The Institute of Finance

Management (IFM)
Department of Insurance
Subject Code:IRU-08610
:
Subject Name

REINSURANCE
PREPARED BY;
MR. MLAPONI, S
 Contents
❑ Definition & Concept of Treaty Reinsurance
❑ Advantage of treaty reinsurance
❑ Disadvantage of treaty reinsurance
❑ Methods of arranging treaty reinsurance
❑ Proportional treaty reinsurance
❑ Type of proportional treaty
❑ Quota share reinsurance
❑ Uses of quota share reinsurance
❑ Surplus reinsurance
❑ Combined Quota share & Surplus treaty
❑ Facultative Obligatory
❑ Question Session.
 TREATY REINSURANCE

 Due to the problems associated with facultative method,

obligatory or treaty type of Reinsurance evolved.
 With Treaty Reinsurance, the cedant enters into an agreement
to transfer a broad category of its risks to the Reinsurer
 For example. The Cedant transfers his entire portfolio of his fire
business to the Reinsurance Company. In return, the Reinsurer
agrees to accept all risks ceded to him under this agreement.
 The Agreement between the Cedant and the Reinsurer is what
is known as a "treaty".
 TREATY REINSURANCE
 The treaty is an automatic facility agreed
before the original risks are accepted . Unlike
facultative reinsurance, treaty requires
primary insurer to cede and reinsurers to
accept the cessions.
 The Beauty with this type of arrangement is
that the Cedant is guaranteed that all risks
falling within the scope of the agreement
and subject to its terms and conditions will
be Reinsured/Protected by the Reinsurer.
 TREATY REINSURANCE
 Treaty reinsurance is reinsurance of many risks
that meet certain pre-agreed conditions e.g.
class, geographical scope, etc.
 They are usually annual contracts, whose terms
are negotiated at the beginning of the contract
period between the ceding company and the
Reinsurer to provide reinsurance protection for
all the business of a certain type or class.
 ADVANTAGE OF TREATY REINSURANCE
▪ In treaty reinsurance there is no individual risk scrutiny
by the Reinsurer.
▪ There is obligatory acceptance by the Reinsurer if the
business meets the conditions of the contract.
▪ Treaty contracts lead to long term relationship in which
reinsurers profitability is accepted, but measured and
adjusted over a period of time.
▪ Cedant get ceding commission, which supplements his
income and can get additional profit commission if
business is profitable, especially on Proportional treaty
reinsurance.
ADVANTAGES OF TREATY REINSURANCE
▪ Administration is quicker and easier than for facultative
reinsurance.
▪ Treaties are less costly to operate than the per risk
(facultative) covers.
▪ One contract encompasses all subject risks.
▪ Smoothening of financial results- losses are shared
between insurer and reinsurer hence variation of loss
experience is smoothened and underwriting results are
stabilized thus improving insurer’s financial
condition/position.
DISADVANTAGES OF TREATY REINSURANCE
▪ There is no freedom of choice since both
parties are tied into the contract.
▪ A disproportionate amount of premium may
have to be ceded to reinsurers on small and
good risks which an insurer would otherwise
like to retain for its own account.
 METHODS OF ARRANGING TREATY
REINSURANCE
 There are two ways of arranging treaty reinsurance:
❖ Proportional
❖ Non proportional
PROPORTIONAL TREATY REINSURANCE
 Depending on how the Risks, Premiums and losses are
shared between the Cedant and the Reinsurer, Treaty
Reinsurance can either be of proportional or non-
proportional nature.
 Proportional treaty agreements are agreement
entered into between an insurer and reinsurer(s)
whereby the insurer agrees to cede and the
reinsurer(s) agree(s) to accept a proportional share of
all reinsurance offered within the limits of the treaty.
 With a Proportional Form of Reinsurance Cover, the
Insurer and the Reinsurer share the sums insured
(Liabilities) in a clearly defined proportion.
PROPORTIONAL TREATY REINSURANCE
 Reinsured& Reinsurer share business proportionately that
is premiums and claims are shared in same proportions.
 Let consider a basic proportional arrangement between
Insurer A and Reinsurer Z. Insurer A enters into a treaty
agreement with reinsurer Z to buy Reinsurance
protection for 40% of the risks it underwrites under its fire
business. under the proportional arrangement, Reinsurer
Z will bear 40% of the liabilities (sums insured) for every fire
risk. In addition to this, 40% of the premium will be
transferred to Z as the cost for the protection. When a
loss arises, Z will pay A 40% of the losses incurred
TYPES PROPORTIONAL TREATY REINSURANCE

