Types of reinsurance methods and loss sharing in Japan's 2011 earthquake

¶ … Reinsurance

For many people, the field of insurance can be very confusing. This is because these organizations will often engage in activities that are designed to reduce risks. Recently, there have been a number of incidents that have led to an increase in liabilities for these firms. The thesis statement will focus on the four different types and the impact of a large natural disaster (i.e. The Japanese tsunami of 2011).

The purpose of this assignment is to understand the strategies that reduce risks and the way they are utilized. This will be accomplished by focusing on: reinsurance methods for sharing in the losses, the excess of loss treaty, the quote share treaty, facultative reinsurance, the surplus -- share treaty and the methods used after the Japanese tsunami. Together, these factors will explain the different tactics utilized in reducing risks and dividing the liabilities among various firms. ("Definition Reinsurance," 2013)

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Reinsurance methods for sharing losses

There are four basic methods that are used for sharing in losses these include: the excess of loss treaty, the quote share treaty, facilitative reinsurance and the surplus -- treaty share techniques Each one of these areas is providing carriers with different strategies they can use to reduce risks .(Wollan, 2002)

Excess loss of treaty

The excessive loss of treaty is specifically based upon a predetermined figure. This is designed to make the entire liability less by having each carrier responsible for a specific amount. In general, this is a normal strategy that is used by the majority of carriers to reduce risks. (Wollan, 2002)

Quota share treaty; premiums and losses

Quote share treaty is when the company that is reinsuring another carrier will share in a percentage of the risks, premiums and losses. This is applied to the carrier's net retained account. Under these calculations, everything is taken into consideration in order to determine the excess of the loss from the catastrophe. (Wollan, 2002)

Facultative reinsurance

Facilitative insurance is when each contract that is reinsured is negotiated separately with different carriers. This is designed to reduce risks and the costs of covering adverse events (which have the possibility of leading to large payouts for customers after a major incident). It is at this point when the losses for the different carriers are reduced by spreading out the liabilities between them.

Surplus -- share treaty

Treaty reinsurance is when different carriers will negotiate a number of events that are covered under one contract. This streamlines the process of reducing risks and allowing the various companies to create an arrangement that will improve their ability to control their liabilities from these events. When this happens, firms can effectively determine the costs of covering specific disasters and offering customers with solutions that will increase their protection. (Wollan, 2002)

Reinsurance methods for sharing losses and the Japan tsunami of March 11, 2011

The Japanese tsunami was the fourth largest earthquake ever recorded. In a report conducted by Aon (2011) they found that these costs are much higher than anyone inside the industry expected. Evidence of this can be seen with the report saying, "The Japanese government currently estimates total economic losses from the Tohoku EQ in March of this year to range between JPY16 to 25 trillion (USD185 to 308 billion), or 3.4 to 5.6% of GDP. In July 2011, the government reported that JPY23 trillion (USD291 billion) would be spent on reconstruction costs for the affected regions. Impact Forecasting estimates that total insured losses for the event will be USD30 billion to USD 40 billion." ('Reinsurance Market Outlook," 2011)

Despite the large increases, nearly all of the outstanding 760 thousand claims were settled in less than one year (i.e. 96%). This is because of the arrangement that the industry made in the aftermath of the disaster to reduce the losses they were facing. The way it worked is the Japanese government played a role in helping to provide relief to those that were affected by the earthquake. This occurred with them offsetting the losses that carriers should have been responsible for under the previous agreement. ('Reinsurance Market Outlook," 2011)

Evidence of this can be in the Aon Report which says, "Despite the significant losses in Japan, the reinsurance industry will likely pay for 40 to 50% of the losses for the earthquake. This, in addition to the coverage provided by the government will result in a lower percentage of loss paid by the reinsurance market than what would have typically been expected for a loss of this size. For example, it is estimated that reinsurers paid approximately 60% of the losses from Hurricanes Katrina, Rita and Wilma in 2005. Post-event, the retrocession back to the non-life companies was further reduced by the government by JPY500 billion for current and subsequent events." ('Reinsurance Market Outlook," 2011)

This is illustrating how the reinsurance sector was able to reduce their costs by partnering with the government. The different methods that were used to decrease their losses were the facultative and the surplus share treaty techniques. This occurred with the industry using the relationship they have with the government to spread out the losses. In the case of the Japanese tsunami, these tactics decreased the industry's exposure by 10%. This helped the sector to lower their risks and the total payouts they were making. ('Reinsurance Market Outlook," 2011)