If you haven’t heard about the term reinsurance, you might only know about the insurance given to individuals and other companies. Reinsurance, on the other hand, is completely different. It is known as insurance for insurers that means insurance companies are getting benefits. It is the practice where the insurers transfer their portion of risk portfolios to other parties. The main focus is to reduce the burden on an insurance company in case it has to pay for a large insurance claim.
There are two terms that are really important in this whole scenario. First, the ceding party and the second is reinsurer. The ceding party is the one whose burden is taken off and transferred to the other party. On the other hand, the reinsurer is the one that accepts a portion of the large obligation the ceding party faces for a share of the premium amount.
Types of Reinsurance With Examples
There are two types of reinsurance. They are facultative and treaty reinsurance.
Facultative reinsurance provides benefits to the insurer for a single risk or a definite package of risks. It is mainly a one-off transaction where the reinsurance company is firm on performing its own underwriting. The underwriting can be some or all the policies of the reinsured. The main goal is to consider each facultatively underwritten policy as a single transaction. The right to reject or approve the policies remains with the reinsurance company. That’s the main reason this policy is less attractive to the ceding party.
For example, ‘A’ is an insurance company and the customer ‘B’ who is the owner of a huge mall comes to ‘A’. It is a large building so the insurance policy is a writer for over $45 million. So ‘A’ has to take the liability to pay $45 million in case the building faces high damage. The insurance company ‘A’ cannot afford to offer such a huge amount so it has to look for a facultative reinsurance company. The facultative insurance must be a liability amount minus affordability amount. Suppose, ‘A’ can afford only $32 million so it will look for $13 million of insurance from a reinsurance company. Once the facultative insurance company is ready to cover the amount it will approve the policy.
In the case of treaty reinsurance transactions, the ceding company is going to transfer all risks within a certain book of business to the reinsurer. In turn, the reinsurance company will agree to remunerate the ceding company’s all forms of risks. Here, the company won’t perform individual underwriting for each policy. The agreement in which the reinsurer accepts this is known as a treaty.
The most important feature of the treaty insurance is that it doesn’t give importance to the individual underwriting by the insurer. This structure transfers the risk factor from the ceding company to the reinsurer. So the reinsurer is vulnerable to the potential risks that will arise if it doesn’t go through the underwriting process adequately.
If we talk about the most common form of treaty reinsurance then it is the proportional treaty one. Here, only a certain portion of the ceding insurer’s original policies goes for reinsurance. If the policies go beyond the set limit, the company won’t cover it.
For example, ‘ABC’ is a reinsurance company that agrees to provide $10 million of the original insurer’s fire insurance policies. This means the ceding company cannot expect a payment of $15 million if it takes a risk with its fire insurance policyholder. Consider that the ceding company agrees to provide a $50 million of insurance with $20 million in its retention limit. So the $10 million of reinsurance is already there but it has to arrange a surplus treaty for the future.
How does Reinsurance work?
It allows insurers to remain solvent in case they face issues in payment for insurance claims. It reduces the net liability on risks that protects them from large or multiple losses. This practice also provides ceding companies with more underwriting capabilities in terms of the number and size of risks.
In the past, insurance companies in the United States have gone through hard times. A lot of companies found a sense of relief after the launch of reinsurance companies.
Benefits Of Reinsurance
It gives ceding companies an opportunity to be more secure. The security is in terms of equity and solvency. This makes them strong as they can face a financial burden even in case of major events.
Through this simple policy, insurers may underwrite policies covering a major section of risk. All this doesn’t even increase the administrative costs to cover the solvency margins.
The reinsurance business form is evolving. If we talk about past then the traditional polices were signed between only two insurance entities. Now, the scenario is changing and expanding. In the year 2014, the Reinsurance Association of America wrote $28.4 billion of premiums. Don’t you think it’s huge? The premiums are increasing year after year. There is even an excess of loss reinsurance. It is not widely practiced. Here, the reinsurer covers the losses that exceed the insurer’s retained limit. This type of contract mainly applies to catastrophic events.
If you own an insurance company then reinsurance is the best policy you can apply for. You don’t know what’s coming in the near future for your company. In a bad year, the total value of claims may exceed more than the premium’s total amount. If the loss is huge, your company will be totally wiped off the market. If you believe your company cannot bare heavy claims then you must look for some good reinsurance companies. Odyssey Reinsurance Group, XL Reinsurance America, and Swiss Reinsurance America Corporation are best. You can even look for other companies and check their details to know about their terms and conditions.
We hope the definition of reinsurance along with its types are clear to you. In case, you still face issues in understanding the basic concept then contact us.