Question

1. What type of reinsurance contract is represented by the illustration above?

2. Describe 2 possible loss scenarios that could be covered by this type of reinsurance contract.

3. If a $10 million covered loss occurs, how much will the primary insurance company pay to its insured(s)? Ignore any deductibles. Show and explain your work.

4. If a $10 million covered loss occurs, how much will the reinsurer reimburse to the primary insurance company? Show and explain your work.

5. If a $25 million covered loss occurs, how much will the primary insurance company pay to its insured(s)? Ignore any deductibles. Show and explain your work.

6. If a $25 million covered loss occurs, how much will the reinsurer reimburse to the primary insurance company? Show and explain your work.

Answer 1

This reinsurance contract is called Top and Drop in which the reinsurance is split in smaller layers and in an event the top layers which are not breached can be reused for subsequent events.

Two loss scenarios are as follows

1) If loss is $150 m, it breaches the top layer. Therefore, this amount is settled but there is no cover for  subsequent events

2) I loss is $25 m, it breaches only the first layer after retention. In this case, the claim of $25 m is settled and $ 127.5 m is available for subsequent events

In the case of loss of $10m, it does not breach the retention layers. So,

- Primary Insurance Company pays $10 m

- Reinsurance Company pays $0

In the case of $25 m loss -

- Primary Insurance Company pays = $10 m + 5% of $(25-10) m = $ 10 m + $0.75 m = $10.75 m

- Reinsurance Company pays = 95% of $(25-10) m = $14.25 m

Here, 95% placed means that primary insurance company would be paying 5% of the losses in excess of 10 m