Chapter Six

Reinsurance
Introduction:
A significant part of an insurance organization is reinsurance. Reinsurance is a
method created to divide the task of handling risk among several insurers. Often
this task is accomplished through cooperative arrangements, called Treaties
that satisfy the ways in which risks will be shared by members of the group.
Reinsurance – Definition
Reinsurance may be defined as the shifting by a primary insurer, called the
ceding company, of a part of the risk it assumes to another company, called the
reinsurer. The portion of the risk kept by the ceding company is known as the
line or retention, and the portion reinsured, the cession. The process by which
a reinsurer passes on risks to another reinsurer is known as retrocession.
In simple words, reinsurance is the shifting of part or all of the insurance
originally written by one insurer to another insurer.
Advantages of Reinsurance
There are four important advantages of reinsurance: they are as follows;
1. Increase underwriting capacity: Reinsurance can be used to increase the
insurance company’s underwriting capacity to write new business. The primary
insurer may be asked to assume liability for loss in excess of the amount that
its financial capacity permits. Instead of accepting only a portion of the risk
and thus causing inconvenience to its customer, the insurance company
accepts all the risk, knowing that it can pass on to the reinsurer the part that
it cannot bear. Thus, reinsurance permits the primary insurance company to
issue a single policy in excess of its retention limit for the full amount of
insurance.
2. Stabilize profits: Reinsurance can be used to stabilize profits. An insurer
may wish to avoid large fluctuations in annual financial results. Loss
experience can fluctuate widely because of social and economic conditions,
natural disasters, etc. Reinsurance can be used to level out the effects of poor
loss experience. For example, reinsurance may be used to cover a large
exposure. If a large, unexpected loss occurs, the reinsurer would pay the
portion of the loss in excess of some specified limit.
Another arrangement would be to have the reinsurer reimburse the ceding
insurer for losses that exceed a specified loss ratio during a given year. For
example, an insurer may wish to stabilize its loss ratio at 70%. The reinsurer
then agrees to reimburse the ceding insurer for part or all the losses in excess
of 70% up to some maximum limit.

Page 1 of 8
3. Reduce the unearned premium reserve: The unearned premium reserve is
a liability item on the insurer’s balance sheet that represents the unearned
portion of gross premiums on all outstanding policies at the time of valuation. In
effect, the unearned premium reserve reflects the fact that premiums are paid in
advance, but the period of protection has not yet expired. As time goes on, part
of the premium is considered earned, while the remainder is unearned. It is only
after the period of protection has expired that the premium is fully earned.
An insurer’s ability to grow may be restricted by the unearned premium reserve
requirement. This is because the entire gross premium must be placed in the
unearned premium reserve when the policy is first written. The insurer also
incurs relatively heavy first-year acquisition expenses in the form of
commissions, state premium taxes, expenses in issuing the policy and other
expenses. These first year acquisition expenses must be paid by the insurer out
of its surplus. For example, a one-year property insurance policy with an
annual premium of Birr 2,400 may be written on January 1. The entire Birr
2,400 must be placed in the unearned premium reserve. At the end of each
month, 1/12th of the premium, i.e., Birr.200 is earned and the remainder is
unearned. On December 31, the entire premium is fully earned. However,
assume that first year acquisition expenses are 20% of the gross premium, i.e.,
Birr.480. This amount will come from the insurer’s surplus. Thus, the more
business it writes, the greater is the short-term drain on its surplus.
Reinsurance reduces the level of the unearned premium reserve required by
law and temporarily increases the insurer’s surplus position.
4. Provide protection against a catastrophic loss: Reinsurance also provides
financial protection against a catastrophic loss. Insurers experience
catastrophic losses because of natural disasters, like earthquake, floods &
droughts. Reinsurance can provide considerable protection to the ceding
company that experiences a catastrophic loss. The reinsurer pays part or all of
the losses that exceed the ceding company’s retention up to some specified
maximum limit.
5. Retiring from underwriting: An insurer can use reinsurance to retire from
the business or from a given line of insurance. Reinsurance permits the
insurer’s liabilities for existing insurance to be transferred to another carrier.
Thus, the policy owner’s coverage remains undisturbed.
Types of Reinsurance:
There are two important forms of reinsurance. They are;
1. Facultative Reinsurance
Facultative reinsurance is an optional, case-by-case method that is used when
the ceding company receives an application for insurance that exceeds its
retention limit. Before the policy is issued, the primary insurer shops around
for reinsurance and contacts several reinsurers. The primary insurer is under
no obligation to cede insurance, and the reinsurer is under no obligation to

