Paul Sanchez
Reinsurance is a type of insurance purchased by insurance companies to protect themselves from financial risks. By buying reinsurance, insurance companies can transfer some of their liabilities to another insurance company, known as the reinsurer, in exchange for a premium. This process is often referred to as insurance for insurance companies and can help protect insurers from large payouts or claims events, such as natural disasters, that could otherwise lead to bankruptcy.
| Characteristics | Values |
|---|---|
| Reinsurance | Insurance for insurance companies |
| Insurer | Ceding party or cedent |
| Reinsurer | Reinsurance company |
| Reinsurance types | Facultative, proportional, non-proportional, treaty, excess-of-loss, risk-attaching, catastrophe |
| Reinsurance benefits | Increased security for equity and solvency, reduced net liability, increased underwriting capabilities, access to substantial liquid assets |
| Reinsurance reasons | Expand capacity, stabilise underwriting results, finance, gain catastrophe protection, spread risk, acquire expertise |
What You'll Learn
Facultative reinsurance
In facultative reinsurance, the ceding company, seeking to mitigate its risk exposure, presents a specific risk to a reinsurer. This submission includes detailed information about the risk, allowing the reinsurer to conduct a thorough underwriting assessment. The reinsurer then decides whether to accept the risk and, if so, at what terms and pricing. The agreement on a facultative reinsurance contract is bespoke, tailored to the nuances of the presented risk.
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Treaty reinsurance
The ceding company's main role in a treaty reinsurance agreement is to identify and delineate the classes of business it seeks to reinsure and manage the claims efficiently. By doing so, the company aims to manage its overall risk exposure, maintain solvency, and optimise its capital efficiency. The ceding company must carefully select its reinsurer partner based on financial strength, reputation, and the reinsurer's expertise in handling specific types of risks.
The two types of treaty reinsurance contracts are proportional and non-proportional contracts. With proportional contracts, the reinsurer agrees to take on a specific percentage share of policies, for which it will receive that proportion of premiums. If a claim is filed, it will pay the stated percentage as well. With a non-proportional contract, however, the reinsurance company agrees to pay out claims if they exceed a specified amount during a certain period of time.
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Proportional reinsurance
Reinsurance is a form of insurance for insurance companies, allowing them to remain solvent by recovering some or all amounts paid out to claimants. It is a contract between a reinsurer and an insurer, where the insurer, also known as the ceding party or cedent, transfers some of its insured risk to the reinsurance company. Reinsurance can be of two basic types: facultative and treaty.
There are two main types of arrangements under proportional reinsurance: quota share and surplus reinsurance. In a quota share arrangement, a fixed percentage of each insurance policy is reinsured. For example, a company may reinsure 75% of its policies, allowing it to sell four times as much coverage while still retaining some of the profits on the additional business through the ceding commission.
On the other hand, a company may opt for surplus reinsurance to limit the losses it could incur from a small number of large claims. In this case, the ceding company decides on a retention limit, and the reinsurer accepts risks exceeding this limit. For instance, if the retention limit is set at $100,000, the ceding company retains the full amount of each risk up to this limit, and the excess is reinsured.
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Non-proportional reinsurance
The main forms of non-proportional reinsurance are excess of loss and stop loss. Excess of loss reinsurance can take three forms: "Per Risk XL", "Per Occurrence or Per Event XL" (or Catastrophe XL), and "Aggregate XL".
In per risk, the cedent's insurance policy limits are greater than the reinsurance retention. For example, an insurance company might insure commercial property risks with policy limits of up to $10 million and then buy per-risk reinsurance of $5 million in excess of $5 million. In this case, a loss of $6 million on that policy will result in a recovery of $1 million from the reinsurer.
In catastrophe excess of loss, the cedent's retention is usually a multiple of the underlying policy limits, and the reinsurance contract usually contains a two-risk warranty. For example, an insurance company issues homeowners' policies with limits of up to $500,000 and then buys catastrophe reinsurance of $22 million in excess of $3 million. In that case, the insurance company would only recover from reinsurers in the event of multiple policy losses in one event (e.g. a hurricane, earthquake, or flood).
Aggregate XL affords a frequency protection to the reinsured. For instance, if the company retains $1 million net any one vessel, a $5 million annual aggregate limit in excess of a $5 million annual aggregate deductible, the cover would equate to five total losses (or more partial losses) in excess of five total losses (or more partial losses).
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Excess-of-loss reinsurance
Alternatively, the contract may specify that the reinsurer is responsible for a percentage of losses over the threshold. In this case, the ceding company and the reinsurer will share the aggregate losses. For instance, if the reinsurance contract states that the reinsurer is responsible for 50% of the losses over $500,000, and the aggregate losses amount to $600,000, the reinsurer will pay $50,000 while the ceding company will be responsible for the remaining $50,000.
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Frequently asked questions
Reinsurance is when an insurance company purchases a policy from another insurance company to cover its risks and those of its policyholders.
Reinsurance is a precautionary measure to ensure insurance companies do not go bankrupt in the event of multiple claims being filed at once. It also helps to stabilise an insurance company's underwriting results, gain catastrophe protection, and spread an insurer's risk.
There are two basic methods of reinsurance: facultative and treaty. Facultative reinsurance is negotiated separately for each policy, while treaty reinsurance covers a broad group of policies.
Facultative reinsurance is for individual, high-value or hazardous risks, such as a hospital, while treaty reinsurance is for broad groups of policies, like all a primary insurer's auto business.
An insurance company must purchase a reinsurance policy from a reinsurance company, also known as a "ceding company" or "cedent". The insurance company then becomes the "ceding party" and transfers its insured risk to the reinsurance company.
