Reinsurance

Functions of reinsurance

There are many reasons an insurance company will choose to reinsure as part of its responsibility to manage a portfolio of risks for the benefit of its policyholders and investors.

Risk transfer

The main use of reinsurance is to allow the ceding company to assume individual risks greater than its size would otherwise allow, and to protect the cedant against catastrophic losses. Reinsurance allows an insurance company to offer larger limits of protection to a policyholder than its own capital would allow. If an insurance company can safely write only $5 million in limits on any one policy, it can reinsure (or cede) the amount of the limits in excess of $5 million to reinsurers.

Reinsurance’s highly refined uses in recent years include applications where reinsurance was used as part of a carefully planned hedge strategy.

Income smoothing, Surplus relief, Arbitrage

Reinsurance can help to make an insurance company’s results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage.

Reinsurance can improve an insurance company's balance sheet by reducing the amount of net liability, and thereby increasing surplus. Surplus, assets less liabilities, is roughly the same as shareholder equity on a balance sheet of a non-insurance company.

The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than what they believe the cost is for the underlying risk.

Contracts

Most of the above examples concern reinsurance contracts that cover more than one policy (treaty). Reinsurance can also be purchased on a per policy basis, in which case it is known as facultative reinsurance. Facultative reinsurance can be written on either a quota share or excess of loss basis. Facultative reinsurance is commonly used for large or unusual risks that do not fit within standard reinsurance treaties due to their exclusions. The term of a facultative agreement coincides with the term of the policy. Facultative reinsurance is usually purchased by the insurance underwriter who underwrote the original insurance policy, whereas treaty reinsurance is typically purchased by a senior executive at the insurance company.

Reinsurance treaties can either be written on a “continuous� or “term� basis. A continuous contract continues indefinitely, but generally has a “notice� period whereby either party can give its intent to cancel or amend the treaty within 90 days. A term agreement has a built-in expiration date. It is common for insurers and reinsurers to have long term relationships that span many years.

Markets

Many reinsurance placements are not placed with a single reinsurer but are shared between a number of reinsurers. (For example a $30,000,000 xs of $20,000,000 layer may be shared by 30 reinsurers with a $1,000,000 participation each.) The reinsurer who sets the terms (premium and contract conditions) for the reinsurance contract is called the lead reinsurer; the other companies subscribing to the contract are called following reinsurers (they follow the lead).

About half of all reinsurance is handled by reinsurance brokers who then place business with reinsurance companies. The other half is with “direct writing� reinsurers who have their own production staff and thus reinsure insurance companies directly.

Copyright 2008 - France BtoB from Wikipédia