Page 2 of 8
accept the insurance. But if a willing insurer can be found, the primary insurer
and reinsurer can then enter into a valid contract.
Advantages: It has the advantage of flexibility, since a reinsurance contract
can be arranged to fit any kind of case. It can increase the insurer’s capacity to
write large amounts of insurance. The reinsurance tends to stabilize the
insurer’s operations by shifting large losses to the reinsurer.
Disadvantages: The major disadvantage of facultative reinsurance is that it is
uncertain. The ceding insurer does not know in advance if a reinsurer will
accept any part of the insurance. There is also a further disadvantage of delay,
since the policy will not be issued until reinsurance is obtained. In times of bad
loss experience, the reinsurance market tends to dry up. Therefore, facultative
reinsurance has the further disadvantages of being unreliable.
2. Treaty Reinsurance
Treaty reinsurance means the primary insurer has agreed to cede insurance to
the reinsurer, and the reinsurer has agreed to accept the business. All
businesses that fall within the scope of the agreement are automatically
reinsured according to the terms of the treaty.
Advantages: Treaty reinsurance has several advantages to the primary insurer.
It is automatic and no uncertainty or delay is involved. It is also economical,
since it is not necessary to shop around for reinsurance before the policy is not
written.
Disadvantage: Treaty reinsurance could be unprofitable to the reinsurer. The
reinsurer generally has no knowledge about the individual applicant and must
rely on the underwriting judgment of the primary insurer. The primary insurer
may write bad business and then reinsure it. Also, if the premium received by
the primary insurer has a poor selection of risks or charges inadequate rates,
the reinsurer could incur a loss.
There are several types of reinsurance treaties and arrangements. They are
as follows;
i) Quota-Share Treaty: Under a quota-share treaty, the ceding insurer and
reinsurer agree to share premiums and losses based on some protection. The
ceding insurer’s retention limit is stated as a percentage rather than as a dollar
amount.
For example, Awash Insurance Company (AIC) and Ethiopian Insurance
Corporation (EIC) may enter into a quota-share treaty by which premiums and
losses are shared 50% & 50%. Thus, if a Birr.10,000 loss occurs, AIC pays
Birr.10,000 to the insured but is reimbursed by EIC for Br.5,000.
Premiums are also shared based on the same agreed percentages. However, the
reinsurer pays a ceding commission to the primary insurer to help compensate
for the expenses incurred in writing the business. Thus, in the example given

