Key Takeaways
- Insurers transfer risk by purchasing reinsurance.
- Facultative covers individual risks; treaty covers groups.
- Proportional shares premiums and losses by fixed ratios.
- Non-proportional covers losses exceeding a set threshold.
What is Reinsurance?
Reinsurance is a risk management tool where primary insurers transfer portions of their risk portfolios to other insurers, known as reinsurers, to stabilize finances and increase underwriting capacity. This process helps companies like Prudential manage large claims and maintain solvency.
By paying premiums to reinsurers, primary insurers receive coverage that reimburses part of their losses, using mechanisms similar to traditional insurance contracts.
Key Characteristics
Reinsurance involves several defining features that shape its use and effectiveness:
- Risk Transfer: Primary insurers cede risk to reinsurers to reduce exposure and protect capital.
- Contract Types: Includes facultative reinsurance for individual risks and obligatory reinsurance for broad policy groups.
- Proportional and Non-Proportional: Shares premiums and losses in fixed ratios or covers losses above retention thresholds.
- Premium Payments: Cedents pay premiums, often based on earned premium, reflecting the coverage period.
- Risk Diversification: Reinsurers spread risks globally, sometimes using retrocession to cede risks further.
How It Works
Reinsurance operates through agreements where the primary insurer cedes part of its risk, agreeing on retention limits and coverage terms. For example, a policyholder claim exceeding a retention might trigger payments from the reinsurer under an excess-of-loss structure.
These contracts often specify sharing ratios, premiums, and claims processing, enabling insurers like UnitedHealth Group to underwrite more policies while managing potential large losses effectively.
Examples and Use Cases
Reinsurance applies across various industries to mitigate risks and stabilize operations:
- Insurance Companies: Firms such as Citigroup use reinsurance to balance risk exposure and comply with regulatory capital requirements.
- Catastrophe Coverage: Protects against massive event losses like hurricanes or earthquakes, where reinsurers cover claims exceeding retention limits.
- Specialized Risks: Facultative reinsurance handles unique or high-risk policies on a case-by-case basis, such as large infrastructure projects.
Important Considerations
When engaging in reinsurance, consider the costs, as reinsurers charge premiums that impact profitability. Contract clarity is essential to avoid disputes over claim triggers and coverage scope.
Also, understanding the range of liabilities covered and selecting appropriate reinsurance types helps optimize risk management for your insurance portfolio.
Final Words
Reinsurance allows insurers to manage risk and capital more effectively by sharing losses and premiums. To optimize your risk strategy, evaluate different reinsurance structures and consult with experts to tailor coverage that aligns with your portfolio’s needs.
Frequently Asked Questions
Reinsurance is insurance purchased by primary insurers to transfer part of their risks to reinsurers. This helps insurers manage capital, stabilize finances, and underwrite more policies by sharing potential losses.
Primary insurers cede risks to reinsurers through contracts that specify premiums, losses, retention limits, and coverage terms. The reinsurer then reimburses a portion of claims above the cedent's retention, helping spread financial exposure.
Reinsurance contracts are mainly facultative, which cover individual high-risk policies, and treaty, which cover broad groups of policies automatically. There are also hybrid agreements combining both approaches.
Proportional reinsurance involves sharing premiums and losses in fixed ratios, such as quota share or surplus share. Non-proportional reinsurance covers losses exceeding a set retention, like excess-of-loss or catastrophe reinsurance.
Excess-of-loss reinsurance means the reinsurer pays for losses above a certain retention. For example, if an insurer retains $20 million on a $100 million claim, the reinsurer covers the remaining $80 million.
Retrocession occurs when reinsurers transfer part of their risks to other reinsurers. This further diversifies and spreads exposure, especially during large catastrophe events.
Facultative reinsurance is negotiated on a case-by-case basis for individual policies, often high-risk. Treaty reinsurance covers an entire portfolio or category of policies automatically under an ongoing agreement.
