2. The more surplus (assets minus liabilities) a company has to “back up” its premium writings, the more financially stable that company will be.
3.Regulators focus on insurer solvency and apply what is known as “statutory accounting principles” which are very conservative.
QUOTA SHARE TREATY AND UNEARNED REVENUE
1. This approach requires that when a policy is issued, the insurer must immediately and fully recognize all the expenses associated with issuing the policy (e.g., taxes, administrative, commissions paid) but can only recognize the premium over the life of the policy.
2. When a policy is written, an unearned premium reserve (a liability) in the amount of the policy premium must be established. The amount of this reserve shrinks over the life of the policy as the premium becomes “earned”.
3. For example, a 12 month policy issued at 1/1 for $100 will have an unearned premium of $100 at 1/1, $75 at 4/1, 50 at 7/1 and so on until the entire premium is earned and the unearned premium reserve is $0 at 12/31.
4. A quota share treaty has the effect of sharing both the unearned premium reserve (through the insurer ceding part of the written premium to the reinsurer) and the administrative expense (through the ceding commission that the reinsurer pays to the insurer for the portion of the written premium that is ceded)
5. The net effect on the insurance company balance sheet is a replenishment of surplus, the amount of which depends on the amount of business ceded to the reinsurer and the level of ceding commission paid to the insurer by the reinsurer.
EXAMPLE CALCULATION
1. A ceding company wants to create surplus relief and strengthen its balance sheet. The reinsurer agrees to assume 50% quota share of all premiums and losses. The reinsurer will pay 30% commission on the premium assumed.
Notes
(i) 8,000,000 – 4,000,000(paid to reinsurer) + 1,200,000 (Commission from Reinsurer) = 5,200,000
(ii)Unearned premium reserve (before) less 50% ceded to reinsurer at 4,000,000
(iii) 2,000,000 (Surplus) + 1,200,000 (Commission Received) = 3,200,000 Surplus
2. In the example above that the Premium-to-Surplus Ratio before the quota share was 4:1 ($8,000,000/$2,000,000). After the quota share, the Premium-to-Surplus Ratio improved to 1.6:1 ($5,200,000/$3,200,000).
REINSTATEMENT OF NON-PROPORTIONAL INSURANCE EXAMPLE
XOL COVER LAYER :500,000 XS 500,000
BASIC PREMIUM: 20,000,000
RATE (0.65%): 130,000
CLAIM: 800,000
DATE OF CLAIM: 01/09/17
PERIOD OF REINSURANCE 01/01/17 TO 31/12/17
CLAIMS FROM THE XL COVER: 300,000
1. If reinstatement is on double pro rata basis (temporis and capita)
(Claims/ Limit of XL cover) * (Policy days to expiry/365) * Premium
(300,000/500,000) * (122/365) * 130,000 = 26,071.33
2. If reinstatement is on pro rata capita only, date is not considered.
(300,000/500,000) * 130,000 = 78,000
RATE ON LINE
1. The relation between reinsurance premium of XOL cover compared to the limit of cover in percentage
XOL Cover : 100,000 xs 100,000
Premium for XOL cover: 25,000
25,000/100,000 * 100 = 25%
2. Pay Back - the period of time need to recover payment of a total claim affecting cover or all of the XOL treaty expressed in years
1/ROL = 1/25 = 4 years.
(Source: MunichRe, Insitute of Insurance Sciences)
