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November 14th , 2024

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TYPES OF REINSURANCE OF INSURANCE CONTRACTS IN GHANA

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Types of Reinsurance of Insurance Contracts in Ghana

Introduction

Reinsurance is a vital tool for the stability and growth of the insurance industry in Ghana. It involves the transfer of risk from one insurance company (the ceding company) to another insurance company (the reinsurer). This allows insurers to share the financial burden of large or catastrophic claims, helping to maintain their financial strength and solvency. In Ghana, reinsurance practices follow global standards, but also have unique characteristics shaped by the local regulatory framework, market dynamics, and risk environment. The National Insurance Commission (NIC) regulates reinsurance in Ghana, ensuring that reinsurance agreements are fair, transparent, and sustainable.

In this context, it is essential to understand the various types of reinsurance used by insurance companies in Ghana. These types of reinsurance arrangements determine how risks are shared between insurers and reinsurers, the financial exposure of the ceding company, and the amount of control the ceding company retains over the risk. The two main types of reinsurance used in Ghana are proportional reinsurance and non-proportional reinsurance, both of which have subtypes. Each type serves different needs and offers different benefits, depending on the type of risks involved, the capacity of the insurer, and the specifics of the insurance contract.

1. Proportional Reinsurance

Proportional reinsurance is the most common form of reinsurance in Ghana. Under proportional reinsurance, the ceding company and the reinsurer share both the premiums and the claims of the insured risk based on an agreed percentage. The insurer cedes a certain proportion of the premium to the reinsurer and, in return, the reinsurer agrees to cover a corresponding proportion of the losses. This arrangement allows the ceding company to share its risks and reduce its financial exposure.

There are two main subtypes of proportional reinsurance: Quota Share Reinsurance and Surplus Share Reinsurance.

a) Quota Share Reinsurance

In a quota share reinsurance agreement, the ceding company and the reinsurer agree to share a fixed percentage of both premiums and claims. For example, if a ceding company has an insurance policy with a premium of GH₵100,000, and a quota share agreement of 30% with a reinsurer, the reinsurer will receive 30% of the premium (GH₵30,000) and will also cover 30% of any claims made on that policy. This method ensures that the reinsurer assumes a fixed, proportional share of both the insurer's risk and the premium income.

  • Advantages:
    • Provides predictable and stable reinsurance costs and returns.
    • The ceding company can offer more competitive products, as the risk is shared.
    • Easy to understand and administer, with fixed percentages for premiums and claims.
  • Disadvantages:
    • The ceding company may have to cede a significant portion of the premium income, which may reduce its profitability.
    • Reinsurers may not be willing to take on a large portion of the business without significant due diligence on the quality of the risk.

b) Surplus Share Reinsurance

Surplus share reinsurance is a more flexible form of proportional reinsurance. Unlike quota share reinsurance, which applies a fixed percentage to all policies, surplus share reinsurance allows the ceding company to retain a portion of the risk up to a certain limit, and then cede the excess to the reinsurer. This type of reinsurance is commonly used for large or high-value risks.

For example, if an insurance company has a policy with a sum insured of GH₵2,000,000 and the ceding company agrees to retain GH₵500,000, it will cede the surplus (GH₵1,500,000) to the reinsurer. The reinsurer’s share is typically determined based on the size of the risk and the excess amount.

  • Advantages:
    • Provides flexibility for the ceding company to retain a higher portion of the premium on smaller risks while ceding larger or more complex risks.
    • Helps in the diversification of risk across different lines of business.
    • Allows the ceding company to underwrite large policies without increasing its exposure significantly.
  • Disadvantages:
    • The ceding company may need to monitor and assess individual risks to determine when the surplus threshold is exceeded, which can be administratively complex.
    • Surplus share agreements may not always be as predictable as quota share reinsurance due to varying levels of risk retention.


