Re Insurance

REINSURANCE

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.

LALA LAJPATRAI COLLAGE OF COMMERCE & ECONOMICS 1

REINSURANCE

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

2) To stabilize loss expanses

3) To protect against catastrophes; and

4) To increase capacity.

Different types of reinsurance contract are available in the market

commensurate with the ceding company’s goals.

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


REINSURANCE

they could otherwise provide. This function of reinsurance is crucial

because they allow all companies, large and small, to offer coverage

limits to meet their policyholders’ needs. In this manner, reinsurance

provides an avenue for small-to-medium size companies to compete with

industry giants. In calculating an appropriate level of reinsurance, a

company takes in to account the amount of its available surplus and

determines its retention based on the amt of loss it cam absorb

financially. Surplus, sometime referred to as policyholders surplus, in the

amount by which the asset of an insurance exceeds its liabilities

A company’s retention may range from a few lakhs rupees o thousand

of crores. The reinsurer indemnifies the loss exposure above the

retention, up to the policy limits of the reinsurance contract. Reinsurance

helps to stabilize loss experience on individual risks, as well as an

accumulated loss under many policies occurring during a specified

period.

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


REINSURANCE

reinsurance to protect against catastrophes in two ways. The first is to

protect against catastrophic loss resulting from a single event, such as the

total fire loss of large manufacturing plant. However, an insurer also

seeks reinsurance to protect against the aggregation of many smaller

claims, which could result from a single event affecting many

policyholders simultaneously, such as an earthquake as a major

hurricane. Financially, the insurer is able to pay losses individually, but

when the losses are aggregated, the total may be more than the insurer

wishes to retain.

Though the careful use of reinsurance, the descriptive effect

catastrophes have on an insurer’s loss experience can be reduced

dramatically. The decision a company makes when purchasing

catastrophe coverage are unique to each individual company and vary

widely depending on the type and size of the company purchasing the

reinsurance and the risk to be reinsured.

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


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."

ORIGIN AND DEVELOPMENT OF REINSURANCE

In the years 1871 to 1873, no less than twelve independent

reinsurance institutions were founded in Germany, of which very few

survive today. The pressure of competition led to unwholesome practices,

and soon many of these newly formed companies found themselves in dire

straits. In branches of insurance, other than fire insurance, we find no

definite tendency in the '70's toward the establishment of separate

reinsurance facilities in Germany. Ernst Albert Masius, in his "Rundschau"

in 1846, deplored the lack of reinsurance facilities in hail insurance. Even at

the present time, this branch of the business lacks adequate reinsurance

service.


REINSURANCE

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.


REINSURANCE

Risks carried by the insurer

The need for reinsurance arises out of the fact that a first or primitive

insurer bears two distinctly different major risks:

(1) The risk that the events insured against will happen among a

number of homogeneous risks;

(2) The risk that certain events insured against will happen among a

heterogeneous group of risk to one or several insured entitled by contract to

an exceptional payment in money or its equivalent, or entitled to

exceptional, costly service.

Case 1:

An insurer contracts to pay $10,000 to the beneficiary of each of 806

persons insured by him at 21 years of age, in event of the death of the

insured during the contract year. This group is homogeneous in respect to

amount insured and class of risk. He charges a net premium of 1.22 per

cent., or $98,332 to meet the expected claims in that year of age.

Case 2:

Assume, however, that the insurer has accepted, as a second instance,

a heterogeneous group composed of 805 risks at $10,000 each and one risk

at $100,000. This produces $99,430 in premiums.

If in Case 1, only 8 deaths actually occur with a uniform coverage of

$I0, 000 each, the premiums are $98,332 and the claims $80,000, leaving an

underwriting profit of $18,332. If in Case 2, the $100,000 policyholder and

seven $10,000 policyholders die, the premiums are $99,430, and the claims

$170,000, or an underwriting loss of $70,570. We had in the first case the

carrier of a group of primary, homogeneous risks, with only a slight hazard

to him that the number of actual claims would exceed the expected. Against

this slight hazard the insurer is supposed to hold paid-in capital and surplus


REINSURANCE

(or "guarantee capital" in case he was a mutual underwriter). Slightly

exceptional losses above the expected are to be made up by slightly

favorable underwriting profits in the long run of the business. In the second

case, the insurer is not only carrying a group of primary, homogeneous risks

but also the secondary risk of selective loss through the death of the

$100,000 policyholder. The quality of the second group of risks is

heterogeneous with respect to the carrier's interests. Insurers have

historically met the second risk through the practice of two varieties of

coinsurance:

(1) External or true coinsurance or

(2) Internal coinsurance or reinsurance.

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.


REINSURANCE

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.


REINSURANCE

From 1850 onwards

By he mid nineteenth century there was a boom in the European

reinsurance business and Germany became the hotbed for reinsurance

activity. Many German reinsurance companies undertook business of; large

scale and new reinsurance companies flourished. But the after-effects of the

two world wars spilled over to the reinsurance markets leading to the

emergence of London as a strong player in the reinsurance sector. One of

the pioneers of the insurance industry, Lloyd's of London, began its

operations in the year 1688. It initially ventured into life insurance only and

because of the ban imposed on marine insurance they could not make much

headway. Once the ban was lifted it opened its business in all the spheres of

insurance activity and with the introduction of excess of loss reinsurance it

aggressively jumped into the fray and became one of the strongest players

in the industry.

