Reinsurance tutorials #6 • The Basics
What is surplus reinsurance?
As an insurance company, you define what you can keep for your own account on a risk, a category of risks, a book of risks you insure on a line of business (such as Fire). This is your retention or net line. You may opt for one single retention, whatever the type of risk, or different retentions. You then have a table of lines. Above this line, you buy from your reinsurers a capacity expressed in a number of lines, the Surplus treaty. The sum of your Net line and Surplus capacity is your gross Line or Gross Underwriting capacity, according to your table of lines and the Surplus number of lines.
Your net line will be defined depending on:
- Your financial strength and solvency requirements
- Your premium volume achieved in that LOB, and the volatility of your book
- Your risk appetite (top management and shareholders)
- The cost of reinsurance
Your net line is usually expressed in sums insured. There are other criteria possible depending on the Line of Business. Here is an example: for Fire Industrial risks, you may use PML (Probable Maximum Loss) which gives you a bigger underwriting capacity.
However, a word of caution: a PML error may endanger your credibility as a skilled underwriting company, cost you the trust of your reinsurers and the capacity and/or price they are prepared to offer.
Higher capacity and bigger imbalance of the treaty thus imply a different price. Reinsurers may ask a minimum PML to limit their commitments, or may include a PML error clause to share the burden of the PML error at the best possible price.
- Larger capacity than a QS with a more limited outflow of premium
- Better balance of your book: you cede the peaks and limit your commitment per risk
- Your net Line may differ according to type of risks
- Reduced volatility allows for more long term investment and higher yields
- Your net loss ratio may differ from and be better than your gross one. Of course, your reinsurers will know about it and discuss the price accordingly
- The more complicated the table of limits, the heavier the administration cost
- You can’t use a Surplus Treaty when you can’t define your retained line (for instance, for unlimited motor liability)
- Fire, Engineering, Marine Hull and many other LOB
Nota bene: Your surplus treaty may not be sufficient to offer the capacity you need to face your clients’ demand or your policy to position yourself on the market facing clients and brokers. On top of your First Surplus, you may then build additional Surplus treaties. The higher capacity you reach, the less the number of risks ceded to the treaty will be, and the higher the imbalance of the treaty. This is another matter to negotiate with your reinsurers.
Other proportional treaties:
- Covers coming on top of your Surplus treaty/ies. The insurer may decide to cede a risk to the treaty and the reinsurer is compelled to accept it
- Open Covers or “Facilities”: there is no link to any retention from the insurer. A professional reinsurer is not fond of “facilities” which may look like a blind cover but there can be a lot of specific conditions agreed upon. Then, as a Reinsurer, everything is a matter of price and negotiation !
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