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CHAPTER 1
INTRODUCTION TO REINSURANCE
INTRODUCTION
The term ‘Reinsurance, also termed as insurance of insurance’. Means
that an insurer who has assumed a large risk may arrange with another
insurer to insure a proportion of the insured risk. In other words, in the event
of loss, if it would be beyond the capacity of the insurer than this reinsurance
process is restored to. In reinsurance, therefore, one insurer insures the risk
which has been undertaken by another insurer. The original insurer who
transfers a part of the insurance contract is called the reinsured and the
second insurer is called the reinsurer. Of course the reinsurance has to pay
reinsurance premium for risk shifted. For example, a man wishing to insure
his premium for 10 lakhs goes to an insurance company, which will accept
the risk if it is satisfied as to the condition of the property. But if it its own
limit is probably Rs 5 lakhs, it will arrange with another company to reinsure
or to take up so much of the risk as exceeds its limits, i.e. Rs 5 lakhs, so that
if the house is burnt down the original insurer would pay the owner Rs 10
lakhs. But they would be recouped 5 lakhs, by the reinsurance offices.
To be effective, the reinsurance policy must be formulated after
carefully considering all aspects of the situation to which it is to be applied.
DEFINITION
Reinsurance is a transaction in which one insurer agrees, for a
premium, to indemnify another insurer against all are part of the loss that
insurer may sustain under its policy or policy or policies of insurance. The
company purchasing reinsurance is known as the ceding insurer: the
company selling reinsurance is known as the assuming insurer, or, more
simply, the reinsurer. Reinsurer can also be described as the “insurance of
insurance companies”
Reinsurance provides reimbursement to the ceding insurer for lasses
covered by the reinsurance agreement. It enhances the fundamental
objectives of insurance to spread the risk so that no single entity finds itself
saddled with a final burden beyond its ability to pay. Reinsurance can be
acquired directly from a reinsurance intermediary.
OBJECTIVES OF REINSURANCE
Insurer purchases reinsurance for essentially four reasons:
1) To limit liabilities on specific risks
4) To increase capacity.
1. Limiting liability:
By providing a mechanism in which companies limit loss exposure to
levels commensurate with net asset, reinsurance companies allows
insurance companies to offer coverage limits considerably higher then
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2. Stabilization:
Insurance often seeks to reduce the wide swing in profit and loss
margins inherent to the insurance business. These fluctuations result, in
part, from the unique nature of insurance, which involves pricing a
product whose actual cost will not be known until sometime in the future.
Though reinsurance, insurance can reduce these fluctuations in loss
experience, thus stabilizing the company overall operating result.
3. Catastrophe protection:
Reinsurance provides protection against catastrophe loss in much the
same way it helps stabilize an insurer’s loss experience. Insurer uses
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4. Increased capacity:
Capacity measures the rupee amount of risk an insurer can assume
based on its surplus and the nature of the business written. When an
insurance company issues a policy, the expenses associated with issuing
that policy-taxes, agents commissions, administrative expenses-are
changed immediately against the company’s income, resulting in a
decrease in surplus, while the premium collected must be set aside in an
unearned premium reserved to be recognized as income over a period of
time. While this accounting procedure allows for strong solvency
regulation, it ultimately leads to decreased capacity because the more
business an insurance company writes, the more expenses that must be
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REINSURANCE
paid from surplus, thus reducing the company’s ability to write additional
business.
PURPOSES OF REINSURANCE
"Reinsurance achieves to the utmost extent the technical ideal of
every branch of insurance, which is actually to effect
(1) The atomization,
(2) The distribution and
(3) The homogeneity of risk. Reinsurance is becoming more and
more the essential element of each of the related insurance
branches. It spreads risks so widely and effectively that even
the largest risk can be accommodated without unduly burdening
any individual."
Fundamentals
In the most widely accepted sense, reinsurance is understood to be
that practice where an original insurer, for a definite premium, contracts with
another insurer (or insurers) to carry a part or the whole of a risk assumed by
the original insurer. By insurers we mean all persons, partnerships,
corporations, associations, and societies, associations operating as Lloyd's,
inter-insurers or individual underwriters authorized by law to make contracts
of insurance. We may define insurance as an agreement by which one party,
for a consideration, promises to pay money or its equivalent, or to do an act
valuable to the insured, upon the happening of a certain event or upon the
destruction, loss or injury of something in which the other party has an
interest. The insurance business is the business of making and administering
contracts of insurance. Insurance contracts are of two types those which
engage merely to pay a sum of money on the happening of an event, or
merely to begin a series of payments on or after the happening of a certain
event, are contracts of investment. Contracts of insurance which engage to
pay money or its equivalent, or the doing of acts valuable to the insured,
upon destruction, loss or injury involving things, are contracts of indemnity.
