What is Reinsurance?

Frequently Asked Questions About Reinsurance

•  What is reinsurance?
• How does reinsurance work?
• What are the different types of reinsurance?
• Expert(s) Who Answered

What is reinsurance?

In a nutshell, reinsurance is an insurance policy bought by an insurance company from another insurance company—or multiple companies—called reinsurers. Also called “insurance for insurers” or “stop loss insurance,” it’s basically a way for an insurance company (i.e., the one who actually sells the policy to a client) to distribute some of its risk and financial burden for more expensive claims. This way, the insurance company is able to offer coverage it otherwise couldn’t.

How does reinsurance work?

Should the stuff hit the fan and cause an insurance client to actually need to collect their huge promised payout, reinsurance will cover losses exceeding the agreed limit with the client’s insurance company. This arrangement can be worked out in percentages or layers, and the cost may be distributed across multiple reinsurance policies through multiple reinsurers, or with just one.

Let’s say an insurance company is worried about providing pricey coverage for hailstorm damage on a client’s homeowners policy. They can connect with a reinsurer and work out a deal that states that they (the insurance company writing the policy, or the “ceding” company) will provide their client’s coverage up to the first $100 million in damages, and the rest will be covered by the reinsurer. In exchange, the reinsurer will collect an agreed percentage of the premium the client pays to the ceding company.

So if the client files a homeowners insurance claim for $150 million in hailstorm damage, the first $100 million will be covered by the ceding company, and the remaining $50 million (or a previously agreed-upon percentage) will be covered by one or more reinsurers. This way, the insurance client gets their full coverage promised, and the ceding insurance company avoids financial ruin thanks to the help they receive when paying out these claims.

What are the different types of reinsurance?

When it comes to reinsurance, there’s no “one-size-fit- all” approach. While there are tons of different options for working out these arrangements, there are two main types of reinsurance agreements to choose from.

Reinsurance is most commonly offering in the following forms:

• Treaty reinsurance: This type of contract dictates that the ceding company and the reinsurer will work together for a specified amount of time and share a “book” of risks, rather than ceding one risk at a time.  
  Proportional contracts are set up so that the ceding company distributes to the reinsurer an agreed percentage share of the policies, and in exchange they will receive a comparative amount of the premiums.   
  Nonproportional contracts are set up so that the reinsurer will only pay out claims that exceed a previously agreed upon amount during a specified time frame.
• Facultative reinsurance: This type of contract cedes a single risk to a reinsurer at a time, which allows the reinsurer to review each risk and determine whether to accept it. The reinsurer may choose to reject specific risks that could hurt their chances of turning a profit. When a reinsurer agrees to take on a specific risk, a certificate is created to outline the agreement between them and the ceding company.