or the line of business. Thus, the company can vary out its business decision with a swift transition for a known cost, without being restricted by policy duration and other considerations. This is also termed as portfolio reinsurance.

Reinsurance process..
The term 'reinsurance' stands for the practice whereby a reinsurer, in return of a premium paid to it, indemnifies another person or company for a portion or all of the liability taken up by the latter due to a policy of insurance that it has issued. This latter party is called the 'reinsured'.

Reinsurance process..
Reinsurance is a type of risk management involving transfer of risk from insurer to the reinsurer. What that reinsurer does is to provide insurance for the insurers on the basis of a contract of indemnity. It works like this the insurer gives the reinsurer a portion of the premium it collects from the insured and in return is covered for losses above a particular limit. A reinsurer enters into reinsurance agreement for a very specific reasoneither the nature of risk insured or the business strategies of the insurer or other possible reasons.

Reinsurance process..
It is an independent contract between the reinsurer and the insurer and the original insurer is not a part of the contract. If the claimant is an individual or even a group of individuals, an insurance company will find it , relatively easy to cover the claims. But if there are a huge number of claims at the same time and the loss is massive and wide spread, this may not be possible. It is in this context that reinsurance plays an important part in determining the success of the insurance business.

Reinsurance process..
A single insurer will not be able to bear the damaging financial impact of such losses. Therefore, an unbearable loss is broken down into bearable units by risk transfers. An insurance company limits the amount of risk it takes depending on there insurance terms along with factors like the worth of its assets, trend of inflation in the economy, a price of the insurance products and the type of risk.

Risk share
Policy holders Contract(policy) Direct insurer Cession Reinsurer Retrocession Retrocessionaire (insurer for a reinsurer)

RETROCESSION Reinsurance companies themselves also purchase reinsurance and this isknown as a retrocession . They purchase this reinsurance from other reinsurance companies. The reinsurance company who sells the reinsurance inthis scenario are known as retrocessionaires. The reinsurance company thatpurchases the reinsurance is known as the retrocedent. It is not unusual for a reinsurer to buy reinsurance protection from other reinsurers. For example, a reinsurer that provides proportional, or pro rata ,reinsurance capacity to insurance companies may wish to protect its ownexposure to catastrophes by buying excess of loss protection. Another situationwould be that a reinsurer which provides excess of loss reinsurance protectionmay wish to protect itself against an accumulation of losses in different branchesof business which may all become affected by the same catastrophe.

Principles of reinsurance
Principle of Utmost Good Faith: Reinsurers maintain utmost faith in underwriters of their company. These underwriters in turn maintain utmost good faith in the underwriters of the primary insurance company. Principle of Indemnity: The principles of indemnity of the insured risk apply automatically on reinsurance. Indemnity limit in reinsurance can be more than the sums insured in there are additional legal expenses against the insurer that are incurred while contesting a claim No reinsurance without retention: The insurer must retain a part of the Risk before reinsuring. Though there cannot be reinsurance of the complete risk, there can be complete retention of a risk . Those risks that are within the retention capacity of an insurer must be retained completely.

Types of Reinsurance
Treaty reinsurance : This method is defined to cover an entire category of risk or line of business in advance. It is obligatory and binding in nature for both the reinsured and reinsurers. So as long as a risk meets all the conditions as given in the reinsurance contract, acceptance of that risk by the insurer is automatic. Reinsurance by this method creates capacity for insurers. Capacity + Coverage of all perils with adequate limits + confidence on security of reinsurers + continuity of reinsurance after a loss.

Types of Reinsurance
Facultative reinsurance : This is for the reinsurance of current single risk and options are open for both the reinsured and reinsurers. In a facultative contract relationship, the reinsurer retains the faculty or power to either accept or reject each individual risk offered to it by the insurer.

Further types..
Facultative and treaty both are further divided as proportional and non-proportional In proportional, the insurer and reinsurer divide the premiums and losses between them at contractually defined ratio. In non-proportional, there is no such ratio is fixed. Losses are apportioned according to the actual amount of loss incurred.