And so, reinsurance may be second insurance of
(a) Contracts of investment and/or
(b) Contracts of indemnity.
There may exist, therefore, two types of insurance business,
depending upon which of these two organic contracts the business engages
to administer.
HISTORY OF REINSURANCE
Reinsurance has a rather illustrious history eating back 10 the
fourteenth century. Even though there is no authentic information of the
first reinsurance contract, it is widely recognized that Lombardians beggar
Develop the concept of reinsurance in circa 1200 AD and from whence the
concept of reinsurance took ground.
1200-1600 AD
The emergence of the reinsurance concept and its slow pace of
expansion was one of the remarkable features of this time. Marine business
was one of the earliest fields that recognized the need of reinsurance to
protect its business from the dangers and rakes of marine transport.
1600-1850AD
Though marine insurance nourished during this period in Europe, it
suffered a set back in UK, where it went largely unrecognized except when
the insurer became insolvent or went bankrupt or died. This ban lasted till
1864 and as such there was no recorded reinsurance business in England.
After the great fire of London in 1666, an interest to insure against fire suit
faced and regulators soon made modifications to reduce their losses. In the
year 1776 royal concession was granted to the Royal Chartered Fire
insurance Company of Copenhagen to undertake fire insurance one of the
earliest recorded fire reinsurance transactions place in 1813 when the Eagle
hire Insurance Company of New York assumed all of the outstanding rim
the Union Insurance Company, but it really executed, as the insurer did not
avail this facility and after this the earliest recorded fire insurance then
which was executed dates back to the year I821 between the National
Assurance Company, Paris, France and the assuming reinsurer the United
Proprietors of Belgium.
Validation of the reinsurance contract by the Supreme Court of New
York boosted a number o\ reinsurance contracts contracted. In l883 the
Supreme Court gave its consent in the case between New York Browery
Insurance Company, the cedent, and the New York Fire Insurance Company,
the reinsurer. This case acted as a catalyst for the emergence of reinsurance
companies and thus began a new era in the reinsurance sector and in \S4A
the current system of life reinsurance took seed. The first life treaty as such
dates back to 1858.
attract other enterprising persons. During the first three years of its business
life the Cologne Reinsurance Company extended its operations in Germany,
Austria, Switzerland, Belgium, Holland and France, and then tried to arrange
treaty contracts with English companies. It seems that domestic English
reinsurance business, at that time, was quite unprofitable to the reinsures and
the Manager of the Cologne was obliged to keep out Of the English market.
On June 24, 1853, a fire treaty was concluded between the Aachen and
Munchener Fire Insurance Company and its subsidiary, the Aachener
Reinsurance Company. This was an early example of a true "first surplus"
treaty under which the reinsurer was allotted one-tenth of every surplus risk,
with certain modifications in respect to various classes of risk enumerated in
the contract. It is interesting to note that the Aachen - Munchener Company
had an earlier arrangement with L' Urbaine, Paris.
CHAPTER 2
PRINCIPLES OF REINSURANCE
WHAT IS REINSURANCE?
When you look at the risks that insurers take on, it is not surprising
that they themselves might want to have insurance. When insurers insure a
risk again, it is called reinsurance.
with other reinsures so that the loss is not so severe for any one
insurer.
2) To avoid undue fluctuations in underwriting results. Insurers want to
ensure a balanced set of results each year without ‘peaks and troughs’.
They can therefore get reinsurance which will cover them against any
unusually large losses. This keeps a cap on the claims the insurer is
exposed to having to pay it.
3) To obtain an international spread of risk. This is important when a
want to insure a risk but are not able to do so their own. By using
reinsurance, the insurer is able to accept the risk by insuring the whole
risk and then reinsuring the part it cannot keep for itself to other
reinsures.
