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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:

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Aviation Insurance 101 - Part 1: Reinsurance

Aviation101_plane.jpgMany wonder how an aviation insurance company can offer coverage for such a high severity/low frequency exposure. There are very few companies that can offer the limits and retentions that aviation insurers can handle, but the only way this can be accomplished is with reinsurance. Essentially insurance for an insurance company.

Aviation insurance is a capital intensive coverage, where insurers commonly offer limits exceeding $100,000,000 (!). Taken to theoretical extremes, this could result in astronomical payouts. Naturally, this fact puts a strain on the capital requirements from rating companies like A.M. Best which in turn can lower your financial ratings.

In order to mitigate the amount of capital allocated for limits offered, the insurers are often wise to pass some of the risk to reinsurers, by buying reinsurance. In other words, just as there is a market for an aircraft owner to buy coverage for their hull and liability, there is a market that offers an aviation insurer coverage, to limit the downside of some of these very high limits.

Yes, hindsight is always 20/20 with any kind of insurance. But prior to buying reinsurance, companies can play the odds by carefully evaluating their own book of business, business strategy, loss history and risk appetite. Armed with a solid understanding of reinsurance options, companies can optimize a re-insurance plan to meet their unique needs.

For starters, here’s a brief lay of the land. There are two main types of reinsurance – Treaty Reinsurance (annual or longer term coverage) and Facultative Reinsurance (one off placements usually). These two types can be purchased separately or together in a blended approach. Within the category of Treaty Insurance, there are two ways to go: proportional or non-proportional, the latter also known as Excess of Loss (XOL).

Let’s start by focusing on Excess of Loss (XOL), because it’s so common, and an efficient springboard for understanding reinsurance. XOL provides coverage for losses in excess of a certain retention. Programs are typically divided into layers of coverage, up to the limit desired by the insurer. Policies are written with different clauses based on company preference and are renegotiated annually. In any given program there may be a combination of reinsurers participating, each with its own appetite for different coverages and layers.
Take a look at a hypothetical XOL program in excess of a $1m Retention, to a maximum recovery limit of $10m.

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The retention of the insurance company (reinsured) is the first $1,000,000 of any loss. In the event of a loss of $5,000,000, the reinsured retains the first $1,000,000; the next $3,000,000 (100%) is paid by the first layer of the XOL program, and there would be $1,000,000 (50%) of the second layer. Therefore, the GROSS recovery in this example is $4,000,000 from the reinsurers.

But that’s merely part of the story. It’s crucial to consider the NET recovery – after all, the reinsured pays a premium to the reinsurer for reinsurance coverage. This premium is rated using what’s called a rate on line (ROL). For layer one, let’s say the ROL is 25%, making the premium $750,000 (25% of the $3m line); layer two’s ROL is 10%, or $200,000; and layer three’s ROL is 5%, or $200,000. The entire premium comes to $1,150,000.

But there’s more to consider: in addition to the premiums due upfront, there’s a reinstatement premium shown for each layer, usually shown as a percentage. In the case of the above, layer one has a 100% reinstatement premium, layer two has a 100% reinstatement premium, and layer three has a 50% reinstatement premium. This means if you use the layer, you’ll have to pay an additional amount. In our example, after the $5m loss, the reinsurers will charge another $750,000 for layer one, and since we only used 50% of layer two, we would get charged 50% of 50%...or $50,000. Finally, the insurer must deduct the costs of the reinstatement premiums from the GROSS recovery, which then gives a NET recovery of $3,200,000.

Still with me? Yes, reinsurance can be complex, but the main takeaway is simple: in the field of aviation insurance, reinsurance programs are a cost of doing business. The example highlights a loss, but the simple fact is, premiums paid for a reinsurance program are expenses that come off the insurer’s bottom line. While it affords coverage and protection from catastrophic losses, it isn’t the same as insurance where the object is to make you whole. Some companies are of the philosophy that only buying coverage for super catastrophic losses is the best way to go, while others buys coverage with very low retentions. There’s no one-size-fits-all answer, and hindsight is indeed 20/20. But as companies begin to understand the nuances of reinsurance options, some measure of prudent foresight can be gained.

In our future installments we will be discussing proportional and facultative reinsurance.

Berkley Aviation Selects the Beech 18 as the 2013 Super Producer Model

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Santa Barbara, CA, December 15, 2013 -- Berkley Aviation, a W. R. Berkley Company, today announced the Beech 18 on floats as the 2013 Super Producer Model. Every year we carefully select a model aircraft – something that inspires us and sets the tone for the year to come. As a gesture of gratitude, we send these models to only our top performing brokers. In years past, we’ve sent a Boeing 787, Bell 525 and Falcon 7X. Each showing the outstanding achievements that raise the bar for distance flown, fuel efficiency and comfort. But this year we’ve decided to reflect on something a little different: the idea that with all this progress, some things never change. Great advancements in the way we fly depend on a mastery of basics. Adaptability, versatility, hard work and common sense are the underpinnings of not only aviation, but aviation insurance. To commemorate 2013, we’ve chosen the Beechcraft 18.

As the longest continuous production run for a piston aircraft, Beech produced 8,000 Model 18s. It’s versatile and solid with timeless attributes that insured its longevity. The ability to adapt to the new requirements of changing times, given its limitations, is a testament to aircraft’s solid adherence to the timeless basics of flying.

We think it is important for the aviation insurance industry to focus on the basics. The majority of the market isn’t emphasizing true underwriting skills. Instead, many companies try to buy market share or write through unprofitable years. They seem to have forgotten the basic responsibility to our shareholders: profit. These short-sighted views will have a dramatic negative effect on some careers. To succeed, we must remember that skill, drive and determination, tempered with experience and talent, lead to longevity in our industry.

Berkley Aviation Names Peter Jarrett Executive Vice President, Chief Operating Officer and Chief Financial Officer

Santa Barbara, CA, November 1, 2013 --  Berkley Aviation, a W. R. Berkley Company, today announced that Peter Jarrett has been named Executive Vice President, Chief Operating Officer and Chief Financial Officer.  Mr. Jarrett will be based in Santa Barbara.   

Mr. Jarrett has over 30 years of experience in the insurance industry and most recently served as the COO and CFO of another aviation insurance company. 

Jason Niemela, President of Berkley Aviation, said “Peter is a proven aviation insurance leader with a long history in our industry.  His leadership qualities and knowledge will help guide Berkley Aviation as we look toward our second decade of operations.”   

Founded in 2005, Berkley Aviation is a premier underwriting manager of aviation insurance, offering a wide range of coverage options to insureds both domestically and internationally. We are a member company of  W. R. Berkley Corporation, one of the nation’s premier commercial lines property casualty insurance providers. 

Berkley Aviation Opens a Northeastern Regional Office

In an effort to improve service to our clients and distribution network, I am pleased to announce that Berkley Aviation, LLC has expanded its geographical footprint by opening an office in the northeast.

We have hired Lester “Les” Wenzel as Vice President of General Aviation.  He will be based in the office at 14 Wall Street in New York City.

We are pleased to have Les join us with his extensive aviation insurance back ground.  He has been actively involved in the northeastern aviation insurance market for 30 years.  He was the Branch Manager for AIG Aviation in New Jersey and more recently had been a broker specializing in general aviation accounts nationwide.  This expansion is part of our long‐term strategy to focus on the regional needs of the brokers and clients.  We will continue our very calculated growth plans while minimizing market disruptions.

Les can be contacted at lwenzel@berkleyaviation.com or on his cell at 609.306.0575

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