Pros and Cons of Layering in Reinsurance

In the previous article, we have already studied the concept of layering and how it related to reinsurance policies. We are now aware that layering is used so that the risk can be comfortably placed between multiple reinsurance companies instead of a single reinsurer having to bear all the risk.

Layering is a very popular method of reinsurance and is used by almost every major reinsurance company in the world.

Hence, every student of reinsurance must have knowledge about the pros and cons of layering. In this article, we will provide details about the same.

Benefits of Layering

There are several benefits that can be attributed to layering. Some of the most important benefits have been listed below:

  1. Can be Shared by Different Reinsurers: The most important benefit of layering is that it enables a syndicate of reinsurers to reinsure the same policy. The risk does not need to be held on the balance sheet of a single reinsurer. Instead, it can be spread out amongst multiple reinsurance companies. This is in line with the basic principle of insurance and reinsurance which encourage the diffusion of risk amongst various parties.

    The benefit of layering is that it creates a standardized mechanism using which the risk of one layer can be transferred from one reinsurer to the other. Such a transfer can even take place via the secondary market.

  2. Better Risk Management: Since multiple reinsurance companies are involved in a layered contract, the risk management related to that contract is better managed. This is because different reinsurance companies have their own methodologies for assessing risks and if multiple models are assessing the same risk, it is likely to be better managed. This is because an individual reinsurer might miss out on certain points. However, when several reinsurers are involved, the chances of negligence are much lower.

  3. Higher Total Coverage for the Insured: There are limits to the amount of risk that a single reinsurance company can take on its balance sheet. As a result, if a reinsurance policy were to be underwritten by only a single reinsurance company, then there would be limitations on the risk that they can undertake.

    As a result, the sum assured offered to the ceding insurer would be much lower compared to their expectations. It is for this reason that reinsurance companies prefer to use layering so that the needs of the customers can be met better.

  4. Lower Capital Requirements: Regulatory bodies around the world have a different set of rules for the amount of money that needs to be set aside for excess of loss reinsurance policies. This is because if a reinsurer is underwriting the top layer of a policy, it is very unlikely that they will face a claim. It is for this reason that regulators are fine even if fewer reserves are set aside.

    The ability to generate less premium while setting aside even less capital in the form of reserves encourages reinsurance companies to underwrite layered policies.

Disadvantages of Layering

The process of layering also causes certain disadvantages to the ceding insurer as well as to the reinsurance company. The details of the same have been mentioned below:

  1. Difficult to Administer: It is important to note that layered reinsurance contracts might need surveys from different staff if a major event occurs. For instance, if the second or third layer of the policy is triggered, then it is likely that two or three separate teams will investigate the same facts.

    This can become quite tedious from the point of view of the ceding insurer who has to undergo the entire process again and again. Also, they receive the claim payments separately from each reinsurer. It can be difficult to track such payments and ensure that the claims which have been made have been settled in a timely manner.

  2. Operational Inefficiencies: Since the entire policy has to be administered by one reinsurer, all the reinsurance companies have to pay a fixed sum of money to that reinsurer so that it can be set aside for administrative and claims management purposes.

    Ceding insurers have often complained about the lack of service provided to them by reinsurance companies. This can be fixed by setting aside a larger chunk of the premium for administrative purposes.

  3. Bankruptcy: Since a layered reinsurance policy is jointly underwritten by several reinsurers, it can lead to several complications. For instance, if one of the reinsurers who is part of the syndicate goes bankrupt and is unable to handle their commitments, then it could impact other reinsurance companies as well. Depending upon the conditions laid down in the contract, the loss would have to be borne either by other reinsurers or by the ceding insurance company!

  4. Disputes and Delay: Last but not the least, layered reinsurance policies are prone to a lot of disputes and delays. This is particularly the case when a big claim is made. Different reinsurance companies have very different standards of internal processing of claims. As a result, some may process claims faster than others. Also, the rejection of a claim by one of the reinsurers also influences the decision of the others. This further leads to delays.

The bottom line is that layered insurance policies have their pros and cons. However, for most parties, the pros far outweigh the cons. This is the reason that layering is common in the industry.

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