Reinsurance and Risk Transfer
Domain 5 tests how an insurer protects its own book: the treaty types, how retention and capacity are calculated, and who the insured can actually sue. Expect numerical items on surplus treaties and conceptual items on facultative versus treaty placement.
Core rules
- Proportional treaties - quota share and surplus - cede a fixed share (quota) or a multiple of the retention (surplus lines) of every risk within the treaty scope.
- Non-proportional covers - excess of loss, working excess, catastrophe excess, stop loss - respond to loss size or loss ratio, not to the individual risk.
- Facultative reinsurance is placed risk by risk and is used for risks outside treaty capacity or outside the treaty scope.
- Reinsurance is a contract between insurer and reinsurer: the insured has no direct right of action against the reinsurer and the original policy terms are unaffected.
- Retrocession is reinsurance of a reinsurer.
Worked example
A surplus treaty sets a retention of 10 crore with 9 lines. The treaty capacity is 10 x (1 + 9) = 100 crore. For a policy of 75 crore, the insurer retains 10 crore and cedes 65 crore. For a policy of 120 crore, the treaty absorbs only 90 crore above the retention, so the remaining 30 crore must be placed facultatively or declined. Reasoning: lines are multiples of the retention, never multiples of the sum insured.
Traps
- Computing lines against the sum insured instead of the retention.
- Assuming a reinsurance claim affects the insured's right to be paid in full.
- Confusing stop-loss (loss ratio protection) with excess of loss (per-risk or per-event).
- Forgetting reinsurance commission, which flows from reinsurer to insurer and improves the net cost of cession.