CMA Final · Risk Management in Banking and Insurance

Structure and Type of Re-insurance: formula sheet

Full chapter guide

Key formulas

Net retention: Net retention = Sum insured − Amount ceded to reinsurer; The part of the risk the cedant keeps for its own account.
Reinsurer's share in a proportional cession: Ceded amount = Sum insured × Cession percentage; Premium and claims are normally shared in the same proportion in proportional arrangements.
Statutory cap on compulsory cession (s.101A): Specified percentage of sum assured ≤ 30%; The Authority specifies the percentage, with Central Government's previous approval. Applies to general insurance policies, not to re-insurance policies.
Solvency rule (s.53A): Assets counted for solvency exclude unpaid-up share capital; Only real assets count when solvency of an insurer is ascertained.
Retention and cession on a risk: Sum insured = Retention + Amount ceded; Amount ceded = Sum insured − Retention, when the risk is above the retention.
Quota share cession: Ceded amount = Cession % × Amount (premium or loss); Cedant keeps (100% − cession %). Applies equally to premium and claims.
Section 6A voting rights: Voting right ∝ paid-up amount of equity shares held; Voting is strictly proportionate to the paid-up amount of equity shares.
Section 6B appeal period: Appeal within 90 days of the order sanctioning the scheme; Appeal goes to the Securities Appellate Tribunal with jurisdiction over the insurer's registered office.
Transfer approval limits (Section 6A(4)): Prior approval if transferee holding > 5% of paid-up capital, or shares transferred > 1% of paid-up equity capital; The 1% test applies to an individual, firm, group or body corporate under the same management, jointly or severally.
Quota share cession: Ceded amount = Quota % × (sum insured, premium or loss); The same % applies to every policy. Retained share = 100% − quota %.
Surplus treaty cession: Surplus = Sum insured − Retention (limited to treaty capacity); If sum insured ≤ retention, nothing is ceded.
Treaty capacity: Capacity = Number of lines × Retention; maximum cover = Retention + Capacity; Any amount above this is outside the treaty and must be placed otherwise, for example facultatively.
Cession ratio (surplus): Cession % = Surplus ceded ÷ Sum insured; Apply this % to premium and to each loss on that risk.
Ceded premium and commission: Net premium paid to reinsurer = Ceded premium × (1 − ceding commission %); Commission is on ceded premium only.
Reinsurer's loss share: Reinsurer's loss = Cession % × Loss; This holds for loss up to the sum insured. Use the cession % of that policy.
Reinsurer's payment on one loss: Recovery = minimum of [ maximum of (Loss − Priority, 0), Limit ]; Used for per risk and per event covers. The loss is the amount of the single risk loss or the total event loss.
Insurer's net retained loss: Net loss = Gross loss − Recovery; Includes the priority plus any loss above priority + limit.
Top of the layer: Layer ceiling = Priority + Limit; Often written as Limit xs Priority, for example ₹40 lakh xs ₹10 lakh.
Stop loss attachment: Recovery = minimum of [ maximum of (Aggregate loss ratio − Attachment ratio, 0) × Subject premium, Limit ]; Use when the cover is stated as a loss ratio. If it is stated in rupees, subtract the rupee attachment from aggregate losses instead.
Facultative reinsurance: Placement: risk by risk | Reinsurer: free to accept or decline | Cedant: free to offer or not; Negotiated for each risk. Best for large, unusual or out-of-treaty risks.
Treaty reinsurance: Placement: class or portfolio, automatic | Cedant: bound to cede | Reinsurer: bound to accept within terms; Agreed in advance for a period, usually renewed. Both sides are obligated within the treaty terms.
Facultative obligatory: Cedant: option to cede | Reinsurer: obligation to accept; The obligation sits only on the reinsurer. This is the one-sided feature to remember.
Section 34F, Insurance Act, 1938: Authority may require modification or non-renewal of a reinsurance treaty or contract, or require prior approval of its terms; Applies where terms are not favourable to the insurer or are detrimental to the public interest. Non-compliance is deemed failure to comply with the Act.
Finite reinsurance: reinsurer's exposure: Maximum reinsurer loss = agreed limit (cap); The cap is low compared with the premium paid, so risk transfer is limited.
Experience account balance: Balance = premiums paid + interest credited − claims paid − reinsurer's fee; A positive balance at the end is usually returned in whole or part to the insurer under contract terms.
Cat bond investor outcome: No trigger: principal + coupon returned. Trigger met: principal reduced by the loss, up to the full amount; Principal is held as collateral, so credit risk to the insurer is low.
Basis risk: Basis risk = insurer's actual loss − recovery under the trigger; Arises with index or parametric triggers. It is zero for indemnity triggers, in which recovery follows the insurer's actual loss.

