The Nature of Reinsurance: A List of Potentially Interesting Web Sites of Relevance To This Book

A GUIDE TO REINSURANCE LAW CHAPTER 1 THE NATURE OF REINSURANCE
1st Edition, 2007
Chapter 1
THE NATURE OF REINSURANCE

A list of potentially interesting web sites of relevance to this book
IRMI.com (International Risk Management InstituteU.S.)
BILA.org.uk (British Insurance Law AssociationU.K.)
BRMA.org (Broker Reinsurance Market AssociationU.S.)
Law.cornell.edu (Cornell UniversityU.S.)
Llgm.com (Le Boef LambU.S.)
Ealaw.com (Edwards and AngellU.S.)
DAC.co.uk (Davies Arnold Cooper)
BLG.co.uk (Barlow, Lyde & Gilbert)
law-now@cmck.com
Insurancereinsurance@bplaw.com (Berwin Leighton Paisner)
Onlinedmc.co.uk
legal-definitions.com
marketreform.co.uk (London Market Slips, Contract Certainty )
INTRODUCTION
The aim of this book is not to teach the principles of reinsurance as such but to try to explain and encourage thought on the legal
principles applying to reinsurance.
However, as we progress through this chapter we hope to explain the basic purposes of the different types/styles of Reinsurance
albeit it at a basic levelthe detail will become more apparent as one reviews words used to express intent within differing styles of
reinsurance contract.
This chapter provides an introduction to the text by:
explaining (or confirming) the basic concepts of Reinsurance
encouraging lateral thinking re the meaning of words in Slips and Wordings
touching on some of the core legal principles that will be explained in more detail later in the course
encouraging further research into some of the issues raised
Within this chapter differing examples of clauses used will be includedin no case are they being put forward as the correct
version. They are being provided as examples of words that are used, and are included to help explain the concepts and core legal
principles from an English law perspective.
With regard to legal principles, except where specifically mentioned these are based on the Common Law of England and Wales. It
could be dangerous to assume that the principles that are outlined necessarily apply elsewhere.
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However, it is important to realise that English legal decisions will be highly persuasive in situations within Common Law based
countries, particularly where there is little local legal discussion on matters such as Reinsurance. Certainly judges in Common Law
jurisdictions do review decisions in other jurisdictions, e.g. England, Australia, Ireland, Singapore, many US states sometimes
agreeing and other times not!
Arbitration
This will be dealt with in Chapter 10 but in reading this and other chapters it is important to remember that many issues are decided
by arbitration. Such decisions do not create legal precedent and are often never reported because of confidentiality clauses. The
growing trend towards ADR (alternative dispute resolution) via mediation should also be borne in mind.
You will see this symbol in this book encouraging you to take a legal time out. Consider the question or case asked using your own
logic, perhaps a little research?then review the answer or opinion given. Please remember you are entitled to your views as much as
Robert Merkin
1st Edition, 2007
anyone else. The important point of these breaks is to encourage you to think laterally through the logic and the reasons for the
decisions made.
On other occasions you will see the coffee cup symbol. Questions here are more to do with reinsurance issuesagain step back and
think through the question and then work through the answer. Even on a law course you might need a calculator.
What follows is based on the authors extensive experience in reinsurance and except where specifically indicated, opinions
expressed reflect his own personal views, not a specific legal opinion.
Legal views come from a range of sourcesparticularly including:
Reinsurance Practice and the Lawpublished by LLP (Informa), prepared by Barlow Lyde & Gilbert;
The Law of Reinsurancepublished by Sweet and Maxwell; CMSCameron McKenna and various notes issued by lawyers such as:
Davies Arnold & Cooper, Barlow Lyde and Gilbert, Berwin Leighton Paisner, Kendal Freeman.
Where appropriate, a full reference has been made to relevant court cases. Cases reported in Lloyds Insurance and Reinsurance
Law Reports can be viewed online at www.insurancelawreports.com. Look for this symbol:
Whether one operates mainly in Common Law jurisdictions or not, the knowledge gained in this and other Modules will still be
invaluable. They should encourage thought on how different people can write the same thing, view the same thing and come to
different interpretations of the meaning, and how other forums and legal bases, e.g. civil law, might view the same things
differently.
Common lawcivil law

A simple review of the core differences as a place to start. In my opinion some of the core differences between common law and
civil law legal systems are:
Common law
Concept from England 12th century
Civil law
Concept from Rome 1st2nd century
--creating standard law
Based on the concept of:

--interpretation of the law as written
--precedent
--decisions of higher courts to be followed by lower court
Meaning of the words used in contracts VERY IMPORTANT

Aims of the parties of lesser importance
Decisions tend to be long and full of legal reasoning
Past court cases very important
Most countries where England was involved tend to have a
common law structure e.g. US (most states), Ireland, Singapore,
Australia, NZ, Caribbean
Based on the concept of interpretation of the Aims of Codes

--no basic concept of precedent
Todays view of the objective of the Code is VERY IMPORTANT

Meaning of the individual word used of lesser importance
Decisions tend to be shortNOT trying to create precedent
Past court cases not normally important
Most of Europe, Asia, Latin America, including newly created
countries, will create a legal system based around codes and their
constitution.
WHAT IS REINSURANCE?
Reinsurance is the transfer of risk from an insurer to another party (reinsurer).
In law?
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Basically reinsurance and retrocession (reinsurance of reinsurance) are seen to be insurance contracts.
insurance of insurers (Reinsurance in Practice, Kiln).
the insurance of contractual liabilities to pay claims incurred under contracts of direct insurance or reinsurance
(Reinsurance, Carter).
any contract which is placed by or for the benefit of an insurer. This seems a simple statement but there has been some
debate whether in law some forms of stop loss are reinsurance (Toomey v. Eagle Star [1994] 1 Lloyds Rep. 516).
In NRG Victory Insurance [1995] 1 All E.R. 533both reinsurance and retro treated as insurance.
What is a reinsurer in law?

A reinsurer is an insurer which deals with other insurers as its policy holders. Supporting the concept of reinsurance being
insurance (Iowa Mutual Tornado Association v. Timmons, 105b N.W.2d 209 (Iowa, 1960)).
Robert Merkin
1st Edition, 2007
Why is it legally important and helpful that reinsurance be seen as insurance?

The fact that Reinsurance is basically seen in common law as insurance helps in many legal scenariosone can revert back to basic
insurance legal principles as a starting point, e.g. utmost good faith. However it is also important to remember that different
jurisdictions may come to different interpretations.
The placing process and clarity of contractThe placing process

Many of the disagreements in reinsurance stem from the placing process:
what was or was not said at the time of placing
the words used on the offer (the slip)
the words used in the Policy or Treaty Wording
Before discussing the differing types of reinsurance the placing process would seem to be a logical place to start fromit will be
covered in more detail in Chapter 2.
In the scenario that follows it is assumed that the risk is placed in the London Market by a broker:
Information provided by client to broker
Placing slip prepared by brokertogether with supporting information
Leader (the person chosen to set the terms and conditions) is offered the risk
-- perhaps more than one potential leader is approached to ensure that the best possible terms are achieved
Firm order is given by the client (reinsured)
Broker proceeds to endeavour to complete the placement
Broker keeps client fully advised of progress
If over placedthe reinsurers acceptances (written lines) are converted into signed lines
An appropriate evidence of cover confirming what has been placed and with whom is prepared and sent to the reinsured by
the broker. An appropriate evidence of cover as per the guidance notes can include;
-- Policy
-- Copy of complete slip
-- Certificate of Insurance
-- Brokers Insurance Document
A PolicyTreaty Wording is prepared for signature by the reinsured and the reinsurers
In a growing number of scenarios it is possible that the slip itself will formally be converted into the policythe concept of the slip
policy. In 2005 and 2006 various initiatives were undertaken to ensure contract certainty at placement timesee marketreform.co.uk
(documents). These include the issuing of:
-- Code of Practice for Contract Certainty, check list and guidance notes
-- Late placement guidance
-- Signed line guidance
-- An augmented slip (now called MRSlip (Market Reform Slip))
-- A market note regarding preparation of subjectivities
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What legal issues do the above steps of the placing process raise?At least 10!Contract certainty
Given that a high percentage of reinsurance is placed using a slipirrespective of what form of reinsurance is being placed it should
be obvious that a well-drafted slip will lead to much less argument in the future re the intention of the parties. In addition it ought to
lead to the production of a more accurate wording (where necessary), with its production being prompt! This unfortunately has not
been the case in many instances in the past.
In the context of contract certainty and slip preparation two very important trends should be highlighted; the MR (Market Reform)
slip and the Code of Practice for Contract Certainty (see Appendix?).
Contract certaintyCode of Practice check list