Basicallythere are three main forms

of proportional treaty reinsurance.
❖Quota share,
❖Surplus and
❖ Fac-obligatory treaties.
 QUOTA SHARE REINSURANCE
 With this form, the Cedant is obligated to cede and the
Reinsurer obligated to accept a fixed proportion (expressed
as a percentage) of each and every risk written by the
cedant.
 For example 30% : 70% . This means the cedant retains 30%
and cededs 70% of each and every risk written by it.
 This would be called an 70% Quota Share treaty. The
amount ceded is what is used to describe the treaty.
 Let consider for example ABC Insurance Company issue a
fire insurance for a commercial building with a sum insured
of 2,000,000,000, the cedent, ABC Insurance in this case will
retain 600,000,000 (30%*2,000,000,000) and cede
1,400,000,000 (70%*2,000,000,000) to the reinsurer.
QUOTA SHARE REINSURANCE
 The Reinsurer agrees to receive a fixed proportion of
each and every risk accepted by the ceding office,
sharing proportionately in all losses and receiving in
return the same proportion of premiums less agreed
commissions.
 Cessions and liability attaches simultaneously and
automatically with that of the reinsured under its
original acceptance.
 Under the Q.S arrangement there is a fixed upper limit
within which the arrangement holds, any amount
above this limit will be reinsured with any other form of
reinsurance or facultatively.
QUOTA SHARE REINSURANCE
 This mean if in the above example the fixed upper limit was
3,000,000,000.00, then risks with sums insured of up to
3,000,000,000 will be absorbed by the quota share
arrangement while risks with sums insured exceeding
3,000,000,000.00 the amount of risk in excess of the
3,000,000,000.00 can be reinsured with an alternative
arrangement e.g. surplus or facultative.
 It is important to specify that the percentage retained by the
ceding company e.g. 20% shall be for net account, and not
to be reinsured. This will prevent the ceding company from
accepting poor business, and reinsuring part of it say
facultatively.
 QUOTA SHARE REINSURANCE
Example 1
Reassured: ABC Insurance Company
 Treaty: Aviation 80% Quota Share with a treaty limit 10,000,000
 Risk accepted as per below

Risk SI Premium Loss

A 8,000,000 200,000 5,000,000
B 10,000,000 500,000 10,000,000
C 12,000,000 850,000 10,000,000
QUOTA SHARE REINSURANCE
 Example 2:
 ABC Insurance Company has arranged a quota share for their bond business. Treaty includes
cover for performance bonds as well as other bonds.
 Other details of the treaty are as follows:-
 Treaty arrangement: 80% Quota share treaty with TZS 6,000,000,000 treaty limit.
Period of cover- 01/01/2022 to 31/01/2022
➢ ABC has issued a performance bond policy to XYZ Construction Company for project it is
undertaking.
➢ The bond was issued on 20/03/2022
➢ The sum insured is 10,000,000,000
➢ Premium rate: 1%
➢ ABC Insurance company subsequently receives a claim of TZS 7,000,000,000 from XYZ Company.
The date of loss is indicated at 06/05/2022.
➢ Required:
Calculate, show all your working how risk, premium and claim will be shared to the treaty
reinsurance.
 QUOTA SHARE REINSURANCE

