Reinsurance and other risk transfer mechanisms
This domain tests the structure, pricing, accounting and risk effects of reinsurance, plus alternative risk transfer. You need to explain what is ceded, what is retained and how recoveries interact with limits and reinstatements.
Core concepts
- Proportional: quota share and surplus; the reinsurer shares premium and losses, often with a ceding commission.
- Non-proportional: per-risk excess of loss, aggregate excess of loss, catastrophe cover and stop-loss. Reinstatements, aggregate limits and event definitions drive the real cover.
- Alternative risk transfer: captives, insurance-linked securities, catastrophe bonds and industry loss warranties.
- Risk effects: reduced net volatility and capital, but credit risk, basis risk, moral hazard and contract wording risk remain.
Worked example
A policy has gross premium £1m and a £600,000 loss. The insurer buys a 40% quota share with 25% ceding commission. Ceded premium = £400,000; ceding commission = £100,000; net ceded premium = £300,000. The reinsurer pays 40% × £600,000 = £240,000, so its result is £300,000 − £240,000 = £60,000 profit. The cedant retains 60% of the loss (£360,000) and net premium of £700,000, before its £200,000 expenses.
Traps that cost marks
Ignoring reinstatement premiums and aggregate limits; assuming a catastrophe cover responds to every large loss; forgetting reinsurer credit risk and collateral; and confusing ceding commission with a profit commission.
Exam tip
Draw the layer. State attachment, limit, aggregate limit, reinstatements and event definition before calculating a recovery.