Non-proportional reinsurance is a type of contract in which the reinsurer intervenes only if the losses exceed a certain threshold (known as retention). Unlike proportional reinsurance, where losses and premiums are distributed proportionally between the insurer and the reinsurer, the non-proportional model can bring a strategic change by reducing the volatility of the insurer’s financial results, exactly as desired.
According to Article 117(3) of the Solvency II Delegated Regulation, non-proportional reinsurance is considered the most beneficial solution for capital optimization and reducing extreme risks. By protecting insurers from losses and reducing financial volatility, this reinsurance model ensures greater stability and efficient capital management.
Rating agencies seek such treaties not only in the last analyzed period but also over a broader history that supports a strategy of reducing volatility.
From a theoretical perspective, this type of reinsurance eliminates arbitrage opportunities and contributes to market equilibrium. An effective pricing theory cannot be designed without integrating this mechanism, as illustrated in the latest chart.
Since 2020, a new movement has been gaining momentum, with the goal of persuading EIOPA to amend the Solvency II standard regime by introducing a proposal to extend it to multiple lines of business.
The current standard formula approach provides for a flat 20% reduction on the volatility factor for premium risk for three lines of business, IF the non-proportional reinsurance plays a dominant role in the risk mitigation.
However, given that the use of an internal model is already permitted, a change in the standard remains unlikely: Risk mitigation techniques.
Non-proportional reinsurance remains the only strategic move capable of providing a competitive advantage for companies that know how to use it correctly. In contrast, proportional reinsurance is limited to reducing net risk, without altering the insurer’s net portfolio position or structure.
Although the benefits are clear, determining the optimal model—including the optimal retention—is extremely complex. This difficulty, combined with challenges related to calculating recoverables (on the best estimates), makes regulators and auditors reluctant to support non-proportional reinsurance.
It is this practice that motivated the creation of this article. We cannot accept sacrificing beneficial solutions for market stability merely for the sake of simplifying processes for third parties.
We are here to support the correct actuarial approach and the proper evaluation of reinsurance assets, especially for the most reliable ones, with a positive impact even for those who seek simplification for the sake of minimal effort.