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Re-insurance
MEANING
Reinsurance is a means by which an insurance company can
protect itself against the risk of losses with other insurance
companies. Individuals and corporations obtain insurance policies to
provide protection for various risks (hurricanes, earthquakes,lawsuits, collisions, sickness and death, etc.). Reinsurers, in turn,
provide insurance to insurance companies.
It is a financial management tool. It is always behind the high
quality insurance program or a complex commercial risk of any
good insurer. Reinsurance industries are maintaining upward surge
all round growth, both in the domestic and global fronts in the last
few years. The untapped, both in life and non life insurance,
particularly in growing economies like India and china, is the center
of attraction to leading players in insurance and reinsurance,
thanks to globalizations and liberalizations of financial services
particularly in last decades.
It is a tool of risk management, mutually support and supplements
each other in providing risk mitigation to the individuals and
organizations at micro level and to the country. Reinsurance is
instrument of risk transfer and risk financing.Reinsurance can be described as contract made between an
insurance company (insurer) and a third party (reinsurer) where in
the later will protect the former by paying losses sustained by it
under the original contract of insurance, unlike primary insurance,
the reinsurance mainly deals with catastrophic risk which are not
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only highly unpredictable but have the potential capacity to cause
hugedevastation thereby threatening the solvency of the insurance
company.
FUNCTIONS OF REINSURENCE
There are many reasons why an insurance company
would choose to reinsure as part of its responsibility
to manage a portfolio of risks for the benefit of its
policyholders and investors :
(1)RISK TRANSFER
The main use of any insurer that might practice
reinsurance is to allow the company to assume
greater individual risks than its size would otherwise
allow, and to protect a company against losses.
Reinsurance allows an insurance company to offerhigher limits of protection to a policyholder than its
own assets would allow. For example, if the principal
insurance company can write only $10 million in limits
on any given policy, it can reinsure (or cede) the
amount of the limits in excess of $10 million.
Reinsuranced s highly refined uses in recent yearsinclude applications where Reinsurance was used as
part of a carefully planned hedge strategy.
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(2) INCOME SMOOTHING
Reinsurance can help to make an insurance
company s results more pre ictable by absorbing
larger losses an re ucing the amount of capital
nee e to provi e coverage.
(3) SURPLUS RELIEF
An insurance company's writings are limite by its
balance sheet (this test is known as the solvency
margin). When that limit is reache , an insurer can
either stop writing new business, increase its capitalor buy "surplus relief" reinsurance. The latter is
usually one on a quota share basis an is an
efficient way of not having to turn clients away or
raise a itional capital.
(4 ) ARBITRAGE
The insurance company may be motivate by
arbitrage in purchasing reinsurance coverage at a
lower rate than what they charge the insure for
the un erlying risk.
(5) REINSURER S EXPERTISE
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The insurance company may want to avail of the
expertise of a reinsurer in regard to a specific
(specialized) risk or want to avail of their rating
ability in odd risks.
(6) CREATING A MANAGEABLE AND PROFITABLE
PORTFOLIO OF INSURED RISKS
By choosing a particular type of reinsurance method,
the insurance company may be able to create a more
balanced and homogenous portfolio of insured risks.
This would lend greater predictability to the portfolio
results on net basis ie after reinsurance an would be
reflected in income smoothing. While income smoothing
is one of the objectives of reinsurance
arrangements, the mechanism is by way of balancingthe portfolio.
(7) MANAGING THE COST OF CAPITAL FOR AN
INSURANCE COMPANY
By getting a suitable reinsurance, the insurancecompany may be able to substitute "capital needed"
as per the requirements of the regulator for
premium written. It could happen that the writing of
insurance business requires x amount of capital with
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y% of cost of capital and reinsurance cost is less
than x*y%. Thus more unpredictable or less frequent
the likelihood of an insured loss, more profitable it
can be for an insurance company to seek
reinsurance.
