What exactly is reinsurance?
Reinsurance, sometimes known as insurance for insurers, is a contract between a reinsurer and an insurer. The insurance company, known as the ceding party or cedent, transfers some of its insured risk to the reinsurance business under this contract. The reinsurance company then assumes all or part of the ceding party’s insurance policies.
The Inception of Reinsurance
According to the Reinsurance Association of America, reinsurance dates back to the 14th century, when it was used for marine and fire insurance. Since then, it has expanded to encompass all aspects of the contemporary insurance market. There are companies in the United States that specialize in selling reinsurance, reinsurance divisions within U.S. primary insurance companies, and foreign reinsurers that are not licensed in the United States. A ceding company may purchase reinsurance from a reinsurer directly or via a broker or reinsurance intermediary.
How Does Reinsurance Work?
Reinsurance enables insurers to remain solvent by recovering a portion or the entire amount of claims paid out. Reinsurance reduces the net liability associated with individual risks and provides catastrophe coverage for large or multiple losses.
The practice also affords ceding companies and those seeking reinsurance the opportunity to expand their risk underwriting capabilities in terms of number and scale. Ceding companies are insurers that transfer their risk to another insurer.
By distributing risk, a single insurance company is able to accept clients whose coverage would be too burdensome for it to manage on its own. When reinsurance occurs, the premium paid by the insured is typically divided among all participating insurance companies.
If one company assumes the risk on its own, the cost could bankrupt or demolish the insurance company, and the loss of the company that paid the insurance premium may not be covered.
Consider, for instance, an enormous hurricane that strikes Florida and causes billions of dollars in damage. If only one corporation sold homeowners insurance, it would be unlikely that it could cover all losses. Instead, the retail insurance company transfers portions of the coverage to other insurance companies (reinsurance), thereby distributing the cost of risk across a large number of insurers.
Insurers purchase reinsurance for four reasons: to limit liability on a particular risk, to stabilize loss experience, to safeguard themselves and the insured from catastrophes, and to increase capacity. However, reinsurance can assist a business by supplying the following:
- Risk Transfer: Businesses can share or transfer certain risks with other businesses.
- Arbitrage: It is possible to generate additional profits by purchasing insurance elsewhere for less than the premium collected from policyholders.
- Capital Management: By transferring risk, businesses can avoid having to absorb significant losses; this frees up additional capital.
- Solvency Margins: The purchase of excess relief insurance enables businesses to take new customers without having to raise additional capital.
- Expertise: Another insurer’s knowledge can assist a business in obtaining a higher rating and premium.
Advantages of Reinsurance
By protecting the insurer against accumulated liabilities, reinsurance enhances the insurer’s equity and solvency by enhancing its capacity to withstand the financial burden imposed by extraordinary, significant events.
Through reinsurance, insurers are able to issue policies covering a greater quantity or volume of risk without incurring prohibitively high administrative expenses to cover their solvency margins. In addition, reinsurance provides insurers with access to substantial liquid assets in the event of catastrophic losses.
Reinsurance Regulation
Reinsurers in the United States are governed on a state-by-state basis. The purpose of regulations is to assure solvency, proper market conduct, equitable contract terms and rates, and consumer protection. In particular, regulations stipulate that the reinsurer must be financially solvent in order to fulfill its obligations to ceding insurers.
Types of Reinsurance
An insurer is protected by facultative coverage for an individual, a specified risk, or a contract. If multiple hazards or contracts require reinsurance, they are individually renegotiated. The reinsurer has the sole discretion to approve or reject a proposal for facultative reinsurance.
A reinsurance treaty is for a fixed period, as opposed to per-risk or per-contract. The reinsurer covers all or a portion of the insurer’s potential risks.
1. Facultative Reinsurance
It is referred to as facultative because the reinsurer has the “faculty” or authority to approve or reject all or a portion of the provided policy. Here, the insurer uses it to cover single or multiple hazards listed in its business book.
Typically, facultative reinsurance covers a singular transaction and is a one-time agreement with the insurance company. Importantly, the primary insurer and reinsurer design a facultative certificate that indicates the reinsurer’s acceptance of a specific risk in the contract.
2. Treaty Reinsurance
The treaty reinsurance represents insurance obtained from another insurer via the insurance company. Additionally, this provides additional protection for the equity of ceding insurers and increases safety in pertinent or exceptional circumstances. Consequently, it is further classified into proportional and nonproportional categories.
In lieu of a contract or per-risk premise, this coverage type is effective for a specific period.
Deconstructing Reinsurance
The reinsurer receives a prorated part of all policy premiums sold by the insurer under proportional reinsurance. In the event of a claim, the reinsurer bears a pre-negotiated percentage of the damages. In addition, the reinsurer reimburses the insurer for processing, business acquisition, and writing expenses.
Non-proportional reinsurance occurs when the reinsurer does not have a proportional share of the insurer’s premiums and losses. The priority or retention restriction is based on either a single risk type or an entire risk category.
Excess-of-loss reinsurance is a non-proportional coverage type in which the reinsurer covers losses that exceed the insurer’s retention limit or excess share treaty amount. This contract is often used for catastrophic catastrophes and covers the insurer on a per-occurrence or cumulative basis over a predetermined period of time.
All claims made during the effective period are covered by risk-attaching reinsurance, regardless of whether the losses happened outside the coverage period. Even if the losses happened while the contract was in effect, no compensation is offered for claims that arose outside of the coverage period.
Reinsurance: Why It’s Necessary for Insurers.
The expansion of an insurance company’s capacity, the stabilization of its underwriting results, financing, the acquisition of catastrophic protection, the spreading of an insurer’s risk, and the acquisition of experience are all examples of common reasons why insurers get reinsurance.
What Are Reinsurance Companies?
Companies that provide reinsurance cover the primary (or ceding) insurers. Here are some well-known examples from a global perspective:
- Munich Reinsurance Company
- Swiss Re Ltd.
- Lloyd’s
- Canada Life Re
- Berkshire Hathaway Inc.
- Hannover Rück S.E.
- SCOR S.E.
- China Reinsurance (Group) Corporation
- Reinsurance Group of America Inc.
- Everest Re Group Ltd.
Summary
Reinsurance, also known as “insurance for insurance companies,” is the consequence of an agreement between a reinsurer and an insurer. In it, the ceding entity or cedent insurance company transfers a portion of its insured risk to the reinsurer. Consequently, the reinsurance company undertakes responsibility for a portion or all of the insurance policies issued by the ceding party. Having reinsurance reduces the likelihood of being subjected to large payouts for one or more claims by transferring risk to another company.
