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Reinsurance features & calculations

T

Trevor

Member
Hi, I am struggling to understand the difference between Risk excess of loss (Individual XoL) and Surplus reinsurance

By definition, Risk XoL is a non-proportional insurance, and Surplus reinsurance is proportional. However I don't really see the difference in their mechanics:

My understanding of Risk XoL, is that it first defines the retention limit.
The insurer will pay anything below this, and reinsurer pays everything above (up to the excess point).
Is this limit the same for all policies, or each policy policies has their unique retention limit? I am unsure about this, please advice.

For surplus reinsurance, I revisited the CP1 CMP to understand it, but got even more confused seeing two different mechanics between CP1 and SP1.

CP1 (CMP 2020 Chapter 29 Section 4.3):
  1. An estimated maximum loss (EML) is determined for each policy.
  2. A unique retention limit is set for each policies
  3. The percentage retained is calculated based on: R = (Retention limit / EML)
  4. When the insured peril happens, the actual cost is known, amount retained by the insurer is: actual claim cost*R
    In other words, the amount retained depends on our choice of EML rather than a fixed monetary amount (therefore proportional)

However in SP1 (CMP 2020 Chapter 26 Section 5.5):
  1. A "global" retention limit is set, all policies are subjected to the same limit
  2. when the actual claim cost is known, the calculation for splitting between insurer and reinsurer is exactly the same as the risk XoL
  3. Knowing the amount ceded by the reinsurer, the percentage ceded is calculated. But this is not involved in any calculation at all.
    This sounds more like a non-proportional reinsurance. The percentage ceded is not used at all.

Comparing these 2, I noticed:
  1. The CP1 and SP1 mechanics are different. Could this be because CP1 was using a general insurance example, SP1 is not?
    ie: the surplus reinsurance mechanic is indeed different across different line of insurance
  2. within SP1, I don't quite see the difference between Risk XoL and Surplus reinsurance.
    Is the retention limit set, unique to policy or global level the only difference?



Another query is about financial reinsurance
Is there a strict rule where Reinsurance Commission and Deposit back arrangement should be parked under?
In the 2020 CMP, these two are considered a feature of original terms reinsurance (something to do with reinsurance premium).
However in the SP1 2020 April (Question 3) past paper, these two are under Quota share reinsurance (something to do with reinsurance claims instead).
Is it correct to mention in as a feature under either of them?
 
Trevor said:
Hi, I am struggling to understand the difference between Risk excess of loss (Individual XoL) and Surplus reinsurance

By definition, Risk XoL is a non-proportional insurance, and Surplus reinsurance is proportional. However I don't really see the difference in their mechanics:

My understanding of Risk XoL, is that it first defines the retention limit.
The insurer will pay anything below this, and reinsurer pays everything above (up to the excess point).
Is this limit the same for all policies, or each policy policies has their unique retention limit? I am unsure about this, please advice.

For surplus reinsurance, I revisited the CP1 CMP to understand it, but got even more confused seeing two different mechanics between CP1 and SP1.

CP1 (CMP 2020 Chapter 29 Section 4.3):
  1. An estimated maximum loss (EML) is determined for each policy.
  2. A unique retention limit is set for each policies
  3. The percentage retained is calculated based on: R = (Retention limit / EML)
  4. When the insured peril happens, the actual cost is known, amount retained by the insurer is: actual claim cost*R
    In other words, the amount retained depends on our choice of EML rather than a fixed monetary amount (therefore proportional)

However in SP1 (CMP 2020 Chapter 26 Section 5.5):
  1. A "global" retention limit is set, all policies are subjected to the same limit
  2. when the actual claim cost is known, the calculation for splitting between insurer and reinsurer is exactly the same as the risk XoL
  3. Knowing the amount ceded by the reinsurer, the percentage ceded is calculated. But this is not involved in any calculation at all.
    This sounds more like a non-proportional reinsurance. The percentage ceded is not used at all.

Comparing these 2, I noticed:
  1. The CP1 and SP1 mechanics are different. Could this be because CP1 was using a general insurance example, SP1 is not?
    ie: the surplus reinsurance mechanic is indeed different across different line of insurance
  2. within SP1, I don't quite see the difference between Risk XoL and Surplus reinsurance.
    Is the retention limit set, unique to policy or global level the only difference?



Another query is about financial reinsurance
Is there a strict rule where Reinsurance Commission and Deposit back arrangement should be parked under?
In the 2020 CMP, these two are considered a feature of original terms reinsurance (something to do with reinsurance premium).
However in the SP1 2020 April (Question 3) past paper, these two are under Quota share reinsurance (something to do with reinsurance claims instead).
Is it correct to mention in as a feature under either of them?
Click to expand...
Hi Trevor

You are right that CP1 is written to include reinsurance for general insurers. So some parts of the CP1 course do not apply to SP1, eg estimated maximum losses.

For the purpose of SP1, whenever we have a fixed benefit (eg CI sum assured), then risk excess of loss and individual surplus are essentially the same.

I would generally expect that the retention would be the same for all policies written under a risk excess of loss treaty (or a surplus treaty). It would be administratively very difficult to have lots of different retention levels. But in theory the retention could be different for different classes of business, eg a different retention for younger policyholders than older policyholders.

Regarding your financial reinsurance question. Remember that original terms can be written as quota share or individual surplus. So the two different types of reinsurance that you are quoting are in fact the same.

Best wishes

Mark
 
Hi Mark,

That is very clear now. Thanks for clearing my confusion!
 
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