Reinsurance is classified as proportional and non-proportional reinsurance. Non-proportional reinsurance name itself indicates the meaning that is it’s not proportional to the reinsurer. Non-proportional reinsurance is an arrangement in which a reinsurer makes payments to an insurer whose losses shall exceed a predetermined retention level. Non-Proportional Reinsurance are mostly facultative or automatic. Non-Proportional Reinsurance is a scheme by which the reinsurer pays only when losses are over an agreed-upon sum. Non-Proportional Reinsurance the reinsurance protection will cover the amounts more than certain pre-defined limits, rather than splitting individual claims in given percentages. Examples of Non-Proportional Reinsurance include Stop Loss and Catastrophe excess of loss cover etc. Non-Proportional Reinsurance is becoming more and more popular nowadays. The three major pricing techniques to determine the sufficient premium for non-Proportional Reinsurance are Exposure Rating, Burning Cost, and Pareto Model.
So a Non-Proportional Reinsurance is a type of reinsurance where the reinsurer does not share same proportions of the premiums earned and the claims which are incurred by the reassured and certain associated expenses. Excess of lass is an example for Non-Proportional Reinsurance. There is no direct sharing of risk in this place.
This type of reinsurance will respond to losses that the insurer suffers and such losses must exceed an amount that is fixed. This is called retention or priority. For example here is a similar situation where insurer is ready to concur to a loss of $1 million for any loss which may happen and they buy a layer of reinsurance of $4 million in excess of $1 million. If a loss of $3 million happens, the insurer will have to pay the $3 million to the insured, and then recover $2 million from its reinsurer. In the given example, the losses above $5 million will be retained by reinsured in case they an excess layer is not purchased by them as second layer for another amount or excess amount. There are mainly two types of non – proportional insurance and they are stop loss and excess of loss.
One way of looking at this type of reinsurance is to ignore the individual risks and consider the portfolio as a impending producer of claims. As an alternative of sharing risks between the direct insurer and reinsurer according to amount insured, claims are to be shared. The liability of the direct insurer is capped at a convinced sum. This is known as the deductible. The reinsurance pays whatever which will exceed this amount.
This form of reinsurance can be used at one extreme to cover comparatively small, high frequency losses or at the other hand it can be used for rare catastrophic events and amid these two extremes there is a wide choice of alternative possibilities.
Thus non proportional reinsurances are the best instruments for businesses which are a bit risky. This can be really useful for the companies with a variety of portfolios too.