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NON PROPORTIONAL

  1. 1. NON-PROPORTIONAL TREATY  Non-proportional treaty is an agreement between a reinsured and reinsurer whereby the reinsurer agrees to pay the reinsured all losses which exceed a certain specified limit (deductible) up to a predetermined upper limit for losses arising out of a portfolio of risks being protected.  Also known as excess of loss treaty as the reinsurer is liable for losses in “excess”of the reinsured’s deductible or retention.  For this commitment to indemnification, the reinsurer receives a reinsurance premium independent of the original premium.
  2. 2. NON-PROPORTIONAL TREATY (cont…) To summarize:  Non-proportional reinsurance treaty: • is based on claim/loss sharing • is only liable for claim above certain level (deductible) • Premium and claims are calculated separately from the original arrangement
  3. 3. NON-PROPORTIONAL TREATY (cont…)  If reinsurance programme is arranged base on both proportional and non-proportional reinsurance treaty, the risks are shared on proportional treaty first.  The portion that is retained by the insurer will then be reinsured on a non-proportional basis.
  4. 4. Combine Proportional and Non- proportional Treaties RM500,000 Sum insured – RM10,000,000 Surplus 5 line Loss RM7,000,000 RM2,500,000 RM7,000,000 Retention Surplus Facultative Insurer will arrange the retention based on non- proportional treaty as follows: RM300,000 xs RM200,000 S/I Loss RM350,000 RM1,750,000 RM4,900,000 Xl recovery Gross loss retention RM350,000 Deductible 200,000 XL Recovery 150,000
  5. 5. Types of Non-proportional Treaty  Per risk excess of loss (working excess of loss) WXL  Per event excess of loss (Catastrophe excess of loss) CXL or CATXL  Excess of loss ratio (Stop loss or aggregate excess of loss)
  6. 6. Example RM450,000 excess of RM50,000  Reinsured retained first RM50,000 of every loss on every risk  Reinsurer agrees to pay for every loss exceeding RM50,000  Therefore, reinsured is able to retained risk of sum insured up to RM500,000 knowing that the maximum claim it may pay under any one loss arising is limited to RM50,000
  7. 7. Operation of XL Risk Loss Retention (RM) Deductible (RM) Non-prptl R/I Recovery (RM) 1 30,000 30,000 - 2 140,000 50,000 90,000 3 450,000 50,000 400,000 4 750,000 50,000 450,000 5 1,200,000 50,000 450,000
  8. 8. Operation of XL  If XL cover is inadequate due to large amount of losses, reinsured can arranged for more than one layer of XL or can increase the limit of that single layer.  If reinsured retained the inadequate cover, the retention of loss will increase which may cause fluctuation in the u/w result or even threaten the financial stability or solvency of the reinsured.
  9. 9. Operation of XL  Single layer of larger XL treaty RM2,000,000 xs RM500,000 Multiple layer of XL treaties 1st layer RM450,000 xs RM50,000 2nd layer RM1,000,000 xs RM500,000 3rd layer RM2,000,000 xs RM1,500,000 Therefore loss of Risk 4 can be distributed as:Retention RM50,000 1st layer RM450,000 2nd layer RM250,000
  10. 10. Reason for Dividing Into Multiple Layer  Splitting the risk excess of loss treaty cover into layers facilitates the placement of reinsurance cover as there is preference or specification in different levels of cover by different reinsurer or reinsurance market
  11. 11. Exercise Working XL: 1st Layer RM200,000 XS RM100,000 2nd Layer RM700,000 XS RM300,000 Gross Retn Dectb 1st Layer 2nd Layer S/I Claim S/I Clm 500k 300k 500k 300k 100k 200k Nil 5,000k 300k 1,000k 60k 60k nil nil 1,000k 600k 1,000k 600k 100k 200K 300K Calculate the claim recoveries under the excess of loss treaty .
