Feb
17
2010
Reinstatement Premiums – A Simple Concept Made Difficult
Author: Donald RowbothamOne of the more difficult aspects of providing outwards reinsurance administration systems is the calculation of reinstatement premiums. The basic concept is very straightforward and certainly calculating the reinstatement premium for the contract is, but, in my experience, the difficulty is that most of our clients want the reinstatement premiums to be calculated by event.
If we take, for example, a simple excess of loss contract where the recoveries are made on a losses-occurring-during basis (LOD) and there is one reinstatement. There could be three events in chronological order that can make recoveries from that contract A, B and C. If event C has claims that are processed first and makes a partial recovery, the corresponding reinstatement premium costs will be attributed to event C but as A and B make recoveries, event C would be refunded. Should the reinstatement premium be reattributed across the events now making the recoveries? Some say yes whereas others will say no. We end up with the situation where, although the contract is LOD, the reinstatement premium is handled as if on a settlement basis.
The problem can also be illustrated with the same contract and events. Event A makes a total recovery and all the reinstatement premium is attributed to event A. Event B then makes a partial recovery. However, event A has a claims refund and half the recovery disappears, event B remains the same and event C makes a partial recovery.
The problem is not too bad as long as the reinstatement premium costs are increasing but, if recoveries are to be refunded and, as such, paid reinstatement premium needs to be recovered, the calculation of the reinstatement premium can become complex especially where the reinstatement provision provides reinstatements at different percentages e.g. 1 free, 5 at 100% and 1 free.
The problem where events start refunding also applies to contracts that are processed on a settlement basis.
The simple way (and probably the correct way) to calculate reinstatement premium is by the contract ignoring any distribution by event and this is the method that most brokers will use. (This also leads to another problem in that the distribution by currency of the reinstatement premium can be different when the settlement basis by event is adopted.) Each time, the total reinstatement premium is calculated to the contract and by deducting the prior reinstatement premium gives the due premium this time. The reinstatement premium could then be distributed across the events making the recoveries and although this wouldn’t reflect the settled basis it would at least mean that the costs were always attributed to the events making the recoveries and the currency distribution would always agree with the brokers.