Regulating Reinsurance
Given the importance of reinsurance there are several guidelines laid down by the IRDA to ensure fair play. Some of these are as follows: Every insurer should retain risk proportionate to its financial strength and business volumes. Certain percentage of the sum assured on each policy by an insurance company is to be reinsured with the National Reinsurer. National reinsurer has been made compulsory only in the non-life sector. The reinsurance program will begin at the start of each financial year and has to be submitted to the IRDA, forty-five days before the start of the financial year

Regulating Reinsurance
Insurers must place their reinsurance business, in excess of limits defined, outside India with only those reinsurers who have a rating of at least BBB (S&P) for the preceding five years. This limit has been derived from India's own sovereign rating, which currently stands at BBB. Private life insurance companies cannot enter into reinsurance with their promoter company or its associates, though the LIC can continue to reinsure its policies with GIC. The objective of these regulations is to expand retention within India, ensure the best protection for the reinsurance costs incurred and simplify administration.

FUNCTIONS OF REINSURANCE
There are many reasons why an insurance company would choose to reinsure as part of its responsibility to manage a portfolio of risks for the benefit of its policyholders and investors: (1)RISK TRANSFER The main use of any insurer that might practice reinsurance is to allow the company to assume greater individual risks than its size would otherwise allow, and to protect a company against losses. Reinsurance allows an insurance company to offer higher limits of protection to a policyholder than its own assets would allow. For example, if the principal insurance company can write only $10million in limits on any given policy, it can reinsure (or cede) the amount of the limits in excess of $10 million.

FUNCTIONS OF REINSURANCE
(2) INCOME SMOOTHING Reinsurance can help to make an insurance companys results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage. (3) SURPLUS RELIEF An insurance company's writings are limited by its balance sheet (this test is known as the solvency margin). When that limit is reached, an insurer can stop writing new business, increase its capital or buy "surplus relief" reinsurance. The latter is usually done on a quota share basis and is an efficient way of not having to turn clients away or raise additional capital.

FUNCTIONS OF REINSURANCE
(4 )ARBITRAGE The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than what they charge the insured for the underlying risk. (5) REINSURERS EXPERTISE The insurance company may want to avail of the expertise of a reinsurer in regard to a specific (specialized) risk or want to avail of their rating ability in odd risks.

FUNCTIONS OF REINSURANCE
(6) CREATING A MANAGEABLE AND PROFITABLE PORTFOLIO OFINSURED RISKS By choosing a particular type of reinsurance method, the insurance company may be able to create a more balanced and homogenous portfolio of insured risks. This would lend greater predictability to the portfolio results on net basis ie after reinsurance and would be reflected in income smoothing. While income smoothing is one of the objectives of reinsurance arrangements, the mechanisms by way of balancing the portfolio.

FUNCTIONS OF REINSURANCE
(7) MANAGING THE COST OF CAPITAL FOR AN INSURANCE COMPANY By getting a suitable reinsurance, the insurance company may be able to substitute "capital needed" as per the requirements of the regulator for premium written. It could happen that the writing of insurance business requires x amount of capital with y% of cost of capital and reinsurance cost is less than x*y%. Thus more unpredictable or less frequent the likelihood of an insured loss, more profitable it can be for an insurance company to seek reinsurance.

CONCLUSION
Reinsurance mean insuring again. It is transfer of insurance risk from one insurer to another. Under reinsurance the original insurer who has insured a risk, insures a part of that risk with another insurer. Reinsurance premium is an income to there insurer and an expense to the insurer. Reinsurance is a good method to diversify and distribute risks of an insurer. Reinsurance even provide technical assistance and rating assistance to the original insurers. Reinsurance is also a contract of indemnity. The object of underwriting is to make a reasonable profit, it is equally essential that the business ceded to reinsurers should also give them a margin. For profit, therefore, the overall quality of business accepted by direct insurers should be good.