  12. 12. XL cover 800k xs 200k S/I Amt loss Retn(S/I) Retn(loss) XL Rec 2,000k 400k 1,000 200k Nil 400k 300k 400 200k 100k 5,000k 600k 1,000 120k Nil
  13. 13. Example Max. sum insured retained: RM1,000,000 Working XL: 1st layer : RM300,000 xs RM50,000 2nd layer : RM650,000 xs RM350,000 Gross Net Loss retn XL covers S/I Clm S/I Clm 1st 2nd 300k 100k 300k 100k 50k 50k - 2,000k 300k 1,000k 150 50k 100k - 1,000k 600k 1,000k 600k 50k 300k 250k 3,000k 1,000k 1,000k 333.3k 50k 283.3k - 1,500k 1,000k 1,000k 666.7k 50k 300k 316.7k 4,000k 3,500k 1,000k 875k 50k 300k 525k
  14. 14. Uses of Non-proportional Treaty  Best way to reinsure liability classes of business  Can increase net retained premium and profit if: • Business is substantially profitable • Incidence of small claim is low
  15. 15. Advantages of Non-proportional Treaty  Simple in administration  Improves net retained position
  16. 16. Disadvantages of non-proportional treaty  Small losses fully fall on net account  Very rapid adjustment in terms following claims experience  There is no ”transfer of risk”. It only provides a :spread of loss” facility
  17. 17. Per Risk/ Working Excess of Loss  An agreement between reinsured and reinsurer whereby reinsurer agrees to pay all ultimate net losses on per risk basis which exceeds reinsured retained loss (deductible) up to an upper limit fixed by the reinsurer. • Ultimate net loss is the total claim actually paid by reinsured in settlement of losses. • It include claim expenses, salvage, subrogation, recoveries and treaty reinsurers inuring to the benefit of the excess of loss cover Total sum actually paid by the reinsured in settlement of its liabilities= Claim paid to policyholder Plus: expenses litigation (if any) Plus: all other expenses of the reinsured (excluding office expenses and salaries of reinsured’s employee) Less: salvages and /or recoveries (if any) Less: recoveries from other insurance company
  18. 18. Features of Risk Excess of Loss 1. Ultimate net loss • Ultimate net loss is the total claim actually paid by reinsured in settlement of losses. • It include claim expenses, salvage, subrogation, recoveries and treaty reinsurers inuring to the benefit of the excess of loss cover
  19. 19. Features of Risk Excess of Loss 2. Per risk cover • Covers losses on every individual risk that exceeds the deductible and falling on the business covered under the treaty. • The cover basis is “each and every loss each and every risk”
  20. 20. Features of Risk Excess of Loss 3. “Working” or “underwriting “cover  Known as “working” because the deductible is low that the reinsurer is expected to be involved in paying claims.  It is a good alternative to surplus treaty in providing protection on per risk basis
  21. 21. Features of Risk Excess of Loss 4. Reinsurance premium (Pricing of Risk Excess of Loss Cover)  No proportional sharing of risk and loss therefore no proportional sharing of original premium  Reinsurance premium rate for risk excess of loss treaty is calculated separately from original premium rate of reinsured.  Reinsurance premium is obtained by multiplying this rate (R/I rate) to the reinsured’s gross net premium income (GNPI) of the business covered by the risk excess of loss treaty.  Calculation of reinsurance premium rate is derived from the burning cost multiply by the loading factor
  22. 22. Cont….  GNPI is Gross (inclusive of acquisition cost) Net (exclude of facultative and prior including proportional reinsurance) Premium Income (premium income written or cashed by reinsured with respect to policy in the reinsurance period less only returned premium and cancelled premiums)  The reinsurance premium must be sufficient to meet reinsurance claim cost, acquisition and administration costs and profit of reinsurer.  The basic method of determining Rates for risk excess of loss treaty is “Burning Cost” method
  23. 23. Burning Cost  Burning cost: a method of calculating the premium in non-proportional reinsurance, in particular excess of loss and stop loss reinsurance, whereby the premium is directly related to the insured's claims experience; the reinsurer reviews the cedant's claims experience to ascertain what proportion of premium income would have been "burned up" by the reinsurance claims.
