Reinsurance and other forms of risk transfer: types of reinsurance: proportional reinsurance
A proportional reinsurance contract may be on a quota share or surplus basis.
Quota share reinsurance
Quota share reinsurance is where the reinsurer takes on a pro-rata share of a particular risk or the total risks in a particular class of business in consideration for a similar percentage of premium, known as premium to quota share.
If, say, a 30 per cent quota share contract is entered into, the reinsurer will agree to accept 30 per cent of the risk, or in the case of a treaty 30 per cent of each and every risk, subject to a maximum sum reinsured as agreed with the insurer.
However, the direct insurer is likely to have greater expenses than the reinsurer, and in particular will have to meet the cost of acquiring the business. It is common practice, therefore, for a part of the reinsurance premium to be offset by a reinsurance commission that passes from the reinsurer to the cedant.
This is not commission in the true sense of a payment made to an intermediary for introducing the business. In economic terms the commission is simply a reduction in the premium. In some cases cedant and reinsurer will simply contract for payment of the net amount.
An example of quota share reinsurance is at GIM8040.
Surplus reinsurance is more difficult and depends on the concepts of lines and retention.
A retention is the proportion of the risk retained by the reinsured (cedant). All risks with a sum insured equal to or below the retention are retained in full by the cedant.
When the sum insured exceeds the retention a proportion of the surplus is placed with the reinsurer.
Reinsurers restrict the amount that can be ceded to them on each risk by limiting it to a multiple of the chosen retention, which is described as so many lines. The amount of the insurer’s retention is one line. A reinsurer may be said to accept, for example, a five-line surplus reinsurance contract, meaning risks up to five times the retention. This type of surplus treaty is also known as variable quota share.
An example of surplus reinsurance is at GIM8050.