THE FIRST INDEPENDENT REINSURANCE COMPANY

In 1846, the first independent reinsurance company was founded in

Germany, the Cologne Reinsurance Company. This was the idea of

Mevissen. He held that an independent reinsurance company would be no

competitor of the direct-writing companies and that it was certain to be

welcomed by and to receive a good volume of business from those

companies. Mevissen's idea of 1846 did not mature, however. For various

reasons the company did not begin business until 1852, and then only with

the assistance of considerable French capital. This marked the establishment

of reinsurance as a specific, independent branch of the business. Out of

small beginnings, this company began to prosper and its example began to


REINSURANCE

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.

FIRST RECORDED REINSURANCE CONTRACT

The first reinsurance contract on record relates to the year 1370, when

an underwriter named Guilano Grillo contracted with Goffredo Benaira and

Martino Saceo to reinsure a ship on part of the voyage from Genoa to the

harbor of Bruges.

As early as the twelfth century, marine insurance began to be

transacted through the so-called "Chambers or Exchanges of Insurance,"

which had for their object, first, the promotion of the marine insurance

business on a solid basis and, second, the settling of disputes arising among

merchants and others concerned in bottomry and respondentia contracts. In

later years, these Chambers or Exchanges of Insurance became corporate

bodiesand instead of remaining confined to the original function of

regulating and registering insurance made by others, actually undertook an


REINSURANCE

insurance business themselves. With the establishment and functioning of

Lloyd's in 1710, there was a marked decline in the transaction of insurance

business through these Chambers or Exchanges. There is a suggestion of

reinsurance practice in the "Antwerp Customs" of 1609. Some mention of

reinsurance practice is to be found also in the "Guidon de la Mer," a code of

sea laws in use in France from a very early date. These marine regulations

were consolidated and published at Bordeaux in 1647 and at Rouen in 1671.

The author of the consolidations was said to have been Cleirac. With the

shift of centers of commerce from the south, southwest and west of Europe

to the north, England's foreign trade grew. Marine insurance followed in its

wake. Some underwriters found they could affect reinsurance with others.

Underwriters were accustomed to assign parts of risks to others at lower

rates, and these reinsures had hopes of finding other persons who would take

parts of these risks at still lower rates. This traffic in premium differences

was so greatly abused that in 1746 it was forbidden. (19 Geo. II, c 37,

Section 4). Under this statute, reinsurance was permitted only if the party

whose risk was reinsured was insolvent, bankrupt or in debt and if the

transaction was expressed in the policy to be a reinsurance. The statute was

more or less of a dead letter and was repealed by 27 and 28 Vict.c 56,

Section I on July 25, 1864


REINSURANCE

CHAPTER 2

PRINCIPLES OF REINSURANCE

WHAT IS REINSURANCE?

Insurers take out their own insurance - this is called 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.

Reinsurance is an extension of the concept of insurance, in that it

passes on part of the risk for which the original insurer is liable. Reinsurance

contracts are slightly more specialists than insurance contracts but for most

part they work in exactly the same way – it is just that the ‘insured’ is

another insurer, known as the ‘reinsured’ (See the Basics of Insurance for an

explanation of how insurance contracts work).

A contract of reinsurance is between the insurer and reinsurer only

and legally there is no direct link between the original insured and any

reinsurer. The original insurer is still the one who must pay any claim from

the insured – the insurer must then make its own separate claim against the

reinsurer.

Reinsurance is important for a number of reasons, including:

1) To protect against large claims. For example, in the case of a fire in a

large oil refinery or a large city hit by an earthquake, insurers will

spread the risk by reinsuring part of what they have agreed to insure


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

country is vulnerable to natural disasters and an insurer is heavily

committed in that country. Insurance may be reinsured to spread the

risk outside the country.

4) To increase the capacity of the direct insurer. Sometimes insurers

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.

Like the direct insurance market, reinsurance usually involves

specialist brokers who have expert knowledge of the market and access to

reinsurance underwriters on behalf of their clients.

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


REINSURANCE

presence in India after independence, the domestic requirement of

reinsurance was netted from mostly was foreign markets mainly British and

continental. For undertaking reinsurance by Indian entities meant drain of

precious foreign exchanged earned by the country. To prevent the outflow of

foreign exchange, in year 1956 Indian Reinsurance Corporation, a

professional reinsurance company was formed by some general insurance

companies. This company started receiving the voluntary quote share

cession from member companies.

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.

The Quality of Service:

The quality of services offered by the reinsurer to their customers

matter a lot in the reinsurance industry. Most customers go for reinsurance

for extra benefits like expertise, experience, and the advisory role of the

insurer. If these services cannot meet customers, expectations, then


REINSURANCE

reinsurance can accepts a rundown of their businesses which the customer

shifting base to the other players providing better services. It is to be

remembered that the reinsurance industry is a highly competitive market and

hence the reinsurance needs to carefully grade its customer.

The Skill Set:

The skill set of the reinsurance is the most important aspect of a

contract to the customer. It matters a lot to a reinsurance too because a skill

set represent the basic amour which it can showcase to its costume. The skill

set generally refers to the underwriting, financial, actuarial, claims

management and last but not the least management skills which it can serve

its clients. Hence the reinsurance gives due consideration to its available

skill set and sees how best it can serve the client with such skills.

Thus reinsurer who takes risk in the hope of gaining the premium volume

ceded to him, as part of a contract, would like to reap the benefits over a

period of time and hope for a long-term relation with its customers.

