Those of us in the insurance industry use the word "reinsurance"
as commonly as we do "lunch." Everybody understands exactly what we
mean when we say reinsurance - Not!!
In truth, reinsurance means a lot of things and can be used for
many different purposes, so it is not as simple as a single word.
We generalize the word "reinsurance" believing that our audience
understands the meaning in the context of the present conversation.
The subject of reinsurance covers way too much to deal with in a
single Blog post, so I am going to break it up into parts over
several weeks to provide context for what "reinsurance" means in
the ALPS relationship with its Main Street Lawyers.
Before I dig into how reinsurance works for ALPS and start
throwing big words around, I think I should define a few key words
that will be relevant to the entire series of articles. For purpose
of these blog posts, I am providing plain language rather than
technical definitions. I hope this permits a better and higher
level understanding of the concepts contained in each of the
following articles. So here I go with definitions:
Attachment Point: The dollar value above which a
reinsurance treaty attaches and becomes an obligation.
Indemnity: The amount of money required to be paid, on
behalf of an insured, by an insurer to a claimant to settle a claim
or pay a judgment, including any assessed court costs.
Capacity: The total amount of insurance coverage an
insurer can issue based on its own capital and reinsurance
ceded.
Allocated Loss Adjustment Expense (ALAE): The amount of
money required to cover the attorney's fees and defense costs in
order to bring a claim against an insured to a conclusion.
Unallocated Loss Adjustment Expenses (ULAE): The amount
of money an insurer expends for adjusters or internally (claims
staff salaries, travel, copies, faxes, etc.) in order to bring a
claim against an insured to a conclusion
Excess Reinsurance: A program of reinsurance where the
ceding company transfers its risk exposure above a certain
attachment point to another party (the reinsurer or reinsurers).
[Example: On a policy risk of $1,000,000 with an excess treaty
attaching at $200,000, the ceding company pays all losses below and
including $200,000 and the reinsurer is responsible for any amount
above the attachment point.]
Cessions Reinsurance: A reinsurance program where the
reinsurer takes 100% of the risk and 100% of the premium
attributable to that layer and pays the ceding company a "ceding"
commission for generating the business and for its work.
[Example: These generally follow a primary layer of reinsurance
with a ceding company retention so that the ceding company has no
risk in this layer.]
Quota Share Reinsurance: A program of reinsurance where
the ceding company sells off a portion of its risk to another party
(reinsurer) on a proportional basis. [Example: The Company and
the reinsurer retain 50% of the premium and each become responsible
for 50% of any loss up to the policy limit.]
Fronting Company: An insurance company which grants
another insurance entity (MGA or Insurer) the right to issue
specific agreed policies on its policy form, or a form that it
specifically gets approved for the entities use. [Example: A
captive RRG needs at least an A- rating to meet the needs of its
members but is not in a position to get an A- rating out of the
gate because of short surplus and seasoning; so it gets another
company to "Front" its policy so that the fronting company's rating
will apply since it technically assumes responsibility to the
insured if the captive fails to pay a righteous claim. In most
cases the fronting company reinsures some or all of the risk above
an agreed attachment point to protect itself from loss. In many
cases the "Front" reinsures 100% of the risk above the attachment
point so they bear no direct risk at all except in the event of
failure of the ceding company.]
Flat Rating: A pricing mechanism where the parties agree
to a specific price or percentage of premium as the price for the
layer of reinsurance. Sometimes a profit commission will be added
to provide for a portion of the agreed premium to be repaid to the
ceding company if the loss experience for the program is good.
Swing Rating: A reinsurance rating process where the
parties agree to a "provisional" rate based on expected results,
but also agree that if the results are better, the price will slide
down to the "minimum" rate and if the results are bad they will
slide up to the "maximum" rate. Settlement of the rate occurs after
a couple of years and finally settles when the last claim for the
treaty period settles.
Stop Loss Coverage: A policy of insurance or reinsurance
agreement whereby the reinsurer/insurer agrees to cover all losses
within a ceding company's retained layer of coverage to a certain
dollar or percentage amount.
Catastrophe Reinsurance or Cat Cover: This coverage
generally falls in the category of stop loss type coverage, but
generally attaches at a very high level so it only pays if a major
insuring event (hurricane) occurs which will impact a multitude of
policies issued by the ceding company.
Capital or Surplus: The assets an insurer holds above its
reserves as determined by Generally Accepted Accounting
Standards.
Admitted Capital or Surplus: The assets an insurer holds
above its reserves which meet the statutory requirements under
Statutory Accounting Standards and defined by an individual State
Regulator.
Well, these will get us going. If, as I write more on
reinsurance I find others that I have forgotten to define, I'll
just drop them in on the fly.
Why do companies need reinsurance anyway? Some companies
(property insurers in particular) reinsure to cover major loss
events that impact multiple insurance policies, some buy it to
expand their ability to write more policies and some to enable them
to offer higher limits than their own internal capital base allows.
To some degree, virtually every primary insurer utilizes
reinsurance to allow flexibility in what it does for its
policyholders.
The insurance industry lives by formulas and ratios. State
Insurance Regulators require that insurance companies not insure
more risk than a multiple of our surplus. For example: The
ideal in the casualty industry seems to be about two ($2.00)
dollars of risk for every one ($1.00) dollar of surplus. A company
with thirty million ($30,000,000) dollars of surplus can write
sixty million ($60,000,000) dollars of insurance. If all policies
had an insured value of one million ($1,000,000) dollars then the
company could issue sixty policies. By reinsuring everything above
one hundred thousand ($100,000) on an excess or cessions basis,
that same company can issue sixty thousand (60,000) with the same
amount of capital and surplus. Simply, insurers borrow
capacity from reinsurers to meet the needs of its customers. This
is just one example but I'll save the others for future articles
when I deal with why some companies use quota share vs. excess or
cessions reinsurance.
Please post your comments and questions about reinsurance and
this article so I can get a sense of where your interests lie for
future posts. As always if you want a more detailed understanding
of any part of this particular article please e-mail your questions
to the address found on the "View from the Corner Office" home page
or call me at 1-800-327-2577. You can also contact our customer
service team who all have a strong understanding of how reinsurance
impacts ALPS policy forms. ALPS policyholders can call or e-mail
their Account Manager and the rest of the world can call or email
Julie Patterson (1-800-367 2577, jpatterson@alpsnet.com),
Matt Pickett (1-800-367-2577, mpickett@alpsnet.com) or
Keith Fichtner (1-800-367-2577, kfichtner@alpsnet.com).