RI Accounting for Proportional Treaties

1. RI Accounting forProportional Treaties Mrs. Achala Nayak Director J B Boda & Co (S) PTE LTD., Singapore

2. What is Reinsurance? • It is a Risk Transfer from an Insurance Company. • It is Insurance of Insurance • An Insurance Company pays Premium to Reinsurance for the Risk Transfer. • A Reinsurance Company pays Losses to the Insurance Company. • All these transactions are in a pre-decided proportion.

3. What is Retention? Retention is an amount, an insurance company is willing to risk for its own account from a single loss

4. Why Reinsurance ? • An Insurance Company has its own limitations to write business, linked to: • Its Capital and Free Reserves. • Size of the Risk, its Occupation & Premium • Accumulation of RisksPremium. • Profitability of Portfolio • Reinsurance Programme used • Market Forces and Reinsurance Capacity available • Such factors influence an Insurer to limit its own retention and to effect Reinsurance

5. NON PROPORTIONAL Facultative (single risk) Treaty (Contracts) (multiple risks) Risk XOL. Catastrophe XOL. Stop Loss XOL PROPORTIONAL Facultative (single risk) Treaty (multiple risks) Quota Share. Surplus Fac. / Obligatory. Open Covers Methods of Reinsurance

6. Facultative RI • Characteristics • Similar to co-insurance; • Simplest and oldest method; • Optional i.e. free choice to decide; • Single risk method; • Full disclosure of all facts. • Follows all original policy conditions

7. Facultative RI • Advantages • In case of a small portfolio, where Treaty is unattractive; • Where risk is outside the scope of the Treaty - e.g. excluded class or Geographic Scope; • Where S I exceeds the Treaty Limit; • Expertise and capacity of big reinsurance can be used, • Where the risk is hazardous and might destabilise the Treaty

8. Facultative RI • Disadvantages • Full disclosure of the material facts. • Delay in seeking support. • High administrative costs in negotiation and administration. • Lower rates of commission. • No Profit Commission. • Risk of overlooking the renewal placement. • Negotiation procedure to be adopted at each renewal

9. Premium and Loss Distribution in Facultative RI

10. Accounts for Facultative • Since Fac RI is a single risk transaction, rendering of statement of premium & Claims known as “Closing” is on individual basis. • At times there is PPW & the Cedant and the Broker must adhere to it. • Closing must follow within a reasonable time after the signed line is advised and certainly before the expiry of the PPW. If for any reason, there is a delay, Reinsurer’s permission needs to be taken for extension of PPW.

11. Name of Broker & Ref. No. Name of Cedant & Ref. No. Name of Assured and location. Period of Cover / Perils Covered TSI, Rate, Deductions Actual working of 100% Premium Reinsurer’s % share and the amount of netpremium Accounts for Facultative

12. Name of Broker & Ref. No. Name of Cedant & Ref. No. Name of Assured and location. Period of Cover Date of Loss Perils covered Cause of loss Amount of Loss Intimated Settled Outstanding Reinsurer’s % share and share of loss Accounts for Facultative • As regards Facultative Claims: • Each claim is Cash Claim, in so far the approval of the reinsurer is concerned. • Irrespective of the amount of the claim, they should not be adjusted in the remittance statement without obtaining concurrence of the reinsurer. • The Facultative claim advice will contain:

13. What is a Treaty? • It is a contract / agreement • Gives automatic and continuous Capacity to an Insurance Company. • Predefined Scope for • Period • Class / Classes of business • Retention and Cession limit under treaty • Geographical Scope • Also exclusions are specified.

14. Quota Share Treaty • Characteristics • Obligatory in nature. • Retention and cession on every risk • Operates on fixed percentage basis. • Meaningful retention required • Advantages • Simple form & easy to operate and administer. • Works like a partnership & Useful for a new company or for a new class of business, where the results of business are unpredictable. • Useful for reciprocal exchange. • Disadvantages • Inflexible method of RI (unless VQS). Fixed percentage of premium on each ceded risk forces large outflow of Premium. • Fails to reduce incurred claims ratio on the retained account. • Capacity offered is limited.

15. How does a QS treaty Work? Every Risk to be Ceded Risk SI 100,000 Premium 20,000 Loss 25,000 Cedant Reinsurer Retains fully 100,000 Premium 20,000 Loss 25,000 Net balance: (5,000) If No Treaty Retains 50% 50,000 Premium 10,000 At 30% rate Gets Comm. of 3,000 Retains Loss 12,500 Net balance: 500 50% QS cession 50,000 Premium 10,000 Pays Comm of 3,000 Loss 12,500 Net balance: 5,500

16. Quota Share Treaty Cession

17. Surplus Treaty • Characteristics • Obligatory in nature. • Cession of policies, where SI exceeds the gross retention. • Hence retention on every policy, but cession may not be on every policy (Like QS). • Placed in terms of lines (not in % like QS) • Capacity Treaty, as capacity can be stretched through number of lines & through creation of first, second and third surplus treaties.

