Risk Financing and Reinsurance
Risk financing answers who pays. Retention ranges from planned deductibles to funded self-insurance, captives (pure or single-parent, group, protected cell, rent-a-captive), risk retention groups under the Liability Risk Retention Act, and public-entity pools. Alternatives to guaranteed-cost programs include large deductibles, self-insured retentions, and retrospective rating, in which final premium depends on the insured's own losses.
Reinsurance fundamentals
Reinsurance is insurance for insurers: it adds capacity, stabilizes results, funds catastrophe losses, offers surplus relief, and supplies underwriting expertise. Treaty reinsurance automatically covers all business meeting the treaty definition; facultative is negotiated case by case for unusual or large risks.
Pro rata forms share premium and losses proportionally: quota share cedes a fixed percentage of every risk; surplus share cedes the portion above the insurer's retention line. Excess of loss responds only above a retention, structured per risk, per occurrence, per policy, or in aggregate (catastrophe cover), often in layers with reinstatements defining how much limit can be restored after a loss.
Worked example
- Quota share: 75% ceded, ceded premium $100,000, 25% ceding commission = $25,000 commission to the cedent; the cedent keeps $25,000 premium and 25% of losses.
- Surplus share: retention line $100,000 with a 9-line treaty gives $1,000,000 capacity; a $500,000 policy cedes $400,000 (80%).
Alternative capital includes catastrophe bonds, industry loss warranties, and sidecars.
Traps
Describing quota share as capping loss per occurrence; forgetting reinstatement premiums; treating facultative cover as automatic; assuming reinsurance relieves the primary insurer of its obligation to the policyholder.