Reinsurance
Reinsurance, often referred to as insurance for insurance companies, is a contract between a reinsurer and an insurer. In this contract, the insurance company—known as the ceding party or cedent—transfers some of its insured risk to the reinsurance company. The reinsurance company then assumes all or part of one or more insurance policies issued by the ceding party.
Reinsurance
Definition
Reinsurance, often referred to as insurance for insurance companies, is a contract between a reinsurance company and an insurance company. In this contract, the insurance company, known as the cedent or ceding company, transfers part of its insured risk to the reinsurance company. The reinsurance company then assumes all or part of the risk associated with one or more policies issued by the cedent.
Origin
The concept of reinsurance can be traced back to 14th century Italy, where merchants protected their shipping businesses by spreading risk. The modern reinsurance market saw significant development in the 19th century, particularly in London and Germany. The establishment of Cologne Reinsurance Company in 1863 in Germany marked the formal beginning of the modern reinsurance industry.
Categories and Characteristics
Reinsurance is primarily divided into two main categories: proportional reinsurance and non-proportional reinsurance.
- Proportional Reinsurance: In this type, the insurance company and the reinsurance company share premiums and losses in proportion. For example, if the proportion is 50%, the reinsurance company will assume 50% of the risk and receive 50% of the premium.
- Non-Proportional Reinsurance: In this type, the reinsurance company only pays when losses exceed a certain amount. For instance, excess of loss reinsurance is a type of non-proportional reinsurance where the reinsurance company steps in only when losses exceed a predetermined limit.
Specific Cases
Case 1: An insurance company provides coverage for a large commercial building with a sum insured of $100 million. To spread the risk, the insurance company enters into a proportional reinsurance contract with a reinsurance company at a 40% proportion. Thus, the reinsurance company will assume 40% of the risk, amounting to $40 million. In the event of a loss, the reinsurance company will pay 40% of the claim amount.
Case 2: Another insurance company provides coverage for a series of natural disasters. To manage potential large payouts, the company enters into an excess of loss reinsurance contract with a limit of $50 million. If the losses from a natural disaster exceed $50 million, the reinsurance company will cover the amount exceeding this limit.
Common Questions
- Does reinsurance increase premiums? Reinsurance typically does not directly affect premiums, but it helps insurance companies manage risk better, which can indirectly stabilize premiums.
- How do reinsurance companies make a profit? Reinsurance companies make a profit by collecting reinsurance premiums and managing risk. If the claims paid out are less than the premiums collected, the reinsurance company makes a profit.
