Chapter 2

Insurance and Risk

After studying this chapter, the student has to able to answer the following
questions:
 What is the definition of insurance?
 what do you mean Adverse Selection and Insurance
 Explain the comparison between Insurance and Gambling
 Explain the comparison between Insurance and Hedging
 Explain, in detail, what are the requirements of risk in order to be insurable?
 Explain, in detail the different types of insurance?
 What is difference between private insurance and social insurance?
 Discuss the difference types of property and liability insurance.
 What are the benefits of insurance?
 Define Reinsurance, and then indicate its benefits and its types in detail.

2.1- Definition of insurance

Insurance is a complicated and intricate mechanism and it is consequently difficult
to define because many authors have concerned with insurance. So, there is no
single definition of insurance but there are many definitions for example.
 Vaughan E. and Vaughan have defined insurance "An economic device
whereby the individual substitute a small certain cost (premium) for a large
uncertain financial loss (the contingency ‫الحادث‬insured against) that would
exist if it were not for the insurance."
 Rejda. G: has defined insurance "The pooling of fortuitous losses by
transfer of such risks to insurers, who agree to indemnify insureds for such
losses, to provide other pecuniary benefits on their occurrence, or to render
services connected with the risk".
 Crane, F.G: has defined insurance "A system of handling risk by
combining many loss exposures units, with the costs of losses being shared
by all of the participants."
A brief survey of the previous definitions reveals differences of opinion among
authors concerning how the insurance should be defined. The definition of
insurance should take into consideration the following elements:
 The general form of insurance as a system.

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  The main purpose of insurance. That is, reducing risks.
 The essential mean for realizing the main purpose of insurance. That is,
paying indemnification if a loss occurs.
 The parties of insurance contract i.e. insurer and insured.

Hence, from our viewpoint : Insurance may be defined as "A system of handling
risks is designed by insurer for reducing risks by combining( pooling ) many
loss exposure unites and to agrees to indemnify the insureds' losses in exchange
of the premiums that are paid by insureds(participants in the system) "

2-2 Basic Characteristics of Insurance

Based on the preceding definition, insurance has 4 characteristics, they are
2-2-1 Pooling of losses: Pooling or the sharing of losses is heart of
insurance

– Pooling involves spreading losses ‫نشر أو توزيع الخسائر‬incurred by

the few over the entire group, so that average loss is for Actual loss.

– In addition, pooling involves the grouping of a large number of

exposure units, so that the Law of Large Numbers can operate to
provide a substantially accurate prediction of future losses.

– Risk reduction is based on the Law of Large Numbers

What the meaning of Law of Large Numbers

•
Law of Large Numbers means, the greater the number of exposures, the
more closely will the actual results approach the probable (expected)
results that are expected from an infinite number of exposures.

Example in class?

Notice : large numbers of exposure units in Pooling should be similar ,

but not identical , and subject to the same Perils

Pooling implies 1- sharing of losses by the entire group

2- Prediction of future losses with the some accuracy
based on the law of large numbers
 The purpose of Pooling is to reduce the variation in possible
outcomes as measured by the standard deviation as indicated in
the following example :-

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 • Example of Pooling: (Explain ?)
– Two business owners own identical buildings valued at $50,000
– There is a 10 percent ( 10 % ) chance each building will be destroyed
by a peril in any year( i.e. fire)
– Loss to either building is an independent event
–
1. Now we can calculate both Expected value and standard
deviation of the loss for each owner (one individual) as follows: -
Solution

1- Without pooling

Expected loss 0.90 * $0  0.10 * $50,000 $5,000

Standard deviation  0.900  $5,000   0.10$50,000  $5,000 
2 2

 $15,000
That is for one individual

2- With pooling
As well , both Expected value and standard deviation of the loss for 2 owners (2
individual) can be calculated as follows: -
2. But, for 2 individuals( 2 Buildings)
a. If the owners instead decide to make a pool (combine) their
loss exposures, and each agrees to pay an equal share of any
loss that might occur:
b. As additional individuals are added to the pool, the standard
deviation continues to decline while the expected value of
the loss remains unchanged , by looking this scenario ( 4
probabilities) i.e no building destroyed, one destroyed from
2 , and 2 building destroyed