In October 2005 a contract certainty Code of Practice and supporting documentation was issued with the aim that this be signed up to
at board level by all members of LMBC, IUA and LMA. The market target was to achieve 85% contract certain placements for 31
December 2006
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1st Edition, 2007
-- estimated 90% was achieved for 31 December 2005

-- for full documentation see marketreform.co.uk
NB: Contract certainty is defined as Contract certainty is achieved by the complete and final agreement of all terms (including
signed down the lines) between the (Re)insured and the (Re)insurers before inception
From a legal perspective a slip complying with this definition may still not be legally certainthis will depend on the drafting of
the document itself. Certainly looking to the future the target should be contract quality at placement time.
LMP
The LMP concept formed part of an overall aim to make the London Market more efficient and professional with one of its core aims
being to create contract clarity at placement time. In 2005 this target was changed to read contract certainty. Although the whole
market reform concept is much wider than just the slip structure the information given by the market reform programme office on
how a MR slip should be presented and what it should contain should be of interest to anyone studying reinsurance and reinsurance
law as it provides a template for a clearer and hopefully legally stronger placement slip.
Contract certainty will only come about by clearer, fuller and more professionally prepared slips at the outset.
For full information on market reform see marketreform.com. For background, the headings of a MR slip are shown in Appendix
1.
NB: The use of the LMP slip was mandated by Lloyds from 2 January 2004 (with certain specific exceptions) with its use also
being actively encouraged by the IUA (International Underwriting Association of London).
One specific legal issue is with regard to an optional heading: recording transmitting and storing information (and the specific
text). It is recommended that this field be used to allow brokers the right to digitally store files and destroy the paper version without
passing the paper file over to their client.
Personally I would include this on my slips if I was the placing broker BUT discuss the situation with my legal advisor before
actually destroying files.
Amongst others:
Responsibilities
-- client responsibilities
-- intermediary responsibilities
utmost good faith
material fact
-- law of agency
When is there a contract in place?
The power of the slip v. the wording
The responsibilities of the leader
Signing down
-- legally acceptable?
-- to what amount?
-- disproportionate signing
-- advising signed lines
When might the brokers cover note have a legal role?
What is the brokers responsibility if reinsurers they have chosen fail?
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What if the wording has not been signed?

Do the words on the slip, policy or treaty wording convey in law what they were intended to?
Another area that is potentially going to cause some interesting legal issues in the future is that the LMA formally confirmed in
February 2007 that a Lloyds slip no longer has to be signed by the LPSO (Lloyds Policy Signing Office). A full slip, stamped and
signed by the underwriters, can be forwarded to the client as the total and full legal confirmation of coverassuming that this
documentation is acceptable to the client and in the country concerned.
All will be dealt with as you work through the book, e.g.:
Utmost good faith, material fact (see Chapter 3).
Robert Merkin
1st Edition, 2007
The role and responsibilities of the leader (see Chapter 2).

The role and responsibilities of the broker (see Chapter 8).
Written linessigned lines (see Chapter 2).
The cover notewhat is its legal value? (see Chapter 2).
The power of the slip v. the contract wording (see Chapter 2).
The basic forms of reinsurance

To save a great deal of repetition a few of the core terms used in reinsurance are explained immediately. Firstly three words used
regularly in proportional treaty reinsurance in particular:
Cedeto give
Cedantthe giver of reinsurance
Cessionwhat is given
The term cedant in many cases is replaced by the term Reinsured or Reassured. Both Reinsured and Reassured are seen as being
interchangeable (not in the same contract) although perhaps Reassured is used more in Marine and Life.
Retrocessionreinsurance of reinsurance (normally referred to as Retro).
Retrocedant (often referred to as the Reinsured!)the buyer of Retro.
Retrocessionairethe acceptor of Retro.
Bordereaux(PremiumLoss)
-- a detailed breakdown, risk by risk of premium or loss supporting the entries within a Quarterly Account under a Pro-Rata
Treaty.
Facultative v. treaty
Facultativeoptional reinsurance normally on a policy by policy basis (facultative derives from facultativomeaning
optional).
-- the reinsured does not have to reinsure the risk (it is not obligatory reinsurance) and the reinsurer(s) has the right to decline
or offer alternative terms.
Treatya deal, which once agreed gives cover for a range of risks in a particular way, over a period of time.
-- once the terms of the treaty are agreed between the parties the reinsured has automatic cover for all risks as specified for a
pre-agreed periodnormally 12 months.
NB: There is a school of thought that will argue that the word treaty infers proportional and that non-proportional arrangements
should be termed contracts.
In general today the word treaty is used for both proportional and non-proportional (Reinsurance Principles and Practice,
Gerathewohl, Vol. 1, p. 374).
In this chapter at least the term treaty is used to differentiate from facultative reinsurance.
Proportional (also called pro-rata) v. non-proportional
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(a) Proportionalthe sharing of risk, premium, acquisition costs and losses based on the amount of risk retained and reinsured
e.g. Factorysum insured
Retention
Reinsurance
1,000,000
100,000
900,000
Retention 100,000
1,000,000
10%
Reinsurance 900,000
90%
Premium will be allocated based on the allocation of the risk (10%90%)

-- with the reinsured being allowed to deduct a pre-agreed amount of commission to cover their acquisition costs.
Losses will be allocated based on the allocation of the risk (10%90%).
(b) Non-proportional (Also known as excess of loss or X/L)
The buying of an amount of cover in excess of a chosen deductible (often referred to as the retention or perhaps even primaryU.S.).
Robert Merkin
1st Edition, 2007
The premium charged by reinsurers for giving the cover will be based on their perception of the chance of a loss or losses to the
particular reinsurance being considered
-- there will normally be no deduction of commission to cover acquisition costs.
Losses will be collectable only for the amount in excess of the deductible.
e.g. Factorysum insured
Retention
Reinsurance
1,000,000
100,000
900,000
Cover
900,000
xs
100,000
Deductible
How would the following loss be allocated over the two different variations?
(i) Loss 50,000 on original policy
(ii) Loss 400,000 on original policy
(a) Proportional
(b) Non-proportional
(i)
(i)
(a) Both losses will be split 10%90% based on the allocation of the risk
(i)
5,000
10%
45,000
90%
(ii)
40,000
10%
360,000
90%
(b)
(i) No claim to the reinsurers (below the deductible)
(ii) Claim 300,000 on reinsurers (400,000100,000 deductible)
Reinsurance typesin summary

Proportional
Facultative
Treatydiffering types (see later)
Non-proportional
Facultative
Treatydiffering types (see later)
FACULTATIVE
Facultative is the earliest form of reinsurance with apparent references back to the 14th century. As already explained facultative is
reinsurance based on individual offers where both parties reinsured and reinsurers have options
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-- do not have to reinsure

-- do not have to accept
-- terms are fully negotiable
Facultative can be placed both proportionally or non-proportionally (often called Fac X/L).
Some of the core issues from a legal perspective include:
Full RI clauseChapter 4
Claim cooperation clauseChapter 7
Claims control clauseChapter 7
Back to back coverChapter 4
Robert Merkin
1st Edition, 2007
-- and/or as original
Many facultatives are placed as slip policies with the intention and expectation that the reinsurance will follow the original
insuranceback to back. terms such as:
and/or as original
all terms clauses and conditions as original
might be used.
Although it will be dealt with later in Chapter 4 the issue of using terms such as those above in facultative reinsurances should be
touched on now.
There is an arbitration clause in the original insurance. The facultative R/I states all terms clauses and
conditions as original.The reinsurers want to go to arbitration, the reinsured does not. Is the arbitration clause
incorporated into the facultative by the use of these words?
Almost certainly not! (HIH Casualty and Gen v. New Hampshire and others [2001] Lloyds Rep. I.R. 244). Incorporation will only
be achieved IF
-- the term is germane to the R/I
-- the term makes sense
-- the term is consistent with the express terms of the R/I
-- the term is apposite for inclusion in the R/I.
This is supported by various other court decisions. NB: Such a phrase would almost certainly not incorporate law or jurisdiction
into the R/I either.
Why facultative?
Reasons for use of facultative might include:
-- to obtain cover for risks which are larger than the reinsured would normally accept
-- to obtain cover for a risk in a class of insurance where the reinsured is not normally involved
-- enabling an insurer to obtain cover on a risk where, perhaps for commercial reasons, they have had to accept the whole or a
very large share
-- where the reinsured does not wish to pass its normal share to Treaty reinsurer(s) (perhaps the risk is very hazardous)
-- the reinsureds normal Treaty protections are not large enough to deal with a particular risk
-- the risk is excluded from the reinsureds Treaty protections
-- the risk is one for which the reinsured has no Treaty protection
Open coversbinding authoritiesline slips (sometimes referred to as facilities)