TYPES OF REINSURENCE
(1) PROPORTIONAL
Proportional reinsurance (the types of which are
quota share & surplus (reinsurance) involves one or
more reinsurers taking a stated percent share of
each policy that an insurer produces ("writes"). This
means that the reinsurer will receive that stated
percentage of each dollar of premiums and will pay
that percentage of each dollar of losses. In addition,
the reinsurer will allow a "ceding commission" to theinsurer to compensate the insurer for the costs of
writing and administering the business (agents'
commissions, modeling, paperwork, etc.).
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The insurer may seek such coverage for several
reasons. First, the insurer may not have sufficient
capital to prudently retain all of the exposure that it
is capable of producing. For example, it may only be
able to offer $1 million in coverage, but by
purchasing proportional reinsurance it might double or
triple that limit. Premiums and losses are then shared
on a pro rata basis. For example, an insurance
company might purchase a 50% quota share treaty;
in this case they would share half of all premium andlosses with the reinsurer. In a 75% quota share, they
would share (cede) 3/4 of all premiums and losses.
The other form of proportional reinsurance is surplus
share or surplus of line treaty. In this case, a
retained e linef is defined as the ceding company's
retention - say $100,000. In a 9 line surplus treatythe reinsurer would then accept up to $900,000 (9
lines). So if the insurance company issues a policy
for $100,000, they would keep all of the premiums
and losses from that policy. If they issue a $200,000
policy, they would give (cede) half of the premiums
and losses to the reinsurer (1 line each). Themaximum underwriting capacity of the cedant would
be $ 1,000,000 in this example. Surplus treaties are
also known as variable quota shares.
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2) NON-PROPORTIONAL
Non-proportional reinsurance only responds if the
loss suffered by the insurer
exceeds a certain amount, which is called the
"retention" or "priority." An example of this form of
reinsurance is where the insurer is prepared to
accept a loss of $1 million for any loss which may
occur and they purchase a layer of reinsurance of
$4 million in excess of $1 million. If a loss of $3million occurs, the insurer pays the $3 million to the
insured, and then recovers $2 million from its
reinsurer(s). In this example, the reinsured will retain
any loss exceeding $5 million unless they have
purchased a further excess layer (second layer) of
say $10 million excess ofs$5smillion.The main forms of non-proportional reinsurance are
excess of loss and stop
(2) RISK ATTACHING BASIS
A basis under which reinsurance is provided forclaims arising from policies commencing during the
period to which the reinsurance relates. The insurer
knows there is coverage for the whole policy period
when written.
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All claims from cedant underlying policies incepting
during the period of the reinsurance contract are
covered even if they occur after the expiration
date of the reinsurance contract. Any claims from
cedant underlying policies incepting outside the period
of the reinsurance contract are not covered even if
they occur during the period of the reinsurance
contract.
(3)
LOSS OCCURING BASIS
A Reinsurance treaty from under which all claims
occurring during the period of the contract,
irrespective of when the underlying policies incepted,
are covered. Any claims occurring after the
contract expiration date are not covered.As opposed to claims-made policy. Insurance
coverage is provided for losses
occurring in the defined period.
(4) CLAIMS MADE BASIS
A policy which covers all claims reported to an
insurer within the policy period
irrespective of when they occurred.
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CONTRACTS Reinsurance can also be purchased on a per policy basis, in
which case it is known as facultative reinsurance.
Facultative reinsurance can be written on either a quota
share or excess of loss basis. Facultative reinsurance is
commonly used for large or unusual risks that do not fit
within standard reinsurance treaties due to their
exclusions. The term of a facultative agreement coincideswith the term of the policy. Facultative reinsurance is
usually purchased by the insurance underwriter who
underwrote the original insurance policy, whereas treaty
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reinsurance is typically purchased by a senior executive at
the insurance company.
Reinsurance treaties can either be written on a
e continuous
or e term
basis. A continuous contract
continues inde
initely, but generally has a e notice
periodwhereby either party can give its intent to cancel or
amend the treaty within 90 days. A term agreement has a
built-in expiration date. It is common
or insurers and
reinsurers to have long term relationships that span many
years.