18. Uses of Surplus Treaty • To handle large risks. • Simple and small risks well within the retention capacity can be fully retained. • Higher retained portfolio generated through retained premium & premium reserves. • Higher underwriting capacity. • Besides receives Profit Commission, if treaty produces profitable results. • Useful for reciprocal trading.

19. How does a Surplus Treaty Work? • Capacity expressed in Lines (Times of Retention). • If retention is say 100,000 and the Surplus Treaty is of 10 lines, then the Capacity is 1,000,000. • Since it is a Surplus Treaty, the Reinsured will retain all risks up to SI of 100,000 and cede the balance to the Surplus Treaty. • Therefore every risk will not go to the Surplus Treaty Reinsure.

20. Surplus Treaty Risks Distribution

21. QS & Surplus Treaties: Cessions

22. Distribution of Risk over QS & Surplus Treaties

23. Distribution of Risk over QS & Surplus Treaties

24. Risk Distribution over an RI Programme

25. Why do we require RI A/c ? • U/W and A/C are inextricably related. • They are two sides of the same coin. • Together they determine the financial performance of the Reinsured and the Reinsurer. • A Statement of Account (SOA) is summary of Ceding Companies transactions of • Premiums and Claims, • For a Class of business, • For a Period of time.

26. Why do we require RI A/c ? • Because: • They are the records of transactions between the parties to an RI Contract. • Information contained in the RI A/c is required by the Reinsurer to enable it to prepare: • A/c for its own retro-cessionaries. • Financial A/c (i.e. Profit & Loss, Balance Sheet) and to file returns to the Regulator. • Provide data for assessment of technical reserves (i.e. unearned premium and O/S loss) and for preparation of underwriting statistics & evaluation of each treaty.

27. Premium Bordereaux • Purpose: • To record each cession of premium to the reinsurance treaties so that: • premiums can be allocated easily to reinsurance; • there is a convenient list of cessions that can be used as the basis for allocating claims; • statistics may be compiled easily; • reinsurers are aware of the type of business that they are accepting.

28. Premium Bordereaux • Class: e.g. fire, accident, etc.. • Month: a bordereau should be prepared for each month. • Page number: to ensure that pages are not misplaced if the bordereau for a month runs onto more than one page. • Date: date of preparation of bordereau. • Reinsurer: to identify the reinsurer to whom the bordereau is to be sent. • Reinsurer’s share: for the reinsurer’s reference.

29. Premium Bordereaux • Cession number: so that each cession to reinsurance can be identified a sequential number is allocated. • Policy number. • Name of insured. • Effective date: date of commencement of policy, renewal date or date of endorsement, alteration, etc. • Expiry date: date of termination, etc. of policy. • Type: type of premium (e.g., 1 - renewal; 2 - new; 3 - endorsement; 4 - cancellation; etc.) • Building: use of building, e.g., dwelling, farm, office, etc. • Sums insured and premiums

30. Claims Bordereaux • Purpose • To record each claim to be recovered from the reinsurance treaties so that: • claims can be recovered correctly from reinsurers; • statistics may be compiled easily; • reinsurers are aware of the losses they are being asked to pay and can establish adequate reserves.

31. Claims Bordereaux • Class: e.g., fire, accident, etc. • Month: a bordereau should be prepared for each month. • Page number: to ensure that pages are not misplaced if the bordereau for a month runs onto more than one page. • Date: date of preparation of bordereau. • Reinsurer: to identify the reinsurer to whom the bordereau is to be sent. • Reinsurer’s share: for the reinsurer’s reference

32. Claims Bordereaux • Policy number. • Cession number: so that each cession to reinsurance can be identified a sequential number is allocated. • Name of insured. • Claim number. • Date of loss: so that the loss can be allocated to the correct year’s reinsurers. • Type of loss: theft, fire, etc. • Payment: to identify multiple part payments of a loss. The column should be completed with “first”, “second”, etc., and, when a final payment is made “final” should be entered so that reinsurers will know that they can close their file on the loss.

33. Claims Bordereaux • Gross loss: the amount of the payment to the insured (or third party) by the company. • Gross expenses: the amount of additional expenses incurred in settling the claim, for example loss adjusters’ fees. • Total loss and expenses: the sum of columns 8 and 9. • Retained loss: the amount of the loss that falls to the company after recoveries from reinsurance. • Losses ceded: the amounts to be recovered from various reinsurance arrangements.

34. Loss Notification SHOULD BE ON COMPANY LETTER-HEAD, MENTION DATE, TREATY NAME & U/W YR The details of the loss are as follow: • Insured: ___________________________________________ • Policy number: ___________________________________________ • Policy period: ___________________________________________ • Claim number: ___________________________________________ • Date of loss: ___________________________________________ • Cause of loss: ___________________________________________ • Circumstances of loss: ___________________________________________ • ___________________________________________ • Estimated gross loss: ___________________________________________ • Estimated treaty loss (100%): ______________________________________ It is/is not expected that a cash loss settlement will be requested in respect of this claim. We will keep you informed of all developments regarding this claim.

