What it means
Insurance companies collect premiums in exchange for promising to pay claims, but a single hurricane or a cluster of large liability claims can wipe out years of profit. Reinsurance lets an insurer sell part of that exposure to another company, keeping the customer relationship while shrinking the potential loss.
The insurer doing the selling is the ceding company, and the arrangement is described as a cession. This matters commercially because reinsurance is how insurers manage capital rather than merely manage risk.
Ceding part of the book reduces the capital a regulator requires the insurer to hold, which frees up capacity to write more business, so a ceding company can grow faster than its own balance sheet would otherwise allow. Reinsurance also smooths reported earnings, which matters to investors and rating agencies.
There are two broad shapes. Proportional treaties, such as quota share, hand over a fixed percentage of every premium and every claim, while non-proportional treaties, such as excess of loss, pay only when claims exceed an agreed threshold.
Proportional deals usually come with a ceding commission, an amount the reinsurer pays back to cover the ceding company's costs of acquiring and administering the business. The critical nuance is that ceding risk does not cede responsibility.
If the reinsurer fails or disputes a claim, the ceding company still owes its policyholders in full, which is why insurers monitor reinsurer credit quality closely and often spread cessions across several reinsurers. This residual exposure is known as reinsurance counterparty risk or reinsurance recoverable risk.
In practice
Real-world examples.
Example
A coastal home insurer cedes 60% of its hurricane-exposed portfolio under a quota share treaty so a single severe season cannot exhaust its capital. It keeps the customer relationships and continues to handle every claim itself.
Example
A commercial motor insurer buys excess of loss cover attaching at $2,000,000 per claim. When a serious accident produces a $9,000,000 settlement, the insurer pays the first $2,000,000 and recovers $7,000,000 from its reinsurers.
Example
A newly launched cyber insurer cedes half its book because it has limited claims history and its regulator requires a large capital buffer. As its data improves over three years it reduces the cession to 25% and keeps more of the margin.
Think of it
“Ceding company is the insurer passing risk on-the one buying reinsurance.
Formula
Calculation
Ceded premium = gross written premium x cession percentage
Retained premium = gross written premium - ceded premium
A regional property insurer writes $80,000,000 of gross premium in a year and cedes 40% of its book under a quota share treaty. Ceded premium is $80,000,000 x 0.40 = $32,000,000, leaving retained premium of $80,000,000 - $32,000,000 = $48,000,000. The reinsurer pays a ceding commission of 25% on the ceded premium, which is $32,000,000 x 0.25 = $8,000,000, and that payment offsets the insurer's own acquisition and administration costs. When claims for the year come in at $50,000,000, the reinsurer takes 40%, or $20,000,000, and the ceding company retains $30,000,000, so its net loss ratio is 30,000,000 / 48,000,000 = 62.5%, exactly the same as its gross loss ratio of 50,000,000 / 80,000,000, which is the defining feature of a proportional treaty.Case study
Seen in the real world.
This is a fictional, illustrative scenario. Cobblestone Mutual is an invented regional insurer writing about $80,000,000 of property premium a year across a single state, which left it dangerously concentrated in one weather system. Its board wanted to grow into two neighbouring states but the regulator's capital requirement made that impossible on the existing balance sheet.
Acting as a ceding company, Cobblestone put a 40% quota share treaty in place with two reinsurers, splitting the cession 25% and 15% so it was not dependent on a single counterparty. The ceding commission of $8,000,000 covered most of its acquisition costs, and the reduced capital requirement freed roughly $15,000,000 of capacity for the expansion.
Two years later a severe hail season produced $50,000,000 of claims. The illustrative reinsurers absorbed $20,000,000, Cobblestone reported a manageable underwriting loss instead of a capital emergency, and the fictional finance director noted in the annual report that the real value of the treaty had been the ability to keep writing new business through the following renewal season.
Watch out
Common mistakes.
- Thinking the policyholder now has a claim against the reinsurer, when the ceding company alone remains liable to the customer.
- Treating ceded premium as pure lost revenue, when the ceding commission and the reduction in required capital are both real economic benefits.
- Concentrating every cession with one reinsurer, which simply swaps insurance risk for a large single counterparty exposure.
Questions
People also ask.
What is a ceding commission?
It is the amount a reinsurer pays back to the ceding company out of ceded premium, intended to cover the commissions and administration the insurer incurred to write the business.
What is the difference between quota share and excess of loss?
Quota share hands over a fixed percentage of every premium and claim, while excess of loss responds only to claims above an agreed attachment point.
Does reinsurance always reduce a regulator's capital requirement?
Only when the risk transfer is genuine and the reinsurer is acceptable to the regulator, so arrangements with little real transfer receive no credit.
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