REINSURANCE IN INDIA
Reinsurance in India dated back to the 1960’s. After independence
there was rapid development of the insurance business. With various sectors
growing in the post independence era the need for reinsuring the
development work was also felt. Since reinsurance industry has negligible
presence in India after independence, the domestic requirement of
reinsurance was netted from mostly was foreign markets mainly British and
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Selection of Customers:
In the reinsurance industry business is acquired in two ways. One is
when a customer directly approaches the reinsurance for ceding their claims
and the other method is when the reinsurer gets their business from the
reinsurance broker appointed by he customer. In certain parts of the world,
reinsurance accepts business routed only through a reinsurance broker. The
important thing to be noted here is that it is not the quantum of business
generated by the reinsurer but the customer for whom they are undertaking
the business. Some go that extra mile by going to their business and
accordingly tailor their policies to fit their needs and business. The more the
reinsurance knows about the business nature of their clients, they can serve
them.
WHY REINSURANCE?
Risk managers and other buyers of insurance rarely think about how
reinsurance affects their company or the insurance they purchase for their
company. Insurance buyers mainly focus on the direct insurers – the
primary, excess, and umbrella carriers that provide the coverage. Smart
insurance buyers look for A--rated or better insurance companies with long
histories. Other buyers rely on their brokers to put together the best quality
insurance program with the best insurance security available. After all, the
insured must rely on the insurance policy issued by the direct insurer.
But what stands behind the A--rated carrier or the high quality
program for a complex risk? The answer is “Reinsurance”. Commercial
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FUNCTIONS OF REINSURANCE
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 $10 million in limits on any given policy, it can reinsure (or
cede) the amount of the limits in excess of $10 million.
Income smoothing
Surplus relief
Arbitrage
TYPES OF REINSURANCE:
1. Treaty reinsurance:
This kind of reinsurance requires that the reinsurer will assume part or
all of a ceding company’s responsibility for certain sections or classes of
business in accordance with the terms of the policy. It is an obligatory
contract as the ceding company has to cede the business and the reinsurer
is obliged to assume the business as per the treaty. It is the preferred type
of reinsurance when groups of homogenous risks are considered.
2. Facultative reinsurance:
A. PROPORTIONAL REINSURANCES:
a) Pro-rata reinsurance:
It is different in that not every risk is ceded but only those that exceed
certain predetermined amounts.
B. NON-PROPORTIONAL REINSURANCE:
a) Excess of loss:
These are the various types of reinsurances. There are firms that offer
their services as well as their products to help new business start up flourish
and succeed.
DOUBLE INSURANCE
OVER INSURANCE
When the amount for which a subject matter is insured is more than
its actual value it is called as over insurance. For over insurance, the only
criterion is the amount of insurance. It can even be with one insurer alone.
For Example:
1) EXTERNAL INSURANCE
2) INTERNAL INSURANCE
Physical damage:
As the new economy’s dominated by computer-base operations,
physical damage losses caused to computer and networks, damage caused
to the infrastructure of the c-commerce business due to power failures or
power surges leading to network or system failures, etc., will become
commonplace.
Business interruption:
These costs may include remediation costs and the addition of
hardware and software such as routers, firewalls and upgrade anti-virus
programs. A mere difficult coverage question arises when business
interruption leads to third party liability.
Privacy issues:
Among the e-commerce risks that have garnered significant publicity
are those concerning rights of privacy. These risks are similar to the
traditional risks inherent in the banking, financial services, and medical
industries. Because so much more personal and financial data is
collected today and stored electronically this issue has become the focal
point for market regulators, governments and also for consumer advocacy
groups.
Reinsures can expect to see third party liability claims arising out of
e-commerce and related websites risk in coming years. Medical, legal,
accounting, and financial services websites are just a few examples of
Internet sites distilling advice, displaying advertising, and encountering
negligence claims for erroneous information posted on the Sites.
Hackers:
E-commerce business activities require that key information and
business processes exist in digital |form and be accessible through web
portals and websites. Should the security of their servers be breached, these
insured and their customers and business partners could suffer significant
harm
Viruses:
With new kind of viruses hitting the www everyday, the potential
damage they can wreck on an e-commerce business is of significant level.
The damage of "I Love You" bug outbreak in 2000 has experts put it may
had caused a worldwide economic impact of $8.75 billion. I he mid-2001
"Code Red" attacks am estimated to have cost $2.62 billion worldwide.
Electronic & digital signatures:
The issues concerning electronic and distal signatures are no longer
whether they are valid or not nationwide, the real issue is what happens
when a hacker or an inquisitive minor forges a signature on an electronic
contract without authorization. Even though new solutions are being
developed to overcome the problem of digital signatures like developments
of Digital IDs, encryption, etc, reinsures should stay informed about any
litigation that may ensue from individuals or entities tampering with digital
signatures and the methods of proving authenticity.
