Get complete information on Reinsurance (Limits and Retention)

Reinsurance is an arrangement whereby an original insurer who has insured a risk insures a part of that risk again with another insurer, that is to say, reinsures a part of the risk in order to diminish his own liability.

The difference between the retention and the total amount of acceptance is reinsured. The limiting or retention and effecting of reinsurance bring about a wider distribution of the risks and secure to the insurer the full advantages of the law of average. It creates an automatic capacity to accept a large amount of risks.

Insurance is a contract between the insurer and the original insured. Reinsurance is a contract between the reinsured (the insurer) and the reinsurer.

Therefore, the original insured is not a party to the contract of reinsurance. Now, if insurer goes into liquidation can the original insured sue the reinsurer for recovery of loss under the policy?

This question involves the protection of the rights of the reinsure’s policyholders. In America, a special provision is made in the reinsurance contracts to safeguard the interests of the reinsure’s policyholder that is the original insured.

A specific clause called ‘loss assumption clause’ is incorporated in the body of the reinsurance contract whereby the original insured can recover his loss on the policy from the reinsurers, if the reinsured goes into liquidation.

Limits:

It is usual to fix a limit up to which the insurer is prepared to lose on risks in a specified class. The limit depends upon the following circumstances:

1. The financial status and premium income of the insurer. A new insurer with small premium income cannot afford to sustain a loss which might become with ease by established insurer with ample reserve.

2. The experienced in a particular class of risk:

(i) The degree of the fire hazard present.

(ii) The extent of the damage likely to be sustained.

(iii) The fire extinguishing facilities available.

3. The limit will vary according to the nature and size of the concerns proposing for insurance.

4. Location and other factors affecting the risk are also taken into account while calculating the amount of limit.

Retention:

After deciding the limit, retention can be easily fixed. Retention is the amount of maximum liability which the insurer can assume on a particular risk. The retention is determined according to the class to which it belongs and to its merit and demerits.

The retention is also decided upon the total amount of insurance in force, the average size of its policies and the amount of surplus find available with it.

It also depends upon the size of company, age of issue, the type of policy and the class of risk. Retention is also known as ‘limit’ or ‘Net holding’ of the insurer.

The ‘Limit’ is based on physical nature of the risk, construction and occupancy, probability to fire, exposure, fire protection, situation of risk, conflagration (adjoining) hazards, special peril Maximum Probable Loss (PML) is also influencing factor of deciding Maximum Amount of Loss (MAL) for the insurer. The different between these two is for reinsurance.

Reinsurance is the transfer of insurance business from one insurer to another. The insurer transferring the business is called the ‘principal’ or ceding or original office and the office to which the business is transferred is called for ‘reinsurer or guaranteeing office’. It is also a contract of indemnity.

The original company must disclose all the material facts to the reinsurer. At the time of loss the reinsurer indemnifies the loss up to the amount of reinsurance. The reinsurance amount is obtained by deducting retention amount from the original policy amount.