Concept of Reinstatement in Reinsurance

Ceding insurance companies take reinsurance in order to protect themselves from massive losses that may occur when catastrophes occur. The problem is that when these catastrophic events do occur, the maximum limit of the reinsurance contract is breached. As a result, ceding insurers may find themselves without any coverage in the middle of the year. This can be very risky for the ceding insurance company since another catastrophic event could severely damage the financials of the ceding insurance company.

In order to overcome this problem, reinsurance companies have started offering reinstatement features that are built into the policy. In this article, we will understand what reinstatement is and how it applies to reinsurance policies.

Why Reinstatement is Necessary?

Catastrophic events can lead to catastrophic losses. Hence, it is possible that the limits of the reinsurance policy may get exhausted in the middle of the year. It is for this reason that reinsurance companies have started providing a feature called reinstatement in their policies.

Reinstatement means that once the limit of the insurance has been exhausted, it may be provided again to the policyholder in the same year. The purpose of this clause is to ensure that the ceding insurance company buying the reinsurance policy is not left without reinsurance at any point in time.

In order to make it financially viable for the reinsurer to provide this service, they are allowed to collect a reinstatement premium as well. The reinsurance company is allowed to decide this reinsurance premium and it can be significantly higher than the original premium which was used for providing the reinsurance policy.

How Does Reinstatement Work in Reinsurance?

The reinstatement feature works in many different ways. In some reinsurance policies, reinstatement is allowed only one time. Most reinsurance policies already include the cost of one-time reinstatement in their premiums upfront.

Hence, ceding insurers do not have to pay the reinsurance premium for the first time. This is a market practice generally followed by most reinsurance companies. However, it may vary based on the individual policy being considered. For subsequent times, the ceding insurer may have to pay a premium. However, this will be considered to be a new insurance proposal and the reinsurance company may have the right to select or reject the proposal based on their risk tolerance at that point in time.

There are other policies in which the reinsurance company collects a larger premium upfront and provides the provision of unlimited reinstatements.

It is important to note that the reinstatement feature can have many variations. For instance, in some policies, the reinstatement feature will only kick in if the entire sum insured has been exhausted. Hence, if there is a sublimit in the policy for individual catastrophes like earthquakes and this sublimit has been exhausted, then it is possible that the ceding insurer may be left without a cover and that the reinstatement feature may still not kick in.

In other cases, the feature may kick in only if the sum assured has been exhausted by one particular event. If the sum insured has been exhausted by multiple events, then the reinstatement feature may not be applicable in such cases. This can be particularly problematic in cases like property insurance where a natural calamity like a flood or natural disaster could cause huge losses and the reinsurance cover may be exhausted.

After this, the ceding insurer may still be left with the claims which arise out of the normal course of business and may have to pay them out of their pocket. In such cases, the definition of a single event and the number of hours that are allowed to be covered become important features of the reinsurance policy. However, most property insurance-related reinsurance contracts are unlikely to have a per occurrence-based reinstatement clause.

Applicability to Reinsurance Contracts

It is important to note that the reinstatement feature in reinsurance policies may not be applicable to all types of insurance contracts. It is generally applicable only to reinsurance contracts built on the excess of loss principle. If the reinsurance contract has been drawn up on a proportional basis, then this feature may not be applicable. Hence, the reinstatement feature also tends to influence the type of reinsurance policies that are commonly selected by the ceding insurance companies.

Calculation of Reinstatement Premium

The calculation of reinstatement premiums can be very different in different reinsurance policies. In some cases, the reinstatement premium may be calculated before the policy has been issued and may be included in the original premium. In such cases, the reinsurer does not have any idea about the risk that they might face. Hence, the premium calculation is done in aggregate based on statistical data on risks faced by reinsurance companies in the past.

In other cases, a reinstatement premium may have to be paid when the original limit of the reinsurance policy has been exhausted. In such cases, the reinsurance company has the data related to the particular risks they are facing. Hence, the reinsurance company will consider the individual factors of the policy being considered for reinstatement and calculate the premium based on the individual risk factors. From an underwriting point of view, this approach helps the reinsurance company make a better decision and avoid losses.

The bottom line is that the reinstatement feature is a very important part of any reinsurance policy. It is important for the reinsurance company as well as the ceding insurer to know exactly how the reinstatement feature in their policy works. The inability to understand the same could have a significant impact on both parties.

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