 For reinsurers Q/share treaty are favorable

since cedant can’t discriminate and generally a
balanced account can be generated.
 The Cedant is disadvantaged because
premiums from good risks, which insurer could
have liked to retain in full are also ceded.
USES OF QUOTA SHARE REINSURANCE
 By new ceding company starting business or
companies entering into a new class of business or
entering a new area and has no statistics or
experience.
 A method of protecting the new company’s paid
up capital which will be exposed from day one of
its operations as it accepts business not necessarily
commensurate to the cash flow position.
USES OF QUOTA SHARE REINSURANCE
 Newline of business being developed and risk pattern is
uncertain.
 Where a ceding company wishes to accept insurance
business and has to provide a share of its own business in
reciprocity. This enables each party to participate into a
wider portfolio at minimal cost.
 Where the loss ratio on surplus treaty has gone out of
control and cannot be corrected immediately.
 Where sums insured are moderate but subject to abrupt
variations in loss ratios from year to year e.g. Hail classes.
 SURPLUS TREATY
 Under this form of reinsurance, the ceding company
agrees to cede and the reinsurer agrees to accept
any amount of risk in excess of the ceding
company's retention.
 All business falling within the scope of the treaty
must be ceded.
 Surplus treaty is used almost entirely for property and
only rarely used for liability reinsurance.
 SURPLUS TREATY
 Cessions/liability attaches simultaneously and
automatically as soon as the cedant’s retention is
exceeded.
 In contrast to Quota share, the surplus is characterized
by the fact that the Reinsurer does not participate in all
risks written by the direct underwriter, but only in those
risks that exceed the cedant’s retention.
 Iffor example, a ceding company retains only 1b
of any one risk for its net account for a Building of
5b, the surplus treaty will offer protection for the
extra 4b while the ceding company retains 1b
 SURPLUS TREATY
 The treaties are arranged in multiple of lines where
one line is equal to the cedant’s retention.
 The Size/Capacity of a surplus treaty is determined
as a multiple of the ceding company's retention
and is normally expressed in terms of "lines".
 ". For a company with a gross retention of 1b, a 15
line surplus treaty will have a capacity of 15b
(1b*15). The total capacity of the treaty will
therefore by the retention + surplus capacity = 1b+
15= 16b
 SURPLUS TREATY
 The ceding company retains more premiums.
 Surplus treaty has high administration costs since
selecting risks to cede to Surplus takes time.
 Commissions are lower than QS because quota
share is more balanced.
 Surplus treaty allows company to accept larger
sums insured than its gross retention, the surplus
being ceded to reinsurers.
 SURPLUS TREATY
 The amount ceded to the reinsurers is surplus to the
amount retained by cedant.
 Surplus treaty allows insurance company to keep for
own account 100% of risk whose sums insured falls
within its retention.
 Premiums are ceded in the same proportions as the
sum insured on the risk and the Reinsurer pays for
losses in the same proportions as acceptance.
 The line or limit of retention is the maximum which the
ceding company can retain but a smaller amount
than the limit can be retained where there is a table
of retention.
 SURPLUS TREATY
 Surplus treaty may be arranged in multiples i.e. 1st Surplus, 2nd
Surplus 3rd Surplus etc. as required by the company if it finds
that it is still placing more business on facultative basis. All the
layers must be based on the size of initial retention on the risk.
Additional capacity can also be achieved by increasing
retention or the number of lines.
 Higher levels of cover 2nd, 3rd etc) will have fewer risks being
ceded to them, and thus lesser premiums will be ceded,
against higher liabilities.
 The fundamental point is that a risk must be ceded through
each treaty in turn, namely that the capacity of the first surplus
must be utilized in full before the second surplus can be used
etc.
 SURPLUS TREATY

 Example 1
 Let assume Insurer X has a retention of 1b and arranged 5 line surplus treaty for its fire
insurance portfolio.
 In its portfolio insurer X has the below risk underwritten

RISK/SI Premium loss

A-4b 2m 1.5b
B-800m 3.5m 200m
C-7b 5m 5b
 SURPLUS TREATY
 Example 2
 ABC Insurance company for its engineering portfolio has arranged 10 line 1st
Surplus treaty and 9 line 2nd Surplus treaty with gross retention of 1b for any one
risk.
 During treaty period ABC Insurance Company has underwrite the below risks.

