Ch 20 REINSURANCE

PURPOSES OF REINSURANCE

(1) to transfer all or portion of company's liabilities (2) to accomplish certain broad managerial objectives, including favorable underwriting results and the reduction of surplus drain from writing new business

Stabilizing Mortality Experience

A closely related use of reinsurance, as yet limited in scope but receiving increasing attention, is to stabilize the primary company's overall mortality experience. This function is associated with so-called nonproportional reinsurance, one form of which transfers to the reinsurer all or a specified percentage of that portion of aggregate mortality claims for a given period in excess of a stipulated norm.

Substandard Reinsurance

For substandard reinsurance on either the coinsurance or the modified coinsurance basis, the primary or ceding company pays the reinsurer appropriate portions of the additional premiums collected from the policyowner, subject to a ceding commission for reimbursement of the ceding company's acquisition expenses. If the reinsurance is accomplished on the yearly reneawble term basis and the substandard risk is classified according to a multiple of standard mortality, the reinsurance premiums are usually calculated on the same multiple of the standard reinsurance rate. If the policyowner is charged a flat extra premium, the primary insurer pays the reinsurer the same premium as for a standard risk, plus an appropriate share of the flat extra premium. The flat extra premiums, however, are not reduced as the net amount at risk declines

Supplementary Coverages

If the basic agreement is facultative, it is likely to cover supplementary benefits as well as the life risk; if it is automatic, a separate agreement may be used for the supplementary coverages, particularly the accidental death benefits. Reinsurance may be provided on either a coinsurance or yearly renewable term basis, depending on the plan used for basic life risks. If the coinsurance plan is used, the premium for the accidental death benefits is based on the premium charged the insured, less a first-year and renewal expense allowance. If the renewable term plan is used, the premium is usually a flat rate per $1,000, irrespective of age of issue or the type of contract issued to the policyowner. The benefits are reinsured on a level-amount basis, because only nominal reserves are accumulated in connection with such coverage.

jumbo clause

It is fairly common for the reinsurer to obligate itself to accept automatically up to four or more times the primary company's retention. However, when the retention limits of the primary company are fairly high, the reinsurer may limit its obligation to an amount equal to the primary company's limit. The agreement specifies that the originating company will retain an amount of insurance equal to its retention limit and will not reinsure it elsewhere on a facultative basis.92 In other words, if the primary company should decide to retain less than the full retention indicated for the particular classification in which the risk falls, the reinsurer is relieved of its obligation under the automatic agreement, and the entire transaction will have to be handled on a facultative basis. The agreement also usually includes a so-called jumbo clause, which stipulates that if the total amount of insurance in force on an applicant's life in all companies—including policies applied for—exceeds a specified amount, reinsurance is not automatically effected.

