⭐ IC-85 REINSURANCE — CHAPTER 2 (COMPLETE REWRITE)
TYPES OF REINSURANCE
(Clean, logical, exam-oriented, rewritten from scratch)
🔷 2.0 PURPOSE OF THIS CHAPTER
Chapter 2 explains HOW risks are shared between insurers and reinsurers.
It introduces the three fundamental reinsurance arrangements:
1. Proportional Reinsurance
2. Non-Proportional Reinsurance
3. Facultative Reinsurance
This chapter is foundational — GIPSA asks MANY questions from here
because it tests whether you understand risk sharing, premium sharing,
retention, and treaty structures.
🔷 2.1 CLASSIFICATION OF REINSURANCE
Reinsurance is classified into:
⭐ A. PROPORTIONAL REINSURANCE
Premium and claims are shared between insurer & reinsurer in the same
proportion.
If cession = 60%:
Insurer keeps 40% of premium & losses
Reinsurer takes 60% of premium & losses
This is called “quota and share”.
A1. TYPES OF PROPORTIONAL REINSURANCE
There are two major proportional treaties:
⭐ 1️⃣ QUOTA SHARE TREATY (QS)
Definition
A fixed percentage of every risk is ceded to the reinsurer.
Example:
QS = 60%
Insurer keeps 40%, reinsurer takes 60%, on ALL risks in the class.
Key Features
Uniform cession
Simple administration
Stabilizes results
Gives capital relief
Reinsurer pays commission to insurer
(flat commission or sliding-scale)
Advantages
Best for new companies with low capital
Smooths loss ratios
Excellent for volatile classes like motor, health
Disadvantages
Cedant gives away too much good business
Reinsurer participates even in small risks unnecessarily
⭐ 2️⃣ SURPLUS TREATY
Used when risks vary significantly in size.
Insurer keeps a fixed retention (e.g., ₹5 lakh).
Risk amount above retention is ceded to reinsurer, up to treaty capacity
(measured in lines).
Key Concepts
Retention: amount cedant keeps on each risk
Line: retention amount
Capacity: number of lines in treaty
→ 10 lines = 10 × retention
Example:
Retention = ₹5 lakh
10-line surplus = ₹50 lakh capacity
Risk SI = ₹35 lakh
Retention = ₹5 lakh
Cession = ₹30 lakh = 6 lines
Advantages
Better alignment between risk and reinsurance
Cedant retains smaller risks fully
Larger risks shared proportionately
Disadvantages
More complex
Requires accurate valuation of SI & retention
⭐ 3️⃣ COMBINATION OF QS + SURPLUS
Used when the insurer wants:
Stability (from QS)
Higher capacity (from Surplus)
Sequence (important for exam):
1. Apply QS first
2. Apply Surplus on the retained portion
Example:
QS = 40%
Surplus = 5 lines
Retention = ₹10 lakh
Process:
1. Cedant retains 60% (after QS), reinsurer takes 40%
2. Then apply 5-line surplus to cedant’s 60% portion
🔥 EXAM TRAPS IN PROPORTIONAL TREATIES
⚠️Trap 1: QS = fixed % for ALL risks; Surplus = variable % depending on
size of risk.
⚠️Trap 2: In Surplus, % ceded = cession / SI, NOT cession / retention.
⚠️Trap 3: QS applied before surplus in combination treaties.
⚠️Trap 4: Lines are calculated using retention, not SI.
⚠️Trap 5: Surplus treaty cannot accept more than its line capacity.
⭐ B. NON-PROPORTIONAL REINSURANCE (EXCESS OF LOSS)
Reinsurer pays losses only above a certain amount called the retention
or deductible.
Premiums are NOT shared proportionally.
Reinsurer charges a negotiated premium based on:
Exposure
GNPI
Rate-on-line
Burning cost
Types of Non-Proportional Reinsurance:
⭐ 1️⃣ PER RISK EXCESS OF LOSS (Risk XL)
Protects against large losses on a single policy.
Example:
Risk XL = ₹45 lakh XS ₹5 lakh
If one risk suffers a loss of ₹30 lakh:
Insurer pays first ₹5 lakh
Reinsurer pays next ₹25 lakh
Used in:
Large property risks
Industrial fire
Engineering
Key point:
One policy = one risk = one limit.
⭐ 2️⃣ CATASTROPHE EXCESS OF LOSS (Cat XL / Per Event XL)
Protects against accumulation of many losses from ONE event.
Examples of events:
Cyclone
Earthquake
Major fire spreading to multiple buildings
Riot
Example:
Cat XL = ₹100 crore XS ₹20 crore
Meaning insurer absorbs first ₹20 crore of event loss; reinsurer pays next
₹100 crore.
