Question

PART 1: Delta Insurance is a property insurer that entered into a surplus-share reinsurance treaty with Eversafe Re. Delta has a retention limit of $200,000 on any single building, and up to nine lines of insurance may be ceded to Eversafe Re. A building valued at $1,600,000 is insured with Delta. Shortly after the policy was issued, a severe windstorm caused an $800,000 loss to the building.

1. How much of the loss will Delta pay? Show your calculations.
2. How much of the loss will Eversafe Re pay? Show your calculations.
3. What is the maximum amount of insurance that Delta can write on a single building under the reinsurance agreement? Explain your answer.

PART 2: Liability Insurance Company writes a substantial amount of commercial liability insurance. A large construction company requests $100 million of liability insurance to cover its business operations. Liability Insurance has a reinsurance contract with Bermuda Re that enables the coverage to be written immediately. Under the terms of the contract, Liability Insurance pays 25 percent of the losses and retains 25 percent of the premium. Bermuda Re pays 75 percent of the losses and receives 75 percent of the premium, less a ceding commission that is paid to Liability Insurance. Based on the preceding, answer the following questions:

1. What type of reinsurance contract best describes the reinsurance arrangement that Liability Insurance has with Bermuda Re?
2. If a $50 million covered loss occurs, how much will Bermuda Re have to pay? Show your calculations.
3. Why does Bermuda Re pay a ceding commission to Liability Insurance?

Answer 1

Reinsurance: It is an arrangement by which insurance companies take insurance policies from other insurers to share their risk.

Surplus share reinsurance: This is a type of reinsurance most commonly used in property insurance, where ceding company(the company which enters into reinsurance treaty with a reinsurer firm) shares only part of the risk with the reinsurer firm i.e the ceding company retains a fixed amount of liability and the rest will be borne by the reinsurer firm.

PART 1

The amount of loss paid by Delta

value of the insured building = 16,00,000$

the amount of loss = 8,00,000$

retention limit of the Delta insurance=2,00,000$

the proportion of risk borne by Delta insurance = 2,00,000 /16,00,000*100 = 12.5%

the amount of loss paid by Delta Insurance = 8,00,000*12.5/100=1,00,000

the proportion of risk borne by Eversafe Re = 14,00,000/16,00,000*100=87.5%

the amount of loss paid by Eversafe Re = 8,00,000*87.5/100 = 7,00,000

The Delta company is the ceding company here ,who can write insurance upto the retention limit specified in the reinsurance treaty,which is $2,00,000 here.