What it means
Insurers collect premiums and pay claims, but a single large claim can threaten a small insurer's finances. To protect itself, the insurer, known as the ceding company, passes part of the risk to a reinsurer.
In a co-reinsurance deal, the reinsurer takes a fixed percentage of every policy covered by the agreement. The key feature is proportional sharing: if the reinsurer takes 70% of the risk, it receives 70% of the premium and pays 70% of every claim, while the ceding insurer keeps the remaining 30% of both.
This keeps the interests of the two companies aligned, because both gain when claims are low and both lose when claims are high. The reinsurer usually pays the ceding insurer a ceding commission, which is a payment to cover the costs of finding, underwriting and administering the original policies.
This matters because the ceding insurer carries those expenses upfront while only keeping a share of the premium. Without the commission, passing on risk would leave the original insurer out of pocket.
Co-reinsurance is common in life and health insurance, where the insurer may want to reduce its exposure to large death or medical claims while keeping the customer relationship. It also supports growth: by sharing the risk, the insurer can write more business without needing to hold as much regulatory capital, the minimum funds it must keep to remain solvent.
An important nuance is that the original insurer remains legally responsible to the policyholder. If the reinsurer fails to pay, the policyholder still expects to be paid by the insurer they bought from.
For that reason, insurers examine the financial strength of any reinsurer carefully before signing. Another variant is modified co-reinsurance, where the reinsurer holds back part of the reserves instead of the ceding company holding all of them.
This changes who earns investment income on the funds, and it affects how the deal looks on each company's balance sheet. Finance teams should compare the accounting treatment of each variant before choosing.
In practice
Real-world examples.
Example
A regional life insurer wants to sell a $10,000,000 group life policy to a large employer, which is too big for its capital. It places 60% of the risk with a reinsurer and keeps 40%, so it can accept the contract and still protect its balance sheet. The employer receives its cover without any change in the insurer it deals with.
Example
A health insurer launching a new product in a new market is unsure about claim levels. It agrees a 50% co-reinsurance deal for the first three years, which limits its losses if claims come in higher than expected. If claims turn out lower than forecast, both companies share the benefit in the same proportion.
Example
A property insurer in a coastal region reinsures 40% of its homeowner portfolio. When a storm causes $5,000,000 of claims, the reinsurer pays $2,000,000 and the insurer pays $3,000,000, which keeps its capital within safe limits. The ceding commission it receives also helps to cover the cost of selling and servicing those policies.
Formula
Calculation
Reinsurer's claim payment = total claim x reinsurer's share percentage
Ceding insurer's retained claim = total claim x (1 - reinsurer's share percentage)
Suppose an insurer writes a policy with an annual premium of $500,000 and agrees a 70% co-reinsurance share. The reinsurer receives 500,000 x 0.70 = $350,000 of premium, and the insurer keeps $150,000. A claim of $2,000,000 arises. The reinsurer pays 2,000,000 x 0.70 = $1,400,000, and the insurer pays 2,000,000 x 0.30 = $600,000. If the reinsurer also pays a 20% ceding commission on the ceded premium, the commission is 350,000 x 0.20 = $70,000.Case study
Seen in the real world.
Cedarpoint Mutual is an illustrative, fictional life insurer that wanted to double its sales of term life cover but had limited capital. The chief financial officer calculated that writing the extra business alone would require an additional $6,000,000 of regulatory capital.
She negotiated a co-reinsurance treaty in which a reinsurer took 50% of each new policy. The insurer gave up half the premium but received a ceding commission that covered most of its sales costs, and its capital need fell by about half.
The illustrative lesson is that co-reinsurance traded some profit for growth capacity. Cedarpoint accepted lower margins per policy because the larger volume produced more total profit. The treaty also let the board approve a faster expansion plan with lower capital strain.
Watch out
Common mistakes.
- Assuming the reinsurer only pays when losses are very large, when in co-reinsurance it shares in every claim from the first dollar.
- Forgetting that the ceding insurer is still legally liable to the policyholder if the reinsurer cannot pay.
- Ignoring the ceding commission when calculating the true profit from a reinsured policy.
Questions
People also ask.
How is co-reinsurance different from excess-of-loss reinsurance?
Co-reinsurance shares every claim in a fixed proportion, while excess-of-loss only pays once a claim passes an agreed threshold.
Why would an insurer give away part of its premium?
It trades some profit for lower risk and for the capacity to write more business with the same capital.
Who decides the sharing percentage?
The insurer and reinsurer negotiate it in the treaty, based on the risk, the capital involved and the price.
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