Differences between Individual surplus and surplus reinsurance

[m3m]

From CP1, we know that the surplus reinsurance works as follows:
First we calculate the % that the insurer will retain, by using retention limit / sum assured, then the reinsurance recoveries will be based on the % ceded out eventually, regardless of the claim amount subsequently (e.g. whether the claim amount from the insured is below the retention limit, the insurer and reinsurer will still pay the cedant the % ceded out, and if the claim amount eventually exceeds the sum assured, the insurer and reinsurer will still be paying in proportion of the %).

However, from SP2, there is individual surplus from Chapter 24. This is an example from page 8:

Imagine a policy with sum assured £100,000. The direct writing company has a retention limit of£40,000 of sum at risk. Consider the situation when reserves are £5,000, when they are £30,000 and when they have increased to £80,000.

With individual surplus, the direct writer retains £40,000 of risk in the first two instances. So thetotal retention is £45,000 (when reserves are £5,000) passing £55,000 of risk to the reinsurer, and £70,000 (when reserves are £30,000) ceding £30,000 of risk. Then, when reserves are £80,000,the remaining sum at risk is £20,000, which is below the direct-writing company’s retention limit.The company therefore does not pass any risk on to the reinsurer.

This feels like surplus reinsurance and individual surplus reinsurance works differently, where surplus reinsurance works like a proportional reinsurance while individual surplus works more like a non-proportional reinsurance, like XoL. May I know the differences between surplus reinsurance (the one described in CP1) and individual surplus (described in SP2), as well as the difference between individual surplus and XoL?

Thank you!

 

[Mark Willder]

From CP1, we know that the surplus reinsurance works as follows:
First we calculate the % that the insurer will retain, by using retention limit / sum assured, then the reinsurance recoveries will be based on the % ceded out eventually, regardless of the claim amount subsequently (e.g. whether the claim amount from the insured is below the retention limit, the insurer and reinsurer will still pay the cedant the % ceded out, and if the claim amount eventually exceeds the sum assured, the insurer and reinsurer will still be paying in proportion of the %).

However, from SP2, there is individual surplus from Chapter 24. This is an example from page 8:



This feels like surplus reinsurance and individual surplus reinsurance works differently, where surplus reinsurance works like a proportional reinsurance while individual surplus works more like a non-proportional reinsurance, like XoL. May I know the differences between surplus reinsurance (the one described in CP1) and individual surplus (described in SP2), as well as the difference between individual surplus and XoL?

Thank you!

Hi Malc

The example of surplus insurance that you quote from subject CP1 is looking at a general insurance policy, eg buildings insurance. Let's say the estimated maximum loss is 100,000 and the retention is 40,000, then the insurer will pay 40% of the claims and the reinsurer will pay 60%. The reinsurer will pay 60% of large claims (say 60% of 100,000 = 60,000 if the building burns to the ground) and the reinsurer will pay 60% of small claims (say 60% of 1,000 = 600 for storm damage to the roof).

Surplus reinsurance can be written on a sum assured or a sum at risk basis.

Let's consider the sum assured basis first. Let's say the sum assured is 100,000 and the retention is 40,000, then the insurer will pay 40% of the claims and the reinsurer will pay 60%. With life insurance policies the claim is always for the sum assured, there are no partial claims such as those for the storm damage with general insurance. So a claim of 100,000 means the reinsurer pays 60% of 100,000 = 60,000. We'd get the identical result if we used excess of loss with a retention of 40,000. So the distinction between proportional and non-proportional reinsurance is just presentational in SP2.

Now let's consider the sum at risk basis. This is the example from SP2 that you quote. The sum at risk is the sum assured less the reserve. Again we have sum assured of 100,000 and retention of 40,000. If the reserve is 5,000 this year then the sum at risk is 95,000 - the insurer takes the 40,000 and the reinsurer takes 55,000. We know from the example above that surplus and excess of loss are the same thing, so we can stop there. But if we wanted to make this sound more proportional, we could note that the reinsurer pays 55,000 out of 95,000 meaning they pay 55/95 = 57.89% of the sum at risk. This percentage would be used to calculate the reinsurer's premium if we used an original terms basis.

I hope the numbers above help.

Best wishes

Mark

 

[m3m]

Hi Mark, thanks for the reply. surplus reinsurance (CP1) seems to be also applicable even if the claim amount is below the retention limit, while individual surplus reinsurance (SP2) will only be triggered if the claim amount exceeds the retention limit. Is my understanding correct?

 

[Mark Willder]

Hi Mark, thanks for the reply. surplus reinsurance (CP1) seems to be also applicable even if the claim amount is below the retention limit, while individual surplus reinsurance (SP2) will only be triggered if the claim amount exceeds the retention limit. Is my understanding correct?

Yes, that's right.

In my CP1 example you can see the claim of 1000 is less than the retention but the reinsurer still pays its percentage. But in SP2 the claim has to be the sum assured - if the sum assured was less than the retention then the insurer wouldn't reinsure it.