It is extremely rare for a ceding company to place a treaty with only one reinsurer, for this would be to entrust too great a responsibility to one undertaking. It is therefore customary to arrange a treaty so that a number of reinsurers share in it, each accepting only a proportionate part of the business ceded.
There are three kinds of reinsurance treaty in general use : Quota-share or Open Treaties ; Surplus Treaties ; and Excess of Loss Treaties.
A quota-share treaty is one under which the ceding company agrees to cede a fixed share of every risk which it accepts from its clients. There is a necessary tendency for reinsurance business to comprise risks of a second class nature, since the better the risk the more the ceding com pany keeps for itself. But in a quota-share treaty this feature is not present. Every risk must be reinsured, whether it be good or bad, large or small. For this reason the quota-share treaty is not greatly used, except by small companies, which can obtain sound reinsurance cover only by offering attractive terms.
The surplus treaty is that in common use. Under this the ceding company first fixes the amount it will keep, which is called its retention, and the remainder of the amount insured constitutes the surplus. This is divided amongst the treaty reinsurers according to their due proportion. The whole surplus is usually divided into percentages, each reinsurer taking 1% or more as agreed of every surplus. But the amount which can be ceded is always governed by the ceding company's reten tion.
An excess of loss treaty is an agree ment under which no part of any individual risk is reinsured, but the ceding company arranges to cover only the excess of any one loss over and above an agreed figure. This is a treaty to guard against catastrophe. A ceding company may arrange to cover itself by reinsurance against the excess of loss over £50,000 in respect of any one fire, the cover to run, say, up to L 1 oo,000 ; i.e., a further L5o,000. Then if one fire results in a loss to that com pany of L5o,000, or less, the reinsurers pay nothing, but if the cost of the fire exceeds that figure the reinsurers pay the amount of the excess, according to their agreed proportions. This kind of
treaty is largely used in motor insurance; but in fire insurance its use is a modern development. In that branch it is operated independently of and in addition to the surplus treaty. The ceding company must still use its surplus treaty to limit its liability on individual risks, taking out an excess of loss cover only to protect itself against heavy conflagrations.
The conditions applying to a reinsurance are, as a rule, the same as those which apply to the original insurance. Thus the reinsurer receives the same rate of premium and must pay its proportionate share of any claim. There are, however, exceptions to this rule. Under an excess of loss treaty the reinsurer receives no specific premium, but is paid a percentage of the total premium income derived by the ceding company from the class of business to which the treaty applies. In marine reinsurance there is a practice to reinsure risks which are affected by a possibility of loss, and in such cases much higher premium may be paid than under the original policy.
The share of premium payable to the reinsurer is subject to a deduction of commission, which varies from 2o% to 35% or, in rare cases, 40% or 45%. Reinsurance commission has to cover not only the agent's commission paid on the original insurance, but also a part of the ceding company's expense of obtaining and dealing with the business. The rate of reinsurance commission depends partly on the level of the expense of dealing with the business and partly on the quality of the treaty. Treaties giving consistently good results can command better terms than poor treaties. As well as commission deducted from premium, the reinsurer has to pay a commission—usually o%—on the profits. In this way the profitable treaty automatically receives better terms than the bad one. The profit on a treaty is computed after making due provision for all claims and liabilities outstanding at the end of the year. The commission is payable on the average of the profit of the year of account, and of the two preceding years, so that a reinsurer shall not be required to pay away part of its profits in a year which follows a year showing a heavy loss.