By its very nature (individual offers, accounts, etc.) facultative is expensive to administer for all parties and therefore various time
and cost saving methods of handling facultative have evolved, all requiring TRUST in varying degrees:
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open coverthe underwriting pen to the reinsured

binding authoritythe underwriting pen to the broker or other party (the cover holder)
line slipthe underwriting pen to the leading underwriter(s) of the facility
Although mentioned under the heading of facultative reinsurance all of these types of arrangement could and do equally apply to
direct insurance.
Open covers
An agreement by the (re)insurer to accept risks, within the terms of the open cover, if the (re)insured decides to cede. In reinsurance
this would often be called a facultative obligatory contract or treaty (Fac Oblig). What can be ceded should be specified by firmly
laid down guidelines.
The important difference between this and proportional treaties such as quota share and surplus (see later) is that risks do not have
to be ceded under an open cover or Fac Oblig but have to be ceded (normally) to quota share and surplus subject to treaty termsthus
an open cover is a half-way house between facultative and treaty.
Robert Merkin
1st Edition, 2007
Binding authority binder

The underwriting pen to accept certain types of risk (as specified) is passed from the (re)insurers to another party (called the cover
holder), e.g. a producing broker. The (re)insurers are automatically bound when the cover holder accepts a risk on their behalf.
Such facilities can be very cost effective for the cover holder. They save time, administration and therefore money. Perhaps they
can also offer too much temptation?
Binding authority placements into the Lloyds Market were mandated to fall within the overall LMP (now MRSlip) structure for all
binders with an inception date of 1/1/2005 and later. There are very strict rules re the structure and operating procedures of Binders
particularly in the Lloyds Market.
Do both open covers and brokers binders create an agency agreement between the giver of the risk and the
(re)insurer?
No.
The open cover is an agreement by the (re)insurer(s) to accept any risks, within the terms of the arrangement, IF they are
ceded.
The binding authority delegates power to the broker or other party to accept risks on behalf of the (re)insurerthus the
broker will be operating as an agent of the (re)insurer.
Lastly:
Line slip
Here it is necessary to remember the placing process mentioned abovethe broker obtaining a quotation from a recognised leader
(a specialist who is likely to be followed by others) who then, having received a firm order from the client, proceeds to visit other
reinsurers to complete the placement. In many situations the same or similar reinsurers will be seen on a regular basis for a particular
class or group of territories by a particular broker.
To save time and administration costs the broker might put together a line slip.
A line slip is an authority (known in the London Market as a facility) given in writing by a number of underwriters which enable the leading
underwriter(s) to agree to proposals for (re)insurance of risks within a prescribed class on behalf of all underwriters subscribing to the line slip
provided that the proposed (re)insurance is within the scope of the terms of the authority (Balfour v. Beaumont (1982) 2 Lloyds Rep. 493).
The base line slip contract would state that subject to the agreement of the leader (or maybe joint leaders) to accept an offered risk
(on a separate slip called an off slip) the following market would automatically be bound for pre-agreed shares.
Words such as the following might be used:
This Line Slip authorises the leading underwriter Mx xxx of ABC Insurances (and ) to bind (re)insurances emanating from
xxxxxxxx Brokers Ltd of xxx,xxx, xxx.in respect of the following classes of business:
xxxx
xxxx
Excluding;
xxxx
xxxx
xxxx
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which shall be binding on all other underwriters hereon following the agreement of the leading underwriter.
In this version of a facility following (re)insurers are relying on the expertise of the leader(s). The following market would
normally receive a schedule of the risks accepted, on a regular basis. Line slips and the declarations under them were brought within
the LMP mandate in summer 2005.
Three specific legal points need to be considered with regard to contracts such as line slips:
What is the legal relationship between the leader and the following market?Is the line slip a contract of
(re)insurance?When are the (re)insurers on riskfrom date of acceptance of the line slip or the date of
Robert Merkin
1st Edition, 2007
acceptance of the off-slip?The leader and a line slip?

A line slip is seen as the following market delegating authority to the leader, creating an agency relationship.
Contract of (re)insurance?
A line slip is seen to be a contract for (re)insurance (IF risks are accepted by the leader they are automatically covered) NOT a
contract of (Re)insurance. This subtle difference means that it probably becomes an ordinary contract in law (buyer beware) and
not a contract of utmost good faith (HIH Casualty and General Ltd v. Chase Manhattan Bank and others [2001] Lloyds Rep. I.R.
191).
The rules of UGF would apply to the offering of the individual risks to the leader(s) but not (in general) to the original line slip
when it was being placed, although there would still be a common law need to disclose unusual features of the transaction.
When are the reinsurers on risk?

When the off-slip is signed by the leading underwriter(s) not when the line slip is accepted (Denby v. English and Scottish
Maritime Ins, The Times, 16 March 1998).
Underwriting agencies/pools
These arrangements which grant power to underwriters to put down their lines on behalf of other (re)insurers should not be confused
with line slips. Here an underwriter makes acceptances on behalf of pool or underwriting agency members. Under a line slip, the
leader or leaders are taking shares for themselves and for other participants on the line slip.
Facultativewhat is wrong with it?

Facultative has the advantage for both parties of being optional, but also some very major disadvantages
-- very high administrationparticularly proportional
-- placement not certain (no automatic cover)
In the mid 1800s the concept for the proportional treaty was developed to overcome these problems.
PROPORTIONAL TREATY
There are three differing types of contract, each with their own peculiarities and purposes:
Quota share
Surplus
Facultative obligatory
The first two could be described as obligatory contractsthe reinsured must (within the terms of the treaty) reinsure applicable
risks, and the reinsurer(s) must (within the terms of the treaty) accept them.
The thirdthe facultative obligatory treatyis a different variation. The reinsured does not have to reinsure any risk but the
reinsurer(s) must (within the terms of the contract/treaty) accept them if they are ceded (see the comments above regarding the open
cover). This variation will be looked at last.
Although anything is possible!, proportional treaties tend to protect specific classes or departments of business, e.g.
in respect of all risks allocated to the reinsureds xxx and yyy accounts, excluding zzz
Quota share treaty

A fixed percentage of each risk (subject to a maximum monetary amount per risk) is automatically reinsured as soon as the insurer
accepts the insurance or part of it.
e.g.
Retention 70%
Reinsuring 30%
This would be called a 30% Quota Share Treaty.
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The percentage being reinsured is always the amount used to describe the treaty.
i.e.
Retain 10% = Cede 90% = a 90% Quota Share Treaty

Retain 60% = Cede 40% = a 40% Quota Share Treaty
Fairly obviously reinsurers are not going to take X% of every risk without some form of overall monetary limit per risk.
An example
The reinsured has decided it wants to retain 70% of every risk (within a particular class) but NOT more than 175,000 per risk
Reinsurers have agreed to take a maximum of 30% of every risk but NOT exceeding (for their share) 75,000 per risk.
Robert Merkin
1st Edition, 2007
This produces what would be described as a 30% Quota Share Treaty.

Maximum Limit for 100% Q/S 250,000 per risk
-- Maximum Limit for Q/S reinsurers 75,000 per risk (30% of 250,000)
-- Maximum Limit for the reinsured 175,000 per risk (70% of 250,000)
How did the reinsured come to decide on this structure?
Firstly by deciding on a retention per risk of a maximum of 175,000 and then reviewing their risk profile to ascertain how much
automatic reinsurance per risk is needed in additionassuming it was practical to place the amount sought.
Retention
The decision on the retention per risk is one of the core decisions in reinsurance. Until the reinsured knows what it can afford to keep
on a risk it cannot decide on its reinsurance needs or design its reinsurance programme.
What factors might have been taken into account in coming to the decision to retain 175,000 per risk?
The calculation of a retention is not a precise science, numerous factors can be taken into account. It usually ends up as a compromise
between;
-- Total capital and free reserves
-- Premium volume in the class/classes being considered
-- Management attitude towards risk
-- Reinsurers attitude (whether within a hard market, softening market)
-- Territory/location
-- Class/quality
-- Regulation
-- Priceterms of reinsurance
It is possible that price, management attitude and reinsurers attitude would be at the forefront of any decision.
For a more detailed view, see swissre.com: Designing a Reinsurance Programmea practical approach.
Graded retentions
Although it is quite common in some markets for insurers to keep a fixed retention on every risk within a class, in many cases
reinsureds vary their retention. This decision might in property for example be based on:
Type of risk within the class
The quality of the risk itself
-- whether the risk itself is good, average, poor
The location of the risk
-- inner city
The ability to change retention depending on varying factors such as the above will help further smooth and balance the retained
portfolio and hopefully the retained results of insurers. The stronger and more diversified the business of the insurer, the less the need
for grading.
From a reinsurers perspective they ought to have a wider spread of risks than many insureds and assuming the base premiums
being charged by insurers are adequate, they can support the concept of graded retentions, if they wish to.
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Premium and claim calculations under a quota share treaty

If you understood the allocation of risk and premium for facultative proportional the Q/S is based on exactly the same set of
conceptseverything is based on the allocation of the risk between the parties
An example
Assuming a 30% Q/SMaximum cession for 100% Q/S 100,000

Risk sum insured
100,000
50,000
40,000
Robert Merkin
Cession (amount given) to treaty

30,000 (30% of 100,000)
15,000
12,000
1st Edition, 2007
20,000
6,000
How is the premium going to be split?

