Reinsurance and other forms of risk transfer: types of reinsurance: proportional reinsurance: surplus reinsurance example
As in GIM8040, a direct insurer writes the following contracts:
A five line surplus reinsurance contract is entered into with a retention of £10,000. The limit of the reinsurer’s liability is 5 x £10,000 = £50,000. Reinsurance payments are calculated as follows:
(Limit of reinsurer’s liability - Retention) / Sum Insured x Claim.
If a claim on policy 1 of £12,000 is paid then the reinsurer will pay £7,200
[(25,000 - 10,000)/25,000 x £12,000]
A claim of £35,000 on policy 2 would result in the reinsurer paying £28,000
[(50,000 - 10,000)/50,000 x £35,000]
A claim of £60,000 on policy 3 would give a reinsurance payment of £24,000
[(50,000 - 10,000)/100,000 x £60,000]
Premiums (gross of reinsurance commission) are allocated on a similar basis:
- Policy 1 (25,000 - 10,000)/25,000 x £200 = £120
- Policy 2 (50,000 - 10,000)/50,000 x £300 = £240
- Policy 3 (50,000 - 10,000)/100,000 x £500 = £200
Where reinsurance is by way of quota share or surplus treaty, premium deposits and loss reserve deposits may appear in the balance sheet. These are usually described as deposits from ceding insurers.
A premium deposit occurs where when reporting underwriting year experience (see GIM2080) the insurer retains part of the ceded premiums as a premium reserve. It will pay interest on the deposits. They are broadly equal in amount to an unearned premium provision (see GIM2100), though the calculation may be less scientific. The retention of such deposits is a safeguard against the credit risk of the reinsurer becoming insolvent and may be a regulatory requirement.
A loss reserve deposit may be encountered when reporting either accident or underwriting year experience. It represents a deposit by the reinsurer of at least part of their share of insurer’s outstanding loss reserves. As with premium deposits, interest is payable on the deposit. Such deposits give comfort to the ceding insurer and may be required by the insurer’s regulator.