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Aviation Insurance 101 - Part 2: Reinsurance Proportional

Aviation101_plane.jpgIn part 1 of the reinsurance discussion we focused on the non-proportional treaty reinsurance commonly known as Excess of Loss (XOL). In this part we will discuss proportional treaty reinsurance which is better known as Quota Share reinsurance. Quota share treaties are written to protect the insurance company or cedent by taking a percentage of the risk.

Quota Share treaties are written based on the actual performance of the underwriting of the insurance company. The reinsurers will offer to protect the cedent for a percentage of the business outlined in the contract. For example the reinsurance company may offer a 20% line on all risks subject to the contract and the cedent will have 80% of the risk. The reinsurance company must have a lot of faith in an insurance company in order to write this type of business since they will get 20% of every loss from dollar one. The benefit for the reinsurance company is the get access to what they believe will be profitable business. The cedent likes this business because they can control their downside risk and also charge a ceding commission.

As with most reinsurance it isn’t an easy choice to simply buy this coverage. If an insurance company is writing very profitable business why would they want to share the profits with another company? And the other side is why would a reinsurer want to write business that isn’t going to make a profit? This type of reinsurance really requires a good relationship between the reinsurer and reinsured. There must be trust that each company will do what they say they will. Transparency is the key to building a long-term reinsurance relationship in the proportional treaty segment.

Unlike the XOL programs we talked about in Part 1, there are no reinstatement provisions. So if there is a loss the reinsurer doesn’t get the opportunity to collect more reinsurance premium. The two companies are bound together by the results of the primary account for the duration of the contract.

Each treaty can build up as much capacity as needed. In some cases the insurance company doesn’t want to take ANY risk and will by 100% quota share capacity. In this case they will utilize their paper to offer coverage and do this for the fee that reinsurers are willing to pay. Another important point is that each type of treaty reinsurance can be purchased as a stand-alone coverage or in combination with the two types. In some cases an insurance company likes to work with long-term partners to offer them the ability to benefit in the direct business, but still protect their capital with a XOL program. In Exhibit A you can see three basic examples for a reinsurance program that has a $50m limit. One is a QS treaty, the second is an XOL treaty and the third is combination of the first two. The combinations are endless, but as you can see the XOL reinsurers take on the layers that they want and miss the first dollar losses (which typically are a vast majority) and the QS partners take a proportion of every dollar of loss.

When evaluating any reinsurance treaty program each company will spend time understanding their portfolio, loss history, planned changes in the next treaty year, rating agency concerns, and capital requirements. It isn’t a simple decision to decide how much to buy, how many reinstatements are needed, is clash coverage for one or two events important, market conditions, etc. Each year a team of people will get together at the insurance companies to discuss what they feel is needed and each will come up with what they feel is going to fit their needs for the next twelve months. The reinsurance is typically the highest non-claim expense for an insurer. If you pick wrong it can be the difference between profit or loss.

Examples of a $50m reinsurance program:

Combined_QS_XOL.jpg

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