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.


REINSURANCE

But what stands behind the A--rated carrier or the high quality

program for a complex risk? The answer is “Reinsurance”. Commercial

insurance cannot exist without reinsurance. The quality of the reinsurance

security purchased by the direct insurer is what helps to insure that loss will

be paid. Quality reinsurer provides special expertise to their direct insurer

client and assists the direct insurer in providing the best possible protection

and risk management for the direct insurer’s own client. Some large

professionals reinsure help small insurance companies expand into new

areas and provide them with technical, actuarial, and claims expertise and

training

FUNCTIONS OF REINSURANCE

There are many reasons why an insurance company would choose to

reinsure as part of its responsibility to manage a portfolio of risks for the

benefit of its policyholders and investors :

1. Risk transfer

The main use of any insurer that might practice reinsurance is to allow

the company to assume greater individual risks than its size would otherwise

allow, and to protect a company against losses. Reinsurance allows an

insurance company to offer higher limits of protection to a policyholder than

its own assets would allow. For example, if the principal insurance company

can write only $10 million in limits on any given policy, it can reinsure (or

cede) the amount of the limits in excess of $10 million.

Reinsurance’s highly refined uses in recent years include applications

where reinsurance was used as part of a carefully planned hedge strategy.


http://en.wikipedia.org/wiki/Hedge_(finance)

REINSURANCE

2. Income smoothing

Reinsurance can help to make an insurance company’s results more

predictable by absorbing larger losses and reducing the amount of capital

needed to provide coverage.

3. Surplus relief

An insurance company's writings are limited by its balance sheet (this

test is known as the solvency margin). When that limit is reached, an insurer

can stop writing new business, increase its capital or buy "surplus relief"

reinsurance. The latter is usually done on a quota share basis and is an

efficient way of not having to turn clients away or raise additional capital.

4. Arbitrage

The insurance company may be motivated by arbitrage in purchasing

reinsurance coverage at a lower rate than what they charge the insured for

the underlying risk

TYPES OF REINSURANCE:

There are two kinds of reinsurances, treaty reinsurance and facultative

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


http://en.wikipedia.org/wiki/Arbitrage

REINSURANCE

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:

This kind of reinsurance is used while considering a particular

underlying risk of an individual contract. It is the reinsurance of all or

part of a single policy after the terms and conditions have been

negotiated. It reduces the ceding company’s exposure to risk from an

individual policy. It is non- obligatory.

In another way, reinsurance is classified as proportional and non-

proportional reinsurances.

A. PROPORTIONAL REINSURANCES :

The two companies share the premium as well as risk. The

reinsurer usually pays a ceding commission.

a) Pro-rata reinsurance:

It is a classification based on the way the two companies share

the risk. The cedent and the reinsurer share a pre decided

percentage of the premium and losses. It is used widely as it

provides surplus protection. There are two types of pro-rata

reinsurance, quota share and surplus share.


REINSURANCE

b) Quota share pro-rata reinsurance:

The primary insurer cedes a fixed percentage of

premiums and loses for every risk accepted.

c) Surplus share 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:

As the name suggests it is not proportional and the reinsurer

only responds if the loss suffered by the insurer exceeds a certain

amount.

a) Excess of loss:

It covers a single risk or a certain type of business.

Catastrophe reinsurance is a type of excess of loss reinsurance.

It provides the captive with a great deal of flexibility.

b) Stop loss reinsurance:

It covers the whole account and is also known as

excessive loss ratio reinsurance.

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.


REINSURANCE

DOUBLE INSURANCE

The subject matter of the double insurance implies that it is insured

with two or more insurers and the total sum insured exceeds the actual value

of the subject matter. It is called as Double insurance. In other words, the

subject mater of double insurance must be insured with different insurers. If

the actual value of the subject matter is more than the total sum insured, it is

not treated as double insurance. In the case of life insurance, double

insurance can be shone profitable because the insured can get full policy

money under all policies. For example if a premises worth of Rs. 2,00,000 is

insured with ‘y’ for Rs. 1,40,000 and Rs. 1,50,000 it is treated as double

insurance because the total value of the subject matter i.e. total of all the

policies exceeds the actual value of the premises. Suppose if it is insured

with X and Y for Rs 70,000 each, there is no 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.

Lords Mansfield, while dealing with these rules of contribution in

case of over-insurance lay down as follows:

In the case of over insurance, the different sets of policies are

considered as making but one insurance, and are good to the extent of the

value of the effects put in risk: the assured can cover an the different

policies, and recover from those, he so sued, to the full extent of his loss,

supposing it to be covered by the policies on which he effects to sue, leaving


REINSURANCE

the underwriter on the policy to recover a ratable sum by way of contribution

from the underwriters of the other policy.

For Example:

Where a merchant, the value of those whose whole interest is $22001,

first effected a policy on his interest at Liverpool for $ 17001, and hen

without fraud another policy on the same interest at London for $22001, he

is allowed to recover the whole amount on the London Policy, and the

London underwriters are allowed to recover a ratable amount by way of

contribution from the Liverpool underwrite.

EXTERNAL AND INTERNAL INSURANCE

Depending on their nature and scope, the risk insurance may be

broadly classified as External insurance and Internal Insurance.

