Reinsurance and Risk Transfer
Types of reinsurance
Reinsurance transfers risk from a ceding insurer to a reinsurer. Know treaty and facultative arrangements, and the difference between proportional (quota share, surplus) and non-proportional (excess of loss, stop loss) covers. Understand retention, cession, limits, layers, reinstatements and the role of retrocession.
Functions and mechanics
Reinsurance provides capacity, stabilises results, protects solvency and supports growth. Candidates must understand how reinsurance affects the ceding insurer's financial statements, including premiums ceded, recoveries and reserves. Know the importance of reinsurance security, credit risk and collateral.
Traps in questions
A common trap is confusing quota share with surplus, or excess of loss with stop loss. Another is assuming reinsurance eliminates risk; it transfers risk but introduces counterparty and basis risk. Questions may also test whether reinsurance recoveries are automatic; facultative covers require individual acceptance.
Worked example
An insurer retains 500,000 per risk and buys a 2,000,000 excess of loss layer above 500,000. A 3,000,000 loss is borne as follows: 500,000 retention plus 2,000,000 reinsurance recovery, leaving 500,000 above the layer (unless further cover exists). Always check the layer limit and any reinstatement provisions.
Exam technique
Identify the reinsurance type, the retention, the limit and the layer, then calculate the split. State any assumptions.
Practical note
Reinsurance programmes must align with underwriting appetite and capital requirements.