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Difficulty: MediumReinsurance Concepts

Crestview Indemnity issues a 12,000,00012,000,000 builders risk policy for a new commercial development. Crestview operates under a 60/4060/40 quota share reinsurance treaty with Apex Reinsurance, wherein Crestview retains 40%40\% of the risk and premiums, and cedes 60%60\% to Apex Reinsurance. A severe windstorm causes exactly 3,000,0003,000,000 in covered property damage. Based on the fundamental principles of reinsurance, how must this 3,000,0003,000,000 claim be settled?

  1. Crestview Indemnity pays the full 3,000,0003,000,000 to the insured and is subsequently indemnified for 1,800,0001,800,000 by Apex Reinsurance.Answer
  2. B
    The insured receives 1,200,0001,200,000 from Crestview Indemnity and must file a direct claim with Apex Reinsurance for the remaining 1,800,0001,800,000.
  3. C
    Apex Reinsurance directly pays the 3,000,0003,000,000 loss to the insured and collects the 1,200,0001,200,000 retained share from Crestview Indemnity.
  4. D
    Crestview Indemnity applies risk avoidance to the ceded portion, paying only 1,200,0001,200,000 to the insured and legally erasing its obligation for the remaining 1,800,0001,800,000.

Answer

Crestview Indemnity pays the full 3,000,0003,000,000 to the insured and is subsequently indemnified for 1,800,0001,800,000 by Apex Reinsurance.
The correct answer accurately reflects the principle of privity in reinsurance. Crestview Indemnity is legally bound by the original insurance contract to pay the policyholder the full amount of the covered loss (3,000,000).Oncethatobligationismet,Crestview′squotasharetreatywithApexReinsuranceistriggered,andApexindemnifiesCrestviewforits3,000,000). Once that obligation is met, Crestview's quota share treaty with Apex Reinsurance is triggered, and Apex indemnifies Crestview for its 60\%share( share ( 1,800,000).

Step-by-Step Solution

1
Determine the legal relationship (privity) between the parties.
The insured only has a contract with Crestview Indemnity. Crestview Indemnity has a separate contract with Apex Reinsurance.
Reinsurance is an agreement solely between insurers. The original insured is not a party to the reinsurance contract.
2
Calculate the financial obligations based on the quota share treaty.
Crestview retains 40%40\% (1,200,0001,200,000) and cedes 60%60\% (1,800,0001,800,000) of the 3,000,0003,000,000 loss.
In a quota share treaty, losses and premiums are shared proportionately based on the agreed percentages.
3
Establish the correct settlement procedure.
Crestview must pay the insured the full 3,000,0003,000,000 policy limit, and then Apex Reinsurance reimburses (indemnifies) Crestview for the 1,800,0001,800,000 ceded share.
The ceding insurer remains fully liable to the policyholder for the entire covered loss, regardless of any reinsurance agreements in place.

Key Concept

Privity of Contract and Reinsurance Indemnification
Estimated Time:1m 30s
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Reinsurance Concepts

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