Fundamentals and Economics of Reinsurance
IC-81 tests reinsurance as a risk-financing and capacity tool. This domain covers why insurers buy reinsurance, the parties involved, and the basic treaty/facultative and proportional/non-proportional split.
Core concepts
- The cedant (ceding insurer) transfers part of a risk to a reinsurer; a retrocessionaire assumes risk from a reinsurer.
- Reinsurance is not coinsurance: coinsurers share the original policy directly with the insured, while a reinsurer has no direct contract with the original insured.
- Functions include capacity, catastrophe protection, stabilization of results, surplus relief, underwriting and pricing support, and global diversification.
- Treaty reinsurance covers a defined portfolio automatically; facultative reinsurance is placed case by case.
- Proportional treaties share premium and losses by fixed proportion; non-proportional treaties respond only above a retention.
Worked example
An insurer issues a fire policy with sum insured INR 100 crore. It retains INR 20 crore and buys a five-line surplus treaty. Each line equals the retention, so treaty capacity is INR 100 crore; the cedant cedes INR 80 crore and keeps INR 20 crore. A INR 50 crore loss is shared 80:20: reinsurers pay INR 40 crore, the insurer pays INR 10 crore. If the policy were INR 150 crore, the treaty could cede only INR 100 crore; the insurer would need facultative cover or accept INR 50 crore retention.
Traps
Do not describe retrocession as the original cession. Do not say reinsurance eliminates the cedant's liability to the insured. Do not ignore the retention when calculating ceded loss. Check whether a line equals the retention or a different agreed amount.