QS Study

Different Treaties in Reinsurance

Treaty Reinsurance is a pre-negotiated agreement between the primary and the reinsurer. Under this method, there is an arrangement between the ceding company and reinsurer that amount of insurance on a policy above the retention of the ceding company shall be submitted for reinsurance and the same shall be accepted by the insuring company.

Common types of Treaty Reinsurance are – Quota Share, Surplus, Excess of Loss, Excess of Loss Ratio (Stop-Loss), and Pools etc.

QUOTA SHARE:

This type of treaty requires the direct insurer to code a predetermined proportion of all its business accepted in a certain class to the reinsurer(s) and the reinsurer(s) also agrees to accept that proportion in return for a corresponding proportion of the premium.

SURPLUS TREATY:

Under this method, the direct insurer agrees to reinsurer only the surplus amount after its retention and the reinsurers agree to accept succession, usually up to a predetermined upper limit. Surplus treaties are usually arranged in lines, each line is equal to the insurer’s owl retention. This means that the insurer can automatically make a gross acceptance of the risk to the extent of his own retention, plus, the amount of retention multiplies by the number of lines for which treaty has been made.

Merits:

  • The cover is automatic as opposed to the facultative system.
  • It is less expensive in comparison to facultative.
  • Unlike a quota system, the ceding company can retain whatever it likes and the balance only ceded.

Demerits:

  • It is not applicable for big liability insurance or for protection against losses of catastrophe.
  • This method is not suitable for new insurance companies.

Excess of loss:

Under this system, unlike facultative, quota or surplus the sum insured does not form any basis and it is not expressed in terms of proportion or percentage of the sum insured. Here the insurer first decides as to how much amount of loss he can bear on each and every loss under a particular class of business. The arrangement is such that a loss exceeds this predetermined amount then only reinsurers will bear the balance amount of loss. Nothing is payable by the reinsurers if the amount of loss falls below this selected amount. There may usually be an upper limit of liability of the reinsurers beyond which they will not pay.

Excess of loss ratio:

This type of arrangement is also known as stop-loss reinsurance and is a bit different from the excess of loss arrangement even though both basically base on loss rather than sum-insured. Here a relationship is usually drawn in between the gross premium and the gross claim over a year in a particular class of business. The arrangement with the reinsurers is such that if at the year and it is found that the total of all losses within the class has exceeded the predetermined loss ratio then the reinsurers will pay the balance loss so as to keep the loss ratio of the ceding company within the predetermined ratio. The treaty may contain an upper limit also.

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