Definition of Reinsurance:
The definition of Reinsurance in simplest terms is “insurance for insurance companies”.
According to Wikipedia, Reinsurance is insurance that is purchased by an insurance company from one or more other insurance companies (the “reinsurer”) directly or through a broker as a means of risk management, sometimes in practice including tax mitigation and other reasons described below. The ceding company and the reinsurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay a share of the claims incurred by the ceding company. The reinsurer is paid a “reinsurance premium” by the ceding company, which issues insurance policies to its own policyholders.
The Need for Reinsurance
There is an important need for reinsurance to help diversify risk. A strong reinsurance marketplace helps ensure that insurance companies can remain solvent and able to pay claims, particularly after a major disaster such as a major hurricane, because the risks and costs are spread between companies, balance sheets, and countries. The spreading of the costs associated with a major disaster has a favorable impact on the local economy after a loss.
There are two basic methods of reinsurance:
- Facultative Reinsurance:
- negotiated separately for each insurance policy that is reinsured.
- purchased by ceding companies for individual risks not covered, or insufficiently covered, by their reinsurance treaties, or for amounts in excess of the monetary limits of their reinsurance treaties and for unusual risks.
- Reinsurers evaluate each risk reinsured, the reinsurer’s underwriter can price the contract to more accurately reflect the risks involved.
- A facultative certificate is issued by the reinsurance company to the ceding company reinsuring that one policy.
- Treaty Reinsurance
- the ceding company and the reinsurer negotiate and execute a reinsurance contract under which the reinsurer covers the specified share of all the insurance policies issued by the ceding company which come within the scope of that contract.
- There are two main types of treaty reinsurance, proportional and non-proportional.
- Proportional reinsurance, the reinsurer’s share of the risk is defined for each separate policy,
- Non-proportional reinsurance the reinsurer’s liability is based on the aggregate claims incurred by the ceding office.