Layering Approach in Reinsurance
The business of reinsurance is to provide coverage against catastrophic events which may be caused by the wrath of nature. We are well aware of the fact that nature can be unpredictable. Even though reinsurance companies are able to predict the timing as well as the impact of natural calamities with a high degree of precision, there is always a chance that an outlier event will cause massive damage. Such outlier events can be black swan events meaning that they are not predictable using any statistical models. However, at the same time, they can easily lead to the bankruptcy of one or several reinsurance companies.
As a result, almost no reinsurance company wants to provide a very high coverage to the ceding insurer. However, at the same time, the ceding insurer is looking for high coverage. It is for this reason that the concept of layering has been introduced in the reinsurance market. Layering is highly popular and almost every reinsurance policy is created with built-in layers. In this article, we will have a closer look at what layering is and what are some of the pros and cons of using layering.
What is Layering?
Layering is an approach that is used for effectively managing risks while underwriting reinsurance policies. The layering approach is used for reinsurances which are underwritten on an excess of loss basis. It also involves several reinsurers underwriting coverage sequentially.
This means that instead of the entire policy being covered by one reinsurer, different layers are created and the risk pertaining to each layer is borne by a different insurer. The ceding insurer may or may not be aware of this arrangement between the reinsurers. This is because usually when the policy is signed, the entire risk is borne by the same reinsurer. However, this risk is transferred to other parties in the secondary market using retrocession.
Example of Layering
To better understand layering, lets have a closer look at it with the help of an example. Lets say that a reinsurance policy has been underwritten by four different reinsurers. The terms and conditions of the policy are as follows:
Now, the amount on the left side denotes the sum assured. This is the maximum amount that the insurer will pay for that layer of insurance. If the losses exceed that amount, then the layer will be considered to be exhausted and the next layer will come into play.
The amount mentioned on the left side can be considered to be the excess. This means that the losses have to reach that amount before that particular layer gets triggered. For instance, the first layer may get triggered at any loss since the amount is $0. However, the third layer will only be triggered after a $40 million loss since $10 million and $30 million will be covered by the first and second layers respectively.
Structuring the Layers
In the case of a layered policy, the reinsurer would generally mention the premium amount with details of the breakup. They would generally provide the details of the premium charged for each layer. There are some details that need to be understood about the structure of a layered reinsurance policy.
The fact of the matter is that layering is a very important arrangement in reinsurance. It is a great tool used to effectively manage the huge risks which arise from insuring unpredictable natural calamities. The pros and cons of this approach have been discussed in the next article.
- Benefits of Reinsurance
- Key Differences Between Insurance and Reinsurance
- How Inflation Impacts Reinsurance
Authorship/Referencing - About the Author(s)
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