30% of the risk to reinsurers, 30% of the premiums to reinsurers
SI
SI
SI
SI
100,000
50,000
40,000
20,000
Cession
Cession
Cession
Cession
Premium (100%)
500
300
400
200
30,000
15,000
12,000
6,000
To quota share
150
90
120
60
Reinsurers are getting 30% of each risk and therefore 30% of the premium
BUTCommission
Although premium is paid pro-rata to the amount of risk being reinsured, the reinsurers agree to commission being deducted by the
reinsured before passing the premiums onto the reinsurers to help cover acquisition costs of the reinsured.
It is the reinsured who has the production and servicing costs of the original insurances NOT the reinsurers.
e.g. Commission 40%
30% quota share, commission40%

Premium (100%) To quota share
SI
SI
SI
SI
100,000
50,000
40,000
20,000
Cession
Cession
Cession
Cession
30,000
15,000
12,000
6,000
500
300
400
200
150
90
120
60
420
Less commission
40%
(60)
(36)
(48)
(24)
168
Thus if quarterly 420

account Premium
Less commission 168
252
In these examples reinsurers receive 30% of each risk, 30% of the premium for each riskless 40% commission and will pay 30% of
any loss under the policies ceded.
Although it may seem simple to many of youif proportional is not totally clear to you take time out and work through the
example below based on a different set ot terms and sums insured.
60% Quota share, commission30%
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SI 90,000
SI 40,000
SI 20,000
SI 10,000
Premium (100%)
300
100
50
30
Cession
Cession
Cession
Cession
To Quota Share
Less Commission 30%
Thus if quarterly account

Premium
Less commission
60% Quota share, commission30%

SI 90,000
Robert Merkin
Cession
54,000
Premium (100%)
300
To quota share
180
Less commission 30%

(54)

SI 40,000
SI 20,000
SI 10,000
Cession
Cession
Cession
Thus if quarterly
account Premium
Less commission
288
24,000
12,000
6,000
1st Edition, 2007
100
50
30
60
30
18
288
(18)
(9)
(5.4)
86.4
(86.4)
201.6
To summarise: premium and claims allocations under all forms of proportional reinsurance are based around the size of the risk and
how it is allocated between reinsured and reinsurers not the size of the premium or any losses.
Quota sharethe contract

To understand the workings of a quota share treaty and to a great extent any of the types of pro-rata treaty a review of some of the
typical clauses making up a typical treaty wording follow.
Is there a particular order in drafting a contract wording?
No, different people will prepare wordings in a different order but the core content stays similar.
Should there be?
From a clarity viewpointyes. I would recommend a consistent house style whenever this is practical.
PREAMBLE
PURPOSE: To establish without any doubt the identities of the parties between whom the Agreement is made and in this example
emphasise the fact that all reinsurers have several (separate) liability
QUOTA SHARE REINSURANCE AGREEMENT between ABC INSURANCE COMPANY LIMITED of London, England (hereinafter
called the Reinsured)
and
The Reinsurers whose names and proportions appear on the attached signing schedules each for its own part and not one for the
other (hereinafter called the Reinsurer).
It is important to remember that unless very specifically stated all participants have a separate (several) liability and that the
individual acceptances are all separate legal contracts with the reinsured even if all contained within one overall document. The words
of this preamble just emphasise this. See also the several liability clause in the signing schedule.
INTEREST CLAUSE
PURPOSE: To establish:
(1) the partnership basis of the Agreement by The Reinsured agrees to cede and reinsurer agrees to accept
(2) the percentage of each risk being ceded
(3) cover is for insurance risks only (not reinsurances) in this example
(4) cover is for all business written in the Fire Departmentsubject to exclusions
(5) the territorial scope is Ruritania only
(6) what perils are covered
(7) the limit of liability under this Agreement per risk
(8) the retention of the reinsured
(9) what constitutes any one risk
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The Reinsured agrees to cede and the Reinsurer agrees to accept by way of reinsurance a fixed proportion of 50% of all insurances accepted or
renewed by the Reinsured in its Fire Department on risks situated in Ruritania against direct and/or indirect and/or consequential loss by Fire and/or
any other peril covered by the Reinsuredsubject to any specific exclusions in Article XXup to a limit of x,xxx,xxx per insurance for the 50% ceded.
The Reinsured agrees to retain for its own account the balance of 50%.
The Reinsured shall be the sole judge as to what constitutes any one risk.
Robert Merkin
1st Edition, 2007
The reinsured agrees to retain for its own account the balance of 50% of all business. Can they buy any other
reinsurances?
Almost certainly they can NOT reduce their share down by further proportional reinsurance but would be able to place Risk X/L
protecting the retention against unexpected larger individual losses and protect the accumulation of losses by Catastrophe X/L. If the
reinsurer wants this retention to be totally unreinsured they should make this very clear (Great Atlantic v. Home (1981) 2 L.R. 219).
FOLLOW THE FORTUNES
(1) that once the reinsured has written a risk they have the protection of this agreement
(2) a maximum policy period any cession
(3) the partnership basis of this Agreement by stating this agreement shall follow the same terms and conditions as are set on
the original insurance
This does not incorporate things that are not germain to the reinsurance (AIG v. The Ethneki (2000) L.R. 243), e.g. Law,
Jurisdiction, Arbitrationsee Chapters 9 and 10
(4) reinsurers will follow the settlements provided they are within the terms of this reinsuranceThis probably does not
cover ex-gratia settlements unless specifically mentioned in the clausesee Chapter 7.
The liability of the Reinsurer shall commence simultaneously with that of the Reinsured.
Each cession will be of no longer duration than 12 months plus odd time, not exceeding 18 months in all.
This Agreement shall be on the same terms, clauses and conditions as original and shall follow the settlements and/or agreements of the Reinsured in
all respects provided they are within the terms and conditions of this Agreement.
PERIOD
PURPOSE: To:
(1) confirm the continuous nature of this agreement
(2) establish the period of the agreement
(3) set out the notice period required for cancellation
(4) set out what action should be taken in the event of notice being given
(5) make clear under what circumstances either of the parties can terminate this agreement, and IF special notice is invoked
what happens to the risks already written.
This agreement comes into force 1 January xxxx, at 00.00am local standard time and applies to all business attaching on or after that date. It is
concluded for an indefinite period but either party may terminate it by giving 3 months notice in writing to the other party at each anniversary date;
the anniversary date shall be regarded as 31 December of any year.
During the term of a notice to terminate, and until its expiry the Reinsured shall renew existing cessions and take new risks in the same manner and in
all respect as if no such notice has been given.
Special cancellation
Either party shall have the right to terminate this Agreement immediately if:
All notice of termination in accordance with any of the provisions of this Article shall be deemed to be served upon despatch or, where
communications between the parties are interrupted, upon attempted despatch.
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In the event of this Agreement being terminated in accordance with this Article the liability of the Reinsurer under current cessions at the date of
termination shall continue in full force until their natural expiry.
SECURITY DOWNGRADE CLAUSE

A comparatively new and topical addition to many contracts. What follows is one of a number of variations of this clause that have
appeared recently. It would normally appear as part of the cancellation clause above within the special cancellation section.
If, in respect of any reinsurer hereon:
(i) the reinsurer ceases underwriting operations completely or withdraws from underwriting the class of business to which it
Robert Merkin
1st Edition, 2007
has designated this reinsurance; or