1) EXTERNAL INSURANCE

External insurance is referred to any insurance a firm facing in

the commercial market. Captive insurers, risk retention group and risk

sharing pools are the important alternative techniques that have been

developed for commercial insurance. The group captives may be

classified into pure captive and association or group captives. Risk

retentions groups are formed for the purpose of retention or pooling

risk.


REINSURANCE

2) INTERNAL INSURANCE

Internal insurance may be described as an alternative to

purchasing insurance in the commercial market. Some public

organisation, enterprise, individual and institutions have established a

fund to meet the insurable losses. As the risk is retained within the

organisation, here is no market transaction of buying insurance cover.

Internal insurance is also termed as self insurance. This mainly

focuses attention and effort on the high frequency and low severity

profile and implies that the losses are predictable. Own damages

motor claims are the best example of self insurance.

NEW ECONOMY & NEW RISKS- ARE REINSURANCE

COMPANIES LISTENING?

The "New Economy" present'; new and significant challenges to

business, government, education; religion, and culture. Geographic borders

are becoming anachronistic symbols of the old economy as the powerful

force of e-commerce tears down artificial obstacles to trans-border trade.

What do all these issues mean for the insurance and reinsurance industry.

While all industries are affected by this electronic sea change in the

world's economy, no industry is more affected than the insurance industry. It

is the insurance and reinsurance industry that provides the protection against

risk that allows businesses to produce their products and expand their markets

and it is this industry that must meets the challenges of the now economy and

protect against old and new risks generated by e-commerce.

Reinsures must constantly monitor court decisions, new e-commerce

coverage products, and changes in technology. The new economy already

has claimants seeking coverage for a range of losses from damaged


REINSURANCE

hardware and software to claims of defamation. Coverage disputes have

arisen about whether this looses is covered under traditional commercial

liability policies ("CGL") or under newer policies specifically designed for e-

commerce risk. Reinsures must be prepared to address new risks as they

arise out of e-commerce transaction.

The following are some of the important issues that reinsurance

companies have to tread undertaking new economy risk.

Ecommerce risk insurance and reinsurance companies have to take

new kind of risks that come bundled with the e-commerce are a variety of

risks that present loss both to the business undertaking e-commerce and the

companies which are writing their risks.

THE IMPORTANT E-COMMERCE RISKS ARE:

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.


REINSURANCE

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.

Intellectual property risks:

The new economy has stretched the boundaries of intellectual

property law to the breaking point. New economy entrepreneurs are finding

ways to use the Internet to allow consumers to locate and "share"

copyrighted works. As many websites compete to provide the best of the

online material, this trend has led to numerous infringement lawsuits

involving the downloading of copyrighted clipart, software, music movies

and TV shows, etc As more and more businesses move onto the Internet,

claims involving intellectual property will only multiply in die coming days.

Third-party negligence claims:

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.


REINSURANCE

OTHER POTENTIAL E-COMMENCE RISKS:

The nature of e-commerce and its modalities of doing business give

rise is to new exposures for insured in the new economy. Reinsures need to

be aware of these potential exposures. Apart from the risk highlighted

above, some of the potential risks lurking which can affect insurance and

reinsurance industry are highlighted below.

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


REINSURANCE

litigation that may ensue from individuals or entities tampering with digital

signatures and the methods of proving authenticity.

Over the course of history, as new ways of doing business have

emerged, the insurance and reinsurance industry has provided protection

against new risks of loss. The e-commerce revolution is no different than

previous changes in the world economy. Insurers and reinsures will have to

adapt and provide the necessary security for the new economy. Reinsures

should start working with their clients to craft properly underwritten new

forms of coverage for these new economy exposures. Reinsurer should

consider reinsuring web based liability covers separately from traditional

liabilities to better analyze these new exposures. Reinsurer must also be

alert to judicial alterations in coverage provisions of traditional CGL and other

third party liability policies as the courts cope with claims for ecommerce

and emotional damages arising cut of e-commerce activities and the

industry/ should reinvent itself to confront the new e-challenges facing the

business community across the world.


REINSURANCE

CHAPTER 3

REINSURANCE UNDERWRITING

INTRODUCTION

Reinsurance underwriting is the process of building up a portfolio of

assumed risks; ii involves selecting the accounts and defining the

conditions/rates at which the accounts are to be accepted for assumption of

risk. It is one of the most vital functions of the management and the ultimate

results of the company depend upon the efficacy. Several arguments have

been put forth as to whether underwriting is an art or a science in fact it several

traits of both – one has to consider the previous results, make

quantitative/qualitative analysis of the results of the previous years. At the

same time it involves a g deal of the underwriter's intuitive judgment and

often his gut-feeling. In the long run it is the correct and positive dynamics

of underwriting that decide the success of a reinsurance company, just as

much as that of an insurance company. Underwriting being a function of

such vital importance holds the key to the success of an organization. History

is witness that very rarely has a reinsurance company got into difficulties

due to a poor investment decision but a major underwriting loss can

critically impair the company and throw it out of business.

FACTORS THAT AFFECT REINSURANCE BUSINESS

For underwriting to be effective in the long run, a clear understanding

of the reinsurance contract is absolutely essential for both the parties. The

cedent company needs this understanding to plan its risk-retention, types of

reinsurance required etc. For the reinsurer, it is necessary to plan for his


REINSURANCE

portfolio, with an eye on the possible accumulations of losses, underwriting

a single large risk etc. After identifying the type of contracts that a

reinsurance company has to underwrite during a period, it has to identify the

various sources of business that it wanes to get involved in. The different

sources of reinsurance business are:

Domestic direct underwriting companies

Foreign direct underwriting companies

Other reinsurance companies

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


REINSURANCE

brokerage, delays in remittances and underwriting being in control. Another

aspect which has to be considered in finalizing a reinsurance contract is the

class and spread of risks. The reinsurance company will have to make a

selection of risks depending on the size and intensity. A single aviation

portfolio may consist of a very small number of large risks, whereas there can

be several small household burglary accounts with limited risk exposure.

