The Purpose of reinsurance is to provide coverage to the direct insurer (the re insured) for losses that it may incur from the policies it underwrites. However, like anything else, this “coverage” can be exhausted. In Non-Proportional reinsurance for example, the cover provided decreases by the amount of loss that the direct insurer recovers from it’s reinsurers. What happens then if the original limit of cover is used up?, the reinsured will have no cover left for any further losses. To manage such, reinsurers will allow the reinsurerd to have the original limit reinstated once it is fully or partially used up by a loss.

Reinstatement can either be limited or unlimited and can also be free or come at cost. When the reinstatement is at a cost, the additional premium paid is known as a reinstatement premium.

According to the Merriam Webster Dictionary, to reinstate simply means to place something back to its former condition or position. For example, laws and policies by a government or parliament can be reinstated. With Reinsurance, coverage provided can be reinstated. We know that in Non-Proportional Reinsurance, the reinsurance structure is arranged as “Cover Limit Xs Priority. The Cover limit is amount of cover that Reinsurer offers the reinsured for each loss, the priority on the other hand is the amount for each and every loss that the reinsured bears on its own. More or less like the excess/deductible in an insurance policy.

When the direct insurer incurs a loss under a primary policy covered by the program, it retains its share of the loss equivalent to the priority and recovers the balance of that loss from the XL reinsurers.

Consider the Example below:

XYZ Insurance company has an 80,000,000 Xs of 20,000,000 per Risk Excess of Loss Reinsurance program for its Accident and Liability Classes of Business. Supposing it incurs a liability claim of 40,000,000, it retains 20,000,000 of the claim and recovers the other 20,000,000 from the reinsurers.

After the recovery, the cover available reduces by the amount of loss paid by the reinsurers. In this case, the cover reduces from 80,000,000 to 20,000,000. If we have more these claims, the cover will keep on reducing until eventually everything is used up.

We can see from the figure above that after claim 3, the available cover limit is only 20,000,000. With Claim No. 4, the reinsured is only able to recover up to a maximum of 20,000,000, this means that from the claim of 45,000,000, the reinsured would have to bear the priority of 20,000,000 and additional un-reinsured loss of 5,000,000

It is difficult to know with certainty how much cover you will need in any given reinsurance period, even with available loss history, reasonable projections of required cover can be easily be understated because, you definitely cannot know how many claims you will get in a given period and of what the magnitude of the claims will be.

To negate such scenarios, reinsurers include a provision to reinstate the initial cover purchased each time it is used up by a loss. But of course, the offer is not free. To have the cover reinstated, a Reinstatement Premium is paid.

The Treaty will of course state the number of reinstatement’s that the reinsurer is wiling to offer. For example; One Reinstatement at 100% additional Premium, or 2 Reinstatements at 100% additional premium etc. Some reinsurers can even give un-limited Reinstatements for free.

Going back to our previous example above, a per Risk XL of 80,000,000 Xs 20,000,000 with one reinstatement at additional premium would mean that ABC has an additional cover of 80,000,000 from which it can use to bring back the original cover limit to its full amount when it is either partially or fully used by a loss.

Confusing? Think of it this way. Joseph has a stall in the market from which he sells oranges. This particular Market day, he has a sack full of 100 oranges which he intends to sell. Given the size of the display table in his stall, he can only display up to 50 oranges at a time. He gets out the first 50 oranges and displays them for customers to buy. The first customer passes by and purchases 10 oranges. From the 50 which he had arranged for display, he now has only 40 remaining. Joseph picks up 10 oranges from the sack and adds them to the 40 on display to bring the total number to 50. He keeps doing this every time a customer purchases until eventually all the oranges are sold.

Let us consider the detailed example below to throw more light into how reinstatements work.

ABC Insurance Company has a Per Risk Excess of Loss Program of 80,000,000 Xs 20,000,000 with one reinstatement. During the reinsurance period, there are five claims 1,2,3, 4 and 5 as shown in the figure below. How will the reinstatement’s be done?

From Claim 1: ABC retains the deductible of 20,000,000 and recovers 20,000,000 from its reinsurers. After recovering this much from the XL program. The amount of cover available for ABC to utilize reduces from 80,000,000 to 60,000,000.00. But recall that it has a reinstatement cover provision of 80,000,000 available for it to use. So using that, ABC utilizes 20,000,000 out of the 80,000,000 available to reinstate its original cover back to 80,000,000.00. As a result, the original cover goes back from 60,000,000 to 80,000,000.

