Reinsurance and Risk Transfer
Reinsurance basics
Candidates must understand treaty and facultative reinsurance, and the difference between proportional (quota share, surplus) and non-proportional (excess of loss, stop loss) arrangements. Know the purpose of reinsurance: capacity, catastrophe protection, stabilisation, financing and expertise.
Key terms
Understand cession, retention, cession rate, ceding commission, reinstatement of cover, aggregate excess of loss, clash cover, risk excess of loss and catastrophe excess of loss. Know the concept of net retention and the effect of reinsurance on solvency capital.
Traps in questions
- Confusing quota share (fixed percentage of every risk) with surplus (percentage above a retention line).
- Forgetting that reinstatement of a reinsurance layer usually costs an additional premium.
- Assuming reinsurance eliminates risk - it transfers risk but introduces counterparty credit risk.
Worked example
A quota share treaty cedes 40% of every risk. A policy of £1,000,000 premium and £600,000 claims is ceded as £400,000 premium and £240,000 claims. The insurer retains 60% of both, so its loss ratio is unchanged, but its exposure to any single loss is reduced by 40%.