Liability Insurance Company writes a substantial amount of commercial liability insurance. A large construction company requests $100 million of liability insurance to cover its business operations. Liability Insurance has a reinsurance contract with Bermuda Re that enables the coverage to be written immediately.
Under the terms of the contract, Liability Insurance pays 25 percent of the losses and retains 25 percent of the premium. Bermuda Re pays 75 percent of the losses and receives 75 percent of the premium, less a ceding commission that is paid to Liability Insurance. Based on the preceding, answer the following questions:
a. What type of reinsurance contract best describes the reinsurance arrangement that Liability Insurance has with Bermuda Re?
b. If a $50 million covered loss occurs, how much will Bermuda Re have to pay? Explain your answer.
c. Why does Bermuda Re pay a ceding commission to Liability Insurance?