CHAPTER 3
REINSURANCE UNDERWRITING
INTRODUCTION
• Reinsurance brokers
Domestic business has various advantages like low acquisition costs,
easy manageability etc and further it is free from ether complications like
adverse fluctuation of foreign exchange, economic instability of the country
etc. It suffers from the drawbacks of low volume and spread of business,
which is essential to build up a stable and profitable portfolio. Further, the
expertise and experience of the reinsures that are spread across the globe are
also denied in case of domestic business. Or the other hand, overseas
business has the advantages of wide geographical spread but the cost of
maintenance may be higher. Further, other complications like difference in
language, legal systems, market practices and exchange control regulations
may surface hence, a healthy balance of domestic and overseas business will
enable the reinsurer to develop a strong, stable and profitable portfolio.
Retrocession treaties among various reinsures could be a source of
underwriting international business with a balanced geographical spread.
But the company should closely watch for higher costs of acquisition and
low profitability. One possible solution to overcome these difficulties is to
develop business through intermediaries or brokers, subject to cost of
surplus amounts to retrocession Aires, for which it may make use of the
quota-share retrocession policy. For the protection of its net retained part an
excess loss cover would be useful. Need for reinsurance is paramount
because a company has to target the maximum amount of business in order
to ensure growth and achievement of its goals. However, while assuming
high amounts of risks it is possible for the growth to sustain large losses
which may have an impact on the capital reserves. To avoid this, an
insurance company has to necessarily go for reinsurance. Several obligatory
treaties can help achieve this requirement by providing automatic cover with
minimum exclusion. Ii is particularly useful for a new insurance company
with a low retention capacity. While arranging for reinsurance, a company
must concentrate on good security of the reinsurer. Good security amounts
to power of withstanding any large risk and not the offer of large
commissions and lower premium rates. Similarly, the reinsurer also judges
whether the cedent company is worth entering into a contract with.
Mutually, the two should decide upon the level of reinsurance arrangements
and the rates at which it is to be finalized.
RECIPROCAL BUSINESS
A company may seek reciprocal arrangement with another reinsurer
in order to have a spread of its business and also to maintain a large volume
of premium income, without affecting its solvency strengths. However a
totally reciprocal arrangement (100%) is not possible and the reinsurance
companies should aim at a mutually agreeable balance. For entering into
reciprocal business, a company should look for the following points.
fundamentally strong, should possess good business ethics, and should have
a good history of treaties. Besides, a thorough knowledge of the conditions
of the country in which a party in is operating, is absolutely essential.
CHAPTER 4
REINSURANCE REGULATION
INTRODUCTION
• Disclosure
• Security
Even Lloyd’s of London would have difficulty meeting its obligations. Due
to these natural disasters and the growing concern about reinsures’ financial
stability, the Financial Accounting Standards Board has tightened generally
accepted accounting principles (GAAP) for reinsurance transactions.
Following FASB’s lead, the National Association of Insurance
Commissioners developed new accounting guidance for reinsurance that was
based on the Standards Board’s action.
DISCLOSURE
In fact, the new part 1 requires, for each reinsured, that the following
disclosures be made:
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SECURITY
Under the law, if security is not deemed to exist, then a credit for
reinsurance against loss reserves is not allowed the ceding company. The
effect on the ceding company in the event that security is not seen to exist is
a charge against its surplus. Since surplus is the vital ingredient in an
insurer’s ability to write business, this is a significant issue.
(3) Every insurer shall cede such percentage of the sum assured on each
policy for different classes of insurance written in India to the Indian
reinsurer as may be specified by the Authority in accordance with the
provisions of Part IVA of the Insurance Act, 1938.
(4) The reinsurance Programme of every insurer shall commence from the
beginning of every financial year and every insurer shall submit to the
Authority, his reinsurance programmes for the forthcoming year, 45
days before the commencement of the financial year;
(7) Insurers shall place their reinsurance business outside India with only
those reinsures who have over a period of the past five years counting
from the year preceding for which the business has to be placed,
enjoyed a rating of at least BBB (with Standard & Poor) or equivalent
rating of any other international rating agency. Placements with other
reinsures shall require the approval of the Authority. Insurers may also
place reinsurances with Lloyd’s syndicates taking care to limit
placements with individual syndicates to such shares as are
commensurate with the capacity of the syndicate.
