Definition
Reinsurance is a financial arrangement that allows primary insurance companies (cedants) to transfer part of their risk exposure to another insurance company (the reinsurer). By sharing potential catastrophic or significant financial responsibilities, reinsurance helps insurance providers maintain stability, ensuring they can pay out claims efficiently and continue operating smoothly.
Examples
- Hazard Insurance on Skyscrapers: Due to the high risk associated with insuring tall buildings, insurance companies purchase reinsurance policies. This allows the risk to be spread so that any significant loss does not severely impact a single firm.
- Natural Disaster Policies: Insurance companies with policies covering damages from natural disasters like earthquakes and hurricanes often buy reinsurance. This reduces their exposure to massive claims following such events.
Frequently Asked Questions (FAQs)
What is reinsurance?
Reinsurance is the process by which primary insurers transfer parts of their risk portfolios to other, often larger, insurance companies to mitigate the potential impact of high claims. This method helps stabilize the insurance market and ensures solvency of insurers.
What types of reinsurance are there?
The two main types of reinsurance are facultative reinsurance, which involves individually underwriting large or special risk cases, and treaty reinsurance, where the reinsurer covers a portfolio or class of business under agreed terms.
How does reinsurance benefit policyholders?
While policyholders are generally unaware of reinsurance arrangements, they benefit indirectly. Reinsurance helps insurers spread their risks, thereby stabilizing the companies and ensuring they can pay policyholders’ claims even in the event of large-scale disasters.
What is proportional reinsurance?
In proportional reinsurance, the reinsurer receives a share of the premiums and pays a proportionate share of the claims. This means that the risk, as well as premiums and losses, are divided in the same ratio.
What is non-proportional reinsurance?
Non-proportional reinsurance, also known as excess of loss reinsurance, involves the reinsurer covering losses exceeding a certain amount. The insurer retains losses below that threshold.
Cedant
The insurance company that passes on part of its risk to a reinsurance company.
Treaty Reinsurance
An agreement between an insurer and a reinsurer to share a set of policies which are predetermined for a specific period.
Facultative Reinsurance
A type of reinsurance that is purchased by an insurer to cover a specific risk or policy.
Excess of Loss Reinsurance
Reinsurance that provides coverage to the insurer for losses exceeding a specified amount.
Risk Retention
The amount of risk that an insurer keeps for itself under a reinsurance agreement.
Online Resources
- Reinsurance Association of America - raa.org
- International Reinsurance Companies - insurancejournal.com
- Association of British Insurers on Reinsurance - abi.org.uk
References
- “Reinsurance Fundamentals and New Developments” by Ruth Gastel
- “Essentials of Reinsurance” by Finance and Insurance Professional Development
Suggested Books for Further Study
- “Reinsurance: Principles and Practice” by Carol Boland
- “Reinsurance Management Strategies” by Thomas E. Davidson
- “Global Reinsurance: Markets, Models and Data” by Robert L. Carter
Real Estate Basics: Reinsurance Fundamentals Quiz
### What is the primary function of reinsurance in the insurance industry?
- [ ] To eliminate the need for individual policyholders
- [ ] To offer new insurance products
- [ ] To expand coverage to new markets
- [x] To transfer part of an insurance company's risk to another company
> **Explanation:** The primary function of reinsurance is to transfer part of an insurance company's risk to another reinsuring company, thus spreading the financial burden of potential claims.
### What type of reinsurance involves individually underwriting large or special risk cases?
- [x] Facultative reinsurance
- [ ] Treaty reinsurance
- [ ] Proportional reinsurance
- [ ] Excess of loss reinsurance
> **Explanation:** Facultative reinsurance involves individually underwriting and covering large or special risk cases that may not be included in a general portfolio.
### What is the term for the insurance company that cedes risk to a reinsurer?
- [ ] Insured
- [x] Cedant
- [ ] Beneficiary
- [ ] Actuary
> **Explanation:** The term for the insurance company that passes on the risk to another insurer is the "cedant".
### Which type of reinsurance involves the reinsurer covering losses that exceed a certain amount?
- [ ] Proportional reinsurance
- [ ] Facultative reinsurance
- [x] Excess of loss reinsurance
- [ ] Treaty reinsurance
> **Explanation:** Excess of loss reinsurance involves the reinsurer covering losses that exceed a pre-determined amount, protecting the insurer from exorbitant claims.
### What is proportional reinsurance?
- [ ] Reinsurance that covers losses over a certain threshold
- [x] Reinsurance where all risks, premiums, and losses are split proportionally
- [ ] Reinsurance that applies only to catastrophic events
- [ ] Reinsurance concerning special risks only
> **Explanation:** Proportional reinsurance involves both the premiums and losses being divided between the primary insurer and the reinsurer by a pre-agreed proportion.
### How does non-proportional reinsurance provide coverage?
- [ ] It splits risks evenly among all reinsurers involved
- [x] It covers only the excess amount of losses above a specified threshold
- [ ] It segregates all risks into equal parts
- [ ] It combines only the lucrative parts of insurance portfolios
> **Explanation:** Non-proportional reinsurance provides coverage for losses that exceed a specified threshold, protecting the primary insurer from large, unexpected claims.
### Which agreement method involves a set of policies covered under pre-agreed terms?
- [ ] Facultative reinsurance
- [ ] Proportional reinsurance
- [x] Treaty reinsurance
- [ ] Excess of loss reinsurance
> **Explanation:** Treaty reinsurance involves an agreement between the insurer and the reinsurer for coverage of a portfolio of policies under pre-agreed terms.
### Who predominantly benefits indirectly from reinsurance?
- [x] Policyholders
- [ ] Bankers
- [ ] Appraisers
- [ ] Real estate agents
> **Explanation:** Policyholders benefit indirectly from reinsurance as it ensures that their insurance company remains solvent and capable of paying out claims.
### What does risk retention refer to in the context of reinsurance?
- [ ] The reinsurer's obligation to invest in the cedant's company
- [ ] Distribution of risk equally among an insurer's employees
- [ ] The insurer's decision to avoid reinsurance
- [x] The amount of risk that an insurer decides to keep for itself
> **Explanation:** Risk retention refers to the amount of risk that the insurer elects to keep rather than cede to the reinsurer.
### What can stabilize the insurance market and ensure payout capability in large scale disasters?
- [ ] Personal loans for insurance companies
- [ ] Higher premiums for consumers
- [x] Reinsurance activities
- [ ] State guarantees
> **Explanation:** Reinsurance activities stabilize the insurance market and ensure companies have the capability to pay out claims even in cases of large-scale disasters.