2. Non-Proportional Reinsurance

Non-proportional reinsurance, also known as excess of loss reinsurance, differs from proportional reinsurance in that the ceding company retains a greater portion of the premium and risk, but the reinsurer only becomes liable once the loss exceeds a certain threshold, known as the retention level or attachment point. In non-proportional reinsurance, the reinsurer’s liability is triggered only if a loss surpasses a certain amount.

Non-proportional reinsurance is typically used for catastrophe coverage, such as natural disasters, large industrial accidents, or any event that could result in large financial losses.

There are two main subtypes of non-proportional reinsurance: Excess of Loss (Catastrophe) Reinsurance and Stop Loss Reinsurance.

a) Excess of Loss Reinsurance

Excess of loss reinsurance provides protection for the ceding company in the event of a large loss. The ceding company retains the first portion of the loss, and once the loss exceeds this amount, the reinsurer covers the excess, up to a pre-agreed limit. This form of reinsurance is particularly useful in protecting against catastrophic losses that could overwhelm an insurer’s financial resources.

For example, if a ceding company faces a loss of GH₵10,000,000 in claims due to a natural disaster, and the excess of loss reinsurance agreement has a retention level of GH₵2,000,000, the reinsurer will cover any losses above GH₵2,000,000, up to the maximum coverage limit.

  • Advantages:
    • Provides protection against large, catastrophic losses that could threaten the financial stability of the ceding company.
    • Helps insurers manage risk and limit their exposure to severe events.
  • Disadvantages:
    • Premiums for excess of loss reinsurance can be expensive, especially in regions prone to natural disasters.
    • May not be suitable for risks that are frequent but low in severity.

b) Stop Loss Reinsurance

Stop loss reinsurance is similar to excess of loss reinsurance, but it is focused on limiting the total loss experienced by the ceding company over a specific period, typically a year. The reinsurer covers any losses that exceed a predetermined percentage of the ceding company’s total premiums.

For example, if an insurance company’s total premium income for the year is GH₵5,000,000, and the stop loss reinsurance contract has a retention limit of 70%, the reinsurer will cover any losses that exceed GH₵3,500,000.

  • Advantages:
    • Protects insurers from cumulative losses over a period.
    • Helps insurers maintain financial stability and meet regulatory requirements.
  • Disadvantages:
    • The reinsurer only becomes involved after a substantial portion of losses have already been incurred, which may limit the amount of immediate protection for the ceding company.
    • Stop loss reinsurance is typically more appropriate for long-tail risks and portfolios of policies rather than individual, high-value risks.

3. Facultative Reinsurance

Facultative reinsurance is a type of reinsurance agreement where the ceding company and the reinsurer negotiate the terms of reinsurance for each individual risk. Unlike treaty reinsurance, where the reinsurer automatically covers a portion of every policy written by the ceding company, facultative reinsurance is more selective and is used for specific, often large or complex risks.

In Ghana, facultative reinsurance is commonly used for industrial or commercial risks, such as large-scale infrastructure projects, where the insurer may need to cede a portion of the risk to protect its solvency.

  • Advantages:
    • Provides flexibility for the ceding company to select the risks it wants to reinsure.
    • Reinsurers have greater control over the selection of risks they are willing to accept.
  • Disadvantages:
    • The negotiation process can be time-consuming and complex, especially for large risks.
    • Facultative reinsurance is generally more expensive than treaty reinsurance due to its case-by-case nature.


Conclusion

Reinsurance is a vital mechanism for managing risk and ensuring the financial stability of insurers in Ghana. The main types of reinsurance—proportional reinsurance and non-proportional reinsurance—offer different solutions depending on the needs of the ceding company and the characteristics of the risks involved. The flexibility of facultative reinsurance and the shared responsibility of treaty reinsurance both play key roles in allowing insurers in Ghana to manage their risk exposures effectively while continuing to offer competitive insurance products. As the Ghanaian insurance market continues to grow, reinsurance will remain a crucial tool for enhancing the industry’s resilience against large-scale losses and promoting sustainable growth.

 

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