Expected loss  0.81* $0  0.09 * $25,000  0.09 * $25,000  0.01* $50,000

 $5,000

Standard deviation  0.810  $5,000  (2)(0.09)$25,000  $5,000  0.01($50,000  $5,000) 2

2 2

$10,607
So,
– As additional individuals are added to the pool, the standard deviation
continues to decline while the expected value of the loss remains unchanged
Conclusion

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Hence, the pool reduce the variation in possible outcomes as measured by the
standard deviation

2-2-2 Payment of fortuitous losses ( ‫ )تصادفية اى غير متوقعة‬fôrˈto͞ oədəs

A fortuitous loss is one that is unforeseen, unexpected, and occur as a
result of chance. That is, loss must be accidental. Insurance is based on
the law of large numbers, and this law is based on the assumption that
losses are accidental and occurs randomly. Consequently, the losses
would be fortuitous.

2-2-3- Risk transfer

Risk transfer means that a pure risk is transferred from the insured to the
insurer, who typically is in a stronger financial position to pay loss than
the insured.
Example premature death, disability, theft ------ etc

2-2-4- Indemnification = compensation

Indemnification means that, the insured is restored to his or her approximate
financial position prior to the occurrence of the loss
Example If your home burns in a fire, and you have homeowner policy. That
policy will indemnify you or restore you to your previous position.

2-3- Characteristics of an Ideally Insurable Risk (Requirements of an Insurable Risk)

Private insurers insure only pure risks. However, some pure risks are not
insurable. So, we ask this question. Are all pure risks insurable by insurance
companies?
The answer in effect, insurance is not always available as a method of handling
risk. That is, some risks are insurable but others are not. We have already seen that
only pure risks can be covered by insurance but other speculative risks are not
insurable. So, may be some persons ask this question. What are the requirements
that distinguish insurable from non-insurable risks?
The answer, the requirements(Characteristics ) that must generally be met if a risk
is to be insurable in the private insurance market are:
 The number of similar loss exposure unit must be large
That is, There must be Large number of exposure units, to predict average loss based
on the law of large numbers
 The loss that occurred must be fortuitous
That is, the loss should be accidental and unintentional, to assure random occurrence
of events

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  The loss must be definite, measurable, and important
That is, the loss should be Determinable and measurable, to determine how much
should be paid
 The loss must not be catastrophe
That is, the large of exposure units should not occur at the same time, to allow the
pooling technique to work

Notice : Exposures to catastrophic loss can be managed or solved by

using 1- reinsurance, 2- dispersing coverage ‫ انتشار التغطية‬over a large
geographic area, or using financial instruments, such as catastrophe bonds
 The probability distribution of losses must be determinable. That is, chance of
loss should Calculable , In other words, insurance company should be able to
calculate both frequency of loss and severity of loss of future losses with some
accuracy. This requirement is very necessary for calculating a proper
premium.

The latter should be sufficient to pay all claims and expenses besides a profit
for insurance company
 The premium should be economically feasible
That is , The insured must be able to pay premium . In other words, For insurance
to be an attractive purchase, the premiums paid must be substantially less than the
face value, or amount of the policy because in this case the people can afford to
purchase the policy

In conclusion, all pure risks (personal risks, property risks, liability risks) can be
insured by insurance companies, because the ideal requirements for insurability
generally can be met. In contrast market risks (i.e. fluctuations of prices- Change
in consumer tastes); political risks (i.e. war) and financial risks are usually
uninsurable by insurance companies or in other words, they are difficult to insure.

In order to understand more clearly you can look at the previous requirements for
risk of fire as an Insurable Risk as indicated in the following figure 2.1

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 Figure 2.1 Risk of fire as an Insurable Risk

As well, look at the previous requirements for risk of unemployment as an

Insurable Risk as indicated in the following figure 2.2, you will find the risk of
unemployment does not completely meet requirements because of the different
types of unemployment and labour .