modification of the coinsurance method

Many companies regard the reinsurer's accumulation of substantial sums of money as an unessential feature of a reinsurance arrangement and one that can be disadvantageous to the primary company. Apart from a company's natural desire to retain control of the funds arising out of its own policies, it may be apprehensive about entrusting another company to accumulate the funds necessary to discharge the primary company's obligations under a policy. This apprehension is heightened by the knowledge that the primary insurer's basic liability to the policyowner or beneficiary is not affected by the reinsurer's inability to make good on its obligation to the primary company. This problem is of more immediate concern when the reinsurer is not licensed to operate in the primary company's home state. In many states the primary company is not permitted to include sums due from the reinsurer as assets in its balance sheet. These considerations have led to a modification of the coinsurance method, under which the primary company retains the entire reserve under the reinsured policy. Under this arrangement, the ceding company pays the reinsurer a proportionate part of the gross premium, as under the conventional coinsurance plan, less whatever allowances have been arranged for commissions, premium taxes, and overhead. At the end of each policy year, however, the reinsurer pays over to the ceding company a sum equal to the net increase in the reserve during the year, less one year's interest on the reserve at the beginning of the year. In more precise terms, the reinsurer pays over an amount equal to the excess of the terminal reserve for the policy year in question over the terminal reserve for the preceding policy year, less interest on the initial reserve for the current policy year. to credit the reinsurer with interest on the initial reserve since a part of the increase in the reserve during the year is attributable to earnings on the funds underlying the reserve, which are held by the ceding company. The reserves are usually credited with interest at the rate used in the primary company's dividend formula or, in the case of nonparticipating insurance, a rate arrived at by negotiation. Under this arrangement, the reinsurer never holds more than the gross premium, as adjusted for allowances, for one year. Under one variation of this method, the anticipated increase is deducted in advance from the gross premium. In many reinsurance transactions using the modified coinsurance plan, the foregoing adjustments are based on the aggregate mean reserves, rather than on the individual terminal reserves. Apart from the reserve adjustment, the modified coinsurance basis is identical to the straight coinsurance basis, and the description of the coinsurance arrangement in the preceding section is equally applicable to the modified form.90 The modified coinsurance plan bears such a strong resemblance in net effect to the yearly renewable term basis of coinsurance that one might question why modified coinsurance would ever be used. One answer is that the premium paid by the primary company is geared to the premium received from the policyowner, rather than being arrived at through negotiation. The second answer is more complex but rests on the fact that under a modified coinsurance plan, reinsurance costs reflect the incidence of expense and surplus drain incurred by the primary company. Under the yearly renewable term plan, the ceding company is responsible for maintaining the reserves at the proper level. Under the modified coinsurance arrangement, however, the reinsurer, out of the premium received from the primary company, must each year turn back a sum equal to the increase in reserves (less one year's interest on the reserve at the beginning of the year), as well as the ceding commission. Over the lifetime of the reinsured policy, the total cost of modified coinsurance and yearly renewable term should be approximately the same, but the net cost of reinsurance in the early years is normally less under modified coinsurance

Reduction in the Sums Reinsured

Once a sum of insurance has been reinsured, the reinsurer is at risk for that amount as long as the amount retained by the primary company remains in force, subject to two important exceptions. One exception is in instances where the total amount of insurance on a particular risk is reduced after a portion of the insurance has been reinsured. This can result from the maturity or expiration of policies in accordance with their terms or through the voluntary termination of policies by nonpayment of premiums. Some Under portfolio reinsurance, policyholders are usually given the right to proceed directly against the reinsurer in pressing a claim for settlement. An exception is made when the entire risk is carried by the reinsurer. Under such circumstances, the agreement provides for consultation with the reinsurer before an admission or acknowledgment of a claim by the primary company agreements provide that the full amount of the reduction will come out of the sum reinsured (up to the amount reinsured), while other agreements call for proportionate reductions in the amounts held by the two insurers.

Types of Plans

Proportional reinsurance is provided under two distinct plans: Yearly renewable term insurance Coinsurance A variation of the latter plan, called modified coinsurance, has also been developed

Recapture Provision

Recapture is usually permitted only after the policies involved have been in force for a specified period of time. This restriction is clearly designed to enable the reinsurer to recover its acquisition expenses. It is customary to restrict recapture of insurance arranged under a renewable term plan to policies in force for 5 or more years, while amounts ceded on a coinsurance basis must typically remain in force for 10 or more years before being subject to recapture. The recapture provision provides an effective method of recovering amounts of insurance previously reinsured when the primary company holds the reserves, as under the yearly renewable term and modified coinsurance arrangements, but it may be ineffective under the coinsurance plan, since the reinsurer is obligated to release only the cash values—not the reserves—for the amounts recaptured. If there is a differential between the surrender value and the reserve under a policy, which is likely, the primary company may conclude that it is not worthwhile to recapture the insurance, at least until the differential between the surrender value and the reserve is insignificant.

Retrocession.

Reinsurer transfers to one or more companies all or a portion of the risk assumed from the primary company

Limiting Amount of Insurance on One Life

Retention limits The most fundamental and prevalent use of indemnity reinsurance is to avoid too large a concentration of risk on one life. All companies, including the giants of the industry, have deemed it prudent to limit the amount of insurance that they will retain on any one life. These maxima, called retention limits, reflect the judgment of company management as to many factors, but they are strongly influenced by the volume of insurance in force, the amount of surplus funds and the proficiency of the underwriting personnel Retention tends to be smaller at the lower and upper age groups and for plans under which the risk element is relatively large