Similarly, even within a class, mere can be variation in risk exposure, like

fire policy for residential dwellings as against that of a large industrial

undertaking or industrial complexes. Hence a proper balance will have to be

struck between various classes; and within a class, between various risks

CLASSES OF BUSINESS POLICY

It is of paramount importance for an underwriter to know at the outset

as to what classes of risks are to be covered viz. Property, Casualty, etc. It

must be ensured that the particular class is a genuine insurance risk which

can be defined and quantified properly so that premium considerations do

not lead to avoidable conflicts. Further, within the class, method of

reinsurance whether proportional/non-proportional, facultative/treaty etc.,

lias to be selected, depending on the reinsurer choice as well as suitability.

DESIGNING A REINSURANCE PROGRAM

Having decided a particular class and amount of business to be

involved in, a company must decide some form of reinsurance which it

requires. Basically the facultative form is more cumbersome, time-

consuming and also more expensive. As such it is always wiser to consider a

suitable combination of treaties.


REINSURANCE

The ultimate choice as regards a particular treaty or a combination of

treaties would depend upon whether the portfolio is exposed to large

individual losses or accumulation of losses from sporadic, isolated events.

Apart from the above, other considerations that have a bearing on a

company's choice of portfolio are:

Administrative costs and ease of operations.

Effect on company's net retained premium income

Whether it wishes to have reciprocal arrangements with

other insurers.

In case of large risks on classes of business such as Fire, Engineering,

Marine hull, etc., a surplus treaty would be the best option for the cedent

company as it would enable retention of a large part of premium income.

However, because of the special skills involved, a company might be

inclined towards reinsuring the business on a risk excess of loss. Further, the

administrative hassles of maintaining a suipbis treaty are more as compared

to those of quota share or excess of icss. It would also enable the company to

attain a higher rate of commission on a quota share treaty. The excess of

loss treaty is also very beneficial in that it is very simple to operate. The

company after deciding on the amount of excess of loss cover protection need

not go for any reinsurance on individual risks. If the company is in the habit of

issuing policies for unlimited liability (motor third party), the final layer of

excess of loss cover should also be for an unlimited amount.

An insurance company which is also involved in inward reinsurance

can increase its capacity to accept large reinsurance risks. However, in order

to keep a check on its net retention, retrocession facility should be made use

of. Depending on its net retention ability, the company can retrocede the


REINSURANCE

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.

Companies with whom reciprocal business is being planned should be


REINSURANCE

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.

The treaties proposed to be exchanged should be reasonably balanced

with an acceptable ratio of

Host of other services apart from providing reinsurance coverage


REINSURANCE

CHAPTER 4

REINSURANCE REGULATION

INTRODUCTION

As recently as fifteen years ago, reinsures’ accounting requirements

were minimal and were addressed in the space of two or three pages in the

NAIC Accounting Practices and Procedures Manual. Since that time,

reinsurance regulatory oversight has increased significantly. The areas in

which these increases have been found include:

Disclosure

Risk transfer assessment and accounting and

Security

This increased regulation has resulted from the regulators’ realization

that the solvency of primary insurers often depends on their ability to collect

under their reinsurance agreements. Since primary insurers cede more than

$50 billion in premiums in any given year to reinsures, the ability to collect

under reinsurance agreements is a very serious issue.

Another significant factor in the pressure that state regulators feel

towards their regulation of the reinsurance industry is the federal

government’s interest in this area. The failure of several large property &

casualty insurers resulting from their inability to collect under their

reinsurance agreements has spurred this federal interest.


REINSURANCE

Several natural catastrophes occurred during the decade of the 1990s

that caused many to fear the imminent collapse of the reinsurance industry.

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

The first area to feel the increase in regulatory oversight is disclosure.

The required additional disclosure permits regulators to perform a more

extensive analysis of a primary insurer’s reinsurance programs and a more

thoroughgoing evaluation of its exposure to additional risk in the event any

of its reinsures fail to fulfill their contractual obligations.

Schedule F in the NAIC Annual Statement provides a detailed

disclosure of information regarding the insurer’s reinsurance. All of the

information on the ceded business can be found there. This schedule was

greatly expanded in 1992 to include eight separate parts. While an analysis

of each part of the schedule would probably provide little in the way of

important information, it is instructive to appreciate the magnitude of the

change between the old part 1 of Schedule F and the new part 1. While the

old part 1 only required financial information concerning reinsurance

payable on paid and unpaid losses to each reinsured, the new part 1 requires

substantial increases in disclosure.


REINSURANCE

In fact, the new part 1 requires, for each reinsured, that the following

disclosures be made:

The paid losses and loss adjustment expenses

The known case losses

The incurred but not reported losses

The contingent commission payable

The assumed premium receivable

The funds held or on deposit

The letters of credit posted and

The amount of assets pledged or compensating balances

The net effect is a significant increase in the disclosure requirements

of reinsurance operations.