  24. 24. BURNING COST  Suitable for WXL that each year produce a regular flow of reinsurance claim which are settled fairly.  Burning cost or pure burning cost is pure reinsurance premium representing the cost of claim to an excess of loss treaty expressed as a percentage of original premium income (GNPI) of the reinsured. Burning cost = amount of XL claims recoverable GNPI of protected portfolio Reinsurance Prem Rate = B.C x Loading factor x 100% Reinsurance Prem Amount = R/I Prem Rate x GNPI
  25. 25. Burning Cost  Burning cost is then loaded with a factor to provide a margin for reinsurer’s expenses and profit to produce “loaded” burning cost or reinsurance premium rate.  The loading factors may range from 100/70 or 100/80. If the premium amount is small, reinsurers may ask for 100/70  Burning cost is computed from past loss experience of an excess of loss treaty.
  26. 26. Burning Cost Calculation XL cover to pay RM400,000 xs RM100,000 Loading factor 100/75 Year GNPI XL clm Burning XL Prem recvable cost Prem Amt Rate (RM) 1. 10,000 Nil 2. 11,000 25 0.0023 0.31% 3,410 3. 12,000 200 0.017 2.27% 27, 240 4. 13,000 400 Calculate the XL premium.
  27. 27. Burning Cost  Burning cost is computed from past loss experience of an excess of loss treaty.  It may be based on: • Fixed rate method - an average experience of past five/three years • Variable rate method – experience a single year but subject to minimum and maximum rates computed from past experience
  28. 28. Fixed Rate Method  The premium rate derived from the pure burning cost which was calculated from the treaty loss experience divided by the GNPI and multiply by the loading factor. Or Fixed Prem Rate = Claim recovl x Loading factor GNPI  Premium rate used will not be changed and will be used until the end of the treaty year.  The reinsurance premium amount for the current year will be obtained by multiplying the premium rate to the GNPI of the current year.
  29. 29. Fixed Rate Method Deposit Premium  The actual/current GNPI is only known at the end of treaty year.  But reinsurer need money to be able to pay claims during the year. So reinsured is required to pay a DEPOSIT premium to reinsurer at the inception of the treaty.  Deposit premium is calculated by multiplying the reinsurance premium rate to the estimated GNPI which normally derived from the previous year. Or Deposit prem = Reinsurance Prem Rate x Estimated GNPI Previous year  At the end of the treaty year, when the actual GNPI is known, the reinsurance premium will be adjusted accordingly.
  30. 30. Fixed Rate Method Minimum Premium  Minimum premium required when using fixed rate method.  Since reinsurer expresses the XL premium as a rate % to GNPI (which at the time of rating is only an estimate) the reinsurer safeguards itself against much lower than estimated XL premium by imposing a minimum amount of premium.
  31. 31. Variable Rate Method The reinsurance premium rate computation is similar to fixed rate EXCEPT that the rate can vary according to claim experience and subject to the limitation maximum and minimum rate. The maximum and minimum normally set at 200% and 50% of the reinsurance premium rate.
  32. 32. Variable Rate Method  Minimum rate % is to ensures that the reinsurers will get the minimum amount of premium for having provided protection even when the XL claims are very low or nil in any year.  Maximum rate % will limits the cost of XL protection to the protected company so that in a very adverse year it will get relief from the XL cover. (Refer to exercise on Variable Rate Calculation)
  33. 33. Variable rate offers advantages to both parties : Ceding company - benefit from low premium rate if it is successful in improving its loss experience and still able to limit for its reinsurance costs Reinsurer - it will assured of the minimum premium and be sure that if loss experience of ceding company deteriorates the premium rate will increase automatically.
  34. 34. Advantages of the Burning Cost Quotation  Given unbiased and relevant data, relatively good prediction of the claims experience  The direct insurer can easily understand the calculation  The data allow the reinsurer to understand the business philosophy and the underwriting practice of the direct insurer.  A trend in loss experience can be built into the premium calculation by weighting the most recent years more heavily.