Page 3 of 8
above, EIC receive 50% of premium less a ceding commission that is paid to
AIC.
Advantages: The major advantage of quota-share reinsurance is that the
unearned premium reserve is reduced. For smaller insurers and other insurers
that wish to reduce a surplus drain, a quota-share treaty can be especially
effective.
Disadvantages: The disadvantage is that a large share of potentially profitable
business is called to the reinsurer.
ii) Surplus-Share Treaty: Under a surplus-share treaty, the reinsurer agrees
to accept insurance in excess of the ceding insurer’s retention limit, up to some
maximum amount. If the amount of insurance on a given policy exceeds the
retention limit, the excess insurance is ceded to the reinsurer up to some
maximum limit. The primary insurer and reinsurer then share premiums and
losses based on the fraction of total insurance retained by each party.
For example, assume that National Insurance Company of Ethiopia (NICE) has
a retention limit of Br.200,000 (called a line) for a single policy, and that four
lines or Br.800,000 are ceded to reinsurer, Nile Insurance Company (NIC).
Thus, NICE’s total underwriting capacity is Br.1, 000,000 for any single
exposure. Assume that a Br.500,000 property insurance policy is issued. NICE
takes the first Br.200,000 of insurance (2/5th) and NIC takes the remaining
Br.300,000 (3/5th). If a loss of Br.5,000 occurs, NICE pays Br.2,000 and NIC
pays the remaining Br.3,000.
Under surplus-share treaty, premiums are also shared based on the fraction of
total insurance retained by each party. However, the reinsurer pays a ceding
commission to the primary insurer to help compensate for the acquisition
expenses.
Advantages: The main advantage is that the primary insurer’s underwriting
capacity is increased.
Disadvantages: The major disadvantage is the increase in administration
expenses. It is more complex and requires greater record keeping.
iii) Excess-of-loss Treaty: An excess-of-loss treaty is designed largely for
catastrophic protection. Losses in excess of the retention limit are paid by the
reinsurer up to some maximum limit. The excess-of-loss treaty can be written
to cover a) a single exposure, or b) a single occurrence, such as a catastrophic
loss from a tornado, or c) excess losses when the primary insurer’s cumulative
losses exceed a certain amount during some stated time period, such as a year.
For example, assume that Awash Insurance Company wants protection for all
windstorm losses in excess of Br.1 million. Assume that an excess-of-loss
treaty is written with National Insurance Company of Ethiopia (NICE) to cover
single occurrences during a specified time period. NICE agrees to pay all losses
exceeding Br.1 million but only to a maximum of Br.10 million.

Page 4 of 8
iv) Reinsurance Pool: A reinsurance pool is an organization of insurers that
underwrites insurance on a joint basis. Reinsurance pools have been formed
because a single insurer alone may not have the financial capacity to write
large amount of insurance, but the insurers as a group can combine their
financial resources to obtain the necessary capacity. For example, the loss
expenses on a crash by Jet can exceed $ 2500 million if the jet crashes, such
high limits are usually beyond the financial capacity of a single insurer.
However, a reinsurance pool for aviation insurance can provide the necessary
capacity. Reinsurance pools also exist for nuclear energy exposures, oil
refineries, marine insurance, etc. The method for sharing losses and premiums
vary depending on the type of reinsurance pool. Pools work in two ways;
First, each pool member agrees to pay a certain percentage of every loss. For
example, if one insurer has a policy owner that incurs a Br.100,000 loss, and
there are 50 members in the pool, each insurer would pay 2% or Br.2000 of
loss, depending on the agreement.
A second arrangement is similar to the excess of loss reinsurance treaty. Each
pool member is responsible for its own losses below a certain amount. Losses
exceeding that amount are shared by all members in the pool.

