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Banking and Insurance - Laws and Practice · Functions in Insurance and Compliance related thereto (Part III)

Reinsurance Function and Compliance for CS Professional

Updated 11 October 2026 · Fact-checked

Reinsurance is insurance bought by an insurer to pass part of its risk to another insurer, the reinsurer. It works through treaty (automatic, whole portfolio) or facultative (case by case) arrangements. Under Section 34F of the Insurance Act, 1938, the Authority can order changes to, or non-renewal of, unfavourable treaties.

Understand Reinsurance Function and Compliance

Reinsurance is the insurance of an insurer. An insurer (the cedant or ceding company) accepts risk from policyholders. It then transfers a share of that risk, and a share of the premium, to a reinsurer. The policyholder still deals only with the original insurer. The reinsurer pays the cedant, not the policyholder.

Why do insurers do this? The main purposes are:
- Limit loss from one large risk or one event, such as a big factory fire or a cyclone.
- Stabilise results across years, so one bad year does not wipe out capital.
- Raise capacity, so the insurer can write bigger risks than its own capital would allow.
- Gain expertise, as reinsurers often help with pricing and underwriting of unusual risks.

There are two broad ways to arrange it. In a treaty arrangement, the insurer and reinsurer agree terms in advance for a whole class or portfolio. Every risk that fits the treaty is covered automatically, and the reinsurer cannot pick and choose. In a facultative arrangement, the insurer offers one specific risk, and the reinsurer decides whether to accept it and on what terms. Facultative cover suits large, unusual or hazardous single risks that exceed treaty limits.

Reinsurance is also split by how risk is shared. In proportional forms (such as quota share and surplus), the reinsurer takes an agreed share of premium and of every claim. In non-proportional forms (such as excess of loss), the reinsurer pays only when losses cross an agreed limit, called the retention.

For compliance, the law treats reinsurance as a matter of public interest. Section 34F of the Insurance Act, 1938 lets the Authority review reinsurance treaties and contracts. If it thinks terms are not favourable to the insurer or are detrimental to the public interest, it can step in. Your answers should link the commercial purpose to this regulatory power.

Key rules to remember

Section 34F(1): order on existing treaties
Authority's opinion that terms are unfavourable to the insurer or detrimental to public interest → order to modify terms or not to renew, at the next renewal date
The order operates when renewal of the treaty or contract next becomes due. Failure to comply is deemed failure to comply with the Act.
Section 34F(2): prior approval order
Reason to believe insurer is entering or likely to enter unfavourable contracts → order that no treaty or contract be entered unless a copy is furnished in advance and terms are approved
This is a pre-clearance power. Non-compliance is deemed failure to comply with the Act.
Quota share (proportional)
Reinsurer's claim payment = Claim × Reinsurer's quota share %
Premium is also shared in the same percentage, usually less a ceding commission.
Excess of loss (non-proportional)
Reinsurer pays = Loss − Retention, limited to the cover limit; nothing if Loss ≤ Retention
Cedant bears the loss up to the retention, and any amount above retention plus limit.

How to solve Reinsurance Function and Compliance questions

Reinsurance questions are either conceptual (types, purpose, differences) or compliance-based (what can the Authority do on given facts). Use one structure for both.

  1. 1Identify the parties: cedant (original insurer), reinsurer, and policyholder. State that the policy contract is unaffected.
  2. 2Name the arrangement in the facts: treaty or facultative, proportional or non-proportional.
  3. 3Explain its purpose in the facts, such as capacity, loss limitation or stability.
  4. 4If the question is about regulation, quote the rule: Section 34F(1) for existing contracts, Section 34F(2) for pre-approval.
  5. 5Apply the rule to the facts: did the Authority form an opinion or have reason to believe terms are unfavourable or against public interest?
  6. 6State the consequence: modification, non-renewal or prior approval, and that non-compliance is deemed breach of the Act.
  7. 7If numbers are given, compute the cedant's retained loss and reinsurer's share separately, then check they add up to the total.
  8. 8Conclude in one clear line and add a practical compliance point, such as keeping treaty copies ready for the Authority.

Quickest way: Four-line reinsurance answer

When to use it: Use for short-answer questions on meaning, types or the Authority's powers when time is tight.

  1. Line 1: define reinsurance as insurance of an insurer, naming cedant and reinsurer.
  2. Line 2: give purposes in a few words: capacity, stability, loss limitation, expertise.
  3. Line 3: contrast treaty (automatic, portfolio) with facultative (case by case, single risk).
  4. Line 4: add Section 34F: Authority can order modification, non-renewal or prior approval of unfavourable reinsurance.

Common mistakes in Reinsurance Function and Compliance

  • Saying the reinsurer pays the policyholder directly

    Students treat reinsurance as a second policy covering the insured.