Quick revision

Reinsurance is insurance of an insurer: the cedant passes part of its risk to a reinsurer.
The original insurer is the cedant; the reinsurer's own reinsurance is called retrocession.
Proportional reinsurance shares premium and claims in the same agreed ratio.
In non-proportional cover the reinsurer pays only the loss above the retention, up to the limit.
Excess of loss: reinsurer pays = loss above retention, capped at the layer limit.
Facultative cover is arranged risk by risk; treaty cover applies automatically to a defined class of business.
Proportional versus non-proportional is a different classification from facultative versus treaty.
Check that retained share plus reinsurer's share equals the total loss in every working.
Under section 34F the Authority can require changes at renewal, or non-renewal, of an unfavourable treaty.
The Authority can also direct that a treaty be furnished and approved in advance before the insurer enters into it.
Alternative risk transfer uses routes other than conventional reinsurance to move risk.
Finite reinsurance focuses on spreading the timing of losses, with limited risk transfer.

Common mistakes

Saying reinsurance makes the policyholder deal with the reinsurer. Fix: State that the cedant remains liable to the policyholder. The reinsurer is liable only to the cedant.
Treating reinsurance as a way to avoid paying claims. Fix: Say it is a way to share the financial burden of claims, not to escape the claim to the insured.
Calling the reinsurer's own reinsurer a 'second reinsurer' or confusing it with the cedant. Fix: The cedant is the original insurer. The retrocessionaire accepts risk from a reinsurer.
Saying the policyholder can claim directly from the reinsurer. Fix: The reinsurance contract is separate. The cedant stays liable to the policyholder.
Ceding the whole sum insured above retention without checking capacity. Fix: Always compute capacity = lines × retention and cap the cession at it.
Applying the treaty's overall percentage to a surplus loss. Fix: Use the cession ratio of the specific policy: surplus ÷ sum insured.
Applying the priority to each policy loss when the cover is per event. Fix: For per event, first total all losses from the one event, then apply the priority once.
Paying the reinsurer the whole loss once the priority is crossed. Fix: Subtract the priority. The reinsurer pays only the excess.
Saying treaty reinsurance means the reinsurer approves each risk. Fix: In a treaty, risks within its terms are ceded automatically. The reinsurer relies on the cedant's underwriting.
Describing facultative obligatory as binding on both parties. Fix: Only the reinsurer is bound. The cedant keeps the option to cede or not.

Exam tips

Always state that the cedant remains liable to the policyholder. Examiners look for this line.
For MCQs on section 101A, remember: Authority specifies the percentage, 30% is the upper limit, applies to general insurance, excludes re-insurance policies.
In case questions, name the exact problem (capacity, catastrophe, solvency) and match the benefit to it. Generic lists score less.
Show the ceded amount and net retention separately in numerical answers.
For 'difference between insurance and reinsurance', use a short two-column style in bullets: parties, contract, insured interest, and who faces the policyholder.
Case-based MCQs often test who is the cedant, reinsurer or retrocessionaire. Trace the direction of cession before answering.
In numerical questions, show retention, ceded amount and percentages as separate lines. This secures method marks.
For Section 6B, learn the sequence and the 90-day appeal. These are common one-line facts.