3 important Methods of Reinsurance

3 important Methods of Reinsurance

1. Shopping or ‘Street’ Reinsurance:

Under this method, there is no standing agreement regarding reinsuring of risk of one company by the other. Each policy is treated on an individual basis. The reinsurer is sought only when the need of reinsurance on a policy arises.

The reinsurer scrutinizes each case on its merits and may accept the risk on any terms and conditions or may decline it. Since the ceding company is not certain about the availability of reinsurance and a term, it will exercise a greater care in selecting the risk.

2. Facultative Reinsurance:

The essential feature of this method is that each individual risk is submitted by the ceding office to the reinsurer who can accept or decline whatever sum they consider appropriate subject to the amount of their acceptance being approved by the ceding office. The reinsurer is offered the particulars of original contract.

The reinsurer will see the plan and report on. The risk offered for reinsurance. The reinsurer may qualify the acceptance subject to plan and report. The ceding office may retain certain amount on the insurance. The agreement does not make it binding upon the reinsuring company to provide reinsurance on a particular risk.

The ceding office is under no obligation to submit all its business to the insurer. When reinsurance facultative, the insurer may obtain reinsurance coverage before accepting to insurer a client to ensure that the reinsurance term do not exceed those applying to direct insurance and to back up the judgment of the original underwrite at the insurer’s office who will after benefit from the reinsurer.

This method differs from the ‘Shopping’ in the sense that the two companies are agreed in advance as to the form in which risks, premium, terms and other details are to be submitted.

Thus, many expenses connected with ‘shopping’ are reduced. Under this method also, the ceding office may have to wait before accepting the original risk till it is accepted for insurance.

When the underwriting rules of the two companies are similar and the plan of insurance seems to be fairly satisfactory, it can be assumed with reasonable safety that the required reinsurance will be available.

The ceding office knowing that the risk may also be declined for reinsurance will be more careful in accepting the original risk and may avoid the higher risk. It may receive valuable advice from the reinsurer.

Facultative reinsurance policies:

As mentioned earlier, a reinsurance policy is essentially different from a reinsurance contract. A reinsurance policy is in respect of risk which is already written and the reinsurance is required for limits in excess of net retention limits and other reinsurance capacities.

It is not obligatory for the reinsured to effect facultative reinsurances and the reinsurers have option open to accept or reject a risk.

Facultative reinsurances are of two types, viz., rata or Contributing Facultative Reinsurance and Facultative Excess of Loss Reinsurance. Reinsurance policies are contracts for risks already written and not for future risks to be written.

A reinsurance policy is issued under Facultative reinsurance and such a policy contains detailed description of the risk, its location, its period of coverage, perils covered, exclusions if any, territorial scope, premium rate, limits of liability, reinsurance commission, etc.

Such policy is for each individual risk reinsured. Generally, there is a convention of not providing profit commission on such reinsurances. Premium and losses are accounted separately as provided therein.

Reinsurance Treaties and Reinsurance policies are not synonymous; reinsurance treaties are contracts for insurance and reinsurance policies or sessions are contracts of insurance.

Facultative reinsurance is not for creation of capacity but it is for risks already underwritten, where limits are beyond the capacity of the insurer. It is a contract of insurance by way of a reinsurance policy for current single risk.

Under Reinsurance Treaty method, the reinsurance contract is for creation of capacity for future portfolio of risk to be underwritten and declared therein.

Again, under Quota Share treaty and Excess of Loss treaty the risks accepted by the ceding office of insurer are automatically reinsured according to the terms of the treaty.

But under Surplus treaties, a risk is reinsured once it crosses the retained limit of liability. Thus under Surplus treaties the reinsured has to declare a risk by an entry on bordereau.

Open covers or Automatic Facultative covers or Facultative obligatory covers are agreements to make future reinsurance where the reinsured has got an option to declare a risk but, once declared, the reinsurer has to accept it as on obligation under the contract. Thus such reinsurance is ‘Facultative’ for reinsured but ‘Obligatory’ for the reinsurer.

3. Automatic or Treaty Reinsurance :

Under this method, there is an agreement between the ceding office and reinsurer office that the amount of insurance on a policy above the retention of the ceding office shall be submitted by it for reinsurance and the same shall be accepted by the reinsuring company.

As soon as the original contract is completed the excess above retention amount becomes automatically reinsured under the agreement.

The ceding office need not even inform the reinsuring office immediately that a risk has been accepted by it. The terms and conditions of the reinsurance contract are the same as of the original insurance contract.

The maximum reinsurance amount acceptable to the reinsurer bears a definite relationship with the retention limit of a ceding company.