    Fix: State that the policyholder's contract is with the original insurer only. The reinsurer reimburses the cedant.

  • Mixing up treaty and facultative

    Both words sound technical and the difference is rarely tied to who chooses.

    Fix: Remember: treaty is automatic for a class of business; facultative lets the reinsurer accept or reject each individual risk.

  • Quoting Section 34F as giving the Authority power to cancel any treaty at once

    Students overstate the power.

    Fix: Section 34F(1) works at the time renewal next becomes due. It requires the Authority's opinion that terms are unfavourable to the insurer or detrimental to public interest.

  • Confusing 34F(1) with 34F(2)

    Both deal with unfavourable reinsurance terms.

    Fix: 34F(1) is about existing treaties: modify or do not renew. 34F(2) is about future contracts: furnish a copy in advance and get terms approved.

  • Treating excess of loss as proportional

    Both transfer loss, so students assume shares are fixed.

    Fix: In excess of loss the reinsurer pays only above the retention. In quota share it pays a fixed percentage of every claim.

Worked examples

Example 1

Suvarna General Insurance Ltd. has a 40% quota share treaty. It collects a premium of ₹50,00,000 on the covered portfolio and faces claims of ₹30,00,000 on it. Ignoring commission, find the premium ceded, the claims recovered from the reinsurer, and the net amounts retained.

Show the solution
  1. Premium ceded = 40% × ₹50,00,000 = ₹20,00,000.
  2. Premium retained = ₹50,00,000 − ₹20,00,000 = ₹30,00,000.
  3. Claims recovered = 40% × ₹30,00,000 = ₹12,00,000.
  4. Claims retained = ₹30,00,000 − ₹12,00,000 = ₹18,00,000.
  5. Check: net result = ₹30,00,000 − ₹18,00,000 = ₹12,00,000, which is 60% of the gross result of ₹20,00,000.

Answer: Premium ceded ₹20,00,000; claims recovered ₹12,00,000; retained premium ₹30,00,000 and retained claims ₹18,00,000.

Example 2

An insurer has renewed the same reinsurance treaty for years. The Authority forms the opinion that its terms are not favourable to the insurer and are detrimental to the public interest. Advise on what the Authority can do and the effect if the insurer ignores it.

Show the solution
  1. Provision: Section 34F(1) of the Insurance Act, 1938 deals with reinsurance treaties and contracts already entered into.
  2. Analysis: the Authority has formed an opinion that terms are unfavourable to the insurer or detrimental to public interest. That is the condition for the power.
  3. Power: it may order the insurer, when renewal next becomes due, to make the modifications it specifies, or not to renew the treaty.
  4. Timing: the order bites at the next renewal, not by cancelling the running contract mid-term.
  5. Consequence: if the insurer fails to comply, it is deemed to have failed to comply with the provisions of the Act.
  6. Practical point: the insurer should review treaty terms before renewal and keep documents ready to justify them.

Answer: The Authority may, by order, require specified modifications at next renewal or direct non-renewal. Ignoring the order is deemed a failure to comply with the Act.

Exam tips

  • Define reinsurance, then immediately contrast treaty and facultative. Examiners often ask for this difference.
  • Cite Section 34F only with its two limbs: (1) modify or not renew at renewal; (2) prior furnishing and approval. Do not add powers not in the section.
  • For case questions, follow provision, analysis, conclusion. Show that the Authority's opinion or belief condition is met.
  • If numbers appear, show cedant and reinsurer shares separately and check that they add to the total.
  • Add one practical compliance line, such as maintaining treaty records for review by the Authority.

Practice questions from Functions in Insurance and Compliance related thereto (Part III)

Reinsurance Function and Compliance: frequently asked questions

What is the difference between treaty and facultative reinsurance?

Treaty reinsurance is agreed in advance for a class or portfolio of business, and covers all qualifying risks automatically. Facultative reinsurance covers one specific risk, which the reinsurer may accept or reject. Facultative is used for large or unusual risks.

Does the policyholder have any claim against the reinsurer?

Generally no. The policyholder's contract is with the original insurer, who must pay the claim. The insurer then recovers the reinsurer's share from the reinsurer.

What does Section 34F of the Insurance Act, 1938 say?

It lets the Authority act on reinsurance treaties or contracts it considers unfavourable to the insurer or detrimental to public interest. It can order modifications or non-renewal at next renewal, or require advance furnishing and approval of future contracts. Failure to comply is deemed a breach of the Act.

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

In proportional reinsurance, such as quota share, the reinsurer takes an agreed share of premium and of each claim. In non-proportional reinsurance, such as excess of loss, the reinsurer pays only the part of a loss above a set retention.