Stop-Loss Reinsurance

Stop-loss reinsurance is highly developed in casualty insurance but it is still in a growth stage in life insurance, serving primarily as a supplement to conventional reinsurance rather than as a substitute for it stop-loss reinsurance arrangements undertake to indemnify the primary company if its mortality losses in the aggregate, or on specified segments of its business, exceed by a stipulated percentage what might be regarded as the normal or expected mortality. The agreements commonly invoke liability on the reinsurer's part if the primary company's aggregate mortality exceeds by more than 10 percent the "normal" mortality, which, of course, must be defined explicitly—or implicitly—in the agreement. Normal mortality is usually defined as a specified percentage of the tabular mortality for the categories of business covered by the agreement. Thus, if the mortality under the policies subject to a particular stop-loss reinsurance agreement is running around 50 percent of the 1980 CSO Table, the agreement might stipulate that the reinsurer will absorb all losses in excess of 110 percent of the normal level of mortality, defined as 50 percent of the 1980 CSO Table rates. Another way to express the reinsurer's obligation is to stipulate that the reinsurer will indemnify the primary company for all claims in excess of a specified percentage of tabular mortality, such as 60 percent of the 1980 CSO Table. Under some agreements, the reinsurer indemnifies the primary company for only a specified percentage (for example, 90 percent) of the excess mortality, an arrangement intended to encourage careful underwriting by the primary company. Under most agreements, the reinsurer's liability during any contract period, generally a calendar year, is limited to a stipulated dollar amount. Under any of these arrangements, if the mortality for the contract period is below the level at which the reinsurer's obligation would attach, the reinsurer makes no payment to the primary company.

Duration of the Agreement

Subject to the provisions described in the preceding section, a reinsurance agreement remains effective for reinsured policies as long as the original insurance continues in force. For new insurance, however, most agreements make provision for cancellation by either party with 90 days' notice. During that period, the agreement remains in full force and effect, and the reinsurer must accept all new insurance exceeding the retention limit with an automatic treaty. It is anticipated that the primary company can make other reinsurance arrangements within a period of 90 days.

recapture of insurance

The other exception applies to increases in the primary insurer's limits of retention and is especially significant to young and growing insurance companies. The provision states that if the primary company increases its limits of retention, it may make corresponding reductions in all reinsurance previously transferred. In the case of a $5 million policy written by a company with a $1 million retention limit, $4 million would originally have been reinsured. If the primary company later increases its retention limit for that particular class of policy to $2 million, it would be permitted to recover $1 million of the $4 million that had been reinsured. This is referred to as the recapture of insurance.

ceding commission

The primary or ceding company pays the reinsurer a pro rata share of the gross premiums collected from the policyowner, and the reinsurer accumulates and holds the policy reserves for the amount of insurance ceded. Inasmuch as the ceding company incurs heavy expenses in putting the original policy on the books, it is customary for the reinsurer to reimburse the primary insurer for the expenses attributable to the amount of insurance reinsured. This reimbursement takes the form of a ceding commission, which includes an allowance for commissions paid to the soliciting agent of the ceding company, There are exceptions to this practice. Sometimes when the ceding insurer offers both participating and nonparticipating policies, all reinsurance will be arranged on the basis of the ceding company's nonparticipating gross premium rates in order to avoid the complexity of dividend accounting. Premium taxes paid to the insured's state of domicile, and a portion of the overhead expenses of the ceding company. Paying a portion of the primary company's overhead recognizes the fact that not only does a reinsurer incur relatively lower expenses on that portion of the face amount assumed by it, but the average amount of insurance per reinsurance certificate is also larger than the average size of the primary insurer's policy. Hence, the administrative expense per $1,000 of insurance is lower on that portion of the insurance reinsured than on the ceding company's normal business, and the reinsurer is willing to share the savings with the company that originated the business. There is normally no sharing of medical and other selection expenses, based on the theory that such expenses are incurred on a per-policy basis and vary only slightly with the amount of insurance. The amount of the ceding commission is negotiated between the ceding insurer and the reinsurer. If the original policy is participating, the reinsurer must pay dividends on the portion of insurance it assumes according to the primary company's dividend scale Mortality rates on reinsured policies as a whole tend to be higher than those on direct business, possibly because of the larger amounts of insurance involved and the less rigid underwriting standards of the many small and medium-sized companies that rely heavily on reinsurance. The anticipated higher mortality is taken into account in arriving at the ceding commission.