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Figure 2.2 Risk of unemployment as an Insurable Risk

2-4- Adverse Selection and Insurance

When the insurance is sold, insurers must deal with the problem of Adverse
Selection . So what is Adverse Selection?
The answer is : “Adverse selection is the tendency of persons with a higher-
than-average chance of loss to seek insurance at standard rates “
Examples
1- High risk drivers who seek auto insurance at standard rates
2- Persons with serious health problems who seek life or health insurance at
standard rates
3- Business firms that have been repeatedly robbed or burglarized seek crime
insurance at standard rates .

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 So this problem (adverse selection) ,If not controlled by underwriting, will
results in higher-than-expected loss levels.

Hence, insurance companies try to control Adverse selection by:

– careful underwriting (selection and classification of
applicants for insurance)
- policy provisions (e.g., suicide clause in life insurance)
2-5- Insurance and Gambling compared
In order to make comparison between Insurance and Gambling listen to this
Example in class ? Explain
Gambling Two horses (or camels)
Insurance Fire insurance
After that, we can explain the confusion between Insurance and Gambling by the
following comparison
Insurance
• Insurance is a technique for handing an already existing pure risk( i.e. fire risk)
• Insurance is always socially productive ,because both parties have a common interest
in the prevention of a loss
• Insurance restore the insured financially in whole or in part if a loss occur
Gambling
• Gambling creates a new speculative risk
• Gambling is not socially productive ,because The winner’s gain comes at the expense of the loser
• Gambling generally never restore the loser to his former financially position.

2-6- Insurance and Hedging compared

We can make comparison between Insurance and Hedging as follows:-
Insurance
• Pure Risk is transferred by a contract because the characteristics of insurable risk
generally can be met.
• Insurance involves the transfer of pure risks(insurable)
• Insurance can reduce the objective risk of an insurer by application of the Law of Large
Numbers

Hedging
• Risk is transferred by a contract, but the risk here is a speculative risk, that may be
uninsurable ( i.e. protection against a decline in the price of agricultural product )
• Hedging involves risks that are typically uninsurable i.e a speculative risk
• Hedging does not result in reduced risk where the risk of adverse price fluctuations is
transferred to speculators who believe they make a profit because of superior knowledge
of market conditions.

2-7- Types of Insurance

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Some of institutions for insurance are private organizations and some others are
governmental organizations. Consequently, insurance may be classified into many
classifications. So, there are several ways in which the various kinds of insurance
can be classified, they are:
The first method: Insurance may be divided into personal or commercial insurance
depending on protecting individuals or protecting organization.
The second method: Insurance can be divided into voluntary or involuntary,
depending upon whether or not it is required by law.
The third method: Insurance may be divided into types that protect against loss of
income. That is life – health insurance (such as death, or disability, or
unemployment) and the types that pay for damage to property. That is property
and liability insurance.
The fourth method: Insurance can be classified into private insurance or
governmental insurance (i.e. social insurance).
In fact, the previous classifications of insurance may differ from country to other.
So, there is no single criterion that can be used to distinguish private insurance
from governmental insurance.
For example. In United States of America, some types of insurance are sold by
government and not all compulsory is governmental insurance (i.e. social
insurance).
From our viewpoint,
The practical classification of insurance can be classified as indicated in figure
(2.3).
Figure (2.3) classification of insurance

