15 March 2022 4 min read

📋 Tell me why? | Structuring a reinsurance treaty

Reinsurance Tutorials #2 - Season 2

1. Very small local or regional companies or long-standing mutuals dedicated to a specific line of business and/or customer segment.

They may be pretty modern in terms of IT tools to control their costs and pilot their business properly but their surplus funds are limited.


They need their reinsurers to provide:


  • Treaty capacity: that capacity will be granted on a Quota share or a non-proportional basis depending on their financial strength and how well their book is balanced
  • Financial security to cope with claims deviation and solvency requirements
  • Proper understanding of their products, mission and, above all, vision
  • A long-term partnership that is secure in all respects
2. Start-ups

May be small at the beginning but ca be act to aggressively increase the size of their operations in terms of products offered and/or geographical scope as today’s ambition is to be positioned worldwide.


These companies are willing to enter the market with their client databases, new concepts on the distribution side, the type of clients they look for, the products they sell, etc.


They may be small at the beginning but belong to grow into large groups that want to spread their wings in their field, such as Tesla, Amazon…


These companies submit a business plan to the controlling authorities which provides:

  • expected losses for the first 3 to 5 years in view of all entry and build-up costs
  • information about the reinsurance contracts concluded to support their growth

Then reinsurers keep their promises and provide:
  • Expertise in the design of the business model, of the product, tariffs and covers
  • Capacity badly needed to underwrite new business
  • Protection against claims deviation. The uncertainties are more important when the company starts with a new product without proper statistics and many hypotheses that could prove too optimistic in terms of claims experience, tariffs, the product being undersold (heavy costs to premiums) or oversold (solvency and/or claims issues)
  • Financial support in the first years of operation, expected return in the ensuing years. Sometimes reinsurers agree, for instance, to a “building cost additional commission” that will no longer apply when the business has grown large enough to cover claims and costs


Why should reinsurers do this? Because:
  • They are always looking for new clients with great expectations who shall replace those that have disappeared due to mergers and acquisitions, or those losing ground, or producing consistently poor results
  • They are willing to support new ideas who can disrupt the market, bring unexpected solutions, broaden the scope of the insurance and reinsurance industry and thus provide a potential flow of additional income
  • They invest in the future on top of their traditional client base that will, for one reason or the other, erode at some stage
  • They want to grow their business and develop new ways to quickly increase turnover which, unfortunately, does not always mean increased income

Reinsurance will be:
  • On a quota-share basis which can be as high as 90% at the beginning
  • XL on retention may be required in view of the uncertainties surrounding the product, the operations, the thin surplus basis and/or potentially unbearable claims deviation
  • Rewarded by the development of this new player that is gradually increasing its market share while others are poorly run, that is agile and that can face the challenges of evolving society, needs, competitors who may disappear…

On the other hand, some more ambitious start-ups, after a good start selling only one product, in one country, (most of the time motor insurance) may want to continue to grow quickly by broadening their product offer, for instance, by adding homeowners’ insurance and/or by entering other markets. For that reason, they need to further tap the financial market for additional funds or work with reinsurance partners on quota-share business.


For example, the US companies Lemonade, Roots…


How long will the investors and the reinsurers involved in the bet prefinance this development with great expectations? That is the question!

3. Well-etablished companies
Financially strong with a broad client basis and reliable data. Such a company will normally not need a quota share treaty, unless it is:
  • Entering a new Line of Business, selling a new type of risk, aquaculture in the eighties, cyber today. Then we are back to square one with all the uncertainties mentioned above
  • Strongly developing one Line of Business and willing to protect: against possible claims deviation in this LOB that has too much of an impact on the global portfolio and solvency ratio
  • Considering a direct pricing strategy too low to allow for profitability and willing to share this strategy with reinsurers while pruning its book and, working on pricing, client segmentation and covers to gradually improve and reach reasonable profit expectations once again
4. Global players 

Global players are large in terms of premium income, financial strength, have a well-diversified and well spread portfolio both in terms of LOB and geographically.


They are less exposed to volatility in addition to the occurrence of large events such as Nat Cats, man-made events or a high frequency of middle-sized events for which they buy reinsurance covers especially Cat XL to mitigate severity and aggregate covers (of all types) to mitigate the frequency issue.


Additionally, they may use, like other companies, quota share treaties when:

  • They are confronted with a new peril to be covered
  • They want to reduce, the volatility that strains their balance sheets because a LOB does not meet their profit expectations
  • The cost of reinsurance is cheaper than requirements for additional capital 

In the recent years, we have seen quite a lot of new quota-share treaties or ones of size. In addition to the above-mentioned reasons, we have noted an increase in the adverse risk attitude of the management boards of companies including major companies.



Differentiation of reinsurance covers according to type of risk

Mass retail products. Here, the single risk sum insured is small and there will usually be:

  • a quota-share reinsurance treaty more for solvency reason than for reasons of volatility
  • An XL on retention to protect against the accumulation of claims for any one event
Industrial, large corporate risks. Here, the primary need is underwriting capacity and this is delivered by reinsurers through:
  • One or several combined Surplus of Line treaties, or
  • A Risk XL program, and even for larger risks it could be
  • A quoted risk XL
Emerging risks or risks where the issue of accumulation is difficult to meet and will be placed by a treaty on a quota share basis, perhaps with a stop loss on retention.


Strange enough when worldwide protection needs increase, the protection gap does as well and the weight of the (re)insurance industry in the GDP decreases despite the arrival of new players, Hedge Funds, Pension Funds… and with the development of new covers such as ILS, ILW, side-cars.


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