(8) The Indian Reinsurer shall organize domestic pools for reinsurance
surpluses in fire, marine hull and other classes in consultation with all
insurers on basis, limits and terms which are fair to all insurers and
assist in maintaining the retention of business within India as close to
the level achieved for the year 1999-2000 as possible. The
arrangements so made shall be submitted to the Authority within three
months of these regulations coming into force, for approval.
(9) Surplus over and above the domestic reinsurance arrangements class
wise can be placed by the insurer independently with any of the
reinsures complying with sub-regulation (7) subject to a limit of 10% of
the total reinsurance premium ceded outside India being placed with
any one reinsurer. Where it is necessary in respect of specialized
insurance to cede a share exceeding such limit to any particular
reinsurer, the insurer may seek the specific approval of the Authority
giving reasons for such cession.
(11) The Indian Reinsurer shall retrocede at least 50% of the obligatory
cessions received by it to the ceding insurers after protecting the
portfolio by suitable excess of loss covers. Such retrocession shall be
at original terms plus an over-riding commission to the Indian
Reinsurer not exceeding 2.5%. The retrocession to each ceding insurer
shall be in proportion to its cessions to the Indian Reinsurer.
CHAPTER 5
INTRODUCTION
Prior to nationalization, India had as many as 63 domestic companies
and 44 foreign insurers operating in the country. As soon as the
government nationalized the insurance industry, five insurance companies
were left to take care of the general insurance needs apart from LIC taking
care of health insurance. The General Insurance Corporation of India and
its four subsidiaries viz. National Insurance Co. Ltd., The New India
Assurance Co. Ltd., Oriental Insurance Co. Ltd. and United India
Insurance Co. Ltd. take care of the general insurance needs in the country.
Apart from these companies, certain state governments like Maharashtra,
Gujarat. Kerala and Karnataka have their own departments of insurance
funds i.e take care of insurance needs.
industry. Many countries in Africa, Asia, including India have opened state
reinsurance corporations.
The main principles behind the encouragement of domestic
reinsurance corporations are as follows:
• To avoid competition:
to their close proximity to each other. Some of the common features, which
make it viable for member countries to be in the RRC are:
1. The member countries have commercial boundaries.
identity.
Setting up an RR.C is no easy task, especially with many member
countries participating; each of them can have their own set of preferences
to choose the best market place to locate the headquarters. The headquarters
may have the following features like well-developed accessibility and good
communication facilities, a well-established commercial background. Added
to that, the presence of a good banking system will provide the smooth
environment for functioning of the RRC.
across the globe and soon started seizing business opportunities wherever
they existed.
1. Give valuable suggestions and help the reinsured tide over the crisis:
Thus, over the years the reinsurance industry has matured in terms of
improved development services and policies offered to the clients. But, it is
to he noted here that the development of reinsurance market is restricted
mostly to the developed economies. Developing economics like India, a few
South East Asian countries, etc, have just recently started their long march
towards the development of more mature Reinsurance market domestically.
CHAPTER 6
REINSURANCE IN INDIA
Until GIC was notified as a National Reinsurer, it was operating as a
holding / parent company of the 4 public sector companies, controlling their
reinsurance programmers’. GIC would receive 20% obligatory cession of
each policy written in India. Since deregulation, GIC has assumed the role of
the markets only professional re-insurer. In order to focus on reinsurance,
both in India and through its overseas offices and trading partners, GIC has
divested itself of any direct business that it wrote prior to November 2000,
with the temporary exception of crop insurance. It currently manages Hull
Pool on behalf of the market, which receives a cession from writing
companies and after a pool protection the business is retro-ceded back to the
member companies. GIC also manages the .Terrorism Pool... Not more than
10% of reinsurance premium to be placed with one re-insurer.
REINSURANCE REGULATION
The placement of reinsurance business from the Indian market is now
governed by Reinsurance Regulations formed by the IRDA. The objective of
the regulation is to maximize the retention of premiums within the country
and to ensure that IRDA has issued the following instructions: Placement of
20% of each policy with National Re subject to a monetary limit for each
risk for some classes. Inter-company cession between four public sector
companies. . Indian Pool for Hull managed by GIC. . The treaty and balance
risk after automatic capacity are to be first offered to other insurance
companies in the market before offering it to international re-insurers. . Each
company is free to arrange its own reinsurance program, which has to be
submitted to the IRDA 45 days before commencement. . No re-insurer will
have a rating of less than .BBB from Standard and Poor’s or an equivalent
rating from AM Best.
THE PROBLEM
THE SOLUTION
THE RESULTS
Conclusion