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Hence, we can shed light upon the preceding classification in brief as follows:-
2.7.1-Private insurance is insurance which is furnished by insurance companies,
as shown by figure (2.3). It consists of two main fields; they are life insurance and
general insurance which called Property and liability insurance or Property and
casuality insurance. These fields are available to individuals and organizations,
so, they are voluntary.
Insurance companies provide two types of coverage life insurance and Property
and liability insurance ( Property and causality insurance )
2.7.1.1 Life insurance comprises two coverages life insurance policies and life
annuities policies
2.7.1.1 Life insurance policies deal with death risk of insured died. Upon the death
of insured person, insurance company pays a sum insured to a designed person
called the beneficiary. Furthermore, the death benefit may be designed to pay for
funeral expenses, uninsured medical bills and other expenses because of death.
2.7.1.2 Life insurance annuities policies concern the risk of living to an old age.
This policies cover survival risk either for a limited period (for example, up to age
of pension) or over life time.
2.7.1.3 Health insurance: This type of insurance covers medical expenses from
sickness. These expenses include doctor hospital bills, the cost of medicines,
private nursing care. Health insurance may also pay the income that an insured
person is unable to earn during period of disability.
2.7.1.2- Property and liability insurance (Property and casuality insurance)
Property insurance indemnifies property owners against the loss or
damage of real or personal property
Liability insurance covers the insured’s legal liability arising out of
property damage or bodily injury to others
Casualty insurance refers to insurance that covers whatever is not
covered by fire, marine, and life insurance

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Property and liability insurance consists of two main types the first is property
insurance and the second is liability insurance. These two types are further divided
into lines or classes. The major types of property insurance that are listed in figure
(2.3) can briefly be discussed as follows:
 Marine insurance is a broad line divided into ocean marine and inland
marine. Ocean marine covers ships or vessels and their cargo. But inland
marine covers goods being carried on land to and from ocean ports.
Moreover, inland marine covers cargo being shipped by air, truck or rail. In
addition this field has expanded to include a variety of other risks relate to
transportation. In addition, inland marine covers personal property range
from common household articles such as jewellery, furs to computer
systems.
 Fire insurance covers the loss or damage to real estate (house – factory –
store) and personal property because of fire, lightning. Moreover, fire
insurance may comprise other risks such as hail, vandalism and windstorm.
In addition, fire insurance may cover indirect loss including rent and profit
and extra expenses because of loss from interruption of business.
 Car insurance is considered the largest line in property insurance. Under the
car insurance, the available coverages include protection against legal
liability claims, payment of medical expenses, payment for theft or damage
to insured cars and protection against uninsured motorists.
 Burglary and theft insurance: this insurance covers the loss of property,
money, because of burglary, robbery, larceny.
 Home insurance: This insurance covers a lot of risks of the home such as
fire, lightning, explosion, windstorm, theft, riot, civil commotion … etc.
 Glass insurance: This insurance covers glass breakage in insured buildings
and stores.
 Boiler and machinery insurance: This insurance covers boiler turbines,
generators, and other power machines … etc.
 Aviation insurance: This insurance provides protection for all types of
aircraft and the passengers, besides cargoes being shipped by these aircrafts.
Finally , Property and casuality insurance coverages can be grouped into two
major categories as indicated in figure 2.4

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• Personal lines: coverages that insure the real estate and personal property of
individuals and families or provide protection against legal liability
• Commercial lines: coverages for business firms, nonprofit organizations,
and government agencies

Property and casualty insurance coverage (figure 2.4)

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 2.7.2-Governmental insurance is insurance which is written by governmental
institutions.. The governmental insurance may be classified into two types they
are: Social insurance and other governmental insurance( i.e Pension Institution)
• 2.7.2-.1 Social insurance Programs
• These programs are financed entirely or in large part by contributions from
employers and/or employees
• Benefits are heavily weighted in favor of low-income groups
• Eligibility and benefits are prescribed by statute
• Examples: Social Security, Unemployment, Workers Compensation.
It is worthwhile to mention that Major social insurance programs include the
following:
 Old age, Disability and premature death insurance.( i.e pension program)
 Health insurance
 Medicare
 Unemployment insurance
 Workers compensation insurance
The preceding social insurance programs may be shown in brief as follows:-
 Old age, Disability and premature death insurance: This insurance
provides pension for worker or employee if he or she arrived at age 60
years old, besides disability benefits for disabled workers, if they expose
to disability. Also, pension for survivors of deceased workers.
 Health insurance: The difference between health insurance under private
insurance program and its counterpart under social insurance program is to
be the first is voluntary but the latter is involuntary. The benefits may be
similar. Health insurance covers losses caused by either accident or illness.
 Medicare: This covers medical expenses of motherhood and childhood.
 Unemployment insurance: This insurance provides benefits to eligible
workers who experience short-term involuntary unemployment.
 Workers compensation insurance: This insurance covers workers against a
job-related accident or disability or disease.

