Reinsurance

Definition of Reinsurance:
Reinsurance simply means “Insurance for Insurance Companies”. More precisely, Reinsurance is
an insurance of insured risk where the insurer retains a part and cedes the balance of a risk to the
reinsurer.

Need For Reinsurance:

A Direct insurer needs reinsurance for the following reasons:
1. To limit (as much as possible) annual fluctuations in the losses he must bear on his own
account;
2. To be protected in case of catastrophe.

The primary insurer is sometimes referred to as the direct insurer, ceding insurer, ceding
company, cedent, or reinsured.
Reinsurer = Retrocedent
 DIFFERENCE BETWEEN COINSURANCE AND REINSURANCE:
Coinsurance, a form of reinsurance, is a system whereby insurer/reinsurer shares direct
responsibility for a risk with one or more insurance companies. The Cedent’s liability is limited
to the amount it underwrites on the original policy.
Reinsurance is considered as the transfer of a part of the risk taken by the direct insurer to
another or second insurer.

The 3 main concerns of risk management:

UNDERWRITING:
Underwriting is the process of examining, classifying and pricing of risks by the primary insurer.
The main task of the underwriting process is to ensure that ---
1. Risks are assessed properly, and terms and conditions are adequate
2. The limits of assigned capacity are respected
3. There are controls for accumulation and peak risks
4. Pricing and wording are appropriate

ASSET MANAGEMENT:
Reinsurers invest the premiums they receive for providing reinsurance cover in the capital
markets which is the responsibility of the asset management department.

CAPITAL MANAGEMENT:
A reinsurer’s capital has to be appropriate for its specific risk profile and appetite. Capital is
needed for those adverse situations when payments exceed premiums and investment income.

Finally we can say, In the risk management process, capital management has the significant task
of aligning capital and risks assumed through insurance and investment activities. If risk
monitoring reveals a gap between risk assumed and the maximum risk bearing capacity of the
insurer (that can be borne by the existing capital base), then either the necessary capital must be
increased or underwriting and investment risks have to be reduced. The latter can be achieved by
reducing underwriting and investment capacity or transferring the risks outside the company
using retrocession or securitization.
CATEGORIES OF REINSURANCE:
Facultative Reinsurance:
In facultative reinsurance, the primary insurer and reinsurer negotiate reinsurance contract for
each risk separately. There is no compulsion for the primary insurer that it should purchase
reinsurance on a policy that it does not wish to insure. Likewise, there is no obligation on the part
of the reinsurer to reinsure proposals submitted to it.

Treaty (Obligatory) Reinsurance:

In Treaty reinsurance, the direct insurer is obliged to cede to the reinsurer a contractually agreed
share of the risks defined in the reinsurance treaty; the reinsurer is obliged to accept that
share;hence the term is obligatory.

Financial reinsurance: Form of reinsurance treaty with reduced transfer of risk and special
consideration of the insurer’s specific accounting features.

Non-proportional reinsurance (excess of loss reinsurance): Form of reinsurance in which the

reinsurer assumes the part of the insurer’s claims that exceed a certain amount, against
payment of a specially calculated premium.
Proportional reinsurance: Forms of reinsurance in which the premium as well as the losses are
shared between the primary insurer and reinsurer in the agreed proportions.

There are two kinds of treaties in the proportional reinsurance category; namely
a) Quota Share Reinsurance
b) Surplus Share Reinsurance
Quota share reinsurance: Form of reinsurance where reinsurer assumes an agreed-upon, fixed
quota (percentage) of all the insurance policies written by a direct insurer within the particular
branch or branches defined in the treaty.
Surplus reinsurance: Form of reinsurance in which the reinsurer will accept the surplus i.e the
amount that exceeds the direct insurer’s retention.
There are three general classes of excess of loss treaties (sometimes referred to as non-
proportional treaties). They are –
a) Per risk excess treaty or per policy excess treaty
b) Per occurrence of loss treaty
c) Aggregate excess treaty

a) Per risk excess treaty or per policy excess treaty : A per risk excess treaty is applicable to
property insurance; the retention and limit apply separately to each risk insured by the primary
insurer. A per policy excess treaty applies to liability insurance; the retention and limit apply
separately to each policy sold by the primary insurer.
b) Per occurrence of loss treaty : Per occurrence excess of loss reinsurance gives indemnity
against loss sustained in excess of the net retention of the primary insurer, subject to the
reinsurance limit, irrespective of the number of risks involved in respect of one accident, event or
occurrence. This kind of reinsurance when applied to property coverage is called catastrophe
excess and when applied to liability coverage is called clash cover.
c) Aggregate excess treaty: Aggregate excess treaties, also called excess of loss ratio or stop loss
treaties are not common. They are used generally in crop hail insurance and for small insurers in
other lines
Comparisons: Direct Insurer and Reinsurer
How reinsurance affects the direct insurer:
The reinsurer adds value in many ways to the services a direct insurer provides to his clients.
 The reinsurer reduces the probability of the direct insurer’s ruin by assuming his
catastrophe risks.
 He stabilizes the direct insurer’s balance sheet by taking on a part of the risk of random
fluctuation, risk of change, and risk of error.
 He improves the balance of the direct insurer’s portfolio by covering large sums insured
and highly exposed risks.
 He enlarges the direct insurer’s underwriting capacity by accepting a proportional share
of the risks and by providing part of the necessary reserves.
 He increases the amount of capital effectively available to the direct insurer by freeing
equity that was tied up to cover risks.
 He enhances the effectiveness of the direct insurer’s operations by providing many kinds
of services