Cession Form

The reinsurance agreement stipulates that the primary insurer, after delivering its policy to the insured and collecting the first premium, is to prepare a formal cession of reinsurance (in duplicate), which gives the details of the risk and schedule of reinsurance premiums, including the ceding commission, if any. One copy of the cession form goes to the reinsurer; the other is retained by the primary company. The form is identical for both facultative and automatic insurance. In effect, it is the individual contract of insurance; the entire reinsurance agreement is incorporated into it by reference. cession form describes the basis on which the reinsurance is being effected—that is, whether it is yearly renewable term insurance, coinsurance, modified coinsurance, or some other type. If one of the coinsurance arrangements is being used, provision is made for paying a ceding commission to the primary or ceding company.

Assumption Reinsurance

Traditionally used to bail out insurance companies that find themselves in financial difficulties. Rather than liquidate company, with almost certain losses to policyowners, 2 companies work out a procedure where solvent insurer assumes policy liabilities of company in distress in exchange for assets underlying the liabilities and the right to receive future premiums under the policies. If the assets are not sufficient to offset the liabilities—a likely circumstance—the reinsurer may place a lien against the cash values of the ceded policies until the deficiency can be liquidated through earnings on the policies. A merger is another situation in which all the business of one company may be ceded to another.assumption reinsurance involves only a segment of the ceding company's business assumption reinsurance involves only a segment of the ceding company's business Likewise, a company may decide to withdraw from one or more states and, in so doing, reinsure all policies outstanding in that geographical area. Assumption reinsurance is always tailored to the particular facts and requirements of the case under consideration and does not lend itself to generalization

Coinsurance

Under the coinsurance plan the primary company transfers (or cedes) the proportion of the face amount of insurance called for in the cession form, but the reinsurer is responsible not only for the net amount at risk but also for its pro rata share of the death claim. In the example cited under yearly renewable term insurance, the reinsurer is liable for the payment of $800,000, irrespective of the policy year in which the insured died. The reinsurer is also responsible for its pro rata share of the cash surrender value and other surrender benefits. In effect, the reinsurer is simply substituted for the primary company with respect to the amount of insurance reinsured. The primary or ceding company, however, remains liable to the policyowner for the full amount of any benefits if the reinsurer becomes insolvent or otherwise cannot pay its share of claims.

Cession

act of transferring the insurance from direct-writing company to the reinsurer

Claims Settlement

any settlement made by the primary insurer with a claimant is binding on the reinsurer, whether the reinsurance was originally automatic or was accepted facultatively by the reinsurer Despite this contractual right to settle claims at its discretion, the primary insurer will invariably consult with the reinsurer in doubtful cases. If the policy is to be settled on an installment basis, the reinsurer will nevertheless discharge its liability by paying a lump sum to the primary insurer. This is true not only of settlement option arrangements but also of contracts, such as the family income and retirement income policies, which provide for settlement on an installment basis. If a policy is settled for less than the face amount, such as might happen from a misstatement of age or the compromise of a claim of doubtful validity, the reinsurer shares in the savings. If the primary insurer contests a claim, the reinsurer bears its proportionate share of the expenses incurred.

PROPORTIONAL REINSURANCE

basic or traditional plans, designed for individual risks, are called proportional reinsurance, because under these plans a claim under a reinsured policy is shared by the primary company and the reinsurer in a proportion determined in advance. The precise manner in which a claim payment is shared depends on the type of plan employed.

automatic agreement

binds the primary insurer to offer—and the reinsurer to accept—all risks that fall within the purview of the agreement. sets forth a schedule of the primary insurer's limits of retention and provides that whenever the primary company issues a policy for an amount in excess of the limit for each policy, the excess amount is to be reinsured automatically. The primary company does not submit the underwriting papers to the reinsurer, and the reinsurer does not have the option of accepting or rejecting the risk.

