Retention, surplus and catastrophe treaty response to one large fire
Bharat General Insurance, a mid-sized non-life insurer with gross written premium of Rs 2,200 crore, renews its industrial fire programme on 1 April. Every fire risk is ceded 20% under a compulsory quota share. The insurer then retains Rs 15 crore per risk and cedes the balance to a five-line surplus treaty. A catastrophe excess of loss treaty sits above the net account at Rs 50 crore excess of Rs 15 crore, with three reinstatements at 100%. A single fire at a chemical plant on 12 August is admitted by the surveyor at Rs 95 crore against a sum insured of Rs 100 crore; the surveyor confirms the reinstatement value at the date of loss did not exceed Rs 100 crore. The same insured group has three other plants in the same industrial estate, each insured for between Rs 80 crore and Rs 100 crore, all placed with the same insurer on identical terms, and all within 2 km of the burning plant. The group also holds a loss of profit policy of Rs 40 crore with the insurer. The treaty schedule lists the classes ceded and does not mention loss of profit.
1. Compute the net amount the insurer bears on the Rs 95 crore fire before and after the catastrophe treaty, showing the cessions.
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Step 1 - Confirm the loss is not further reduced. The admitted loss Rs 95 crore sits below the Rs 100 crore sum insured and the surveyor has certified that value did not exceed the sum insured, so no average applies. If the value had been Rs 105 crore, the admitted loss would first fall to Rs 95 x 100/105 = Rs 90.48 crore, and every cession below would shrink accordingly - a step worth checking before ceding.
Step 2 - Cede proportionally. Proportional treaties share the loss in the same ratio as the sum insured.
- Quota share 20%: Rs 95 crore x 20% = Rs 19.00 crore ceded
- Surplus: capacity = 5 lines x Rs 15 crore retention = Rs 75 crore, and Rs 65 crore of the Rs 80 crore remaining sum insured is ceded, i.e. 65%: Rs 95 crore x 65% = Rs 61.75 crore ceded
- Retention 15%: Rs 95 crore x 15% = Rs 14.25 crore retained
- Check: 19.00 + 61.75 + 14.25 = Rs 95.00 crore.
Step 3 - Test the catastrophe layer. The catastrophe treaty attaches at Rs 15 crore of net loss per event. The insurer's net loss on this event is Rs 14.25 crore, which is Rs 0.75 crore below the attachment point. The catastrophe treaty pays nothing. No reinstatement is consumed.
Step 4 - Note the design point. The retention of Rs 15 crore per risk and the Rs 15 crore catastrophe deductible are identical, so on a single-risk total loss the catastrophe treaty can never respond; it only works for an event involving more than one net retained risk, or where a retained loss is enlarged by a non-proportional exposure such as the loss of profit policy. That is legitimate structuring, but the committee should know it.
2. The loss of profit claim is Rs 18 crore. Explain how the treaty schedule affects the outcome, and quantify both scenarios.
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Step 1 - Establish whether the loss of profit policy is ceded. The treaty schedule lists the classes ceded and does not mention loss of profit. Facultative or treaty cession requires a written agreement; a class not listed is not automatically covered merely because it is fire-related. The reinsurance department must check the schedule, any endorsements, and the slip's definitions of 'business written' before assuming any cession. Assume, for the calculation, the two possible outcomes.
Step 2 - Scenario A: loss of profit is not ceded. The insurer bears all Rs 18 crore net. Combined net loss on the event = Rs 14.25 crore + Rs 18.00 crore = Rs 32.25 crore. Catastrophe treaty recovers Rs 32.25 crore - Rs 15 crore = Rs 17.25 crore, leaving the insurer with a net Rs 15.00 crore.
Step 3 - Scenario B: the policy is ceded on the same proportional terms. The retention is a monetary Rs 15 crore, not a percentage, so on a Rs 40 crore sum insured the insurer retains 15/40 = 37.5% and cedes 62.5% (20% quota share = Rs 8 crore of sum insured, surplus Rs 17 crore). On an Rs 18 crore loss: quota share Rs 3.60 crore, surplus Rs 7.65 crore, retained Rs 6.75 crore. Combined net loss = Rs 14.25 crore + Rs 6.75 crore = Rs 21.00 crore. Catastrophe treaty recovers Rs 6.00 crore, leaving the insurer with a net Rs 15.00 crore.
Step 4 - Draw the conclusion. Either way the catastrophe layer caps the net at Rs 15 crore, but the route differs: in Scenario A the catastrophe layer is heavily used (Rs 17.25 crore of a Rs 50 crore layer), in Scenario B only Rs 6 crore is used, and the proportional reinsurers absorb the rest. That matters for reinstatement consumption and for pricing. The immediate action is to obtain written confirmation of the cession position before any recovery is booked, and to endorse the treaty schedule at renewal so the position is never in doubt again.
3. The group's four plants sit within 2 km of each other. What accumulation questions should the reinsurance committee address?
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Step 1 - Define the event. The catastrophe treaty responds to an event, not to a policy. The committee must fix the event definition in the wording: a single fire, a blast with subsequent fire, an earthquake, a windstorm. Four plants within 2 km are one earthquake and one windstorm exposure, and probably one fire exposure if there is any common cause such as a shared pipeline, warehouse or power supply. The estate should be treated as a single accumulation zone in the exposure model.
Step 2 - Quantify the worst case. Combined sum insured across the four plants is roughly Rs 360 crore. At the current 15% retention that is a net Rs 54 crore maximum event, or Rs 54 crore + loss of profit. Against a layer of Rs 50 crore excess of Rs 15 crore, the maximum recovery is Rs 50 crore, so the insurer's absolute net on a total estate loss is about Rs 4 crore if the loss of profit is not ceded, and more if the loss of profit is ceded separately. But the layer is shared with every other catastrophe in the year, so a second large event erodes it fast.
Step 3 - Address the specifics. What is the per-risk limit in the surplus treaty, and does one 'risk' mean one plant or the whole estate? Is there an hour or event clause that aggregates all four policies? Do the three reinstatements at 100% mean the insurer must pay full additional premium for each, and can it afford to? Is there an accumulation control on line size, so that the underwriter cannot write a fifth plant in the same estate without a referral? Does the loss of profit policy share the same event definition and the same accumulation aggregation?
Step 4 - Decide. Recommend three actions: an estate-level accumulation register with a hard line-size cap per zone; a written reinsurance opinion on whether the four plants aggregate as one event for both the surplus and the catastrophe treaty; and a check that the catastrophe layer's limit is adequate against the modelled estate loss including loss of profit, buying a fourth reinstatement or raising the limit if it is not.