Risk SI Premium Loss

A 1Ob 5m 5b
B 15b 7m 10b
C 17b 10m 17b
D 7oom 1m -
E 20b 12m 10b
COMBINED QUOTA SHARE & SURPLUS
 As soon as the quota share by itself cannot absorb the whole
portfolio, it can be complimented by a surplus arrangement
 In cases where the quota share and surplus forms are
combined under one treaty, the gross retention constitutes the
quota share treaty.
 Therefore the retention of the cedant and quota share treaty is
equivalent to one line on the surplus arrangement and this is
known as cedant’s gross retention.
 The Surplus treaty is defined by a number of gross lines, each of
which is equivalent to 100% of the quota share capacity.
COMBINED QUOTA SHARE & SURPLUS
 Example:
 ABC Insurance company has the following reinsurance program in place for
its property portfolio:
 75% Quota share treaty with a 100% cession limit of TZS 2bn
 A three line surplus treaty subject to a maximum cession of TZS 6bn.
 ABC Insurance underwrite a factory with a sum insured of TZS 7bn and
charge a rate of 0.3%.
 After a six month a factory burns down a total of TZS 2bn claim was raised.
 Required:
Show how liability, premium and loss will be shared in its treaty program.
FACULTATIVE OBLIGATORY TREATY (FAC-OBLIG)
 This Form is a Union between the principles of facultative
and treaty methods with the distinguishing feature being
that it is facultative for the cedant and obligatory for the
reinsurer.
 The Cedant is not obliged to offer all businesses to
reinsurers whether they fall within the scope of treaty, but
if he does cede, the reinsurer must accept the risk ceded.
 This form of reinsurance is less favorable with most
reinsurers since the onus is on the reinsurer to accept all
risks that the cedant decides to include leaving them
exposed to the cedant selecting the most hazardous risks
from its portfolio.
FACULTATIVE OBLIGATORY TREATY (FAC-OBLIG)

 The treaties are arranged to provide additional

capacity, without the expense and uncertainty
of facultative method.
 Risks are fewer & larger than under surplus
arrangement.
 A high degree of trust should exist between the
insurer and reinsurer so that the reinsurer can
receive a reasonable spread of risks from the
cedant.
 ARRANGEMENT OF FAC-OBLIG
 Capacity under Fac Oblig can be expressed as a multiple
of cedants’ gross retention or as an fixed monetary
amount.
 If liability is expressed as a multiple of cedant’s retention as
in surplus treaty, then the treaty is a Pure Facobligatory
Treaty.
 If the Reinsurer’s liability is expressed solely as an absolute
amount or limited to a maximum liability sum, without any
reference being made to cedant’s retention, then it is an
open cover.
 Usual arrangement: Retention; Surplus-Facobligatory-
facultative.
Review Questions
1. What is treaty reinsurance?
2. What is difference between treaty and facultative reinsurance?
3. What are the advantage of treaty reinsurance?
4. XYZ Insurance company has 60% quota share treaty with 100% cession limit of TZS 10bn
for its engineering business portfolio. During the treaty the company has issued below
policies;
Risk SI Premium Loss
1 TZS 7bn TZS 5m TZS 3bn
2 TZS 12 TZS 10m TZS 10bn
3 TZS 5bn TZS 3m TZS 5bn

Required:
Calculate, show all your working how the liability, premium and loss will be shared on the
treaty.
Any Question?
DISCUSSION TUNAANZA LINI SASA…..?