ASSESSMENT OF RISK TRANSFER & ACCOUNTING

In additional to substantially increased disclosure requirements, the

NAIC’s Accounting Practices and Procedures Task Force has modified the

NAIC’s accounting guidance.

The Accounting Practices and Procedures Manual identify the

essential ingredient of a reinsurance contract as the transfer of insurance

risk. This element of insurance risk transfer is essential because it enables a

reinsurance contract to qualify for loss reserve credit, and this credit is an


REINSURANCE

important financial consideration. The Manual goes on to state that

investment risk is not an element of insurance risk.

The result of this requirement that there be an insurance risk is to curb

a practice that the insurance regulators consider a misuse of reinsurance

contracts. However, the regulators have used changes in accounting

requirements rather than regulatory restraint to bring about the change. A

failure of a reinsurance contract to contain insurance risk will result in the

reinsurance balances being accounted for as deposits rather than qualifying

for loss reserve credit.

SECURITY

Heightened regulatory oversight is primarily the result of concern

about the financial soundness of reinsurers. This heightened oversight is

intended to assure that reinsurance assures 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.

Security is not deemed to exist if:

The reinsurer is not authorized or accredited and

The reinsurance from the unauthorized insurer is not secured

by funds withheld, trust funds or letters of credit


REINSURANCE

The result of this increased regulatory oversight is a much

increased security for primary insurer and, ultimately, for their

policy owners. For reinsurers, the decade of this heightened

regulatory oversight has been a period of significant turmoil and

change.

PROCEDURE TO BE FOLLOWED FOR REINSURANCE

ARRANGEMENTS

(1) The Reinsurance Programme shall continue to be guided by the

following objectives to:

a) maximize retention within the country;

b) develop adequate capacity;

c) secure the best possible protection for the reinsurance costs incurred;

d) Simplify the administration of business.

(2) Every insurer shall maintain the maximum possible retention

commensurate with its financial strength and volume of business. The

Authority may require an insurer to justify its retention policy and may

give such directions as considered necessary in order to ensure that the

Indian insurer is not merely fronting for a foreign insurer.

(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.


REINSURANCE

(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;

(5) Within 30 days of the commencement of the financial year, every

insurer shall file with the Authority a photocopy of every reinsurance

treaty slip and excess of loss cover note in respect of that year together

with the list of reinsures and their shares in the reinsurance

arrangement;

(6) The Authority may call for further information or explanations in

respect of the reinsurance Programme of an insurer and may issue such

direction, as it considers necessary;

(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


REINSURANCE

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.

(10) Every insurer shall offer an opportunity to other Indian insurers

including the Indian Reinsurer to participate in its facultative and treaty

surpluses before placement of such cessions outside India.

(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.

(12) Every insurer shall be required to submit to the Authority statistics

relating to its reinsurance transactions in such forms as the Authority

may specify, together with its annual accounts.


REINSURANCE

INWARD REINSURANCE BUSINESS

Every insurer wanting to write inward reinsurance business shall have

a well-defined underwriting policy for underwriting inward reinsurance

business. The insurer shall ensure that decisions on acceptance of

reinsurance business are made by persons with necessary knowledge and

experience. The insurer shall file with the Authority a note on its

underwriting policy stating the classes of business, geographical scope,

underwriting limits and profit objective. The insurer shall also file any

changes to the note as and when a change in underwriting policy is made.

OUTSTANDING LOSS PROVISIONING

(1)Every insurer shall make outstanding claims provisions for

every reinsurance arrangement accepted on the basis of loss

information advices received from Brokers/ Cedants and where

such advices are not received, on an actuarial estimation basis.

(2) In addition, every insurer shall make an appropriate provision

for incurred but not reported (IBNR) claims on its reinsurance

accepted portfolio on actuarial estimation basis.


REINSURANCE

CHAPTER 5

THE INDIAN REINSURANCE MARKET

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.

Before nationalization, a large number of domestic and foreign

companies used to operate in India. For their reinsurance needs, they

used to access international reinsurance markets and hence there was

no visible reinsurance market in the country. But the formation of two

reinsurance corporal ions in the country to take care of domestic

needs has provided the much-needed impetus for the growth of

domestic reinsurance industry.

Early Reinsures in India

The year 1956 saw the launch of the India Reinsurance Corporation,

a professional reinsurance company formed by some general

insurance companies. This company started receiving the voluntary

quota share cessions from member companies. Yet another


REINSURANCE

reinsurance corporation called Indian Guarantee and Genera!

Insurance Co. was opened in the year 1961 this company was formed

to supplement the role of the Indian Reinsurance Corporation. With

this set-up, a regulation was promulgated which made it statutory on

the part of every insurer to cede twenty percent in Fire and Marine

Cargo, ten percent in Marine Hull and Miscellaneous insurance and

five percent in Credit and Solvency business to two approved Indian

reinsures as mentioned above.

As new innovations started appearing in the market, the idea of

formation of pools received a boost in the country during the late

1960s. Under this method, a pool was created to deal with certain

hazardous classes of business or as a means of increasing the business

retained within the country. The premium income and claims are

pooled together and usually divided in proportion to premium written

by each member. As a consequence, in the year 1966, the Indian

Insurance Companies Association initiated the formation of

reinsurance pools in Fire and Hull departments to increase the retained

premiums in the country.