(ii) the reinsurers security rating from Standard & Poors (or any future agency employed by the reinsured for the purpose
of reinsurance security rating) is downgraded to BBB+ or below (or equivalent from any future agency, as determined by
the Reinsured)
the reinsured shall have sole option to cancel this agreement immediately by giving notice in respect of the participation of such reinsurer.
In the event of this agreement being terminated in accordance with this Article the liability of the reinsurer under current cessions at the date of
termination shall continue in full force until their natural expiry.
It is agreed that the reinsured shall have sole discretion in assessing the above and in invoking the provisions of this clause.
Whether this clause or variations of it are legally strong or clear is a different issueit is possible the answer is no.
EXCLUSIONS
PURPOSE: To establish what is not covered by this agreement remembering this is proportional reinsurance and meant to be a
contract based on sharing risks, acquisition costs, premiums, losses, etc.
Core exclusions are likely to fall into three broad categories:
(1) Those relating to territory
(2) Those relating to peril
(3) Those relating to class
and then detailed specifics within some, e.g. those relating to war, terrorism, nuclear, etc.
Will include a variation of the following:
Notwithstanding anything contained herein to the contrary, this Agreement excludes:
(A) War, invasion, act of foreign enemy, hostilities or warlike operations (whether war be declared or not), civil war
(B) Mutiny, civil commotion assuming the proportions of or amounting to popular rising, insurrection, rebellion, military or
usurped power, or any act of any person or persons acting on behalf of or in connection with any organisation the object
of which are to include the overthrowing or influencing of any de jure or de facto Government by terrorism or by any
violent means.
(C) Nuclear Energy Risks Exclusion Clause (Reinsurance) (1994)
(WORLDWIDE EXCLUDING USA & CANADA)
This Agreement shall exclude Nuclear Energy Risks whether such risks are written directly and/or by way of reinsurance and/or via Pools and/or
Associations
For the purpose of this Agreement Nuclear Energy Risks shall mean all first party and/or third party insurances or reinsurances (other than Workers
Compensation and Employers Liability) in respect of:
(I) All Property on the site of a nuclear power station. Nuclear Reactors, reactor buildings and plant and equipment therein
on any site other than a nuclear power station.
(II) All Property, on any site (including but not limited to the sites referred to in (I) above) used or having been used for
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(a) The generation of nuclear energy, or

(b) The Production, Use or Storage of Nuclear Material
(III) Any other Property eligible for insurance by the relevant local Nuclear Insurance Pool and/or Association but only to
the extent of the requirements of that local Pool and/or Association
(IV) The supply of goods and services to any of the sites, described in (I) to (II) above, unless such insurances or
reinsurances shall exclude the perils of irradiation and contamination by Nuclear Material.
Except as undernoted, Nuclear Energy Risks shall not include:
(i) Any insurance or reinsurance in respect of the construction or erection or installation or replacement or repair or
maintenance or decommissioning of Property as described in (I) to (III) above (including contractors plans and
equipment).
(ii) Any Machinery Breakdown or other Engineering insurance or reinsurance not coming within the scope of (i) above.
Provided always that such insurance or reinsurance shall exclude the perils of irradiation and contamination by Nuclear Material.
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1st Edition, 2007
However, the above exemptions shall not extend to:
(1) The provision of any insurance or reinsurance whatsoever in respect of:

(a) Nuclear Material
(b) Any Property in the High Radioactivity Zone or Area of any Nuclear Installation as from the introduction of Nuclear
Material orreactor installationsas from fuel loading or first criticality where so agreed with the relevant local Nuclear
Insurance Pool and/or Association.
(2) The provision of any insurance or reinsurance for the undernoted perils:
-- Fire, lightning, explosion;
-- Earthquake;
-- Aircraft and other aerial devices or articles dropped therefrom;
-- Irradiation and radioactive contamination;
-- Any other peril insured by the relevant local Nuclear Insurance Pool and/or Association;
in respect of any other Property not specified in (I) above which directly involves the Production, Use or Storage of Nuclear Material as from the
introduction of Nuclear Material into such Property.
Definitions
Nuclear Material means:
(i) Nuclear fuel, other than natural uranium and depleted uranium, capable of producing energy by a self-sustaining chain
process of nuclear fission outside a Nuclear Reactor, either alone or in combination with some other material,
and
(ii) Radioactive Products or Waste

Radioactive Products or Waste means any radioactive material produced in, or any material made radioactive by exposure to the radiation
incidental to the production or utilisation of nuclear fuel, but does not include radioisotopes which have reached the final stage of fabrication so as to
be usable for any scientific, medical, agricultural, commercial or industrial purpose.
Nuclear Installation means:
(i) Any Nuclear Reactor;

(ii) Any factory using nuclear fuel for the production of Nuclear Material, or any factory for the processing of Nuclear
Material, including any factory for the reprocessing of irradiated nuclear fuel; and
(iii) Any facility where Nuclear Material is stored, other than storage incidental to the carriage of such material.
Nuclear Reactor means any structure containing nuclear fuel in such an arrangement that a self-sustaining chain process of nuclear fission can
occur therein without an additional source of neutrons.
Production, Use or Storage of Nuclear Material means the production, manufacture, enrichment, conditioning, processing, reprocessing, use,
storage, handling and disposal of Nuclear Material.
Property shall mean all land, buildings, structures, plant, equipment, vehicles, contents (including but not limited to liquids and gases) and all
material of whatever description whether fixed or not.
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High Radioactivity Zone or Area means:
(i) or nuclear power stations and Nuclear Reactors, the vessel or structure which immediately contains the core (including
its supports and shrouding) and all the contents thereof, the fuel elements, the control rods and irradiated fuel store;
and
(ii) or non-reactor Nuclear Installations, any area where the level of radioactivity requires the provision of a biological
shield. Also likely to have exclusions for Terrorism, Electronic Date Recognition.
UNDERWRITING POLICY
Robert Merkin
1st Edition, 2007
PURPOSE:
Having established a partnership with the reinsured, to make sure that the philosophy of the reinsured does not alter, e.g. Graded
Retention tables.
The Reinsured undertakes not to introduce, without the prior approval of the Reinsurer, any change in its established acceptance and underwriting
policy of those insurances to which this Agreement relates.
ERRORS AND OMISSIONS

Paragraph 1
PURPOSE: To ensure; that neither party is disadvantaged by an inadvertent error or omission of the other party (i.e. forget to cede a
risk) providing that no greater liability shall be imposed on the Reinsurer and that the clause shall not override any specific terms and
conditions contained in the Agreement.
Any delay error or omission on the part of the Reinsured in rendering any account or furnishing any advices or making any entry in the Reinsurance
Memoranda or notifying any claim or giving any information which ought under the provisions of this Agreement to be given to the Reinsurer shall not
invalidate any reinsurance hereunder or release the Reinsurer from any obligation hereby imposed on it. It is however understood that any delay error
or omission shall be corrected immediately upon discovery.
Paragraph 2
PURPOSE: To re-emphasise the partnership which exists between the parties.
It is agreed that for all things coming within the scope of this Agreement the Reinsurer shall follow, to the extent of its interest, the fortunes of the
Reinsured.
Do you think this clause allows the core purpose of the contract to be changed because of a mistake?
In law it is very clear that this clause is seen to be in place to deal with minor matters and NOT to allow the core purpose of the
contract to be changed because of a mistake (Pan Atlantic Insurance v. Pine Top Insurance [1993] 1 Lloyds Rep. 496 (C.A.); 2
Lloyds Rep. 427 (H.L.)).
PREMIUM AND COMMISSION
-- how the consideration for the contract (premium) shall be calculated.
-- what is the basis of the premium (in this case Original Net PremiumONP)
-- on what the commission is based.
To confirm:
-- the proportional nature of the contract
OGPONP
Whether reinsurers are to receive their proportionate share of the original insurance premium (OGPoriginal gross premium) or after
someone has deducted something e.g. local agency commission (ONPoriginal net premium), this must be made clear. It is a very
important part of any proportional Treaty.
The Company shall pay to the Reinsurer the latters proportion of the Original Net Premium which shall be defined as Gross Premiums received less
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local brokeragenot exceeding 10%received by the Reinsured in respect of all cessions made under this Agreement.
The Reinsurer shall allow to the Reinsured a further commission of xx% computed on the Reinsureds share of the Original Net Premium (sometimes
referred to as Over-riding Commission).
ACCOUNTS
-- when the accounts are to be rendered
-- when balances due are to be paid
-- how often the accounts are to be prepared
Robert Merkin
1st Edition, 2007
The Reinsured shall render accounts quarterly as at 31 March,

30 June, 30 September and 31 December in each year,
within 45 days after the close of each quarter.
What do you think of this clause?