Indemnity Reinsurance

characterized by a series of independent transactions whereby the primary insurer transfers its liability with respect to individual policies, in whole or in part, to the reinsurer. It is extremely widespread and may be used for any one of several reasons

Yearly Renewable Term Insurance

derives its name from the fact that the primary company, in effect, purchases term insurance on a yearly renewable basis from the reinsurer illustrated by a $1 million ordinary life policy issued on a male aged 35 by a company with a retention limit of $200,000. Under such circumstances $800,000 of insurance would ostensibly be transferred to the reinsurer. However, in the event of the insured's death, the reinsurer would pay not $800,000 but only the net amount of risk under an $800,000 policy. If the insured should die during the first policy year, the reinsurer would be liable for $800,000 less $8,820.96, the first-year terminal reserve under the policy in question. If death occurred during the 8th policy year, the reinsurer would remit $727,213.52 to the primary company—the face amount less the 8-year terminal reserve of $77,786.48. The reserves under the $800,000 of life insurance transferred to the reinsurer are held by the primary insurer and, in the event of the The figure is the full net level premium reserve under the 1980 CSO aggregate table plus 4 percent interest. Small and medium-sized companies, which are an important segment of the reinsurance market, almost invariably use the Commissioners Reserve Valuation Method. On that reserve basis, there would be no reserve under an ordinary life policy at the end of the first year, so the amount at risk would be the face of the policy. insured's death, would be added to the reinsurer's remittance to make up the full payment of $800,000 due under the reinsured portion of the original policy. The primary insurer would, of course, also be solely responsible for payment of the $200,000 of coverage it retained—which, in turn, would be composed of the net amount at risk and the accumulated reserves under $200,000 of coverage. either the primary company or the reinsurer prepares a schedule of the amount at risk for each policy year under the face amount being reinsured. premiums are generally graded upward with duration under a wide variety of schedules. Some schedules grade the premium upward over a period as long as 15 years. There may be no charge other than a policy fee of nominal amount—for example, $5 or $10 for the first year of reinsurance coverage. The premium schedule may also reflect, through a policy fee or in some other manner, the amount of insurance involved. The expense loading is lower than in direct premiums since the primary company pays all commissions, medical fees, and other acquisition expenses connected with the policy. (Under most reinsurance agreements, the premium tax is borne by the reinsurer in the form of a "refund" to the primary company.) As a further cost concession, some agreements of this type provide that the primary company share in any mortality savings on the reinsured business.

REINSURANCE AGREEMENT

describe the classes of risk that will be subject to reinsurance, the extent of the reinsurer's liability, and the procedures by which the transactions are to be carried out

facultative agreement

establishes a procedure whereby the primary insurer may offer risks to the reinsurer on an individual case basis. The essence of the arrangement is that the primary company is under no obligation to offer—and the reinsurer is under no duty to accept—a particular risk. Each company reserves full freedom of action, and each risk is considered on its merits. The arrangement takes its name from the fact that each party retains the "faculty" to do as it pleases with respect to each specific risk.

Transferring Substandard Insurance

fifth application of indemnity insurance, closely related to the fourth, is to transfer all policies of substandard insurance. This use is brought into play when the primary insurer does not write substandard insurance on any basis. Yet in order to offer a full range of services to its agency force, the company may work out an arrangement whereby it can channel all applications from substandard risks to a reinsurer equipped to classify and underwrite such risks. Finally, with group insurance and pension plans, the company with which the master contract is placed may transfer portions of the coverage to several other insurers under instructions from the policyowner. Such an arrangement is specially fashioned and arises because the policyowner, for business reasons, wishes to divide the coverage among several insurers while looking to one for overall administration of the case.

Catastrophe Reinsurance

first developed for property-casualty insurance lines. As its name implies, it usually provides for payment by the reinsurer of some fixed percentage, ranging from 90 to 100 percent, of the aggregate losses (net of conventional reinsurance) in excess of a stipulated limit in connection with a single accident or castrophic event, such as an airplane crash, explosion, fire, or hurricane. Catastrophe reinsurance is clearly intended to serve only as a supplement to proportional reinsurance agreements. The level of losses at which the reinsurer's liability attaches may be expressed in terms of dollar amount or number of lives. The contract usually covers a period of one year and limits the reinsurer's liability for that period. The coverage is attractive to insurance companies that have a concentration of risks in one location, such as might arise under a group insurance policy. The risk involved is essentially accidental death attributable to a catastrophic occurrence. While the reinsurer's liability under a catastrophe type of agreement is high, the probability of loss was perceived to be low prior to the attack on the World Trade Center on September 11, 2001. Hence, the premiums for this type of coverage have generally been low. Premium increases will be imposed and the viability of this coverage may be more limited in the future. The expense element of the premium is minimized through the use of aggregate reporting procedures.

