Written by Reinsurance is a form of insurance whereby an underwriter or a direct insurer transfers to another insurer( the reinsurer) all or parts of the risks or liabilities already under the insurance contract that he writes.
It is the business of protecting an insurance company against excessive losses resulting from its insurance operations.
Reinsurance is an insurance contract between two parties, the primary insurer and the reinsurer, whereby the reinsurer agrees to protect the insurer against part of its risk in return for the premium to be paid by the primary insurance.
In essence, reinsurance is insurance for insurance companies. It is not insurance for regular customers.
Reinsurance serves as a way for an insurance company to diversify its risk exposures by sharing it with another insurance company, called the re-insurer, which doesn’t have a direct relationship with the insured person or company.
Reinsurance helps insurance companies manage their risks by transferring a portion of the potential losses they face.
Why do insurance companies buy reinsurance?
1. To increase the underwriting capacity of the insurer: One reason why an insurer may buy reinsurance is to increase his underwriting capacity.
When an insurer purchases a reinsurance policy from a reinsurer, he is able to draw upon the reinsurer’s capital base, so that he has more capacity to continue underwriting himself.
2. To spread risk: Reinsurance serves as an effective means of risk transfer and risk spreading.
An insurance company may buy reinsurance to spread all or part of the insurance policies it has underwritten.
Whenever an insurance company buys a reinsurance policy, it cedes all or a portion of its risks to the reinsurance company so that in the event of a claim, the reinsurer will pay a portion of the claim, up to the limit of the reinsurance contract.
3. To comply with Government regulations: Another reason why insurance companies may buy reinsurance policies is to comply with regulatory requirements.
For instance, in some countries, insurance companies are legally required to maintain certain levels of solvency and they may achieve this by reinsuring some portion of their risks.
4. To secure protection against catastrophic events: Catastrophic events, such as hurricanes, have the capacity to induce mass pay-out.
To protect against catastrophic risk, the insurance company may buy reinsurance so that the in the event of a large claim, the reinsurer will pay a portion of the large claim.
5. To take advantage of the expertise of the reinsurer: Reinsurance companies typically have expertise and experience in managing specific risks.
Reinsurers are often in possession of a wealth of historical data that can help insurers understand the businesses they are entering, either in a new country or in a new line of business altogether.
Also, the reinsurance companies may have a better understanding and ability to manage the risks that the primary insurer has assumed.
So, an insurer may purchase risk to benefit from the expertise and experience of the reinsurer.
Importance of Reinsurance
1. Provides financial security: An insurance company needs to manage its affairs in such a way that a large number of losses do not affect its financial stability.
Reinsurance helps insurance companies achieve this by providing a source of funds to pay claims in the event of a catastrophic loss, which triggers a large number of losses.
2. Increased capacity: An insurance company can underwrite large numbers of insurance policies provided it has the financial capacity and required solvency to do.
If an insurer buys a reinsurance policy, he automatically transfers all or some part of the risk to the reinsurer.
This allows the insurer to increase the amount of insurance coverage he is able to provide to clients.
3. Improve risk diversification: Another benefit or importance of reinsurance is that it allows the insurer to diversify his risk portfolio.
Reinsurance allows insurance companies to diversify their risk portfolio by providing a mechanism through which insurance companies can transfer some or all risks to another insurance company known as the reinsurer.
4. Assists in the absorption of new exposures: Reinsurance assists an insurance company in managing and absorbing new and emerging risks.
These new risks may result from economic changes, social changes, and changes in insurance methods.
An insurance company can benefit from transferring some of its risk exposures to a reinsurance company, which may have the expertise and resources to manage the new risks.
Furthermore, reinsurance helps to mitigate the potential impact of new risk exposure on the financial stability and solvency of the insurance company by providing the necessary resources and advice.
5. Improved solvency: Another advantage of re-insurer is the improved solvency that it can help insurance companies attain.
This is due to the fact that reinsurance provides a source of funds to insurance companies to pay claims in the event of a catastrophe, which can help improve the solvency of the insurance company.
By improving solvency, reinsurance helps insurance companies comply with minimum solvency requirements set by regulatory bodies.
6. Increased stakeholder confidence: Reinsurance makes an insurance company more financially stable and secure.
It increases public confidence that the insurance company will be able to pay out claims if something catastrophic happens.
7. Reduces the ceding insurer’s unearned premium reserve requirement: Unearned premium reserve is the portion of the insurance premium that has been collected but not yet earned because the policy period has not yet expired.
The ceding insurer is required to keep a certain amount of unearned premium reserve as a buffer to ensure that it has enough funds to pay claims in the event of a catastrophic loss.
Whenever an insurance company buys reinsurance, it is able to transfer some of the risks to the reinsurance. thereby reducing the amount of unearned premium reserve that it is required to hold
The advantage of a reduced unearned premium reserve requirement is that it increases the surplus of the insurer, allowing it to expand its business more rapidly than would otherwise be possible.
Conclusion
To summarize, reinsurance is the transfer of all or part of the risks of an insurance company to another insurance company, called the reinsurer.
There are several reasons why an insurance company may buy reinsurance, including, to spread risk, increase the underwriting capacity of the insurer and comply with Government regulations.
Reinsurance is important because it boosts the capacity of the insurer and promotes financial security, risk diversification, and increases the solvency of insurance businesses.