With the original cover reinstated back to 80,000,000, the reinstatement cover available drops down to 60,000,000.

For Claim 2: ABC retains its deductible of 20,000,000 and recovers 10,000,000 from its XL program and just like we saw for claim 1, the reinstatement cover drops from 60,000,000 to 50,000,000.00

The same happens for claim No 3. However, after this claim, the amount of cover available for reinstatement has now dropped to only 20,000,000

Now this is where this gets interesting. Claim No. 4 is 45,000,000, of this, ABC retains its deductible of 20,000,000 and recovers only 25,000,000 from the reinsurer. After it makes this recovery, its reinsurance cover drops from the 80,000,000 to 55,000,000. So ordinarily, we would expect that ABC would reinstate the amount of loss i.e. the 25,000,000 so as to bring the cover back to 80,000,000 but this is not the case

Why? Because, the only amount of cover it has in its reserves to reinstate the loss amount is 20,000,000. So instead of reinstating the 25,000,000, ABC reinstates only 20,000,000 of the loss which then brings back the original cover limit from 55,000,000 to 75,000,000

The Reinstatement cover available is now fully used and since any further loss will not be subject to reinstatements, ABC will have to use the available cover that is left without any further reinstatements until it is used up entirely.

I had earlier mentioned that the reinstatements usually come at an extra cost called the reinstatement premium (R.P).

There are two ways in which the reinstatement premium is calculated;

Reinstatement at Pro-rata as to amount Reinstatement at Pro-rata as to time.

Reinstatement @ Pro-rata as to Amount: – with this method, the reinstatement premium is calculated basing only on the size of the loss.

Reinstatement Premium= (Loss to the Reinsurer/Cover limit) *Reinsurance Premium

The Treaty agreement will usually state the % of additional premium on which the reinstatement premium should be calculated. It could be 100%, 70% or even 50%. If it is 100%, then that percentage of the reinsurance premium charged will be used in the calculation of the reinstatement premium, if it is 50%, then only 50% of the reinstatement premium will be used and so on.

Consider the Example Below;

Using the example above, assuming the premium charged for the cover was 6,000,000 and the treaty allowed 1 reinstatement prorata as to amount at 80% additional premium, then the reinstatement premiums will be calculated as below;

The Reinstatement premium should only be calculated on that amount of loss that is reinstated back to the treaty. You cannot expect the reinsurer to pay reinstatement premium for the amount of cover he hasn’t reinstated. A case in point is claim No. 4. The Amount recovered from the reinsurer was 25,000,000 but since only 20,000,000 was reinstated (because that was what was available), the Reinstatement Premium will be calculated on the 20,000,000

The Reinstatement Premium is deducted from the Amount recoverable from the reinsurer. As such, the amount the reinsurer pays for the loss is net of the reinstatement premium. e.g. for Claim No.1, the Net Amount Recoverable from the reinsurer will be 20,000,000-1,200,000 = 18,800,000

The Same would apply for claims 2,3 and 4.

Reinstatement @ Pro-rata as to time: – With this method of calculation, premium is calculated basing on the siz3e of the loss and prorated for the number of days from the occurrence of the loss to the expiry of the treaty.

Reinsurance Premium = (Loss to the Reinsurer/Cover Limit) * No of days from date of loss/365*Reinsurance Premium.

From our previous example, the dates of occurrence for each of the losses is given in the table below.

The Reinstatement Premiums for each of the claims would be calculated as per the figure below;

If you look closely at the reinstatement premiums calculated from both methods, you will notice that the Premium Calculated from the pro-rata as to time method are much lower than that from the prorate as to amount method;

This is because the prorate as to time method goes ahead to incorporate the time element for the loss in its calculation. As a matter of preference, this method is considered unfair to the reinsurers and is hardly used.

During the reinsurance period, the reinstatement premium is calculated based on the minimum and deposit premiums determined at the beginning of the year. At the year’s end, the reinstatement premium will be calculated using the final reinsurance premium and the required adjustment premiums paid.

Please find attached below a reinstatement template which is useful to calculate the reinstatement premium for treaties with 1 or 2 layers. Feel free to contact me on LinkedIn (https://www.linkedin.com/in/toderitaalin/), Twitter or via e-mail (alin.toderita@gmail.com) for further information.