2.7.2-.2 Other Government Insurance Programs

The government provides a variety of other forms of insurance in particular, for
poor people. For example, the governmental assistance for emergency
accidents (i.e. Flood in Jeddah ), and purchasing Vaccines for treating all
people inside Saudi Arabia.( i.e Vaccines for treating from CORONA)

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2.8-Benefits of insurance
In effect, the insurance has an essential benefit. It is the cooperation among
insureds that who expose to the same risk by sharing losses. Moreover, many
other benefits are provided by insurance. Some of these benefits are social and
some others are economic benefits. These benefits can be summarized in the
following points:
I) Reduction of uncertainty and worry: By insurance, the worry and fear may
be reduced whether before or after a loss:
o Persons insured for long-term disability do not have to worry about
the loss of earnings if a serious illness or accident occurs.
o Homeowners who are insured enjoy greater peace of mind because
they know; they are covered if a loss occurs.
o Family heads who have adequate sum insured of life insurance
policy, they are less worry about the financial security of their
dependents in the event if premature death.
As a result, a service is provided by insurance. It is reimbursing insureds for
economic aspects of losses.
II) Prevention of loss: In all forms of insurance, increasing emphasis is
placed on prevention of loss. Through improved construction, installation
of safeguards and rehabilitation, insurance companies have made
material contributions to society. Everyday insurance companies employ
a wide variety of loss prevention including safety engineers and
specialists in fire prevention, occupational safety and products liability
‫السلامة المهنية والمسؤولية عن المنتجات‬
Hence, we can say the prevention of loss in first instance is really the greatest
insurance as Benjamin Franklin mentioned "An ounce of prevention is worth
a pound of cure".
Property and liability insurers are ideally situated to pursue prevention of
loss activities. Some of these important activities include
 Prevention of Auto thefts
 Prevention of boiler explosions
 Fire prevention

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  Educational program on loss prevention
 Prevention and detection of arson losses.
Hence, many activities are made by insurers, through prevention services, to
make the need for indemnification as small as possible. So, these activities
reduce both the direct and indirect or consequential losses.
III) Indemnification for loss: In many forms of insurance, particularly in
property and liability indemnification permits, individual, families,
business firms and society to restored to their former financial position
after a loss occurs. Examples:
o If the individuals and families have insurance policies, they can
maintain their financial security if they have indemnification because
they are restored either in part or in whole after a loss occurs.
Moreover, they are less likely to apply for public assistance or to seek
financial assistance from relatives and friends.
o If the business firms collected indemnification. It also permits firms to
remain in business and employees to keep their jobs.
o Suppliers of firms will continue to receive orders and customers can
still receive the goods and services they desire.
Hence, the indemnification for loss contributes greatly to individuals,
family and business firm's stability and therefore is considered one of the
most important social and economic benefits of insurance.
IV) Insurance is a source of investment funds: It is worthwhile to mention
that insurance industry is an important source of funds for capital
investment and accumulation. That is due to premiums, which are
collected in advance of loss and funds not needed to pay immediate
losses. Consequently, a lot of these funds are invested in different
business.
For Example: (Rejda: 2001, P. 29)
 Structure of hospital and factories
 Housing developments
 Purchasing new machines and equipment
Hence, the investment funds increase society's stock of capital goods and
promote economic growth and full employment. Moreover insurance

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 companies, also invest in social investments, such as housing, banking, tourist
companies and other economic projects …. etc.
V) Enhancement of credit for persons and firms: In effect, insurance
enhances a person's credit and as well firms' credit. Insurance permits
person or firm to borrow a loan because it gives greater assurance that the
loan will be repaid. For example
o When a person purchases a house, the bank requires property
insurance policy on the house before the mortgage loan is granted.
The property insurance policy protects the bank if the house is
damaged or destroyed.
o When business firm seeking a temporary loan for seasonal business
may be required to insure its inventories before the loan is made.
o When a person purchases a car and financed by a bank. The latter
requires physical damage insurance on the car before the loan is made.

