Reinsurance: Arbitrage | Method of Reinsurance | Purpose of Reinsurance

Reinsurance is a means by which insurance company can protect itself with other insurance companies against the risk of losses, individuals and corporations obtain insurance policies to provide protection for various risks (hurricanes, earthquakes collisions, sickness and death etc.) reinsurers in turn provide insurance companies. The company, requesting the cover is called the cedant and the reinsurer can be called the ceded, although the letter term is not in common use.

Arbitrage

The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate that what they charge the insured for the underlying risk, which can be in the area of risk associated with any form of asset that is being issued or loaned against. It can be a car, a mortgage, an insurance (personal, fire, business etc.) and alike.

In general, the reinsurer may be able to cover at a lower premium that the insurer because.

The reinsurer may have some intrinsic cost advantage due to economies of scale or some other efficiency.

Reinsurers may operate under weaker regulation than their clients. This enables them to useless capital to cover any risk and to make less prudent assumptions when valuing the risk.

Method of Reinsurance

The method of reinsurance is determined one of five different ways.

  • Pro- Rata Basis: A reinsurer receives a percentage of the premium collected by the original insurance company for the business covered under the contract. The reinsurer pays the same percentage of losses incurred on this business.
  • Excess of loss Basic: The reinsurer agrees to accept all losses over a certain amount. This is the most common form of reinsurance.
  • Per Risk Excess of Loss: The reinsurer agrees to pay all losses over a certain amount on any one risk that is underwritten by the original company. This allows the original company to underwrite larger policies.
  • Catastrophic Excess of Loss: The reinsurer agrees to pay the total loss over a certain amount on all accumulated losses involved in a catastrophe. This protects the original company in the event of a catastrophic loss.
  • Aggregate Excess of Loss/stop loss: the reinsurance agrees to pay all losses over a certain amount for the original company’s losses for the period of the contract.

Purpose of Reinsurance

Mr. Diew pointed out six motive of reinsurance, they are as follows:

  • Alleviation of radical changes in surplus due to unfavorable motility results.
  • Relief through coinsurance, from heavy surplus drains due to large amounts of new business
  • Use of the reinsurer as an independent underwriting check.
  • Use of the reinsurer’s help on questionable claims.
  • Drawing upon the reinsurer’s experience for guidance on various home office practices such as application, issue, policy forms, accounting and reserve methods, investments and agency and personnel problems
  • Meeting certain nonrecurring problems such as excess amounts and special plans of contingent insurances.

The primary purpose of reinsurance is to allow the cedent to lay off to the reinsurer a portion of the losses covered by the cedent’s policies, sometimes, however, the cedent wishes the reinsurer to assume the risk of the manner in which the cedent handles losses as well as the losses themselves (i.e. risk transfer).

The Nigerian Reinsurance Corporation Decree of 1977

Nigerian Reinsurance Corporation Decree No. 49 of 1977. The federal government hereby decrees as follows (Section 2).

  • Subject to the provision of this Decree the corporation shall have power, within or outside Nigeria to carry on reinsurance of any class of insurance business including life insurance business and to reinsure against loss of any kind arising from any risk.
  • Without prejudice to the generality of sector (1) of this section the corporation shall have power to do any of the following
    • To reinsure with any insurer carrying on insurance of reinsurance business, any risk undertaken by the corporation and for that purpose to enter into reinsurance contracts.
    • To accept the reinsurance of any park or risk under taken by any other person (being risk such that the corporation has power to reinsure against) and retrocede any part of such risk.
  • Save as may be expressly provided for by an order to make under subsection (5). Below, the corporation shall have power to do anything or to enter into any transaction which in the opinion of the Board is calculated to facilitate the due performance of the functions of the corporation under this decree, and in particular the corporation may:
    • Acquire any undertaking of any registered insurer or acquired hold or have any share or stock in or any financial interest in any such undertaking
    • Acquire and invest in any other profitable business
    • Assist in organizing training schemes for employees of any Registered insurer
  • Notwithstanding, the provision of this section, the African Reinsurance companies operating in Nigeria with respect to the 5 percent compulsory sessions emanating from Nigeria.
  • Where the commissioner is of the opinion that is in the public interest to do so, he may be prior to the approval of the federal executive Council by order published in the Gazette abridge or restrict the power of the corporation to any extent necessary and when se abridged or restricted the power of the corporation to any extent necessary.
  • For the avoidance of doubt, it is hereby declared that the foregoing provision of this Decree relate only to the capacity of the capacity of the corporation as a statutory corporation and nothing in the said provision shall be constructed as authorizing the disregard by the corporation at any rule of law.
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