Reinsurance

London Market Practice

Carol Boland

• Publisher: Informa Law from Routledge
• Year: 2020
• ISBN:
  9781000286083
• Edition: 2
• Topic: Law
• Subtopic: Financial Law
• Index: Law

This is a useful handbook for anyone involved in the current London Market. It leads the insurance professional through all aspects of reinsurance practice from the development of reinsurance to the methods used including: risk placement, legal contracts, policy wordings, accounting, claims and run-off. It uses charts, forms and diagrams to show many aspects of reinsurance practice. Full appendices are included giving examples of slips, cover wordings and key clauses.

CHAPTER 1

WHAT IS REINSURANCE?

“Man owes his success to his creativity. No one doubts the need for it. It is more useful in good times and essential in bad.” (EDWARD DEBONO, Lateral Thinking for Management)

WHAT IS REINSURANCE?

Is reinsurance really necessary?

This may seem a strange question to pose at the start of a book on reinsurance practice; it is, however, one worth considering. The idea that, fundamentally, insurance operations need to purchase reinsurance is a concept that should, and in some cases must, be viewed with an open mind.

However, there can be no reinsurance without insurance, and understanding the principles of insurance is a prerequisite to understanding the principles of reinsurance. So, the history of the development of insurance seems like a good place to begin an account of reinsurance practice.

The history of reinsurance is brief when set against the annals of insurance, as insurance in a non-commercial form has existed as long as the recognition of risk itself; parents insuring against infirmity in old age through their children, and family units joining together into larger protective groups to form a society.

By the sixteenth century the practice of insurance became well established among the shipping merchants of the day, and the increasing volume of trade in the seventeenth century led to the establishment of the first professional insurers. Much of the insurance business of the day was carried out at Mr Lloyd’s coffee shop in London, where the establishment acted as a central meeting place where many of the merchants gathered to discuss maritime matters.

Indeed, it was Mr Lloyd’s coffee shop which provided the site for the first insurance market situated under one roof. This single market lives on in the guise of Lloyd’s, which, up to the introduction of corporate insurers, followed the tradition of individuals as insurers of risks.

With the advancement of capitalism in the late eighteenth century and the onset of the Industrial Revolution, many new threats and risks to capital were evident. So it was that the nineteenth century saw the rapid development of non-marine insurance as the demand for cover increased and insurance became a profitable line of business.

THE DEVELOPMENT OF REINSURANCE

The development of a reinsurance market took a rockier road. Reinsurance of marine risks is thought to be as old as commercial insurance, but it was not until 1864 that the practice in the UK was legalised and the ban on marine reinsurance was removed. Previously, reinsurance had been considered as a form of gambling.

As reinsurance of fire business appeared unattractive to UK insurers, co-insurance remained a more common way of spreading the risk. Insurers wishing to spread their risks then had to turn to the continental merchant banks for their reinsurance protection.

It was in continental Europe, in the early 1800s, that automatic treaty reinsurance was first developed and there are numerous examples on record of facultative and treaty reinsurance arrangements at that time.

However, it took until 1852 for the first independent reinsurance company to be established, and that company was the Ruchversicherrungs Gesellschaft of Cologne. Several German companies, including the Aachener Ruck, followed suit, proving themselves to be as productive as their forerunner. Unfortunately, British reinsurers who decided to enter the field found that their initial experiences were not so fortuitous.

In the 1870s, quite soon after setting up, a number of UK reinsurance companies went into liquidation. The reasons for their lack of success are not altogether clear, but the UK retained its role as a modest reinsurance market for some time, with its European counterparts continuing to hold the stronger market position.

It is in 1880 that we find the earliest trace of excess of loss reinsurance, as established by Mr Cuthbert Heath of Lloyd’s, and not until 1907 do we find the establishment of Britain’s oldest and longest operating reinsurance company, the Mercantile and General.

Then came the First World War, which brought with it a curtailment in trading relationships between the UK and its primary reinsurance markets. This forced companies to look within their own national boundary for cover and Lloyd’s, a late entrant to the reinsurance market, began to take a more active role, attracting a large volume of business from the United States of America.

By the end of the Second World War London had successfully established itself at the heart of the international reinsurance market. The City of London had become the centre for reinsurance capacity and expertise, with capital provided by British and overseas companies and also those many individuals who were members at Lloyd’s.

Other reinsurance markets overseas, particularly in Germany and the United States, continued to develop their major domestic reinsurance markets and many of these overseas companies set up branches and contact offices in the London market where they provided, as they still do, a large part of the reinsurance capacity available in London.

What is this business of reinsurance?

In a few words it may be described as the passing on of all or part of a risk by one insuring party to another. Or, put another way, the business of insuring the insurers.

Reinsurance is essentially, though not exclusively, an international business. It is “essentially” so because the widest spreading of risk is fundamental to the character of reinsurance.

With any portfolio of risks the law of large numbers can only apply where there are an indefinite number of identical risks. As this cannot be the case, insurers will always operate under an imperfect application of the law. The limitations in applying the law of large numbers and the desirability of spreading the risk for an insurer are just as relevant to a prudent reinsurer.

The reason why reinsurance is purchased is, fundamentally, to reduce the degree to which claims fluctuate from those expected. A list of reasons to purchase reinsurance may look something like this:

Reinsurance may be purchased to:

— Protect the financial stability of insurers from adverse underwriting results.

— Stabilise claims ratios from one year to the next.

— Minimise claims accumulation from losses within and between different classes.

— Geographically spread the risk.

— Increase capacity.

— Increase the profitability of insurers through permitting greater flexibility in the size and types of risk accepted.

— Secure technical support and help.

As reinsurers also purchase reinsurance, or retrocession cover, these arguments for purchasing cover may also apply to reinsurers.

Insurers may also require additional services provided by reinsurers, such as expertise help in the rating of large risks which are outside their technical capabilities. This service can be particularly important to a small insurer operating in a developing country.

Established reinsurers may also be of assistance in the training of reinsurance personnel in areas such as underwriting, claims and technical processing.

METHODS AND TYPES OF REINSURANCE

There are two main methods by which insurance business may be reinsured:

— proportional, and

— non-proportional.

Proportional reinsurance business is a method by which all premiums and losses on a risk or portfolio of risks are shared proportionately.

Figure 1: methods of reinsurance

Non-proportional reinsurance is where the reinsurers agree to pay for losses above, or in excess of, a certain amount, up to an agreed limit, in return for a predetermined premium.

Within each of these two methods of reinsurance there are two main types of reinsurance:

● facultative, and

● treaty.

The various types of facultative and treaty reinsurances shown in Figure 1, Methods of Rei...