Key Concepts
Two-risk warranty (minimum 2 risks must be affected)
Event definition
Aggregate event losses
⭐ 3️⃣ STOP LOSS (Loss Ratio Excess of Loss)
Protects entire portfolio if the loss ratio exceeds a threshold.
Example:
Stop Loss = 120% XS 80% loss ratio
Meaning:
Insurer pays first 80%
Reinsurer pays between 80%–120%
Above 120% insurer again pays
Used in:
Health
Motor
Volatile classes
⭐ 4️⃣ AGGREGATE EXCESS OF LOSS
Protects against annual cumulative losses, not per-loss and not per-event.
Example:
Aggregate XL = ₹50 lakh XS ₹5 lakh (aggregate basis)
If total year losses = ₹40 lakh:
First 5 lakh by insurer
Next 35 lakh by reinsurer
Used when:
Many small losses accumulate
Per-risk XL is not enough
⭐ 5️⃣ UMBRELLA EXCESS OF LOSS (Whole Account XL)
High-layer cover sitting above multiple underlying XOL treaties.
Example:
Underlying treaties:
Fire XL
Engineering XL
Motor XL
Umbrella XL sits over all of them as a top layer, providing additional
protection.
Used for:
Large insurers with multiple lines
Managing extreme tail risk
🔥 EXAM TRAPS IN NON-PROP TREATIES
⚠️Trap 1: Per Risk XL ≠ Cat XL.
Per Risk = one policy
Cat XL = many policies, one event
⚠️Trap 2: Stop-Loss is based on loss ratio, not rupee amount.
⚠️Trap 3: Aggregate XL applies to total yearly losses, not per accident.
⚠️Trap 4: Event definition must be satisfied for Cat XL.
⚠️Trap 5: Rate-on-line is Premium / Limit, not attachment.
⭐ C. FACULTATIVE REINSURANCE
Case-by-case reinsurance for specific, individual risks.
Used When:
Risk is too large for treaty
Risk is unusual or hazardous
Treaty excludes it
Cedant wants special terms
Process:
1. Cedant prepares a slip containing all risk details
2. Reinsurer reviews and evaluates
3. Reinsurer may accept, decline, or modify
4. Once accepted – cover applies only to that risk
Types:
Facultative obligatory
Facultative automatic
Pure facultative
🔥 FACULTATIVE VS TREATY (EXAM TABLE)
Point Facultative Treaty
Basis Individual risk Portfolio/class
Freedo Reinsurer can Reinsurer must
m reject accept
Speed Slow Fast
Based on
Pricing Case-by-case
GNPI/exposure
Admin High Low
Use Large, unusual Continuous
case risks protection
🔷 SUMMARY OF CHAPTER 2
Reinsurance can be:
Proportional → premium & losses shared proportionately
Non-Proportional → reinsurer pays beyond deductible
Facultative → risk-specific optional cover
Understanding this classification is essential before learning treaty
structures.
🔥 CHAPTER 2 — EXAM TRAPS
1. Surplus treaty = variable % cession; QS = fixed %.
2. Non-prop XL does NOT share premium proportionately.
3. Cat XL protects against accumulation, not large single losses.
4. Aggregate XL ≠ Stop-Loss.
5. Facultative is always risk-specific, not mandatory.
🔑 CHAPTER 2 KEYWORD GLOSSARY
Term Meaning
QS Fixed % of every risk ceded
Cession above retention, up to
Surplus
lines
Line Retention unit in surplus
XL Excess of Loss
Deductible Retention in XL
Cat XL Event-based XL
Stop loss Loss ratio XL
Aggregate XL Annual total-loss cover
Facultative Individual risk reinsurance
Combination
QS + Surplus
treaty
🎯 CHAPTER 2 — MCQs (Exam Quality)
1. In Surplus treaty, cession is determined by:
A. Fixed percentage
B. Loss experience
C. Relationship of risk SI to retention
D. GNPI
Answer: C
2. Per-Risk XL responds when:
A. A catastrophe hits many risks
B. Loss on one policy exceeds retention
C. Loss ratio exceeds threshold
D. Yearly losses exceed deductible
Answer: B
3. Stop-Loss reinsurance covers losses:
A. Above SI
B. Above retention per risk
C. When loss ratio exceeds certain level
D. Only above aggregate attachment
Answer: C
4. Facultative reinsurance is used when:
A. Treaty capacity is insufficient
B. Treaty excludes risk
C. Risk is hazardous or unique
D. All of the above
Answer: D
5. Cat XL requires:
A. One risk involved
B. Two-risk warranty
C. Flat commission
D. Premium sharing
Answer: B