A very bad example?
Perhaps should be tighter?
No references to when balances to be paid by either party
-- with the accounts (balances due to reinsurers)?
-- within X days of receipt (where balances due from reinsurers)
No reference to penalties if not complied with? (NB: Normally there are none.)
A better version perhaps:
(a) The accounts between the Reinsured and the Reinsurer in respect of the business under this Agreement shall be closed as
stated in the Schedule and rendered by the Reinsured as soon as possible thereafter but in any event not later than two
months after the end of the stated period.
(b) Accounts shall be confirmed by the Reinsurer within one month of receipt but inadvertent errors and/or omissions in the
accounts shall not delay the payment of any balance due hereunder unless such errors and/or omissions have a major
effect on the remittable balance. Any necessary correction shall be made in the next account rendered hereunder except in
those cases where the error and/or omission has a major effect on the remittable balance necessitating an immediate
adjustment.
(c) Balances due to the Reinsurer shall be paid by the Reinsured at the same time as the accounts are rendered and balances
due by the Reinsurer shall be paid at the time of confirmation by the Reinsurer.
Perhaps also adding in the following
OVERDUE BALANCES
Any amounts outstanding after the date on which settlement is due should be subject to the payment of interest by the debtor. Interest shall be
calculated at the rate stated in the Schedule and remain payable until the date upon which payment is received by the creditor.
RATES OF EXCHANGE CLAUSE

(sometimes called Currency Conversion Clause)
PURPOSE: To specify:
If risks are from various countries and premiums/claims in differing currencieshow to account to reinsurers.
For the purpose of this Agreement currencies other than the currency in which this Agreement is written shall be converted into such currency at the
rates of exchange used in the Reinsureds books or where there is a specific remittance for a loss settlement at the rates of exchange used in making
such remittance.
NB: When considering non-proportional later do not confuse the purpose of this clause with the currency fluctuation clause
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PROFIT COMMISSION
In many cases, if the treaty has made a profit as far as reinsurers are concerned, reinsurers are willing to allow the reinsured
further commission to encourage good resultsthis clause explains the basis of calculation.
As this is to calculate whether reinsurers have made a profit, an item called reinsurers expenses or management expenses is
specified to be included in the debit side of the calculation. Its purpose, to ensure that reinsurers only pay a profit commission after a
deduction has been made to help cover their own acquisition costs.
-- on what basis a profit commission is payable by reinsurers
-- when any profit commission is payable
Robert Merkin
1st Edition, 2007
-- what items are to be taken into account

-- the amount of reinsurers management expenses provision
-- the deficit carry forward provision
This clause explains in detail the calculations of additional commission that reinsurers are willing to give after taking into account 3
negotiable factors.
(a) The amount of profit commission payable
(b) The amount of reinsurers expenses
-- in this case 5% of written premium is added to the OUTGO to cover some of the costs of the reinsurer in accepting the
business (it is an accounts functionno one receives it!).
(c) The deficit if any from previous years calculationsin this case any deficit shall not be carried forward for more than
three years
In this particular contract the Treaty is on a clean cut basis meaning that each year can be closed off at the end of the
yeartherefore the reference to portfolios (see the next clause).
In addition to the Commission provided for in this agreement the Reinsurer shall allow the Reinsured a Profit Commission of 20% on the actual net
profit for each year. Such Profit Commission shall be calculated as at the 31 December in accordance with the following formula:
INCOME
(a) Original Net Premiums ceded to the treaty
(b) Credit of an amount equivalent to the Premium and Loss Portfolios as specified in this wording
OUTGO
(a) Debit of an amount equivalent to the Premium and Loss Portfolios as specified in this wording
(b) X% Commission calculated on item (a) of INCOME
(c) Losses paid and expenses incurred less salvages and recoveries received
(d) 5% for Reinsurers Management Expenses calculated on item (a) of INCOME
(e) Deficit, if any, brought forward from the previous year or years
The balance of the statement shall be the profit on which the Profit Commission is calculated.
Any Profit Commission due to the Reinsured shall be taken into account in the settlement of the next Quarterly balances rendered.
In the event of the Profit Commission statement showing a deficit to the Reinsurer by reason of the OUTGO exceeding the INCOME then the
total of such deficit shall be added to the OUTGO of the Profit Commission statement for the ensuing Year or Years (as the case may be) and no
Profit Commission shall become payable to the Reinsured in respect of such ensuing year or years unless and until the previous deficit has been
recovered and a net profit re-established provided however, that the deficit of any one year shall not be carried forward into the Profit Commission
statement of more than three subsequent years.
In the event of termination of this Agreement the final Profit Commission statement shall be rendered after all liability has elapsed.
PORTFOLIO CLAUSE
Premium and loss portfolios
A method of transferring un-expired liability (premium portfolio) and outstanding losses (loss portfolio) from one year to the next
thereby alleviating large administration costs.
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If left on an underwriting year basis (e.g. marine cargo) where all premiums and all claims on policies issued during the treaty
year go back to the reinsurers of that year there is substantially higher administration and the higher possibility of Security Failures.
For example marine cargoon an underwriting year basis:
Year 1 4 quarterly accountsYear 1
Year 2 4 a/csYear 1 + 4 a/cs Year 2
Year 3 4 a/csYear 1 + 4 a/cs Year 2 + 4 /cs Year 3
Then an ever-growing number of accounts for perhaps up to 6 years or more.
Robert Merkin
1st Edition, 2007
PURPOSE:
making provision for portfolios
confirming method and amount
what action to take if materially unfair (in the opinion of the reinsured).
As soon as practical, but not later than 3 months after the start of the year Reinsurers will be credited with a Premium and Loss portfolio as herein
provided
Credit 50% of the Net Premiums ceded, less Treaty Commission to cover the unexpired risk still current at 31st December of
the preceding year
Credit 90% of the Reinsurers share of all outstanding losses as at 31st December of the preceding year
Each Year will be closed at the end of the year and the portfolio transferred to the next year as herein provided.
As soon as practicable, but not later than 3 months after the end of the year, a portfolio account for the year in question shall be drawn up and
certified by the Reinsured and a copy thereof sent to the Reinsurer constituted in accordance with the following formula:
Debit 50% of the Net Premiums ceded, less Treaty Commission to cover the unexpired risk still current at 31st December
Debit 90% of the Reinsurers share of all outstanding losses as at 31st December.
In the event of any material alteration which in the opinion of the Reinsured renders any transfer in accordance with this ARTICLE inequitable
between one year and another, the Reinsured will effect an appropriate adjustment.
CLAIMS SETTLEMENT CLAUSECASH LOSSPLA

-- how losses will be handled by the reinsured
-- what involvement or not reinsurers have in loss settlement decisions
-- size of cash loss limit
-- size of preliminary loss advice limit
Claims settlement clause
The Reinsured at its sole discretion and without any right on the part of the Reinsurer to interfere, shall adjust, settle or compromise all claims and
losses. Every such adjustment, settlement and compromise, including ex gratia with reinsurers prior consent, shall be binding on the Reinsurer.
The Reinsured shall likewise, at its sole discretion, commence, continue, defend, compromise, settle or withdraw from actions, suits or prosecutions,
and generally do all such matters and things relating to any claims or losses as in its judgement may be beneficial or expedient, and all payments
made and costs and expenses incurred in connection therewith shall be shared by the Reinsurer in proportion to its liability for the claim or loss. Any
share of expenses in connection with the settlement of claims shall not include expenses and salaries of employees or office/expenses of the company.
The reinsurer on the other hand shall be entitled to share in all recoveries of salvage or otherwise.
If, however, there was no loss in the end at all, just costs, possibly another sentence could be added:
In the event of there only being costs in respect of the investigation and/or defence of a claim that would have fallen under the reinsurance, reinsurers
agree to pay their proportionate share based on the cession of the original risk to the Treaty.
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Cash loss provision

It is quite possible that there can be a long delay between the occurrence of a major loss to the reinsuredperhaps at the start of the
quarter and rendition of the accounts and receipt of funds from reinsurers well after the end of the quarterthis clause is intended to
help speed up the processwhether it is strong enough and actually has the necessary effect is a different topic and outside the scope
of this course.
All loss settlements shall be debited in account but where a loss falling under this Agreement attains or exceeds the sum of xxx,xxx in respect of any
one loss, the Reinsurer shall pay its share to the Reinsured within 14 days of application.
Preliminary loss advice(PLA)

If reinsurers are accepting this treaty without bordereaux they will not be aware of any larger losses within the quarterly accounts,
unless requested under a cash loss.
Robert Merkin
1st Edition, 2007
This clause ensures that reinsurers are aware of major losses.

