What it means
Reinsurance is insurance for insurers. When an insurer writes a large or unusual risk, it may pass part of it to a reinsurer in return for part of the premium.
In an assisted placement, the reinsurer's support is built into the sale itself, so the policy can be offered on the strength of the cover behind it. The support can take several forms.
The reinsurer may agree to take a fixed share of every policy in a book, known as quota share, or to cover losses above an agreed amount, known as excess of loss. It may also give underwriting guidance, so that the insurer is comfortable writing the risk.
For the insurer, the benefits are capacity and stability. Passing part of the risk reduces the chance that one large loss will damage its capital.
It can also allow the insurer to enter a new class of business with the reinsurer's expertise and data. The reinsurer receives a share of the premium and may pay a ceding commission to the insurer to help cover its costs of acquiring and servicing the business.
The reinsurer also takes on a share of the claims. Because the reinsurer depends on this flow of premium, it has an interest in the quality of the underwriting.
The phrase appears in different forms in different markets, and some government-backed schemes use similar names for programmes that give reinsurance to insurers writing in hard-to-insure areas. Anyone reading a contract or a report using the phrase should check the definition in context.
The common thread is that reinsurance is used to make a placement possible. Insurers also need to think about the counterparty.
The value of the reinsurance depends on the reinsurer being able to pay claims years later, so credit quality matters as much as price. Many buyers spread their risk across several reinsurers for this reason.
In practice
Real-world examples.
Example
A small insurer wants to write contractors' liability policies but lacks the capital for large claims. A reinsurer agrees to take 50% of each policy, which allows the insurer to start writing business.
Example
A managing agent places a portfolio of property risks with a panel of insurers. A reinsurer supports the placement by agreeing to cover losses above a set amount.
Example
A start-up insurer in a new line of business accepts the reinsurer's underwriting guidelines as part of the deal. The reinsurer reviews the book each quarter and adjusts its terms based on the results. If the claims experience is better than expected, the insurer can negotiate a higher ceding commission at renewal.
Formula
Calculation
Ceded premium = gross premium x cession percentage
Ceding commission = ceded premium x commission rate
An insurer writes $2,000,000 of premium on a new class of business with a 40% quota share reinsurance arrangement. Ceded premium = $2,000,000 x 40% = $800,000. If the reinsurer pays a 25% ceding commission, commission = $800,000 x 25% = $200,000. The insurer keeps $1,200,000 of premium and receives $200,000 to help pay its acquisition costs.Case study
Seen in the real world.
Brackenridge Insurance is an illustrative, fictional insurer that wanted to write cover for small restaurants. It had little claims history in the class and its capital could not support a large loss from a single fire.
A reinsurer agreed to take a 50% quota share and to cover any single loss above $500,000. With that support the insurer launched the product, wrote $4,000,000 of premium in its first year and learned about the class with limited risk. The finance team also tracked claims by restaurant type, so that it could discuss pricing changes with the reinsurer at renewal. The illustrative lesson is that reinsurance can act as the foundation for a new business line as well as protection against loss.
Brackenridge also spread the quota share across two reinsurers so that it did not depend on a single partner. Each year the finance team reviewed the claims paid under the arrangement and the reinsurers' financial strength before agreeing to renew.
Watch out
Common mistakes.
- Assuming the phrase has a single fixed legal meaning, when its use differs between contracts and markets.
- Believing that ceding risk removes responsibility to policyholders, when the original insurer remains liable to its customers.
- Overlooking the cost, when the insurer gives up part of the premium and must also manage the reinsurer's credit risk.
Questions
People also ask.
What is a ceding company?
It is the insurer that passes part of its risk and premium to a reinsurer.
Does the reinsurer deal with policyholders?
Usually not, since the original insurer handles the policyholder relationship and claims while the reinsurer pays its share to the insurer, and the policyholder may never know a reinsurer is involved.
Is this the same as a state reinsurance scheme?
Not necessarily, because some government programmes use similar names for different arrangements, so each scheme's own rules apply.
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