Reinsurance

As in case of other insurance lines, insurance companies in trade credit and surety buy reinsurance mainly for risk management and capital relief reasons. Reinsurers with a broad product and geographical diversification can offer value to insurance companies, as their capital costs might benefit from a broader diversification. Since the underlying business of trade credit and surety can be impacted by fluctuations due to economic cycles, reinsurance can furthermore contribute to the financial stability of insurance companies over the cycle.

The “follow the fortunes” clause normally states that the reinsurer shall follow the underwriting fortunes of the reinsured in respect of risks which the reinsured has accepted under insurance contracts and are part of the reinsurance agreement. This should extend as well to cancellations, reductions, removals, or other alterations affecting the business ceded as well as to claims provided by the reinsured as long as the reinsured acts in such a competent manner as it would not be reinsured. The parties to a reinsurance treaty may choose to deviate from this general rule.

Under proportional reinsurance treaties, reinsurers have to assume an expected loss ratio for the defined period bearing in mind the underlying attachment principle. Considering the loss ratio expectation as well as the original costs of the insurance company, the cost remuneration (reinsurance commission) from reinsurers in favour of the insurance company is determined. Under non-proportional treaties a price is to be determined based on an expected loss above the agreed deductible of the insurance company following the underlying attachment principle. Under non-proportional reinsurance treaties there is no specific compensation for the original costs of the insurance company as there is no proportional sharing of premium and losses. To finalize the pricing for proportional and non-proportional reinsurance treaties the reinsurer has to add its own costs including capital costs and margin requirements.

Trade credit and surety are specialty insurance and reinsurance classes with very specific characteristics. Different to other classes these business lines need knowledge about default probabilities of corporates, economic developments in trade sectors and economic as well as political developments in countries. Since many insurance companies have specialized in these lines of business, reinsurers have done the same in order to respond to the insurance company’s demand in a professional way.

Because of its nature of risk-sharing reinsurance adds to a credit insurer’s or surety’s financial stability.

Additional to risk-sharing, a broad product and geographical diversification offered by the reinsurer may lead to lower capital costs for the credit insurer or surety.

Proportional reinsurance is in our lines largely offered in the form of a so-called “Quota share agreement”. Under such an agreement insurance companies share with the reinsurer premium, costs and losses in a proportional way for all qualifying risks with the same cession level. Other forms of proportional reinsurance treaties include  “Variable Quota share agreements” or “Surplus treaties”. Under those agreements insurance companies share  premium, costs and losses proportionally but with different cession levels by size of risk.

In case of non-proportional reinsurance, premium, costs and losses are not shared in a proportional but non-proportional way. Under such an agreement insurance companies agree to accept all losses up to a predetermined level. The reinsurer agrees to reimburse the insurance company for losses above the predetermined level and up to the reimbursement limit provided for in the contract. The reinsurance premium payable for such coverage is calculated separately based on the expected loss under this treaty. The most common form of non-proportional reinsurance is the “per risk/obligor cover”. Coverages which function on an aggregated basis across a portfolio are also possible but are less common.

In these lines of business different forms of reinsurance buying are known. Pure proportional treaties, pure non-proportional treaties and a combination of both. The choice of the insurance company for a certain type of reinsurance cover can be influenced by their own risk appetite and risk bearing capacity as well as regulatory conditions. Proportional reinsurance tends to give full capital relief under most regulations whereas non-proportional reinsurance might occasionally not give full relief. If it comes to risk management both coverages give, of course, full benefit to the insurance company. In both cases the financial rating of the reinsurer is of high importance.

Under an obligatory reinsurance agreement a reinsurer participates in a cedent’s total, precisely defined insurance portfolio. This is in contrast to facultative reinsurance where the reinsurer participates in a particular individual risk.

Facultative reinsurance is used in both credit insurance as well as surety albeit it is used more frequently in surety. This has to do with occasionally bigger single contracts which might lead to facultative reinsurance needs above potentially existing obligatory reinsurance agreements.

In trade credit as well as in surety, insurance companies might give separate covers for the same buyer/sector/country several times. This can lead to so-called accumulation. In order to control and manage the maximum exposure accordingly, insurance and reinsurance companies have a detailed accumulation control in place. Depending on the individual risk appetite and risk bearing capacity per mentioned category, insurance companies seek reinsurance coverage for which reinsurance companies offer their support.