The Reinsured shall advise the Reinsurer as soon as possible after receiving notice thereof of any claim which is estimated to attain or exceed xxx,xxx
to the Treaty.
RESERVE DEPOSITS
Premium Reserve Depositsthe reinsured retaining a % of premiums from the quarterly A/C and releasing this amount at a later date plus a
pre-agreed amount of interest.
Loss Reserve Depositsthe reinsurers funding the reinsureds outstanding losses.
Both may be sought by a reinsured as a security reservein most cases they are only likely to be given where it is a legal
requirement in the reinsureds country of domicile
NB: In the US, for example, an irrevocable letter of credit might replace the loss reserve deposit.
OFFSET CLAUSE
PURPOSE: To establish the right to deduct from any payment due to the other party any amounts owed to them by the other party.
A difficult clause to implement if it includes the words underlined as it can be very hard to implement on other agreements which
may be direct (not through a broker) or through another broker and are definitely separate legal contracts.
Either party may at its discretion offset against any amounts advised to and due from the other party hereunder any amounts which have been
previously advised and are due at that time under this or other Agreements.
Clauses common to both proportional and non-proportional

The following clauses or variations of them are going to be found in all the variations of treaty reinsurancewhether proportional or
non-proportional so they will only be presented once unless there are specific reasons for including elsewhere.
INSPECTION OF RECORDS CLAUSE
PURPOSE: To make clear:
the reinsurers rights to investigate the business being ceded under this agreement
when the rights can be taken
what can they see
for how long they have the rights
who will pay for the copying
The Reinsurer or their representatives may at any time during normal office hours, inspect and take copies of the Reinsureds records and documents
which relate to business covered under this Agreement. It is agreed that the Reinsurers right of inspection shall continue as long as either party has a
claim against the other arising out of this Agreement.
Many versions of this clause also deal with the issue of costs involved in such situations and the said representatives may arrange
for copies to be made at the Reinsurers expense of any of the records containing such information as they may require and be
entitled to.
AMENDMENTS AND ALTERATIONS
PURPOSE: To create the means whereby any amendment to the Agreement may be made without having to cancel and replace the
entire wording.
The terms of this Agreement may at any time be altered by mutual consent of the parties hereto and evidenced by Addendum signed by a responsible
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official of each of the parties hereto or by correspondence between responsible officials of the parties hereto. Such Addendum or correspondence shall
be deemed to be an integral part of this Agreement.
NB: Would recommend that one should always use addenda (and perhaps reflect this in the wording)letters get lost and are not
numbered!
INTERMEDIARY
PURPOSE: To define the role of the broker where there is one despite the broker not being party to the contract.
Although the broker is not a party to the contract the broker will be mentioned in the contract to clarify their responsibilities.
Getaline Insurance Brokers Limited of are hereby recognised as the intermediary negotiating this Agreement for all business hereunder. All
Robert Merkin
1st Edition, 2007
communications (including but not limited to notices, statements, premiums, return premiums, commissions, taxes, losses, loss adjustments, expenses,
salvages and loss settlements) relating thereto shall be transmitted to the Reinsured or the Reinsurer through Getaline Insurance Brokers Limited.
Certain intermediary clausesparticularly those involving U.S. domiciled brokersare likely to have the following paragraph
inserted:
Payment by the Reinsured to the intermediary shall be deemed to constitute payment to the Reinsurer. Payment by the Reinsurer to the intermediary
shall be deemed only to constitute payment to the Reinsured to the extent that such payments are actually received by the Reinsured.
This section of the clause was introduced following a major collapse of a broker in the 1970s (Pritchard and Baird) and the
requirements of NAIC (National Association of Insurance Commissioners) to seek protection for domestic insurers.
LAW AND JURISDICTION
This very important area has been overlooked particularly in facultative and is now a specific field in the LMP slip.
PURPOSE: To establish the laws under which any disagreement about the functioning of this agreement should be conducted and
what jurisdiction can hear the case
The original policies underwritten by the Reinsured shall be based on English Law and Jurisdiction.
A clause that the author finds is misunderstood surprisingly regularly. The clause in this section is to do wth interpretation and
disagreements over the contract between the (re)insured and (re)insurers. It has nothing to do with coverage given under the cover as
such. Lloyds Memos Y3327 and Y3406 specifically refer to this area.
What do you think of the above clause? Does it protect all the parties?
It only deals with a specific insurance issue. It makes no reference to the basis of law and jurisdiction in the reinsurance! (It is a
local jurisdiction clause.)
A more comprehensive clause might be along the following lines;
This Agreement shall be subject to the jurisdiction of the High Court of Justice or its equivalent in the country specified in Item xx of the Schedule
which shall apply the laws of the country specified in Item xx of the Schedule as the proper law of this Agreement.
The issues of law and jurisdiction will be dealt with in Chapter 9for now it should be noted that unless a clause is (a) included
(b) included in a strong and clear specific manner it is not certain that the law and jurisdiction wanted by one party or the other will
necessarily be achieved.
Perhaps a better version of the clause clarifying how both the reinsurance contract and the underlying risks are to be handled with
regard to proper law might read like thisif this is what is wanted by the parties.
This reinsurance shall be governed by and construed according to English law. Any arbitration tribunal or other Forum, however, shall construe any
terms and conditions of the original insurance and any obligations deriving therefrom which are or become governed by some other law, rule,
practice or jurisdiction as having the same meaning and/or effect as has or would be given to them under such law, rule, practice or jurisdiction.
The inclusion of a proper law and jurisdiction clause may also influence how the following clause can be interpreted and
implemented in different jurisdictions.
ARBITRATION
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PURPOSE: To determine:
-- how any disputes between the parties should be handled
-- the methodology for the Arbitration
-- the location of the Arbitration
-- the proper law of the Arbitration
All matters in difference between the parties arising under, out of or in connection with this Agreement, including formation and validity, whether
arising during or after the period of this Agreement, shall be referred to an arbitration tribunal in the manner hereinafter set out.
Unless the parties appoint a sole arbitrator within 14 days of one receiving a written request from the other for arbitration, the claimant (the party
requesting arbitration) shall appoint his arbitrator and give written notice thereof to the respondent.
Robert Merkin
1st Edition, 2007
Within 30 days of receiving such notice the respondent shall appoint his arbitrator and give written notice thereof to the claimant, failing which the
claimant may apply to the appointer hereinafter named to nominate an arbitrator on behalf of the respondent.
Before they enter upon arbitration the two arbitrators shall appoint a third arbitrator. Should they fail to appoint a third arbitrator within 30 days of
the appointment of the respondents arbitrator then either of them or either of the parties may apply to the appointer for the appointment of the third
arbitrator.
The three arbitrators shall decide by majority. If no majority can be reached the verdict of the third arbitrator shall prevail.
The third arbitrator shall also act as Chairman of the Tribunal.
Unless the parties otherwise agree the arbitration tribunal shall consist of persons (including those who have retired) with not less than ten years
experience of insurance or reinsurance as persons engaged in the industry itself or as lawyers or other professional advisers.
The arbitration tribunal shall, so far as is permissible under the law and practice of the place of arbitration, have power to fix all procedural rules for
the holding of the arbitration including discretionary power to make orders as to any matters which it may consider proper in the circumstances of the
case with regard to pleadings, discovery, inspection of the documents, examination of witnesses and any other matter whatsoever relating to the
conduct of the arbitration and may receive and act upon such evidence whether oral or written strictly admissible or not as it shall in its discretion
think fit.
The appointer shall be the Chairman for the time being of ARIAS (UK) or if he is unavailable or it is inappropriate for him to act for any reason, such
person as may be nominated by the Committee of that ARIAS (UK). If for any reason such persons decline or are unable to act, then the appointer
shall be the judge of the appropriate Courts having jurisdiction at the place of arbitration.
All costs of the arbitration shall be determined by the arbitration tribunal who may, taking into account the law and practice of the place of
arbitration, direct to and by whom and in what manner they shall be paid.
The place of arbitration shall be xxxxxx, xxxxxxx.
The proper law of this Agreement shall be the law of xxxxxxxx.
The award of the arbitration tribunal shall be in writing and binding upon the parties who covenant to carry out the same.
SIGNING SCHEDULE
This wording will then be followed by a Signing Schedule. It is very common for the Signing Schedule to be headed with a Several
Liability Clause.
SEVERAL LIABILITY
PURPOSE: To (re)confirm: Each reinsurer is only liable for their proportion of any obligations under the contract NOT that of any
other reinsurer.
The subscribing Reinsurers obligations under contracts of reinsurance to which they subscribe are several and not joint and are limited solely to their
individual subscriptions.
The subscribing Reinsurers are not responsible for the subscription of any co-subscribing reinsurer who for any reason does not satisfy all or part of
its obligations.
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One of the compulsory fields in the LMP slip is reference to several liability.
Surplus treaty
The next form of proportional treaty reinsurancehow does it operate?
Whilst the Q/S treaty means giving away a share of every risk within the rules of the treaty, the surplus has a different purpose and
method of operation.
The surplus is providing automatic reinsurance for any risk that is surplus to the reinsureds retention. All smaller risks remain
retained 100%.
Here again the core decision is how much the reinsured can afford to keep on one riskbased on capital, management attitude,
reinsurers attitude, territory, location, price, etc.
Robert Merkin
1st Edition, 2007
Once this decision is made, a decision on the automatic capacity needed under the surplus can be made.
Treaty limit
Reinsurers limit the amount of capacity that they are willing to give to a multiple of what is retained and ensure there is a proportional
relationship between what is retained and ceded.
An example
Retention per risk 175,000
Seeking automatic capacity per risk up to a further 1,750,000
The treaty would be described as a 10 line surplus treaty (line means retention)
Retention
175,000
10 Line Surplus
Max limit 1,750,000
Automatically issue a policy for

1,925,000
(10 175,000 + 175,000)
A further decision would have to be made by the reinsured as to whether to seek reinsurers agreement to introducing graded
retentions as mentioned earlier (as the risk is seen to get worse by the underwriter as the retention decreases). By decreasing the
retention on a specific risk the amount of automatic reinsurance available under the surplus treaty decreases.
Retention
A 175,000
B 100,000
F 25,000
10 Line Surplus
Max limit 1,750,000
1,000,000
250,000
Automatically issue a policy for

1,925,000
1,100,000
275,000
How would you allocate the following risks?