  35. 35. Possible Difficulties with Burning Cost Quotation  A burning cost calculation comes to a misleading result if the data are old or incomplete or if the composition of the portfolio has changed or will changed  A burning cost calculation results in a nil-premium if there simply happened to occur no layer-claims in the historical data
  36. 36. Combination of Proportional treaty and Excess of loss treaty A company has a reinsurance program based on 10 lines surplus treaty and excess of loss treaty to cover the retention (net account) of RM150,000 excess of RM50,000. If the company accepted a risk of sum insured RM1,000,000 and on the same risk a loss of RM400,000, calculate how much is the claim recovery for proportional treaty and excess of loss treaty.
  37. 37. The Bersatu Maju Insurance Berhad has a reinsurance program based on 10 lines surplus treaty and has also affected two layers of working excess of loss to cover against any individual losses as follows: 1st layer - RM400,000 XS RM100,000 2nd layer - RM1,000,000 XS RM500,000 The company experience losses under each risk as the following Risks Sum Insured(RM) Losses (RM) A 1,500,000 900,000 B 5,000,000 1,000,000 C 6,000,000 4,000,000  Calculate the total of the losses retained by the company and the total reinsurance recoveries under the proportional and excess of loss treaty.
  38. 38. Application or Uses of Excess of Loss Treaty  As an alternative to proportional reinsurance to limit reinsured’s loss on per risk basis  As a supplementary reinsurance protection to the reinsured with high gross retention under a proportional treaty
  39. 39. Advantages of WXL Advantages: i) Ease of administration Only keeping track of any large losses which exceed the deductible ii) Primary insurer can retain more premium income iii) Reduction of the impact of large claims and retain up to the deductible
  40. 40. Disadvantages of WXL  Reinsurance premium rate are subjected to rapid and wide fluctuations depending on claims and GNPI  If all claims less than deductible, the primary insurer pay premium for nothing – cost may high  No protection for frequent losses under deductible  Reduced cash flow as deposit premium has to be paid at the inception of treaty  No commission payable  Less continuity of relationship than proportional treaty
  41. 41. Catastrophe Excess of Loss  Cat XL covers the reinsured’s retention against the natural catastrophe ie accumulations resulting from numerous losses caused by the same event : natural disaster (windstorm, earthquake, flood hail etc) or large man-made loss events (fire disaster, plane crashes, train derailments riots etc)  This cover provides insurers with loss reimbursement from reinsurer , irrespective of the number of risks or per event XL as long as not more than the upper limit.
  42. 42. Cont…  The maximum loss for the reinsured’s account (deductible) will often be limited not only to one risk but also to one event (accumulation)  The cover can be triggered both by an individual loss per risk or by an aggregate loss per event.
  43. 43. Illustration of CATXL Cover pay up to RM800,000 xs RM200,000 a.o.e Net retention RM1,000,000 One event affect the following risks: Risk S/I Amount of Loss(RM) A 500,000 200,000 B 2,000,000 200,000 C 20,000,000 600,000 Calculation of CATXL recovery: Risk Net Retention S/I Loss Amt A 500,000 200,000 B 1,000,000 100,000 C 1,000,000 30,000 Total net loss 330,000 XL Loss retention 200,000 CATXL recovery 130,000 =====
  44. 44. CATXL Calculation WXL/R RM700,000 xs RM300,000 CATXL/Event RM4,400,000 xs RM600,000 Loss No Loss Amt Share loss Share of loss Deductible to WXL/R cover 1. 80,000 80,000 0 2. 500,000 300,000 200,000 3. 250,000 250,000 0 4. 700,000 300,000 400,000 5. 300,000 300,000 0 6. 400,000 300,000 100,000 7. 1,000,000 300,000 700,000 8. 600,000 300,000 300,000 Total 3,830,000 2,130,000 1,700,000 Aggregate loss = 3,830,000 Total recovery under WXL/R = 1,700,000 Total recovery under CATXL = 2,130,000 – 600,000 = 1,530,000 Total loss retention by reinsured = 600,000
  45. 45. Features of CATXL  It protects the reinsured’s net account in respect of accumulation of claims in any one event or occurrence as defined in the contract e.g hurricane, flood, earthquake etc  Reinsurer’s pays ultimate net losses exceeds the reinsured’s loss limit for one event.  The cover basis is each and every loss occurrence (per event)  It intended to cover the catastrophe risks which the treaty usually subject to ‘Two Risks Warranty’ that is to avoid against cover per event in which only one risk involved.