Utilizing the Reinsurer's Expertise

fourth use of indemnity reinsurance is to take advantage of the reinsurer's underwriting judgment. A company may also enter into a reinsurance agreement with another company to receive advice and counsel on underwriting matters, rates, and policy forms. This purpose is usually associated with small, newly organized companies that cannot afford a large enough staff to deal with all aspects of its operations

NONPROPORTIONAL REINSURANCE

in recent years increasing interest has developed in an approach that relates the reinsurer's liability to the mortality experience on all or a specified portion of the primary company's business, rather than to individual or specific policies of insurance. Widely used in property-casualty insurance, this approach is referred to as nonproportional reinsurance, because the proportion in which the primary company and the reinsurer will share losses is not determinable in advance. This type of nonproportional reinsurance coverage is available from both American and European reinsurers in three forms: stop-loss reinsurance, catastrophe reinsurance, and spread-loss reinsurance.

Experience Rating

increasingly common for reinsurance agreements to contain a provision permitting a primary company to share in any mortality gains or losses arising under reinsured policies. This is a form of experience rating found in many lines of insurance, including the various group coverages written by life companies. In this case, the primary company is treated as the policyowner, and the mortality refund (or surcharge, as the case might be) is calculated on the combined experience under all reinsured amounts with a particular reinsurer. common arrangement is to have the primary insurer participate in any gains or losses on reinsurance amounts below a specified limit and not participate in the experience on amounts in excess of such limit. The purpose of this variation is to permit the primary company to share in the favorable mortality experience of the bulk of reinsured risks but to avoid the undesirable fluctuations in its overall experience that might result from unpredictably heavy mortality among very large risks. (Note that arrangements that permit the primary insurer to share the gains from favorable mortality experience on reinsured risks lessen the importance of recapture provisions.) Mortality refunds are a matter of accounting between insurance companies and should not be confused with dividends to policyowners, although under participating policies, all or a portion of the savings may be passed on indirectly to policyowners. Agreements that provide for sharing mortality savings on reinsured risks with the primary company are usually referred to as experience-rated agreements.

Insolvency of the Primary Insurer

reinsurance agreements are regarded as contracts of indemnity, and the reinsurer's liability is measured by the actual loss sustained by the primary insurer. An important exception is in the case of the primary insurer's insolvency. Virtually all agreements provide that the reinsurer must remit in full to the insolvent carrier that issued the original policy, even though the claim against the insolvent company will have to be scaled down. Many states, including New York, will not permit a primary company to treat amounts due from reinsurers as admitted assets or to deduct reserves held by reinsurers from its policy liabilities unless the reinsurance agreement requires the reinsurer to discharge its own obligation in full in the event the primary company becomes insolvent. It is important to note that a claimant under a reinsured policy issued by a company that is insolvent at the time of the claim is not permitted to bring action directly against the reinsurer but must look to the insolvent carrier's general assets for the settlement of the claim. On the other hand, when the issuing company is insolvent, the reinsurer is given the specific right to contest claims against the primary insurer in which it has an interest, with all defenses available to the reinsurer that are available to the primary insurer

Spread-Loss Reinsurance

the reinsurer collects an annual premium of a stipulated minimum amount, of which a certain portion (such as 20 percent) is allocated to expenses and profit, with the balance credited to a refund account until the account reaches a specified maximum figure, such as the sum of 3 years' premiums. During any calendar year when the primary company's aggregate death claims (net of conventional reinsurance payments) exceed a specified limit, the reinsurer pays the claims in excess of the limit but adjusts the premium to reflect the claims experience. The agreement provides that any amounts paid by the reinsurer for a given year, plus 20 percent, must be returned to the reinsurer by the primary company during the next 5 years. The spread-loss agreement can be terminated by either party, with proper notice, at the end of any contract year, except that the primary company cannot terminate the arrangement under circumstances that would cause a loss to the reinsurer. In other words, the reinsurer must be permitted to recover all payments made to the primary company. It is apparent that the main purpose of this type of reinsurance is to spread the financial effects of an unfavorable mortality experience in any one year over a period of 5 years. About the only risk the reinsurer takes is the continued solvency of the primary company. Consequently, the mathematical basis of the premium charge is completely different from the other two forms of nonproportional reinsurance.

