Reinsurance Tutorials #11 - Season 2
Hi everybody 👋
Today we will focus on loss occurrence clauses in Cat treaties.
For excess of loss treaties, the Reinsurer is liable for the total amount of the ultimate net losses sustained by the Reinsured, in excess of the retention for each Loss Occurrence.
For excess of loss per-risk treaties, a loss at the insurance level is equal to a loss at the reinsurance level. Cat excess of loss treaties, by nature, define the accumulation of several individual insurance losses as a single reinsurance claim.
The purpose of a Cat excess of loss treaty is to protect the Reinsured against adverse loss experience resulting from the accumulation of losses arising from a single, major natural disaster or major event such as a hurricane, tornado, earthquake, flood, windstorm, bushfire, etc.
Let’s start! ⏬
A loss occurrence clause has two parts:
- the first part defines which losses may be aggregated
- the second part is the hours clause which specifies the duration and the extent of any one loss occurrence as defined in part 1
Which individual losses can be aggregated? In Cat excess of loss treaties, the purpose is to aggregate all individual losses sustained by the Reinsured directly or indirectly occasioned by any one disaster, accident, loss, or series of disasters, accidents or losses arising out of one event.
To be aggregated, each individual loss must comply with the causal requirement, either directly or indirectly.
Moreover, this causal requirement must refer to the same event. But what is an event? The term is not often defined by the reinsurance contract. An event must meet three criterias, called unity tests or assessments: 1. Locality unity, 2. Time unity; 3. Causality unity.
- Locality or location unity refers to the territorial scope where the loss occurred. Space varies according to the type of event. Some storms may have a track up to 5,000 kilometers.
- Time unity. A subsidiary hours clause is triggered when the definition of loss occurrence does not suffice.
- Causality unity is probably the most important criteria. It refers to the peril or the occurring event.
The definition of loss occurrence is extremely important in an excess of loss treaty. The broader it is, the more the Reinsured can aggregate individual losses and reach the deductible amount.
Hours clause
The subsidiary hours clause enables the Reinsurer to limit the individual losses that the Reinsured can aggregate in accordance with the time or the duration of their occurrence. It defines a timeframe to aggregate losses. Therefore, it benefits the Reinsurer as it reduces its exposure to loss.
This timeframe may vary depending on whether the event is a natural catastrophe or not. Typically, a time period of 72 or 168 hours is set. But it may also be set at up to 502 hours.
Let’s take the example of a hurricane that occurs over a 12-day period (288 hours) in several countries. The hours clause limits the aggregation of losses arising from the hurricane for 72 consecutive hours. The Reinsured can select when the window applies to maximize its recovery. It can choose when the losses start to accumulate.
Indeed, most loss occurrence clauses state that if a catastrophe is of greater duration than the periods defined, the Reinsured may divide the catastrophe into two or more “Loss Occurrences”:
- provided no two periods overlap
- provided no period commences earlier than the date and time of the occurrence of the first recorded individual loss suffered by the Reinsured in the catastrophe.
The clause may also list the number of hours for each peril and state a number of hours of non-listed perils, which may raise a dispute as to the scope of the hours clause. The hours clause impacts reinstatements of coverage and consequently the annual aggregate limit.
Some loss occurrence clauses give the Reinsured freedom to define what can be aggregated or not and interpret the clause in a manner that is to its advantage. Whenever there are different perils which are not connected to each other by an unbroken chain of causation, the hours clause may specify that the Reinsured is allowed to choose the applicable number of hours.
Calculating loss amounts on the basis of an hours clause is an ongoing challenge faced by Reinsurers and the Reinsured.
Conclusion
With increasing catastrophe losses worldwide, it is obvious that the industry will have several opportunities to sort out loss occurrence clauses. Clear and mutual understanding of the clauses benefits all parties, Reinsured, Reinsurer and Broker, and can avoid dispute after the occurrence of an event.
For the next video, let’s have a look at the differences between proportional and non-proportional Cat treaties with Laurent.
Thanks for your attention!
Bye for now 👋
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