There are two important goals o
contract wording whichwe need to keep in
mind:
1. A contract should be short, concise and easy to
understand;
2. The contract should contain terms and provisions thatlend
Themselves to ready and uniform interpretation;The focus of the contract should imply the utmost good
faith principle. This principle assumes that both parties are
so knowledgeable on the subject matter to be dealt with
and possess such a degree of sophistication as to preclude
the necessity for long complex declarations of intent and
implementation
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REINSURENCE INDUSTRY
As one of the business market research paper has put it
e Reinsurance is an international, multibillion dollar industry
that is vital to the financial stability of all types of
insurance companies.f It is a method of ceding part of the
financial risk the direct insurers assume by accepting risk
from risk owners, particularly mega risk, mainly against the
earthquakes, tsunami, terrisom, etc.
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However, in terms of magnitude / size, reinsurance is
highly complex global business and for example, it accounts
for more than 9% of the total premiums generated from
property.
The whole mechanism of insurance and reinsurance being adynamic process. The electronic media and internet
technology have substantially added to the efficiency and
simplification of mechanism of reinsurance operations. The
increased use of information and internet technology by
the insurance companies have made collecting, compiling,
and data warehousing of updated technical data on millionsof mega risk faster and also revolutionized the procedural
input on underwritings, accounting and claims processing
and settlement by both primary insurance and reinsurance.
The new type of electronic system specific transactional
methodology since put in place has cut short the
embarrassing delays in reinsurance acceptance, cessions
and adjustment or settlement among the participatingcompanies. Looking to the latest trend and overwhelming
success rate of multi benefit life insurance products like
ULIPs and pension plans, which combine risk cover with
investment components.
GENERAL INSURANCE
COMPANY
GIC, the sole reinsurance company of our country, by
virtue of its experience and exposure in providing
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reinsurance support and guidance to its erstwhile non life
insurance subsidiaries for more than three decades, has
excellent organizational and technical skills in taking care
of reinsurance arrangements for the present insurance
market of India life and non life and has sinceadequately established itself as the national reinsurance
leader.
Meanwhile, GIC reinsurance as part its strategy to
expand its operation and to make its present felt globally
has recently upgraded its representative offices in London
and Dubai. Incidentally, the sole national reinsurer of Indiaalso has another representative office in Moscow. GIC has
developed necessary skills and has qualified manpower to
take care of growing needs of the expanding Indian
industry.
For the financial year 2006-07, through GIC
reinsurance recorded an overall underwriting loss of Rs.
75.95 cr, it has achieved a robust growth of more than156% in its net profit at Rs. 1531 cr, as against rs.598 cr
during the corresponding period period in the previous year.
GIC ranks 21st among non life insurers with a net worth of
$1.4 bn. As per GIC reinsurance chairman, it is positioned
as the lead reinsurer in the Afro-Asian region and other
emerging economies. during 2006- 07, the premium incomefor GIC Reinsurance went up from Rs. 200 to Rs.270 cr. It
is learnt that its international reinsurance business
amounted to 22% of its total turnover for the year.
3rd Asian Reinsurersd Summit was organized by GIC of
India, in February 2003 at Mumbai. Eleven reinsurers from
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Japan, China, Hong Kong, Singapore, Taiwan, Korea,
Indonesia, Malaysia, Singapore, Philippines and India
participated in the summit with the aim of reinforcing of
strengths for mutual development, undertaking joint
research, data sharing & information management andfurthering business co-operation
CHALLENGES FOR
REINSURENCE MARKET
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Prior to nationalization in 1973, the reinsurance market
in India had a much diluted presence in the industry. The
foreign companies operating in India were managing their
risk portfolio with their parent companies overseas. To
safeguard the identified and limited risk of insurancecompanies, local companies created India Insurance Pool.
The developments after nationalizations insurance industry
created a new body with the merger of India Reinsurance
and Indian Guarantee for its reinsurance business to
support the technology and engineering mega projects.
