Reinsurance as a condition of an effective activity of an insurance company
Reinsurance is a system of economic relations in which the insurer, taking insurance risks, part of the responsibility for them (taking into account its financial capabilities), on agreed terms, to other insurers to create a balanced portfolio of contracts insurance, ensuring financial stability and profitability of insurance operations (simultaneously, the corresponding share of the insurance premium is transferred). Thus, reinsurance is a necessary condition for the effective operation of any insurance company.
Insurance is based on probability theory and the law of large numbers, according to which the cumulative effect of a large number of random factors leads to a result that is almost independent of the case under certain general conditions. Accident is manifested as a pattern. In most cases, insurance companies do not have the ability to create a perfectly balanced portfolio of risks, since the number of insurance objects is small or the portfolio contains major and dangerous risks that introduce elements of disproportion into the portfolio. In addition, practice shows that any insurance company, even with careful selection of risks, when taking them for insurance can not create a portfolio of fully isolated insurance objects, since insurance conditions usually cover various hazards to which the insured objects can be exposed simultaneously at the onset of disasters: floods, hurricanes, earthquakes, devastating fires, etc. However, due to the fact that the financial resources and even all assets of any insurer make up only a small portion of the total amount of its liability to the insured for the whole portfolio of insured objects, the above-mentioned disasters (insured events) can not only significantly undermine the financial base of the insurance company, but also lead her to total bankruptcy.
Reinsurance is achieved not only protection of the insurance portfolio from the impact on it of a series of large insured events or even one catastrophic event, but also that payment of insurance compensation amounts for such cases does not place a heavy burden on one insurance company, but is performed collectively by all participants .
The insurer who accepted the risk for insurance and transferred it in whole or in part to reinsurance to another insurer is called the assignor . An insurer that accepts reinsurance risks is reinsurer . Having taken into reinsurance the risk, the reinsurer can partially transfer it to the third insurer. This operation is usually called a retrocession , and a reinsurer who passes the risk into retrocession is a retrocessionist .
The need for reinsurance is caused by the concentration of material values and, consequently, the growth of insurance amounts for a large number of objects (for example, giants, space insurance, insurance of electronic computing systems and expensive modules).
Eccentric in reinsurance is the amount of risk that is subject to reinsurance in excess of one's retention by the insurance company that took the risk for insurance. Own deduction - economically justified level of the amount within which the insurance company leaves (holds) on its responsibility a certain portion of insured risks, transferring to the amount exceeding that level. In the process of reinsurance and establishing the level of its own withholding, the insurer faces a dilemma:
- if the limit of own deduction is set at a low level, the insurance company is forced to transfer an excessive portion of the premium that it could save;
- if the limit of own deduction proves to be too high, the financial stability of the insurer may be undermined.
Reinsurance contract capacity - the maximum aggregate amount of risk that comes to the company's own deduction of the risk of insurance.
In terms of the nature of the transfer of risks, reinsurance operations are divided into optional (voluntary) and contractual (obligatory). The optional method is that the reinsurer and reinsurer are given the opportunity to independently assess and possibly accept risks transferred in whole or in part.
The transferring insurance company does not bear any obligations and can offer one kind of responsibility that can be accepted or rejected by the reinsurer. This type of reinsurance provides exceptional freedom to the parties in their choice. Contractual reinsurance is based on contractual relations between the reinsurer and reinsurer, which are binding and must be clearly formed and implemented. The contract is a legal document, including in the judicial or arbitration proceedings of the parties.
Reinsurance contracts are divided into two groups:
- proportional agreements (quota agreement, an ex- cessive agreement, an agreement of the sum's excess);
- disproportionate contracts (the contract of the excess of loss, the contract of the excess of unprofitableness).
Proportional contracts provide that the risk liability to be transferred to reinsurance is divided between the insurer and the reinsurer in proportion and in relation to the insured amount, which assumes proportional participation of the reinsurer and the assignor in all risks, premiums and losses. In accordance with the quota agreement , the insurance company transfers to reinsurance in the share (quota) agreed with the reinsurer, all risks accepted for insurance for a certain type of insurance or a group of related species, without exception. Under quota agreements, each risk for a particular type of insurance falls into reinsurance regardless of size.
