Reinsurance Study Guide

📖 Core Concepts Reinsurance – insurance bought by a primary insurer (cedant) to pass part of its risk to a reinsurer, reducing volatility and increasing capacity. Cedant – the primary insurer that cedes risk. Reinsurer – the entity that assumes the transferred risk in exchange for a premium. Proportional (Pro‑Rata) Reinsurance – premiums and losses are shared in a fixed percentage; the reinsurer may pay a ceding commission. Non‑Proportional (Excess‑of‑Loss) Reinsurance – the reinsurer pays only after the cedant’s losses exceed a pre‑set retention (priority). Facultative vs. Treaty – facultative covers a single, individually‑underwritten risk; treaty covers a whole class of business under a standing agreement. Contract Bases – risks‑attaching (covers policies issued in the period), losses‑occurring (covers losses occurring in the period), claims‑made (covers losses reported in the period). Lead vs. Following Reinsurers – the lead sets contract terms; followers subscribe to those terms. Retrocession – a reinsurer passes on portions of the risk it has assumed to other reinsurers. Fronting – an insurer issues a policy in a jurisdiction where it isn’t licensed and reinsures the risk to a licensed reinsurer. --- 📌 Must Remember Reinsurance increases underwriting capacity, smooths earnings, and provides surplus relief. Proportional treaties give the cedent surplus relief; excess‑of‑loss treaties protect against large, infrequent losses. Facultative = per‑risk; Treaty = portfolio/class. Retention / Priority = the amount the cedent keeps before the reinsurer pays. Ceding commission compensates the cedent for acquisition, admin costs, and profit margin. Assumption reinsurance transfers both risk and policyholder liability to the reinsurer after notice. Fronting creates a credit‑risk exposure for the cedent because the reinsurer must honor claims. --- 🔄 Key Processes Risk Transfer Workflow Cedant identifies risk to cede → selects reinsurer → negotiates terms (proportional vs excess‑of‑loss, retention) → pays premium → reinsurer assumes loss exposure. Proportional Treaty Accounting Premium received × share % → cedent retains same % of claims → reinsurer receives ceding commission (if any). Excess‑of‑Loss Claim Payment Total losses of period → compare to retention → if losses > retention, reinsurer pays (losses – retention) up to limit. Retrocession Chain Primary reinsurer → receives ceded risk → retrocedes part of that risk → new reinsurer becomes “retrocessionaire.” Fronting Arrangement Local insurer (fronting) issues policy → immediately reinsures to licensed reinsurer → fronting retains minimal liability, mainly credit risk. --- 🔍 Key Comparisons Proportional vs. Non‑Proportional Proportional: Fixed % of premiums and claims shared; provides surplus relief. Non‑Proportional: Only losses above a retention are shared; provides catastrophe protection. Facultative vs. Treaty Facultative: Handled case‑by‑case; used for large or unusual risks. Treaty: Pre‑negotiated for a whole class; more efficient for volume business. Risks‑Attaching vs. Losses‑Occurring vs. Claims‑Made Risks‑Attaching: Covers policies written in period, regardless of when loss occurs. Losses‑Occurring: Covers losses that happen in period, regardless of policy start date. Claims‑Made: Covers losses both occurring and reported in period (often with retroactive date). Lead vs. Following Reinsurer Lead: Sets terms, often larger share. Following: Accepts same terms, usually smaller share. --- ⚠️ Common Misunderstandings “Reinsurance eliminates all risk.” – It only transfers part of risk; the cedant still retains the retention. “Proportional = always cheaper.” – Not necessarily; costs depend on ceding commission and risk profile. “Fronting means the fronting insurer has no liability.” – The fronting insurer still bears credit risk if the reinsurer defaults. “Excess‑of‑loss covers every loss.” – It only pays after the retention is exceeded; small losses stay with the cedant. “Assumption reinsurance instantly makes the reinsurer the policyholder’s insurer.” – It requires notice and release; until then the cedant remains liable. --- 🧠 Mental Models / Intuition “Slice‑and‑Share” – Think of proportional reinsurance as slicing every premium and claim cake into fixed percentages. “Safety Net” – View excess‑of‑loss as a net that only catches losses that are higher than a set height (the retention). “Chain of Custody” – In retrocession, risk passes down a chain, similar to a relay race; each hand‑off adds a new layer of protection (and credit risk). “Front Door vs. Back Door” – Fronting is a back‑door entry to a market; the front‑door (licensed reinsurer) ultimately backs the policy. --- 🚩 Exceptions & Edge Cases Surplus Share Limits – The cedent can set a retention (e.g., $100 000) per risk; any amount above is ceded, but the arrangement may include a “maximum share” cap for the reinsurer. Stop‑Loss (Aggregate Excess‑of‑Loss) – Often expressed as a % of gross premium; triggers when total losses exceed expected loss + a margin, protecting against higher‑than‑expected frequency. Claims‑Made with Retroactive Date – If a loss occurred before the retroactive date, the reinsurer is not liable even if reported during the contract term. Regulatory Limits on Fronting – Some jurisdictions restrict fronting arrangements or require local capital backing. --- 📍 When to Use Which Use Proportional (Surplus Share) when: you need surplus relief, want to retain a predictable share of each loss, and have a diversified portfolio. Use Excess‑of‑Loss (Per‑Risk) when: a single large loss could threaten solvency (e.g., high‑limit policies). Use Per‑Occurrence (Cat) excess‑of‑loss when: exposure to catastrophic events (hurricanes, earthquakes) dominates. Use Aggregate (Stop‑Loss) when: you want protection against higher‑than‑expected loss frequency over a period. Choose Facultative when: the risk is large, unusual, or outside treaty scope. Choose Treaty when: you have a homogeneous block of business and want operational efficiency. Select Lead Reinsurer when: you need a market‑standard pricing benchmark; follow with additional capacity from following reinsurers. --- 👀 Patterns to Recognize Retention + Layer Structure → Typical in excess‑of‑loss: cedant retains up to retention, reinsurer covers next layer, possibly followed by additional layers. “Premium × Share = Ceded Premium” → Appears in every proportional treaty. “Losses > Retention = Reinsurer Pays” → Core trigger for all non‑proportional contracts. Fronting + Reinsurance = Credit Risk Flag → Whenever a policy is issued in an unlicensed jurisdiction, look for a fronting arrangement. Treaty Language “All Risks Attaching” vs. “All Losses Occurring” → Spot the contract basis to determine timing of coverage. --- 🗂️ Exam Traps Confusing Basis Types – Selecting “risks‑attaching” when the question describes losses that happen after the policy period; the correct answer is usually “losses‑occurring.” Assuming Fronting Eliminates Liability – Test‑writers may list “no liability for fronting insurer” as a distractor; remember the credit‑risk exposure remains. Mixing Up Facultative and Treaty – A question describing a single high‑limit policy likely points to facultative, not treaty. Ceding Commission Misinterpretation – Some items claim the commission is profit for the reinsurer; actually, it compensates the cedent’s acquisition and admin costs. Retention vs. Limit – A trap may present a “limit” figure as the retention; recall retention is what the cedent keeps, while limit is the maximum the reinsurer will pay. ---