EIOPA · 2114
Reinsurance
- Regulation
- Guidelines on basis risk
- Article
- Guideline 3 - Insurance risk-mitigation techniques with no material basis risk
- Topic
- Reinsurance
- Submitted
- 2020-02-24
- Answered
- 2021-12-17
Question
"...or the fixed exchange rate is provided in the reinsurance contract."
I haven't been able to figure out how fixed rates means no material basis risk in the reinsurance contract. Could you please give an example? How are retention and limit dealed with in an excess of loss reinsurance?
Answer
If the reinsurance contract is denominated in a different currency than the risk exposure, basis risk exists due to the currency mismatch. However, if the contract already states a fixed rate, there is not basis risk due to the currency mismatch as the exchange rate is known beforehand. In this case, the reinsurance contract would be equivalent to a contract denominated in the same currency than the exposure and any relevant amounts as the retention or the limit can be easily expressed in any of the two currencies just applying the fixed rate.
This Q&A is published by European Insurance and Occupational Pensions Authority and is non-binding. It does not constitute legal advice. Updated weekly from official ESA sources.
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