When it comes to expressing the period applicable to an excess of loss reinsurance contract, there are two common ways of defining which losses fall within the contract period.
Losses Occurring During
LOD (Losses Occurring During) basis, does exactly what it says and states that the contract will respond to any losses that occur within the contract period. In property insurance (per-risk and catastrophe covers) it is quite straightforward, because the losses generally start at a precise time.
There are a few minor provisos, such as losses that start just before the contract expires and continue beyond expiry, or losses that last several days and may be divided into several distinct events for recovery purposes. Those are quite easily dealt with by appropriate conditions in the contract wording.
LOD in Liability contracts can be a little more tricky, because some losses cannot be attributed to a sudden event. A good example is seen in Employers’ Liability, where an employee could suffer a work-related illness as a result of long-term exposure to hazardous substances or working practices. Again, appropriate clauses are written into the reinsurance contract and I hope to deal with these in later blogs.
Risks Attaching During
RAD (Risks Attaching During) contracts will cover all policies that incept during the contract period, irrespective of when the losses occur. Depending on how the original policies are worded, the losses could emerge several years after the policy itself has expired.
So, using what’s left of my 500 word allowance, let’s discuss the relative merits and drawbacks of each basis.
Starting with LOD:
- Single premium adjustment at year end, usually based on accounted GNPI for period makes for simple accounting
- No automatic run-off cover is provided when the contract is non-renewed, unless specially negotiated
- Less risk of reinsurer default. If a reinsurer goes into liquidation after the contract has expired, there is no possibility of further losses occurring under the contract. The panel of reinsurers can be changed annually and the effect of the change is immediate with no “tail”
- Invoking a reinsurer downgrade clause during the contract period can be effective (pro-rata return of premium) as the contract is only exposed to losses occurring within a defined period
- Original premium income will be accounted over 2 or more years, so contract premium may be readjusted several times. If there are reinstatement premiums, these may also need to be adjusted to reflect the evolving contract premium
- Run-off cover is not an issue here. If the reinsured stops writing the class of business and the contract is not renewed, it will continue to cover the policies until all liability has ceased
- Invoking a Downgrade Clause is not as effective. If the reinsurer is downgraded after the contract has expired, there is no point in invoking the clause, because there will be no premium refund, but liability will continue
If a client is considering switching from one basis to another, there are plenty of pitfalls, so beware.
This post was originally published July 9, 2013.