35. Cash Loss (CL) • To enable immediate recovery of very large losses. • If CL Limit is 1,000,000, a loss recovery of more than 1,000,000 becomes eligible for immediate Cash Call. • CL settlement by Reinsurer is kept in suspense A/c which is squared off when that particular loss is included “Paid Claims” of statement of account & CL Credit is given to reinsurers who have paid the claim.

36. Submission of SOA • At regular intervals, a: • treaty account will be dispatched to all reinsurers. The account will contain technical and financial items and forms a statement of amounts due to or from the reinsurer.

37. Credited to Reinsurers Premiums net of returns and cancellations. PR Released. LR Released. Interest on Reserves. P P/F incoming. L P/F incoming. Refund on Cash Loss Debited to Reinsurers Ceding Commission. Tax on Premium. PR retained. LR retained. Paid Claims. P P/F Withdrawal. L P/F Withdrawal. Profit Commission. SOA will usually have following debit and credit items

38. Company Letter HeadU/W Year 2009 Quarter 3rd Q Treaty Name & Quarter Period: 1.7.09 to 30.9.2009 Date

39. Periodicity of rendering Accounts • Accounts can be rendered on Quarterly, Half-yearly basis. • Traditionally Quarterly system is used and is more desirable for Reinsurers as accounts prepared on longer duration delay receipt of premium & also delay submission of information.

40. Commission • Consideration to meet actual net acquisition cost, excluding salaries of staff. • An agreed % of Premium, paid by the Reinsurer to the Reinsured. • Influencing factors: 1. Type of Treaty. 2. Class of business. 3. Country. 4. Results. • Usually uniform to all participants. • May differ for reciprocity.

41. Commission • Usually three methods employed: • Flat Percentage method. • Flat Percentage plus Additional Percentage. • Sliding Scale method.

42. Flat % Commission • This is the simple and most commonly used method. • The percentage of commission is defined in the treaty slip, say 35%. This percentage is to be applied to the gross or net premium, accounted in that Quarter (as defined in the terms) to arrive at the commission. • Gross Accounted Premium 1,000 X 35% = 350 commission.

43. Flat + Additional Commission • This is rather uncommon method. • A fixed percentage of commission is guaranteed. • Besides, depending on the loss ratio, at the end of the year additional commission is payable to the Cedant. • Example commission 30% + 2 ½ % is LR below 60%.

44. S/S Commission • Sliding Scale method ensures that the actual rate payable is directly related to the loss ratio. • Which means more commission in good years and lower commission in bad years. • Key factors: • Payment of provisional commission. • Calculation of loss ratio. • The Sliding Scale of Commission table. • Minimum and Maximum rate of commission payable. • Payment of actual commission due.

45. S/S Commission • Provisional Commission: • Unless loss ratios are known, the actual commission can not be determined. Hence provisional (interim) commission payable. Usually this is fixed mid-way between the minimum and maximum rate. • Minimum rate is 25% • Maximum rate is 35% • Provisional Commission will be 30%. This is considered equitable as neither party can pre-judge the final result of the treaty.

46. S/S Commission • Calculation of Loss Ratio will depend on method of accounting – whether Underwriting year or Accounting Year. • For underwriting year method of accounting it is unusual to have S/S commission e.g. Engineering, Marine and Aviation business – because these years take many years to fully develop. • Reward for profit are dealt with through Profit Commission.

47. Calculation of L/R for S/S commissionrun-off Treaties • Loss ratio, being calculated at various points in development of one u/w year, will keep on changing until all liabilities expire. The rate of commission directly related to loss ratio, the actual level of commission payable to the Cedant will fluctuate and adjustments will have to be done accordingly. Amount of administrative work involved in this calculation is enormous.

48. S/S Commission Table • As per practice, the treaty terms would include a detailed scale of commission payable related to actual loss ratio. • To determine the actual rate of commission payable all that is necessary is to select the appropriate rate from the scale. • Example: Loss Ratio 52.8% Commission 28.50% Loss Ratio 66.60% Commission 21.50% Loss Ratio 78.20% Commission 15.50%

49. S/S Commission- Min & Max Rates • The S/S commission will have a min rate and a max rate. • The min rate reflects the least amount of commission that the Cedant requires to take care of its acquisition costs. • The max rate reflects the highest amount of commission the Reinsurer is willing to give. • S/S commission itself includes the rewards for profitability, hence it is not usual to encounter the S/S commission and the PC in the same treaty, although it may happen in practice.

50. Calculation of L/R for S/S commission • Formula used: (U/W year based treaties) Incurred Loss X 100 Earned Premium