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CMA Final · Risk Management in Banking and Insurance

Structure and Type of Re-insurance for CMA Final Paper 20B

Reinsurance is insurance bought by an insurer (the cedant) from another insurer (the reinsurer) to share its risk. It is structured as proportional (shares premium and claims in a fixed ratio) or non-proportional (reinsurer pays only above a retention), placed facultatively or by treaty. Solve questions by identifying the type, then applying its sharing rule.

What this chapter covers

This chapter explains how an insurer passes part of its risk to another insurer. You study why insurers do this, who the parties are, and the main forms of cover: proportional, non-proportional, facultative and treaty. It ends with alternative risk transfer (ART) and finite reinsurance, which move risk through routes other than traditional cover.

The chapter is mostly conceptual, but numerical questions are common. You may need to split a premium and a claim under a quota share or surplus treaty, or find the reinsurer's payment under an excess of loss layer. Those workings are short once you know the sharing rule for each type.

It connects to the rest of Paper 20B in two ways. First, it is a risk-transfer tool, so it links to risk identification, measurement and treatment of insurers. Second, it links to insurance regulation. Under the Insurance Act, 1938, section 34F lets the Authority act on reinsurance treaties that are not favourable to the insurer or are detrimental to the public interest. It can require changes at the next renewal, or non-renewal. It can also direct that a treaty be furnished in advance and approved before the insurer enters into it. Failure to comply is treated as failure to comply with the Act. Know this in plain words.

Reinsurance is central to how an insurer controls its exposure and capital, so examiners can test it through Section A MCQs, a case scenario in 1(b), and a 14-mark descriptive or numerical question. The chapter rewards clear classification and short, correct workings. If you can name the type, state its sharing rule and give one reason for using it, you can score well on both MCQs and written answers without needing long study.

Structure and Type of Re-insurance: topics in the order to study them

  1. 1Concept and Need for ReinsuranceStart here because every later type is a different answer to the same need: sharing risk, stabilising results and adding capacity.
  2. 2Parties and Structure of Reinsurance ArrangementsYou need the terms cedant, reinsurer and retrocession before you can read any treaty or numerical question.
  3. 3Proportional (Pro-rata) ReinsuranceIt is the simplest sharing rule, with premium and claims split in the same ratio, so it builds your numerical base.
  4. 4Non-Proportional (Excess of Loss) ReinsuranceStudy it after pro-rata so you can contrast the two: here the reinsurer pays only above a retention, not a fixed share.
  5. 5Facultative and Treaty ReinsuranceThis is a different axis of classification, how cover is placed, and it applies to both proportional and non-proportional forms.
  6. 6Alternative Risk Transfer and Finite ReinsuranceFinish with the less traditional routes, which are easier to grasp once you know what ordinary reinsurance does.

How to prepare Structure and Type of Re-insurance

Treat this chapter as two classifications plus a few simple sharing calculations. Build a clear map first, then practise numbers.

  1. Read the need for reinsurance and write three or four reasons in your own words, such as capacity, stability of results and protection against large losses.
  2. List the parties and their roles. Draw one small diagram showing the policyholder, cedant, reinsurer and retrocessionaire.
  3. Learn the two main classifications separately: proportional versus non-proportional, and facultative versus treaty. Then combine them in a grid so you see that the axes are independent.
  4. Practise numerical questions on quota share, surplus and excess of loss. Write the retention, the cession and the reinsurer's payment on separate lines and check that they add up to the loss.
  5. Read the regulatory point in plain words: the Authority's power over unfavourable or harmful treaties under section 34F of the Insurance Act, 1938.
  6. Finish with ART and finite reinsurance. Note what each does and how it differs from conventional cover.
  7. Attempt MCQs on definitions and one case scenario, then write one full 14-mark answer with a classification, a working and a short conclusion.

Common mistakes in Structure and Type of Re-insurance

  • Confusing the cedant with the reinsurer.

    Fix: Remember that the cedant cedes business and the reinsurer accepts it. Label each party in every diagram.

  • Treating facultative and treaty as alternatives to proportional and non-proportional.

    Fix: Keep two separate axes: the sharing basis (proportional or not) and the placing method (facultative or treaty). Practise naming both for each example.

  • Applying a percentage share in an excess of loss problem.

    Fix: In excess of loss, subtract the retention first, then apply the limit. Only the amount above the retention is recovered.

  • Not checking that retained and ceded amounts add up to the loss.

    Fix: Add the cedant's share and the reinsurer's share at the end of every working. They must equal the total loss.

  • Ignoring regulation and writing only theory.

    Fix: Add a line on the Authority's power under section 34F of the Insurance Act, 1938, in plain words, when a question asks about oversight of treaties.

  • Describing finite reinsurance as full risk transfer.

    Fix: State that finite reinsurance involves limited risk transfer and works mainly by spreading losses over time.

Last-day revision: Structure and Type of Re-insurance

  • 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.

Structure and Type of Re-insurance practice questions

Structure and Type of Re-insurance in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Structure and Type of Re-insurance: frequently asked questions

What is the difference between proportional and non-proportional reinsurance?

In proportional reinsurance, the reinsurer takes an agreed share of premium and pays the same share of every claim. In non-proportional reinsurance, the reinsurer pays only the part of a loss above the retention, up to a limit. Premium is not split in the same ratio as risk.

What is the difference between facultative and treaty reinsurance?

Facultative reinsurance is arranged for an individual risk, and the reinsurer can accept or decline each one. Treaty reinsurance is an agreement covering a defined class or portfolio of business, so eligible risks are ceded automatically.

Does the Insurance Act, 1938 deal with reinsurance treaties?

Yes. Section 34F lets the Authority act if a treaty is not favourable to the insurer or is detrimental to the public interest. It can require changes at the next renewal, or non-renewal, and can direct that a treaty be furnished and approved in advance.

Are numerical questions common in this chapter?

They can appear, usually short ones on quota share, surplus or excess of loss. Learn the sharing rule for each type and always check that the parts add up to the total loss.