Three risks Category B
Sum insured
(a) 100,000
(b) 800,000
(c) 2,000,000
Category B risk = Retention of 100,000
Retention
(a) 100,000
100%
(b) 100,000
12.5%
(c) 100,000
5%
10 Line Surplus
0
The balance?
0
700,000
87.5%
1,000,000
50%
0
900,000
45%
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As it is proportional reinsurance the allocation of the premium and any losses are based on the allocation of the risk itself as shown in
the percentages in italics above. In example (c) the reinsured has not got enough automatic treaty capacity. The reinsured is likely to
endeavour to try to place the balance as facultativein this example proportionally.
It is possible that if there are enough risks above the capacity of the first surplus to justify it that the reinsured might seek to place
another Treatya second surplus. If this was the case the picture would look slightly different.
Retention
100,000
100%
100,000
12.5%
100,000
Robert Merkin
10 Line Surplus
0
15 Line Second Surplus

0
700,000
87.5%
1,000,000
0
900,000

5%
1st Edition, 2007
50%
45%
The second surplus normally only picks up risks after a share has been placed with the first surplus as shown above.
In the example above a 10 line first surplus and a 15 line second has been used. Whether the reinsured can place a second surplus
and, if so, for how many lines, will be based on negotiations between reinsurers and reinsured.
Facultative obligatory
Before looking at any specific clauses applicable to a surplus we will finish looking at Proportional treaty by considering the
facultative obligatory treaty (Fac Oblig).
The way to understand this arrangement is to see its title as separate statements:
Facultativeoptional for reinsured
Obligatoryfor the reinsurer
Treatya contract for a period of time
The Fac Oblig normally sits after other proportional treaties. The main difference between the Fac Oblig and surplus is that
under the surplus the reinsured normally must cede (give) a cession to surplus reinsurers (as in both examples above) if the risk is
large enough. Under the Fac Oblig the reinsured can decide whether to cede nothing, something or a full amount. If a cession is
made, it must be accepted by reinsurers.
How might it work?

Sum insured 4,100,000
Retention
100,000
10 Line 1st S
1,000,000
20L 2nd S
2,000,000
10L Fac Oblig

1,000,000
Fac
0
10 Line 1st S
1,000,000
20L 2nd S
2,000,000
10L Fac Oblig

0
Fac
1,000,000
or
Retention
100,000
The reinsured could in fact cede any amount between 0 and 1,000,000 to Fac Oblig.
Can be unlined!
Under exceptional circumstances (a very soft treaty market) it might be possible to find Fac Obligs without mention of linejust a
treaty LimitIn this situation there is no relationship between the retention and how much can be reinsured under the contract, just a
maximum cession per risk.
For example, sum insured 1,155,000
Retention
5,000
10 Line 1st S
50,000
20L 2nd S
100,000
Fac Oblig
1,000,000
(Treaty limit)
Fac
0
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Do you have to have a retention to make cessions to the above treaties?

A retention is not inferred into a Fac Oblig (Phoenix General Ins Co. of Greece SA v. Halvanon Ins Co. Ltd [1985] 2 Lloyds Rep.
599) or any other proportional treaty. If the reinsurer expects there to be one, this should be made very clear at the time of placement.
In another case (Sail v. Farex (1995) L.R.L.R. 116) the Court of Appeal commented that if the reinsureds presentation is not clear it
is up to the reinsurer to ask whether a retention applies. However, where there is reference to line it is inferred that there is a
retention. Line = retention.
How would any premium or loss be allocated in the example immediately above?Sum insured 1,155,000
Based on the allocation of the sum insured
Sum insured 1,155,000
Retention
Robert Merkin
10 Line 1st S
20 Line 2nd S
Fac Oblig
1st Edition, 2007
5,000
50,000
100,000
0.43%
4.33%
8.66%
1,000,000
(Treaty Limit)
86.58%
CONTRACT DOCUMENTATION, FOR THE SURPLUS AND THE FACULTATIVE OBLIGATORY TREATY
All the clauses reviewed above under the Q/S would be found in a treaty wording for either surplus or Fac Oblig. The only clause that
would be different would be the reinsuring clauseexplaining how the treaty operates.
OTHER PROPORTIONAL ISSUES
Quota share as well as surplus?
Whilst it is common to have only a quota share or only surplus(es), it is possible to have a proportional treaty programme with both
quota share and surplus(es) in conjunction.
PML and pro-rata treaties?
Although the examples given above have been based on the sum insured (SI) of each riskif the reinsured operates on a PML
(probable maximum loss) or equivalent basis and reinsurers will agree, the treaties could be placed based on the reinsureds PML
assessments.
An example
Retention
1,000,000 PML
5 Line Surplus
5,000,000 PML
Risk SI 12,000,000
PML 25%
How would the risk, premium and any losses be allocated in this example?
First, reduce the SI down by the PML 12,000,000 25% = 3,000,000
Then, think proportional allocation of the risk PML = 3,000,000
Retention
1,000,000 PML
33.33%
5 Line Surplus
2,000,000 PML
66.67%
Premium and claims would be allocated 33.33%/66.67%.
But what if the PML is wrong?Loss of 6,000,000How is the loss allocated?

33.33%
2,000,000
66.67%
4,000,000
The loss would still be allocated based on the split of cession 33.33%66.67%the fact that the PML is wrong is just
unfortunatethe treaty was offered to reinsurers on a PML basis and they accepted it, knowing there could be PML failure.
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Some treaties now include specific clauses limiting reinsurers exposure if the PML failure is too great.
PML clause
(Limitation of liability where an estimated PML is exceeded)
(1) The reinsurance is based on the Probable Maximum Loss (PML). When fixing the PML of any risk the ceding company shall act as prudently and
carefully as possible.
(2) If in the case of a loss occurrence the PML forming the reinsurance basis for a specific risk proves to be too low, the additional liability of the
reinsurers shall be limited to a further 50% of the amount of the PML.
Robert Merkin
1st Edition, 2007
This provision shall not apply;
-- to losses caused by crashing aircraft

-- in case of concurrent arson in several, spatially separated areas within one risk
-- these are to be treated as separate loss occurrences under the clause
-- in cases where the PML is exceeded as a result of the estimate not having taken into account disaster-like events related
neither directly nor indirectly to the risk insured.
This provision shall override any other clause or condition of the treaty and, in particular, the errors and omissions clause.
AGGREGATE LIMITS UNDER PROPORTIONAL TREATIES

Another issue particularly in a hard market is where reinsurers impose overall limits in the event of a catastrophe. If no aggregate
limit is imposed:
Reinsurers receive a proportionate share of the premium of every risk
Reinsurers receive a share of every risk
Reinsurers would have to pay their share of any claim under policies ceded
-- giving a potential for unlimited liability any one event!
This has become a very topical issue again, since the 2004 Caribbean Hurricanes, Charley, Frances, Ivan and Jeanne.
An example of a clause showing how it might work is as follows:
IF THE TOTAL of the Earthquake Sums Insured ceded, as per the latest accumulation report due or as per the date of the loss if lower exceeds the
overall cession limit as specified in the Schedule then in the event of a loss all claims recoverable from the reinsurers shall be reduced in the relation
which the cession limit bears to the total of the earthquake sums insured ceded.
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A variation just imposes a maximum limit for any one event on the treaty.
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A GUIDE TO REINSURANCE LAW CHAPTER 1 THE NATURE OF REINSURANCE

1st Edition, 2007