is insurance that is purchased by an insurance company (the "ceding company
" or "cedent" or "cedant" under the arrangement) 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 reinsurer may be either a specialist reinsurance company, which only undertakes reinsurance business, or another insurance company. Insurance companies that sell reinsurance refer to the business as 'assumed reinsurance'.
A healthy reinsurance marketplace helps ensure that insurance companies can remain solvent (financially viable), particularly after a major disaster such as a major hurricane, because the risks and costs are spread.
There are two basic methods of reinsurance:
- Facultative Reinsurance, which is negotiated separately for each insurance policy that is reinsured. Facultative reinsurance is normally purchased by ceding companies for individual risks not covered, or insufficiently covered, by their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurance treaties and for unusual risks. Underwriting expenses, and in particular personnel costs, are higher for such business because each risk is individually underwritten and administered. However, as they can separately evaluate each risk reinsured, the reinsurer's underwriter can price the contract to more accurately reflect the risks involved. Ultimately, a facultative certificate is issued by the reinsurance company to the ceding company reinsuring that one policy.
- Treaty Reinsurance means that 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. The reinsurance contract may oblige the reinsurer to accept reinsurance of all contracts within the scope (known as "obligatory" reinsurance), or it may allow the insurer to choose which risks it wants to cede, with the reinsurer obliged to accept such risks (known as "facultative-obligatory" or "fac oblig" reinsurance).
There are two main types of treaty reinsurance, proportional and non-proportional, which are detailed below. Under proportional reinsurance, the reinsurer's share of the risk is defined for each separate policy, while under non-proportional reinsurance the reinsurer's liability is based on the aggregate claims incurred by the ceding office. In the past 30 years there has been a major shift from proportional to non-proportional reinsurance in the property and casualty fields.