Reinsurance Structure and Rating
Reinsurance questions test structure and pricing at once: what risk are you transferring, what does it cost, and what does it do to the volatility of results and to capital?
Structures
- Proportional: quota share (fixed percentage of premium and losses) and surplus (share of sums insured above a retention). Both share expenses through ceding commission.
- Non-proportional: risk excess of loss (per-risk layer), catastrophe excess of loss (per-event layer), aggregate excess of loss and stop loss (annual loss-ratio cover).
- Features: retention, limit, number of reinstatements and whether they are free or paid pro rata, aggregate deductible, event definition and hours clause (commonly 72 hours for windstorm), and whether cover is on an occurrence or claims-made basis.
Rating
Experience rating uses the ceded loss history. Exposure rating uses the insurer's risk profile plus the reinsurer's loss curves to estimate the expected loss to the layer, expressed as a rate on line (RoL) = expected loss ÷ limit. Catastrophe layers are usually rated from a model blended with experience, and model uncertainty is a central negotiation point.
Worked example
A property portfolio has gross premium ₹100 crore. Exposure rating gives the expected loss to a ₹5 crore xs ₹10 crore catastrophe layer as 2.75% of gross premium = ₹2.75 crore. RoL = 2.75 ÷ 5 = 55%. With a 20% loading for expenses, profit and model uncertainty, the quoted RoL is 66%, so premium = 0.66 × ₹5 crore = ₹3.3 crore. If the first reinstatement is free and the second is paid pro rata, a full-limit loss leaves a further ₹3.3 crore of reinstatement premium payable for a second full limit of cover.
Traps
Confusing the limit with the expected loss; forgetting that paid reinstatement premium is an additional cost in the loss ratio; assuming an aggregate-limited catastrophe programme protects premium risk in a year of many small events; treating reinsurer recoveries as certain when credit risk is real.