Reinsurance Programme Design After a Catastrophe Model Reveals a Capital Gap
Bharat General Insurance has gross written premium of ₹2,400 crore and a net worth of ₹310 crore. Property and engineering business has grown 28% in two years and now forms 45% of the book. The reinsurance programme is a 40% quota share on property and engineering, a surplus treaty of ₹150 crore excess of a ₹40 crore retention each risk, and a catastrophe excess-of-loss cover of ₹60 crore excess of ₹40 crore with one reinstatement. The company has just won a single petrochemical risk of ₹500 crore in Gujarat. Its catastrophe model shows a 1-in-200-year earthquake loss of ₹900 crore gross on the property portfolio. The appointed actuary warns the board that the current programme leaves the company exposed to a loss larger than its net worth. The CFO objects that buying more cover will push the combined ratio past 115% and the solvency ratio (1.62 times the required margin) below comfort. The programme must be filed with the regulator by 31 March.
1. Quantify the two exposures: the single petrochemical risk and the earthquake scenario. What net figure does the company carry in each case under the current programme?
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Single risk - ₹500 crore petrochemical complex.
- Quota share 40% cedes ₹200 crore; ₹300 crore remains.
- Surplus treaty: retention ₹40 crore each risk, capacity ₹150 crore excess. It absorbs ₹150 crore of the remaining ₹300 crore.
- Net retained = 300 - 40 - 150 = ₹110 crore on one risk.
Catastrophe - ₹900 crore gross earthquake loss.
- Quota share 40% cedes ₹360 crore; net ₹540 crore.
- Cat XL: ₹60 crore excess of ₹40 crore. The layer attaches only above a retained ₹40 crore and is capped at ₹60 crore; the reinstatement is irrelevant for a single event. Recovery = ₹60 crore.
- Net after recovery = 540 - 60 = ₹480 crore.
Against a net worth of ₹310 crore, a single modelled event leaves a net loss of ₹480 crore: on a 1-in-200-year event the company is technically insolvent. The single-risk gap of ₹110 crore is more than a third of net worth on one account, which any competent underwriter should have refused without facultative support.
The 1.62 times solvency ratio is measured on a going-concern basis and gives no comfort here: the solvency margin is a regulatory buffer for ordinary volatility, not a catastrophe fund.
2. Design a revised reinsurance structure that brings the retained catastrophe loss within 60% of net worth, and show the arithmetic. State any assumption you make.
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Target. Retained cat loss ≤ 60% of ₹310 crore ≈ ₹186 crore, say ₹180 crore. Against a gross loss of ₹900 crore, the programme must cede or recover ₹720 crore.
Revised structure (illustrative):
- Quota share reduced from 40% to 25% on property and engineering, to keep more of the good business: cedes ₹225 crore on the event; net ₹675 crore.
- Per-risk protection: surplus capacity raised from ₹150 crore to ₹350 crore excess of ₹40 crore, plus facultative cover for the top of the petrochemical risk. On the ₹500 crore risk, after 25% quota share ₹375 crore remains; retention ₹40 crore plus surplus ₹335 crore (within the ₹350 crore capacity) leaves nothing uncovered.
- Catastrophe XL: ₹500 crore excess of ₹175 crore, one reinstatement. Net cat loss before XL is ₹675 crore; the layer attaches at ₹175 crore and covers ₹500 crore, so recovery = 675 - 175 = ₹500 crore, exhausting the layer exactly. Net retained = ₹175 crore, within the ₹180 crore target.
- Add an aggregate stop-loss or second-event cover, because the reinstatement restores the layer only once and a second quake in the same year would be uninsured.
Assumptions: capacity and pricing are available at renewal; the loss is a single occurrence; the model's gross loss of ₹900 crore is accepted. If the catastrophe market is hard, the alternative is to cut gross accumulations - reduce line size in the seismic zone - which reduces the need to buy cover rather than paying for it.
3. The CFO argues that additional reinsurance will push the combined ratio past 115% and weaken solvency. How should the board weigh cost against protection, and what governance steps does the filing require?
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Reframe the comparison. Reinsurance cost is a certain small outflow; catastrophe retention is an uncertain loss that can exceed net worth. A combined ratio of 115% is painful but survivable; a ₹480 crore net catastrophe loss is not. The board should compare the cost of cover with the capital it replaces - if ₹500 crore of extra catastrophe cover costs, say, ₹25 crore, the company is buying protection equal to more than one and a half times its net worth for a small fraction of the capital at risk. That is usually the cheaper capital.
But do not buy everything. Reinsurance cannot make an underpriced portfolio profitable. Growth of 28% in property and engineering, now 45% of the book, is the underlying problem: growth outrunning capital. Any programme change must be paired with line-size limits per risk, accumulation caps per seismic zone and rate action on the worst-performing accounts. Otherwise the company pays for reinsurance and still loses money on what it keeps.
Solvency treatment. Recoveries are recognised in the solvency computation only where the reinsurer meets the security requirements; unrated or collateral-light reinsurers give little capital relief. Check the credit standing of every participant and spread the programme so no single recovery is at risk.
Governance and filing. The board must approve a documented reinsurance programme and retention policy before filing with the regulator, within the prescribed timeline and in the prescribed order of preference for domestic and overseas markets. Verify the current obligatory cession percentage and filing format against the regulator's latest reinsurance regulations rather than reusing last year's programme. Minute the appointed actuary's opinion on adequacy, and record why the chosen retention is consistent with the risk appetite the board has adopted.