2.9-Reinsurance
As we have already mentioned the insurance is a system for reducing the risk for
insured. Also, Reinsurance is a system for reducing the risk for an insurer,
particularly, natural disaster, and commercial airline disasters. Hence, reinsurance
is a method by virtue of it an insurer transfer (buys insurance) rather than charges
risk (sell insurance). In effect, reinsurance expands risk sharing and makes the
insurance business more safety for both the original insurer and the original
consumer (insured).
The following questions may be raised about reinsurance:
1- What is reinsurance system and how reinsurance work?
2- What are the benefits of reinsurance?
3- What are the kinds of reinsurance?
2.9.1-Definition of reinsurance
Reinsurance is "an arrangement by which an insurance company transfer or shift
all or a part of its risk (insurance originally written) under a contract (or contracts)
of insurance to another insurance company.

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The company transferring the risk is called the ceding company or accepting
company and the company that accepts part or all risk (from the ceding company)
is called reinsurer.
By contemplating the arrangement between the ceding company and the reinsurer
company we notice that:
 The first company purchases insurance protection from the second company.
 The second company assumes responsibility for part of losses under an
insurance contract or may be assume full responsibility for the original
insurance contract.
 Reinsurance involves risk transfer from party to another.
 Reinsurance distributes the losses between two parties (the ceding company
and reinsurer).
Notice: The amount of insurance retained by the ceding company is called the
net retention or retention limit. But, the amount of insurance ceded to the
reinsurer is called the cession.

2.9.2-Benefits of reinsurance
In effect, reinsurance has many benefits whether for companies (ceding company –
reinsurer) or original insured or agent. These benefits may be summarized as
follows:
1- Reinsurance increases the financial stability of insurer by spreading risk and
therefore the insurer will be able to pay its claims.
2- Reinsurance facilitates placing large exposure unit with one company and
consequently, it reduces the time spent for seeking insurance and it
eliminates the needs for numerous policies to cover one exposure unit.
3- Reinsurance help small insurance companies to stay and to continue in
business, thus increasing competition in insurance industry.
4- Reinsurance increases insurance company's underwriting capacity.
5- Reinsurance stabilizes profits because; the insurer may wish to avoid large
fluctuations (as a result of social and economic conditions, and disasters) in
annual financial results.

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 6- Reinsurance provides financial protection against a catastrophic loss because
of natural disaster, industrial explosions, commercial air lines disasters …
etc.
2.9.3-Kinds of reinsurance
In fact, Reinsurance may be classified into three kinds (see figure 3.2). They are
i) Facultative reinsurance
ii) Treaty reinsurance
iii) facultative treaty reinsurance
Furthermore any type of the previous three types may be further classified as
proportional or no proportional.
1-Facultative reinsurance
Facultative reinsurance is an arrangement between the original insurer (the ceding
company) and the reinsurer by which every party retains full decision making
powers with respect to each insurance control. That is, for each insurance contract
is issued, the original insurer decides whether or not to seek reinsurance and in the
same time, the reinsurer retains the flexibility to accept or refuse each application
for reinsurance on a case by case basis.
By contemplating the Facultative reinsurance, we may say it has some advantages
and some disadvantages, they are:
Advantages of Facultative reinsurance:
 It is used when a larger amount of insurance is desired.
 It has flexibility because a reinsurance contract can be arranged to fit any
case.
Disadvantages of Facultative reinsurance:
 It is uncertain because the ceding company does not know in advance, if the
reinsurer will accept any part of the insurance.
 It needs time, because, the policy will not be issued until reinsurance is
obtained.
2-Treaty reinsurance
Treaty reinsurance is an arrangement between the original insurer (the ceding
company) and the reinsure by which, the original insurer is obligated automatically
to reinsure any new underlying insurance contract and the reinsurer is obligated to
accept certain responsibilities for specified insurance.

