Catastrophe Reinsurance Programme Restructure and Capital Trade-offs

Under the current programme, the 1-in-200 gross loss of £220m leaves a net loss of £120m: the retention is £50m and the layer recovers £100m. Under the alternative, the lower attachment of £20m means recovery starts earlier, but the limit is only £80m, so the same event leaves £140m net. The alternative therefore costs £72m against £81m, a saving of £9m, but it increases the tail loss by £20m and reduces the cover above £100m. It is cheaper and helps more frequent events between £20m and £50m, but it is less protective for severe catastrophes and may increase capital requirements if the 1-in-200 net loss drives the SCR.

The trade-offs are: cost versus tail protection; earnings volatility versus capital; and basis risk, because the cat model may not capture all perils or may misestimate the 1-in-200 loss. The per-risk layer is separate and does not solve catastrophe accumulation. Counterparty risk also matters: a lower-layer programme may involve more reinsurers or different collateral terms. I would compare the net loss at several return periods, not just 1-in-200, and calculate the cost of the additional capital under the alternative. The CRO's preference for more protection is justified only if the risk appetite requires it; the CFO's saving comes at a real increase in net tail risk.

I would recommend a blended or restructured programme rather than either quoted option. The insurer should first confirm its risk appetite for a 1-in-200 net loss and the capital cost of retaining £140m versus £120m. If the SCR is £180m, a £140m net cat loss is a large fraction of capital and could threaten coverage. A lower attachment is useful for frequency, but the reduced limit leaves the tail exposed.

Options include: buying the alternative but adding a top layer, such as £40m excess of £100m, if priced efficiently; increasing the retention on the current structure to reduce cost while keeping the limit; or using a co-participation or parametric cover for the lower layer. I would ask the reinsurer to quote a reinstatement and a multi-year deal. The decision should be based on the marginal cost of capital versus the marginal premium, not on premium alone. If the top layer is unavailable or expensive, the current programme may be better value despite the higher headline cost. I would also check collateral and counterparty ratings. The final recommendation should be minuted with the risk-appetite rationale.

Reinsurance recoverables are a credit exposure and, under Solvency II, may attract capital and default-risk charges. I would assess each counterparty's credit rating and financial strength, the concentration of recoverables by reinsurer, and the ranking of the insurer's claim in an insolvency. Collateral, trust funds, letters of credit and funds-withheld arrangements reduce the exposure; I would review their legal enforceability and valuation. The terms matter too: offset clauses, set-off rights, and whether recoveries are payable on paid claims or on notification. I would model recovery lags and dispute risk, especially for catastrophe claims where loss adjustment takes time. For the alternative programme, I would check whether the lower attachment increases the number of recoveries and therefore operational and credit exposure. I would also consider the reinsurer's exposure to the same catastrophe, which creates correlation. The output should be a net-of-credit-risk view of the programme, not just a gross premium comparison.