  46. 46. Definition of Catastrophe  A clear definition of occurrence or event is important to determine how many losses/claims may be aggregate for the purpose of affecting a reinsurance  What is catastrophe? • Define as some specific, enexpected, sudden, shocking and external happening. • It can be located in time and place and is the proximate cause of each and every loss • The catastrophe must be peril that covered by the treaty
  47. 47. Definition of Catastrophe Cont…  Catastrophe covers involving natural peril exposures almost invariably include “Hour Clause”  “Hour Clause” which limit the deemed duration of any one event to a pre-agreed maximum period of so many days or hours or geographical areas of loss.
  48. 48. Hour Clause  “Hour clause” imposes time and/or geographical on catastrophe event or occurrence.  Example of ‘Hour Clause” refer to page 68  This clause applies to elemental perils such as flood, windstorm, earthquake etc and also riot and strike.  It enables aggregation of losses occurring within a period of 72 consecutive hours as “one event”  The ceding company has the ability to select the starting point or the first period of 72 hours.  One event for flood losses sometimes extends over 168 hours.
  49. 49. Example of Hour Clause Application Consider the following losses by windstorm covered 72 hours clause on a cover with loss retention of RM2,000,000 Date Time Loss Amt (RM’000) Alt A Alt B 7.1.2005 7.1.2005 7.1.2005 8.1.2005 8.1.2005 8.1.2005 9.1.2005 10.1.2005 10.1.2005 11.1.2005 11.1.2005 6.00 a.m 10.00 a.m 9.00 a.m 9.00 a.m 12.00 noon 8.00 p.m 8.00 p.m 11.00 a.m 5.00 p.m 7.00.a.m 1.00 p.m 50 50 50 1,000 500 2,000 1,500 1,500 2,500 500 300 5,150,000 1st event 4,800,000 2nd event 9,500,000 One event CATXL recovery 5,950,000 7,500,000
  50. 50. The reinsured has protected portfolio with WXL/R RM700,000 xs RM300,000 per risk and CATXL of RM4,400,000 per event xs RM600,000 per event Calculate how much is the claim recoveries under WXL and CATXL Claim recoveries under WXL = 1,700,000 under CATXL = 2,130,000 – 600,000 = 1,530,000 Loss No Loss Amt Loss Retention WXL Recoveries 1 2 3 4 5 6 7 8 80,000 500,000 250,000 700,000 300,000 400,000 1,000,000 600,000 TOTAL 80,000 300,000 250,000 300,000 300,000 300,000 300,000 300,000 2,130,000 - 200,000 - 400,000 - 100,000 700,000 300,000 1,700,000
  51. 51. Exercise 2 Consider the following losses by hurricane covered 72 hours clause on a cover with loss retention RM1,000,000 Date Time Loss Amt 22.8.06 5.00 p.m 100,000 i) 22.8.06 8.00 p.m 200,000 22.8.06 11.00 p.m 50,000 23.8.06 3.00 a.m 80,000 23.8.06 8.00 a.m 130,000 ii) 23.8.06 3.00 p.m 20,000 24.8.06 6.00 a.m 500,000 1st event = 24.8.06 2.00 p.m 300,000 24.8.06 4.00 p.m 450,000 24.8.06 6.00 p.m 280,000 24.8.06 8.00.p.m 340,000 25.8.06 12.05a.m 120,000 25.8.06 8.00 a.m 400,000 26.8.06 6.00 a.m 310,000 26.8.06 2.00 p.m 60,000 26.8.06 5.00 p.m 55,000 26.8.06 11.00 p.m 600,000 TOTAL 3,995,000  Calculate the recovery if ceding company choose to start the first hour on: i) 22.8.06 at 5 p.m. ii) 23.8.06 at 8 a.m
  52. 52. XL cover: 1st layer 300,000 xs 200,000 2nd layer 500,000 xs 500,000 Risks s/I claims 1 3,000,000 2,000,000 2 15,000,000 12,000,000 Calculate the XL recoveries

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