For quota agreements, commission fees are usually higher than for other reinsurance contracts. In addition, the commission in certain cases can be increased by an agreed amount of unforeseen expenses.
Exceptional insurance is a more complex kind of proportional reinsurance. The excident agreement stipulates that all risks accepted for insurance, the insurance amount of which exceeds its own retention of the transferring company, are subject to transfer to reinsurance within a certain limit (excess).
The main factors determining the amount of one's own deduction are the premium amount, the average profitability of the operation for the relevant type of insurance, the territory of distribution of the insured objects, practical experience of underwriters, the amount of expenses for conducting business.
In case of reinsurance on the basis of excess amount , the insurer establishes its own retention at a certain level, called in practice reinsurance of the line. Damage exceeding the line indicated by the insurer is subject to reimbursement by the reinsurer within the limits of the number of lines specified in the contract.
It is important to note that the costs of servicing the ex-cessive contracts are much greater than under the quota reinsurance contracts. The study of each risk, the determination of its share in an exceptional contract, the establishment of priority in absolute terms, the grouping of risk, the assessment of possible losses increase the cost of conducting reinsurance in an ex- cessive form. Despite this, this form is more interesting for the assignor, and therefore is more often used in practice. An inferior company can establish its own retention, as well as differentiate it for specific risk groups, which makes it possible to keep to itself all small risks. However, for reinsurers this means that the most dangerous risks can fall into its portfolio. The size of one's own retention can be reviewed. These advantages for the reinsurer compensate for its high costs for conducting business, as well as a smaller commission compared to quota contracts.
Reinsurance percentage is the ratio of the reinsurer's share to the insured amount of the risk. It forms the basis for mutual settlements between the reinsurer and reinsurer, both for reinsurance payments and for insurance payments.
The essence of disproportionate reinsurance is that the possibility of reinsurance is determined solely by the magnitude of the loss and is not tied to the size of the insured amount, i.e. There is no proportional division of responsibility but a separate risk and corresponding original premium. The premium for this type of reinsurance is usually determined as a percentage of the annual premium received by the assignor in respect of the portfolio accepted for insurance and transferred to reinsurance.
The common feature of these contracts is that priority is the absolute value (in the contract of the excess of loss) or the percentage expression (in the contract of the excess of unprofitableness) within which the assignor independently bears the responsibility and provides compensation in case of damage, but the original insurance contract. Losses exceeding the priority shall be reimbursed by the reinsurer within the limits provided by the liability limit contract. This limit is expressed as the absolute value in reinsurance contracts on the basis of the excess of loss or as a percentage of the earned or accrued premium in the case of an unreasonable loss contract.
The loss event as a reinsurance instrument takes effect only when the final amount of the loss for the insured risk as a result of the insured event resulting from the same incident stipulated amount. The responsibility of the reinsurer over this amount is limited to the limit that is the priority of the transfer company. The applicability of insurance based on the excess of loss is largely dependent on the specific features of the particular type of insurance, the features of the insurance portfolio subject to reinsurance, and the adequacy of the premium size to the amount of insurance cover. Quite often, reinsurance of excess losses is used in such branches of insurance, where, as a rule, losses are only of small and medium size, and large losses are an exception.
The main content of the loss event (stop loss) is that the insurance company protects the general results of the business for a particular type of insurance in case the loss exceeds the contract percentage or its size.
Reinsurance of excess loss ratio refers to the entire insurance portfolio and aims to protect the financial interests of the insurer from the consequences of an extremely large loss ratio, which is defined as the percentage of the insurance indemnity paid to the amount of insurance premiums collected. The reason for the extremely large loss ratio may be the occurrence of a small number of very large losses or the occurrence of a significant number of small losses.
Thus, reinsurance is designed to equalize the insurance amounts taken on insurance risks and thereby balancing the insurance portfolio, bringing the potential liability of the insurance company in line with its financial capabilities.
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