Page 5 of 8
 Chapter Seven
Insurance Business in Ethiopia
Origin and Development of Insurance in Ethiopia:
The origin of insurance business in Ethiopia was in the year 1905. The major
role was played by Bank of Egypt in establishing insurance business in
Ethiopia. At that time, Bank of Egypt had been an agent of a foreign insurance
company. The major concentration was on fire insurance and marine
insurance. In 1954, a study was conducted to improve the insurance
operations in Ethiopia. the study was conducted by Ministry of Trade &
Industry. At that time, there were 19 insurance companies operating in
Ethiopia. Out of 19, only Imperial Insurance Company was as Ethiopian
insurance company established in 1951. The remaining 18 companies were
acting as agents of foreign insurance companies. Moreover, these companies
were concentrated on port towns.
Another study was conducted in 1960 by the Ministry of Trade & Industry. By
that time, the number of insurance companies operating in Ethiopia increased
to 33, of which 32 are foreign insurance companies. Of 32, only 9 companies
had been registered as life insurance companies, and there were only 541 life
insurance policies issued by these 9 companies.
Proclamation No.:281/1970
In order to have an effective control over the insurance companies in Ethiopia,
the government announced the declaration on October 8th 1970. This
proclamation is also considered as one of these basic proclamations that had
brought about a significant change in the insurance industry. It also laid for
the first time, the basic principle that enables the government to control the
insurance industry in an effective way.
Before this proclamation, the insurance has considered as one of the
businesses in the country. There was no regulation with regard to the
subscribed capital and paid-up capital which is required to set up an
insurance company in the country. Besides, there was no control over the
operations of insurance companies in the country. Thus, ultimately the
authority to control the insurance companies was given to the Ministry of
Trade & Industry.
As per the provisions of the proclamation, the Insurance Council was
established. The council consists of Trade & Industry Ministry, Finance
Ministry, Transportation Ministry, Planning Commission Head, National
Environmental Development and Social Affair Ministry, as its member. The
following were the important functions of the Insurance Council;
1. Controlling & encouraging insurance business in the country.
2. Developing & implementing policies/strategies that creates a favorable
conditions for re-insurance & investments.

Page 6 of 8
Apart from the Insurance Council, the government has set up the Insurance
Controller Office, which represents the Ministry of Trade & Industry, in
controlling the insurance business in Ethiopia. At that time, the Licensing
Authority was with the Insurance Controller Office. It has given licenses for the
following;
 15 domestic Insurance Companies, 36 agents of insurance companies, 7
brokers, 11 loss adjustors and 3 actuaries.
After four years, i.e. in 1975, the Transitional Socialist Government of Ethiopia
(later, the Ethiopian Socialist Government) had nationalized and united the
then existing private insurance companies and thus Ethiopian Insurance
Corporation was officially established on January 1, 1976. The EIC was
monopoly for the past 19 years and the revenue earned by EIC had grown from
Br.50 million (in 1976) to Br.254 million (in 1993/94).
Proclamation No.: 86/1994
Following the demise of the Communist regime and the adoption of the New
Economic Policy in the country, a new proclamation, under Proclamation
number 86/1994, was declared with the aim of encouraging the participation
of domestic investors in the insurance business. According to this
proclamation, the National Bank of Ethiopia is authorized and assigned to
exercise basic duties regarding the operation of insurance in the country.
Besides, the NBE started performing the following duties;
1. Giving recognition to any newly emerging insurance companies in the
country, by way of issuing licenses to them.
2. Controlling the overall functions of the insurance companies in the
country.
3. Devising & implementing the efficient strategies to develop the insurance
services in the country.
Thus, since 1994, 8 insurance companies were set up in the country with the
initial paid-up capital of Br.56.5 million. As per Article 201/1994, the paid-up
capital of the EIC was increased to Br.61 million. By year 2000, the total
capital of all insurance companies went up to Br.340.2 million. At present,
there are seventeen insurance companies.
Government Regulation of Insurance
Why insurance is regulated?
1. Insurance is a commodity people pay for in advance and whose benefits are
reaped in the future, often by someone entirely different from the insured and
who is not present to protect self-interest when the contract is made.
2. Insurance is affected by a complex agreement that few lay people
understand and by which the insurer could achieve a great and unfair
advantage if disposed to do so.

Page 7 of 8
3. Insurance costs are unknown at the time the premium is agreed upon, and
there exists a temptation for unregulated insurers to charge too little or too
much. Charging too little results in the long run in removing the very security
the insured thought was being purchased; charging too much result in
unwanted profits to the insurer.
4. Insurance is regulated to control abuses in the industry. As in any line of
business, abuses of power and violations of public trust occur in insurance.
These include failure by the insurer to live up to contract provisions, changing
up contracts that are misleading and that seem to offer benefits they really do
not cover, refused to pay legitimate claims, improper investments of policy
holder’s funds, false advertising, and many others.

Page 8 of 8