INDIAN REINSURANCE PROGRAM

The Indian reinsurance industry is characterized by development of a

market reinsurance Programme, which influences the working of Indian

business entities and the way they do reinsurance.

The chief features of the Programme are as follows:

1. To achieve maximization of the retention capacity within the country.


REINSURANCE

2. Retention of the domestic insurers to be achieved through obligatory

cessions, pools, etc.

3. To protect inter-company and individual retentions by providing them with

excess of loss covers.

4. To make provisions, wherein different classes of business can be ceded to

treaties based on quota share or surplus basis.

5. To make most of the outward treaties by the companies by providing

automatic covers and restore facultative reinsurance in few case?

As we have noted earlier, general reinsurance business in India is

carried on by four subsidiaries of the General Insurance Lid. These

companies, to meet their own reinsurance needs, made arrange a man is with

foreign companies. Apart from reciprocal arrangements, G1C and its

subsidiaries accept non-reciprocal inward reinsurance from overseas

markets. Apart from providing the above two facilities, GIC also takes care

of inward facultative reinsurance.

Since the business generated by the Indian Markets if not of huge

amount in international markets, they have to merely follow the trend in the

markets and only in some cases, do the Indian players get to dictate the

terms of the agreement in the intentional markets.

STATE REINSURANCE CORPORATION (SRC)

The role and importance of establishment of state reinsurance

corporations was highlighted by world development organizations like

UNCTAD (United Nations Conference on Trade and Development). With the

encouragement received from multilateral bodies like UNCTAD many

countries have established their own stale reinsurance corporations to take


REINSURANCE

care of the reinsurance needs arising out of their domestic insurance

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 conserve foreign exchange:

For developing countries like India, foreign exchange is a

precious resource and it needs to be spent very cautiously. The setting

up of these corporations will prevent draining of foreign exchange

resources from the country in the form of premiums to overseas

reinsure.

To prevent excessive dependence:

Depending on a foreign country for reinsurance coverage for a

long period of time is not advisable. Because at the times of war,

especially, and political tensions, the reinsurer country may not allow

the reinsurer to discharge its liability and it may drastically affect the

insured's business.

Creation of market place:

The setting up of state reinsurance corporation will help in

developing the domestic reinsurance market and lay a strong foundation

for development and growth of the domestic reinsurance industry.

To avoid competition:

In a domestic market, where the insurance industry has not


REINSURANCE

advanced on, the presence of a strong state reinsurance corporation will

help prevent setting up of new reinsurance companies, betting up - of

more reinsurance companies in less advanced will create wasteful and

destructive forces.

Better bargaining capacity:

Presence of a single state reinsurance corporation will

increase bargaining capacity of the country vis-à-vis internal agencies.

Develop local market:

The presences of state reinsurance corporations will help

nurture the domestic reinsurance industry and develop the reinsurance

skills.

It is to encourage the growth of SRCs, many rules were

implemented to ensure that SRCs get their due business and grow

strongly in the market.

The following are some of the measurers:

1. SRCs receive their business by means of statutory access by way of a

certain percentage of all insurance business from domestic insurance

companies.

2. The insurance companies in the country are encouraged to voluntarily

utilize the facilities and services of SRCs, apart from meeting their

obligatory cessions with SRCs.

3. Even though the provision of obligator) cessions is thrust upon the

domestic companies, they have the freedom lo reinsure their exposures

with global market players and utilize their services once they have

fulfilled compulsory cessions to SRCs.


REINSURANCE

How SRCs Contain Their Exposures

When a state reinsurance corporation takes exposures of the domestic

insurance companies, SRCs will be exposed to the risks of their customers

from all angles. In order to prevent the havoc of running their business with

heavy and bad exposures (which may occur sometimes), SRCs go in for

retrocession (The method wherein a reinsurer will go in for reinsurance

coverage with another reinsurance company). Thus, state reinsurance

corporations may receive all the reinsurance business from local direct

insurers to foreign reinsures any business they do not wish to retain. Even

SRCs have a provision wherein they can retrocede shares out of the national

pool to each company in proportion to the volume of its cession to the pool.

Hence, retrocession plays an important role for working of state reinsurance

corporations.

THE ROLE OF REGIONAL REINSURANCE CORPORATIONS

Similar to the need of setting up SRCs. a need was felt to set up

reinsurance corporations on geographical regional countries wise. Basically,

a regional reinsurances corporation will look into the reinsurance reduces

arising among a group of neighboring nations. These corporations were

proposed to be set up in different developing nations of the world. \n

example of this method of forming a regional reinsurance corporation is the

Asian Reinsurance Compotation, which was set up at Bangkok. The

participants in this corporation are Afghanistan, China, India, Philippines,

South Korea, Sri Lanka and Thailand.


REINSURANCE

The basis for setting up regional reinsurance corporations

depends upon some common features which the member countries share due

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.

2. Well-developed communication facility exists between the member

countries.

3. The economic and trade ties between the member countries being well-

developed, free flow of trade exists between them.

4. The member countries may share some common customs, language and

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.

PROFESSIONALISM IN THE REINSURANCE INDUSTRY

Running a reinsurance company is not similar to running any other

business. It requires in-depth knowledge of the insurance industry apart from

requiring specialized skills, proper control, and a nack to brood over statistics

and devise appropriate policies to meet customer needs. Ml these have

necessitated a professional approach towards the industry. With increased

demand for cover and keener competition among insurance companies,


REINSURANCE

specialized reinsurance companies like marine reinsurance, life reinsurance etc,

emerged. For a successful growth, the reinsures realized the need to fan out

across the globe and soon started seizing business opportunities wherever

they existed.

