Types of Reinsurance and Reinsurance Program Design

Reinsurance agreements are unique, negotiated, and non-standardized contracts designed to meet specific primary insurer needs.
The two primary transaction types are treaty and facultative reinsurance, which are further categorized by how obligations are divided.
Allocation methods include pro rata (proportional) and excess of loss (non-proportional) approaches.
In pro rata reinsurance, the primary insurer and reinsurer share amount of insurance, premiums, and losses in the same proportions.
The reinsurer pays a ceding commission to reimburse the primary insurer for policy acquisition expenses.
Pro rata reinsurance is preferred by new insurers or those with limited capital due to its effectiveness in providing surplus relief.

Quota Share Reinsurance: A fixed percentage is used to share insurance amounts, premiums, and losses. Often applied to property insurance and may include a per occurrence limit to restrict catastrophe recovery.
Surplus Share Reinsurance: The reinsurer assumes the "surplus" share of insurance that exceeds a stipulated dollar amount known as the "line."
Reinsurance capacity in surplus share is expressed in multiples of the line (e.g., a $9$ -line treaty with a $\$300,000$ line provides $\$2,700,000$ in capacity).
Surplus share is typically used for property insurance and requires the use of a bordereau (a periodic history report provided by the primary insurer).
Line Guides: Documents used to communicate the minimum and maximum lines a primary insurer can retain based on loss severity.

Flat Commission: A fixed percentage of ceded premium with no adjustments for loss experience.
Profit Sharing (Contingent) Commission: A predetermined percentage paid to the primary insurer if the reinsurer achieves greater-than-expected profits after deducting losses, expenses, and a minimum margin.
Sliding Scale Commission: An initial commission adjusted based on the actual profitability of the reinsurance agreement.

The reinsurer responds only when losses exceed a primary insurer’s retention, known as the attachment point.
Premiums are negotiated as a percentage (rate) of the subject premium (underlying premium).
Reinsurers generally do not pay ceding commissions under these agreements.
Working Cover: An excess of loss agreement with a low attachment point designed to spread frequent, expected losses over several years.
Co-participation Provision: Requires the primary insurer to remain responsible for a percentage of losses above the attachment point (e.g., $95\%$ of $\$20,000,000$ xs $\$5,000,000$ implies the primary insurer retains $5\%$ of the layer).
Loss Adjustment Expenses (LAE): Handled either as "pro rata in addition" (shared by the same percentage as the loss) or "LAE included in the limit" (added to the loss amount to determine the attachment point).

Per Risk Excess of Loss: Applies separately to each risk/building; often includes a per occurrence limit to restrict total payout from one event.
Catastrophe Excess of Loss: Aggregates retained losses from a single event. Includes a loss occurrence clause (hours clause) specifying time limits for aggregation ( $72$ hours for hurricanes, $168$ hours for earthquakes).
Per Policy Excess of Loss: Used primarily with liability insurance.
Per Occurrence Excess of Loss: Used for liability; may involve a clash cover with an attachment point higher than the limits of any single underlying policy to protect against multiple policy involvement (e.g., auto and general liability).
Aggregate Excess of Loss: Covers total losses over a period (usually one year) exceeding an attachment point stated as a dollar amount or loss ratio. When using a loss ratio, it is called "stop loss reinsurance."

Finite Risk Reinsurance: Multi-year ( $3$ to $5$ years) agreements where limited risk is transferred, and investment income is an underwriting component. Premiums can reach $70\%$ of the reinsurance limit.
Catastrophe Bonds: Insurance-linked securities issued through Special Purpose Vehicles (SPVs) that forgive interest or principal payments if a specified catastrophe loss exceeds a threshold.
Industry Loss Warranty (ILW): Coverage triggered when industry-wide losses from a specific event exceed a threshold.
Catastrophe Risk Exchange: A forum allowing insurers to trade risks, diversifying geographic or cause-of-loss concentrations.
Contingent Surplus Note: Allows an insurer to obtain funds immediately at a pre-agreed interest rate, increasing assets without increasing liabilities.
Sidecar: A limited-existence SPV that provides additional capacity through quota share agreements with private investors.

Growth Plans: Rapid growth drains surplus; pro rata agreements provide ceding commissions to replenish it.
Type of Insurance: Personal lines are more homogeneous and need less reinsurance than commercial lines which have higher hazards and coverage requirements.
Geographic Spread: Wider geographic spread stabilizes loss ratios; concentration in catastrophe-prone areas increases the need for specific catastrophe covers.
Insurer Size: Small insurers need more reinsurance to stabilize loss ratios based on the law of large numbers.
Financial Strength: Stronger insurers with liquid assets can tolerate higher retentions and lower reinsurance costs.

Regulatory Requirements: State regulations generally limit net written premiums to a $3:1$ ratio relative to policyholders' surplus and restrict net retention on a single loss exposure to $10\%$ of surplus.
Management Risk Tolerance: Reflects willingness to assume risk to stabilize earnings and maintain investor/stakeholder confidence.
Limit Considerations: Treaty limits are influenced by maximum policy limits, potential extracontractual obligations (damages from bad faith claim handling), excess of policy limits losses, and catastrophe model estimations.