Reducing the Drain on Surplus

third use of indemnity reinsurance is to reduce the drain on surplus caused by writing new business.the expense of putting a new policy on the books greatly exceeds the first-year gross premium.

Yearly Renewable Term Insurance Reinsurance

• Primary insurer retains reserves for portion of policy reinsured. • Reinsurer charges premium on at-risk portion of reinsured amount ($500,000 reinsured), if primary insurer maintains $30,000 reserve for portion reinsured, it results in $470,000 at risk amount. • Reinsurer liability is limited to at-risk amount if insured dies. • Primary insurer allowed to retain more of the premium. • Primary insurer liability for a claim is the full amount retained, plus the reserve for the reinsured portion several advantages associated with the yearly renewable term basis of reinsurance. It permits the primary company to retain most of the premiums, giving rise to a more rapid growth in assets—a matter of special concern to small and medium-sized companies. For the same reason, it may be favored when the reinsurer is not licensed to transact business in the domiciliary state of the primary company, which would mean that the primary company would not be permitted to deduct the reserves on the reinsured policies from its overall reserve liability. (The same situation may lead to the use of a modified coinsurance arrangement.) This plan of reinsurance is also easier to administer than the more complicated coinsurance arrangements. Finally, it is thought to be more suitable for nonparticipating insurance where costs are fixed in advance.

Coinsurance Sharing

• Proportional sharing of premiums • Proportional sharing of reserve liability • Proportional sharing of dividends (if policy is participating) • Reinsurer issues ceding commission to the primary insurer for acquisition costs incurred on the portion reinsured • Primary insurer responsible for policy loans 89. In most—if not all—states, the ceding company is not permitted to deduct premium taxes on amounts of insurance transferred to reinsurers. By the same token, reinsurers are not required to pay premium taxes on insurance assumed under reinsurance agreements. In the event that the original policy is terminated voluntarily, the reinsurer is liable for its pro rata share of the cash surrender value. If the policy is surrendered for reduced paid-up insurance, the reinsurer may remain liable for its proportionate share, or its share may be reduced by paying the appropriate cash surrender value to the primary insurer. Should the policy be exchanged for extended term insurance, the reinsurer usually retains its proportionate share of liability, although its share may be reduced by any policy indebtedness. The reinsurer does not ordinarily participate in policy loans, settlement options, or installment settlements under family income or maintenance policies. The reinsurer's obligation in the event of the insured's death is discharged by a single-sum payment to the ceding company.

Stop-Loss Features

• Reinsurer assumes all losses over an agreed threshold (exceeds normal claims expectation) • Threshold is tied to both a stated level of standard mortality table experience and more than 100 percent of primary insurer's past mortality experience • Price and terms negotiated This approach to reinsurance lends itself to great flexibility, since the agreements can be written to cover only selected portions of the primary company's business with varying levels of mortality and with varying duration periods. The premium for stop-loss reinsurance is arrived at by negotiation and involves the use of highly refined actuarial techniques, as well as a large portion of judgment. The basic appeal of this coverage is that it provides protection against adverse mortality experience arising out of an unexpectedly large number of small claims or an unexpected increase in the average size of claims. It is a form of reinsurance on the amounts at risk retained under conventional reinsurance agreements. Because the unit cost of protection under this approach is less than under proportional reinsurance, a company can reduce its total outlay for reinsurance by increasing its retention limits under conventional agreements and reinsuring the retained amounts under stop-loss arrangements. Another advantage of this approach is its relative ease of administration, attributable to the absence of individual policy records. Adherents to conventional (proportional) reinsurance arrangements see many practical disadvantages to stop-loss reinsurance. They point out that it is short-term, rate-adjustable, cancelable coverage available under conventional arrangements. They call attention to the limit on the reinsurer's liability, as well as exclusion of the war risk. They emphasize the restrictions on the primary company's underwriting practices necessarily imposed by the reinsurer. Finally, they question for a number of reasons whether any cost savings will, in fact, be realized in the long run.