This thinking process led to the emergence of a professional global

reinsurance industry.

The last hundred years have seen tremendous industrialization the

world over and with it the need and necessity to protect against various risks

inherent in the business. The emergence of New York as an important

financial hub apart from London and the opening of reinsurance exchanges

in the USA, and setting up of new insurance centers in Bermuda, Panama,

Hong Kong, Singapore and West Asia with tax concessions and easy

regulatory affairs has led droves of insurance companies to set up their

operations in these places. Today, it has become a norm rather than an

exception in this industry to broker deals worth several billions.

The youth and development of reinsurance has brightened many changes

in the practice of the reinsurance industry. Today's professional reinsurance

companies are they which are financially sound. Technically resourceful and

who have the expertise in their domain of reinsurance coverage today we find

all the reinsurance companies extending one or more of the following services

to their clients.

1. Give valuable suggestions and help the reinsured tide over the crisis:


REINSURANCE

2. Helping clients in seeing up a suitable reinsurance

program.

3. Organize training program for the executives of the reinsured

companies.

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

CASE STUDY ON GIC

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


REINSURANCE

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.

GENERAL INSURANCE CORPORATION OF INDIA

GIC as a national re-insurer is providing useful capacity to all

insurance companies.

BREAK-UP OF NET PREMIUM INCOME & CLAIMS

Figures in INR millions

Division Premium Claims

Indian Reinsurance 21,996.3 19,898,2

Foreign Inward 1591.4 1498.9

Aviation 244.1 186.1

Crop 2,880.6 1367.6

Total 26,712.3 2,950.8

Corporation's Financial Results - (Class Wise)

Figures in INR million

Fire Miscellaneous Marine Total

Net Premium 6,349.9 18,286.5 2,075.9 26,712.3

Net Earned Premium 5,070.8 17, 46.4 2,267.5 2,384.7

Net claims 3,562.3 18,078.3 1,310.2 22,950.8

U/W Profit/loss -672.5 -5,013.7 512.2 -5,174.0

Class-wise Profit/Loss after

Investment income -13.7 -544.5 1077.5 519.3


REINSURANCE

GIC AS INTERNATIONAL RE-INSURER

Backed by experience of more than three decades in handling the

reinsurance requirement of the Indian market, GIC has now placed itself as

an effective .Reinsurance Partner to Afro-Asian countries and also other

markets. If offers a capacity of US$ 50 million on facultative risks and US$

10 million for treaty business.

CAPACITIES OFFERED BY GIC FOR FOREIGN INWARD

BUSINESS:

Figures in USD

Other than Aviation PML SI Spares

Treaty 4 Mln. 10 Mln.

Facultative 20 Mln. 50 Mln.

Hull Liability Spares

Aviation


REINSURANCE

Facultative 5 Mln.* 30 Mln.* 5 Mln.*

Treaty 300,000***


REINSURANCE

CASE HISTORY: INSURANCE COMPANY SAVES 33% IN TIME

AND UP TO 55% IN COST FOR POLICY UNDERWRITING

THE PROBLEM

A global reinsurance company wanted to reduce the time required for

submitting quotes and writing policies. Depending upon the complexity of

the coverage requested and the required reviews, underwriters would take

from a few hours to a few weeks to issue a quote and write a policy. The

company wanted a solution that would shorten the cycle time, bring quick

return-on-investment, and require minimal time commitment from lead

underwriters.

THE SOLUTION

Over an eleven-week period, the company's best underwriters spent 2-

3 hours per week working with AcappellaÂ® Software consultants to

implement a streamlined quoting and policy writing processes. This

included not only supporting the information gathering efforts, but also

guiding the thinking behind the quoting process. In addition, the customized

software application was to produce most of the written policy

automatically.

THE RESULTS

The company achieved all of its goals. Using the Acappella-

generated application, the company achieved a 33% reduction in the time it

takes to develop a quote and document a submission (time-to-decision).


REINSURANCE

Savings in the cost of underwriting were also significant. Previously, the

underwriters spent an average of 16 hours per quote. Using the Acappella

generated application, they now spend about six hours. A greater percentage

of the background research and other data gathering activities is now being

handled by the assistant underwriters, following the best practices laid out in

the application. The new workload redistribution saved 42% in the cost of

quoting and 55% in the cost of writing a policy (cost-to-decision).


REINSURANCE

Conclusion

1. Every insurer should retain risk proportionate to its financial strength

and business volumes.

2. Certain percentage of the sum assured on each policy by an insurance

company is to be reinsured with the National Reinsurer. National

reinsurer has been made compulsory only in the non-life sector.

3. The reinsurance programme will begin at the start of each financial

year and has to be submitted to the IRDA, forty-five days before the

start of the financial year.

4. Insurers must place their reinsurance business, in excess of limits

defined, outside India with only those reinsurers who have a rating of

at least BBB (S&P) for the preceding five years. This limit has been

derived from India's own sovereign rating, which currently stands at

BBB.

5. Private life insurance companies cannot enter into reinsurance with

their promoter company or its associates, though the LIC can continue

to reinsure its policies with GIC.

6. The objective of these regulations is to expand retention within India,

ensure the best protection for the reinsurance costs incurred and

simplify administration.


Documents

Re Insurance