Catastrophe Reinsurance Renewal and Sidecar Capital Relief

The two structures solve different problems.

• Cat XL: The current £100m xs £25m programme protects against a single large event above £25m. The renewal offer at 18% ROL costs £18m for £100m of limit, versus £14m expiring. That is a 29% price increase. The renewal also has only one reinstatement (versus one free plus paid reinstatements) and a £10m aggregate deductible. Fewer reinstatements matter because the current year already had two events: the free reinstatement was used, and a third event would have limited cover. The aggregate deductible adds £10m of retained frequency cost. The three-year lock-in gives certainty but removes the ability to re-price if the market softens or loss experience improves.
• Sidecar: A 10% quota share cedes 10% of premium and losses on the whole property account and pays a 25% ceding commission. It reduces net exposure and can provide capital relief, but it is not a catastrophe tail solution: it shares all results, including good business, and only reduces the net cat loss by 10%. The 5% vertical slice retained by the insurer (0.5% of the account) aligns interests but does not change the risk transfer materially. The 25% commission may or may not cover the insurer's acquisition and administration costs; if the expense ratio is above 25%, the sidecar is expensive on a margin basis.
• Cost of capital comparison: The XL is expensive at 18% ROL, but it buys tail protection. The sidecar is cheaper on a premium basis but cedes profit and does not cap the tail. Using both may over-transfer risk and overpay; using neither may breach the board's 0.5% exhaustion appetite.

Recommendation: retain a cat XL programme but negotiate the renewal; use the sidecar selectively, not as a substitute.

• Do not accept the three-year flat deal as offered. The 18% ROL and reduced reinstatements transfer more risk to the insurer while increasing cost. Seek a one-year renewal with one free reinstatement, or a multi-year deal with a rate review after year one and a reinstatement structure that reflects the two-event experience. If the reinsurer will not move, compare the cost of a cat bond or a collateralised aggregate cover for the tail layer.
• Check the limit against risk appetite. £100m xs £25m may not be enough for a 99.5% TVaR event on a £250m property account concentrated in commercial and SME property. The board's 0.5% exhaustion probability must be tested with a catastrophe model, not assumed. If the limit is insufficient, buy more limit or reduce concentration; do not rely on the sidecar to solve a tail problem.
• Use the sidecar for capital and earnings volatility, with conditions. A 10% quota share can help the Solvency II ratio and reduce volatility, but only if the ceding commission is at least the insurer's cost of writing the business. The 5% vertical slice is acceptable for alignment. Consider a smaller share, or a sidecar limited to the cat-exposed segments, to avoid ceding profitable non-cat business.
• Retention: keep the £25m per-event retention unless the model shows it breaches appetite. The aggregate deductible of £10m is acceptable only if the insurer has capital for frequency; otherwise negotiate it away.

Basis risk and capital treatment

• Basis risk: The cat XL responds to a modelled event, but the insurer's actual loss may differ because of non-modelled perils, demand surge, claims inflation or coverage disputes. The sidecar has no event basis risk in the same sense, but it introduces counterparty and collateral risk. The board should see both: the XL protects the tail but may not pay for a loss that is large to the insurer but below the model's event definition; the sidecar pays proportionally but is only 10%.
• Capital: Under Solvency II, both XL and quota share can reduce the SCR if the contract is effective and the counterparty is recognised. The sidecar may give more reliable capital relief because it is proportional, but the XL is more capital-efficient for tail risk. The actuary should test the net SCR under a range of cat scenarios, including a second event and a reinsurer downgrade.
• Communication: tell the board that the cheapest option on expected cost is not the best option on risk appetite. The 18% ROL is a price for certainty; the sidecar is a price for capital relief. Recommend a blended structure and set triggers for revisiting if the cat model changes or a large event occurs.