The capacity of a surplus treaty is always a multiple of the ceding company's retention. Further multiples of the retention or lines can be added beyond the 'first' surplus treaty, becoming the 'second' surplus treaty.
The mechanics of ceding a risk under a surplus treaty do not differ from those of an individual facultative proportional cession. There are, however, substantial differences in the creation of any surplus treaty.
Let us assume a four-line surplus treaty, giving the insurer an automatic underwriting capacity of USD 5,000,000 (USD 1,000,000 own gross retention plus USD 4,000,000, comprising four surplus lines each of USD 1,000,000).
The insurer has accepted five risks, all of the first-class construction. If the insurer decided to retain its maximum gross retention then the risks would be apportioned to the surplus treaty as follows:
Let us assume a four-line surplus treaty, giving the insurer an automatic underwriting capacity of USD 5,000,000 (USD 1,000,000 own gross retention plus USD 4,000,000, comprising four surplus lines each of USD 1,000,000).
The insurer has accepted five risks, all of the first-class construction. If the insurer decided to retain its maximum gross retention then the risks would be apportioned to the surplus treaty as follows:
Risk
|
Original sum insured
|
Company retains
|
Cedes to surplus
(iv)
|
||
in USD
|
in USD
|
in %
|
in USD
|
in %
|
|
(i)
|
(ii)
|
(iii)
|
(iv) = (iii)/(ii)
|
(v) = (ii)-(iii)
|
(vi) = (v)/(ii)
|
1
|
1000000
|
1000000
|
100.00%
|
Nil
|
0.00%
|
2
|
2500000
|
1000000
|
40.00%
|
1500000
|
60.00%
|
3
|
3200000
|
1000000
|
31.25%
|
2200000
|
68.75%
|
4
|
4000000
|
1000000
|
25.00%
|
3000000
|
75.00%
|
5
|
5000000
|
1000000
|
20.00%
|
4000000
|
80.00%
|
It is important to note that a cession does not have to be a direct multiple of the gross retention, nor does the insurance company have to retain its stated maximum on a particular risk. If this were to be the case, the surplus capacity would be commensurately reduced. Once a cession has been made, it remains at that percentage. Only rarely would reinsurers allow revised retention and cession to be made.
If a claim of USD 500,000.00 occurred, then the insurer and reinsurers would share the loss proportionate to the risk they undertook:
If a claim of USD 500,000.00 occurred, then the insurer and reinsurers would share the loss proportionate to the risk they undertook:
Claim
|
Original sum insured
|
Company retains
|
Cedes to surplus
|
Claim to surplus
|
|
in %
|
in USD
|
in %
|
in USD
|
||
(i)
|
(ii)
|
(iii) =
1000000/(ii)
|
(iv) =
(iii)x(i)
|
(v) =
100%-(iii)
|
(vi) =
(v)x(i)
|
500000
|
1000000
|
100.00%
|
500000
|
0.00%
|
0
|
500000
|
2500000
|
40.00%
|
200000
|
60.00%
|
300000
|
500000
|
3200000
|
31.25%
|
156250
|
68.75%
|
343750
|
500000
|
4000000
|
25.00%
|
125000
|
75.00%
|
375000
|
500000
|
5000000
|
20.00%
|
100000
|
80.00%
|
400000
|
Two important words need explanation:
A 'cession' is that amount of an original risk that is ceded to a proportional treaty. The word applies to all forms of proportional reinsurance, whether facultative or treaty.
A 'line' describes the monetary amount of the insurance company's gross retention taken on an original risk. Surplus treaties are normally a specified multiple of that gross retention, resulting in surplus capacity being described as 'x lines of y maximum gross retention.' There are also cases where surplus capacity is constructed on the insurer's net retention or gross retention after quota share cession, but we shall concentrate here on surplus capacity geared to gross retention.
One the terms and conditions of a surplus treaty have been finalised, then the insurer is obliged to cede all risks greater than its chosen retention and falling within the scope of the treaty agreement and the reinsurer is obliged to accept all such cessions.
Both contracting parties, the insurer and reinsurer, therefore have identified obligations under the treaty and they are automatically bound in advance to transact business in the manner specified, with no freedom of choice available to either party.
Whereas an individual facultative cession has to be specifically agreed between the parties, a cession to a proportional treaty is of immediate effect.
A 'line' describes the monetary amount of the insurance company's gross retention taken on an original risk. Surplus treaties are normally a specified multiple of that gross retention, resulting in surplus capacity being described as 'x lines of y maximum gross retention.' There are also cases where surplus capacity is constructed on the insurer's net retention or gross retention after quota share cession, but we shall concentrate here on surplus capacity geared to gross retention.
One the terms and conditions of a surplus treaty have been finalised, then the insurer is obliged to cede all risks greater than its chosen retention and falling within the scope of the treaty agreement and the reinsurer is obliged to accept all such cessions.
Both contracting parties, the insurer and reinsurer, therefore have identified obligations under the treaty and they are automatically bound in advance to transact business in the manner specified, with no freedom of choice available to either party.
Whereas an individual facultative cession has to be specifically agreed between the parties, a cession to a proportional treaty is of immediate effect.
Source:
John Pyall. 1999. Reinsurance. The Chartered Insurance Institute.
Previous
« Prev Post
« Prev Post
Next
Next Post »
Next Post »
How Surplus Treaty Reinsurance Works
4/
5
Oleh
Fajar Nindyo