Some of the major issues in accounting have beenundertaken considering the recent developments in the
business. The return from foreign companies are to be
incorporated when received up to 31st march and returns
from Indian companies and state insurance funds received
as of different dates are accepted up to the date of
finalization of accounts. Arising out of the occurrence of
disastrous like terrorist attack on world trade center etc.which brought about unprecedented loss of life and
property and thereby unbearable liability and operational
crisis onto the reinsurance industry world over.
There is a wide difference between the rates required
by the international reinsurers and those charged by the
domestic insurers leading to the price affordability as anissue. Where there are tariffs, like a case of India, the
customers cushioned from the rate of increase in the
international market. Such impositions are required to be
self absorbed.
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The Indian market is in absence of the competitive
environment of the international reinsurers at the local
level, and has depended mainly on the domestic market
understanding and basing probability of business ceded
rather than on underwriting and risk information criteria.A regular interaction for regional co-operation has to
be developed to set up a framework of the areas of co-
operation and the mechanism, with this India has to
compete with the global reinsurance giants. However, the
tightening of reinsurance premium in India has been
attributed to the low volumes. As market become global,country regulators face challenges in policy formulation for
creating a market that develops and keeps confidence of
the industry and for keeping international trade regulation
intact.
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WHAT INDIA NEEDS TO DO?
The opening up of the market as a whole and insurance
sector in specific has created a potential for the Indian
companies also to pool up bigger fund to support the
capital intensive sectors. The market has to ensure that
the domestic companies increase their own capacities and
introduce more strict guidelines as first hand risk
carriers. Insurance companies have to establish the
business relations with their reinsurer to prevent them
from worldwide reinsurance cycle that affects on capacityand stability.
Worldwide the reinsurers are becoming strict on technical
results of the insurance, therefore a disciplinary watch is
required on insurance business as it is the base of
reinsurance. The above problems or difficulties are not
very new for a sector that is the transition. Since, some
of the products are losing the importance (like proportiona
treaty), it is necessary to have sufficient premium income
to maintain the balance and to bear unexpected losses. To
have the best rates and terms from reinsures, the risk
profile and exposure to catastrophe risk information
transfer to reinsurer should be comprehensive and reliable.
Due to the market opening through the WTO operation,there is net outflow expected in the premium from the
developing countries as they have a low capitalization in
most of the insurance companies. This could lead to
weaken the objective of the serious efforts for the
regional cooperation developments amongst the nations.
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The efforts towards developing a synergetic approach to
model a successful cooperation will require to work on
many areas simultaneously rather than organizing efforts
only for one direction and loosing others, they are as
follow:
Pooling of financial resources
Creating Investment opportunities
Pooling of technical resources
Joint ventures, alliance and partnership
Research and developments Pooling of information
Developing standard accounting system for business
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GLOBAL POSITION Arising out of the occurrence of disastrous likeHurricane ,terrorist attack on world trade center etc.
which brought about unprecedented loss of life and
property and thereby unbearable liability and
operational crisis onto the reinsurance industry world
over. The huge amount of losses incurred, in the
aforesaid events, forced the reinsurers to hike therates substantially and also change the terms and
conditions of reinsurance arrangements. The law and
regulations governing reinsurance operation in some of
the advance and developing countries have seen few
changes, making them more stringent in reinsurance
acceptance and compulsory cessions to the local
reinsurance companies.
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CONCLUSION
Reinsurance means insuring again. It is transfer of
insurance risk from one insurer to another. Under
reinsurance the original insurer who has insured a risk,
insures a part of that risk with another insurer.
Reinsurance premium is an income to the reinsurer and an
expense to the insurer. Reinsurance is a good method todiversify and distribute risks of an insurer. Reinsurance
even provides technical assistance and rating assistance to
the original insurers. Reinsurance is also a contract of
indemnity. The object of underwriting is to make a
reasonable profit, it is equally essential that the business
ceded to reinsurers should also give them a margin. Forprofit, therefore, the overall quality of business accepted
by direct insurers should be good.
Today, the environment is more like a business than a
gentlemen's club. You have more players, more deals, and
contracts can vary greatly between reinsurers. Disputes
are no longer resolved by a handshake. They are more
frequent and more difficult to resolve.
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