5

Outline

Catastrophe Reinsurance

PURPOSES                                                                                208
CATASTROPHE PERILS                                                        211
THE OCCURRENCE TREATY                                               216
     Contract Provisions
          Contract Percentage Coverage: Coreinsurance
          Layered Coverages
          Reinstatements
          Exclusions
          Application of Coverage
          Definition of Loss Occurrence
     Claims
     Rating
          Factors to Consider
          Rating Approaches
DESIGNING THE CATASTROPHE PROGRAM                 229

     Catastrophe Limit and Loss Retention
          Reinsurance Limit
          Concentrations
          Underlying Covers
          Adjusting Losses
     Changes
     Retention
          Leverage and Liquidity
          Aggregate and Occurrence Protection
          Company's Participation
          Layers
          Choosing Amounts
          Programming Options
     Sample Programs: Small, Regional, Large Reinsureds
     Continuity
SUMMARY                                                                               239

5

Catastrophe Reinsurance

by John F. Cannon *

     There are four urgent reasons for any insurance company to focus on its exposure to perils associated with catastrophes affecting properties the company has insured. A catastrophe can be defined as a sudden, violent, physical manifestation that causes widespread and severe property damage. (Casualty catastrophe perils are covered in the chapter on casualty excess of loss.) The reasons are urgent because, if ignored, the perils can be life threatening for the company. Catastrophes are relative in strength and some are worse than others.

1. Catastrophe perils are unpredictable. Compared with primary insurance perils of a noncatastrophe nature, catastrophe perils are unpredictable as to location, frequency, and severity of the catastrophe. For the individual company, the timing of a catastrophe may be the worst possible.

2. Catastrophe exposure for the company is unknown. While the amount of primary insurance liability for any company is measured by summing the policy limits, the amount of catastrophe exposure cannot be determined with any precision until after the event.

3. The law of large numbers (averages) is limited in its benefit to the reinsured in catastrophes. Catastrophes are infrequent occurrences, particularly as they affect an individual insurance company.

4. The potential of unreinsured catastrophe exposures is deadly to the insurer. If not managed properly, catastrophe perils can destroy the insurance enterprise. While the company's intent is to protect the


* Retired Executive Vice President, THE MERCANTILE AND GENERAL REINSURANCE COMPANY OF AMERICA and THE TOA-RE INSURANCE COMPANY OF AMERICA, 177 Madison Avenue, Morristown NJ 07962-1930. An autobiography follows the chapter. This chapter has been a collaborative effort with Messrs. Patrick J. Clark and Vincent S. Potts, Vice Presidents of M&G and Toa-Re, to whom the author expresses his gratitude for their help. Editor's Note: In revising the chapter, "The Property Catastrophe Reinsurance Contract," written by Robert S. Gilliam, Jr. for the original edition of this book, John Cannon and associates prepared an entirely new manuscript except for the 1980 sections, "Formula Rating" and "Continuity," which were reproduced.

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