Types of Reinsurance, With Worked Examples
Two questions classify every arrangement: how it is placed, and how losses are split.
Reinsurance is classified two ways, and IC-01 questions mix them freely. The first asks how the cover is arranged: one risk at a time (facultative) or a whole class of business under one agreement (treaty). The second asks how premium and losses are split: in fixed proportions (proportional) or only above a set amount (non-proportional).
The two cut across each other. A treaty can be proportional or non-proportional, and so can a facultative placement.
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Facultative vs Treaty
What it covers
Facultative
A single risk or a defined package of risks
Treaty
A whole class or segment of business
Obligation
Facultative
Neither side is obliged: the cedant offers, the reinsurer may accept or decline
Treaty
Automatic within its terms: the cedant must cede and the reinsurer must accept
Duration
Facultative
The period of the one policy
Treaty
Usually one year, often renewed
Best for
Facultative
Very large or unusual risks outside the treaty
Treaty
Routine flow of business
Drawback
Facultative
Slow and costly to place risk by risk; cover is uncertain until accepted
Treaty
Less flexibility on any one risk
| Point | Facultative | Treaty |
|---|---|---|
| What it covers | A single risk or a defined package of risks | A whole class or segment of business |
| Obligation | Neither side is obliged: the cedant offers, the reinsurer may accept or decline | Automatic within its terms: the cedant must cede and the reinsurer must accept |
| Duration | The period of the one policy | Usually one year, often renewed |
| Best for | Very large or unusual risks outside the treaty | Routine flow of business |
| Drawback | Slow and costly to place risk by risk; cover is uncertain until accepted | Less flexibility on any one risk |
Proportional Reinsurance
The reinsurer takes an agreed share of each risk, and receives the same share of premium and pays the same share of every loss. It usually pays a ceding commission.
- Quota share
- A fixed percentage of every risk in the class is ceded. Illustration: on a 30% quota share, a ₹10 crore policy cedes ₹3 crore; a ₹1 crore claim costs the reinsurer ₹30 lakh.
- Surplus
- The insurer keeps up to its retention, called one line, and cedes the surplus above it, up to a set number of lines. Small risks stay entirely with the insurer; large ones are shared.
A Surplus Treaty, Worked Through
Illustrative figures.
- 1
The treaty
Retention (one line) ₹2 crore; treaty capacity four lines, so up to ₹8 crore can be ceded.
- 2
The risk
A ₹6 crore warehouse. The insurer keeps ₹2 crore and cedes ₹4 crore: a one-third and two-thirds split.
- 3
The loss
A ₹3 crore fire. The insurer pays ₹1 crore net, the reinsurer ₹2 crore, matching the split. Premium was shared the same way.
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Non-Proportional Reinsurance
No sharing of each risk. The reinsurer pays only when losses go above an agreed figure (the deductible or priority), up to a limit. It is priced separately rather than as a share of premium.
- Per risk excess of loss
- Protects against a large loss on any one risk. Illustration: ₹4 crore in excess of ₹1 crore. A ₹3.5 crore loss costs the insurer ₹1 crore and the reinsurer ₹2.5 crore; a ₹80 lakh loss stays wholly with the insurer.
- Catastrophe excess of loss
- Protects against many losses from one event, such as a cyclone, added together.
- Aggregate excess of loss (stop loss)
- Protects against total losses over a period, usually a year, going above an agreed amount or loss ratio.
One Line to Remember
Proportional reinsurance shares risks; non-proportional reinsurance shares losses. If a question mentions lines or a percentage of every policy, it is proportional. If it mentions a figure losses must exceed, it is excess of loss.
How IC-01 Tests This
Questions describe an arrangement in one sentence and ask you to name it: "the reinsurer pays only losses above a specified amount" is excess of loss; "premiums and losses shared in a fixed ratio" is quota share; "excess of loss covering all losses in a period" is aggregate. The trap is confusing surplus with excess of loss, because both involve an amount the insurer keeps. In surplus, the insurer keeps a share of the sum insured; in excess of loss, it keeps the first slice of the loss.
FAQs
What is the difference between facultative and treaty reinsurance?expand_more
Facultative reinsurance is arranged risk by risk, and neither side is obliged to offer or accept. A treaty covers a whole class of business automatically for a period, usually a year.
What is proportional and non-proportional reinsurance?expand_more
In proportional reinsurance the reinsurer takes a fixed share of each risk, its premium and its losses. In non-proportional reinsurance the reinsurer pays only the part of a loss above an agreed amount, up to a limit.
What is the difference between quota share and surplus treaty?expand_more
A quota share cedes the same percentage of every risk. A surplus treaty lets the insurer keep each risk up to its retention and cedes only the amount above it, so the ceded share varies by risk size.
What is excess of loss reinsurance with example?expand_more
Cover that pays losses above a set figure. On ₹4 crore in excess of ₹1 crore, a ₹3.5 crore loss is paid ₹1 crore by the insurer and ₹2.5 crore by the reinsurer.
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