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By contemplating the treaty reinsurance, we may say it has some advantages and
some disadvantages.
Advantages of Treaty reinsurance:
 It is automatic and no uncertainty or delay, in particular to the ceding
company.
 It does not need time, so there no delay for writing the treaty between the
ceding company and reinsurer.
Disadvantages of Treaty reinsurance:
 It is unprofitable to the reinsurer, in particular, if the ceding company has
written bad business and then reinsures it.
 The premium received by the reinsurer may be inadequate, in particular, if
the ceding company has accepted risks by inadequate rates.
Treaty reinsurance can be arranged by several types, including:
 Quota-share treaty: by virtue of this treaty both the ceding company and
reinsurer agree to share premiums and losses based on a prespecified
percentage (for example 60%).
 Surplus-share treaty: by virtue of this treaty the reinsurer agrees to accept
amount of insurance in excess of the ceding insurer's retention limit, up to
some maximum
For example: Given that ABC insurance company has homeowner policy at
sum insured 500000 S.R and it has surplus –share treaty with Spanish
reinsurance company. Assume that ABC insurance company has retention
limit 100,000 S.R (retention limit = line = 100,000). It takes the first 100,000
S.R of homeowner insurance policy or one fifths and Spanish reinsurance
company takes the remaining 400,000 S.R or four –fifths.
So, if the premium income equals 5000 S.R and the loss 10,000 S.R.
According to the surplus share treaty the premiums and losses can be
distributed as follows:
500,000 S.R policy
ABC insurance company 100,000 (on line) = (1/5)
Spanish reinsurance company 400,000 (4 on line) = (4/5)
5,000 S.R premium income
ABC insurance company 1,000
Spanish reinsurance company 4,000
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 10,000 S.R loss
ABC insurance company 2000 (1/5)
Spanish reinsurance company 8000 (4/5)
 Excess of loss treaty: By virtue of this treaty, the reinsurer is required to
accept amount of insurance that exceed the ceding insurance company's
retention limit
For example:
Given that Misr insurance company wants protection for all Egyptian airline
disaster losses in excess of 5 million Egyptian pounds. Assume that excess
of loss treaty is written with Swiss reinsurance company to cover single
occurrences during one year. According to this treaty, Swiss Reinsurance
Company agrees to pay all losses exceeding 5 Million Egyptian pounds, but
only to a maximum of 10 Million L.E. Hence, if an Egyptian aircraft had
exposed to crash and loss 20 Millions ; Swiss Reinsurance Company will
pay 5 Million L.E

 Reinsurance Pool: By virtue of this treaty, two or more than two insurers
may agree altogether to establish an organization of insurers for
underwriting insurance on a joint basis.
This reinsurance pool can be formed, if there is a group of insurers would
like to combine their financial resources to obtain the necessary capacity.
For example:
A reinsurance pool for aviation insurance can provide the necessary capacity for
covering the hull of aircraft and liability loss on a commercial jet that exceed 600
million S.R if the jet should crash. Also a reinsurance pool for marine insurance
can provide the necessary capacity for covering vessels and their cargo loss, if
vessel exposed to drowning.
A notice: Sharing losses and premiums varies depending on the type of
reinsurance pool.

3-Facultative treaty reinsurance

By virtue of this treaty, the ceding company is obligated to reinsure specified
contract (like treaty) while the reinsurer has freedom to decide whether to accept or
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reject reinsurance on each contract (like the facultative). Alternatively, this treaty
as well, means the ceding company may give the option to reinsure but the
reinsurer should automatically accept all contracts offered for reinsurer.

Reinsurance

Facultative
Facultative Treaty Treaty
Reinsurance

Quota share Surplus share Excess of loss Reinsurance pool

Figure (2.5) Kinds of Reinsurance

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