What it means
Reinsurance is insurance for insurers. An insurer that writes policies may not want to keep all the risk, so it pays a reinsurer to take on part of it.
Most reinsurance covers whole portfolios, such as every motor policy written in a year. Spot reinsurance is different because it covers one particular policy or one risk, negotiated on its own terms.
An insurer might choose spot cover when it is asked to insure something large, such as a major factory, a satellite or an offshore project. Taking the whole risk would be too much for its capital, but turning the business away would lose a valuable customer.
Spot cover is the solution that lets it keep both its capital and the customer. The reinsurer examines the single risk in detail, because it cannot rely on the law of large numbers, the principle that results become more predictable across many similar policies.
As a result, pricing is more bespoke and the terms are usually negotiated case by case. Spot reinsurance is closely linked to facultative reinsurance, where the reinsurer is free to accept or decline each risk offered to it.
The advantage for the insurer is precise protection for the exposure it is worried about, and the drawback is more time, effort and often a higher cost per unit of cover than a bulk arrangement. On the accounts, the premium the insurer pays away reduces its net written premium, and the recoveries it expects from the reinsurer appear as a reinsurance asset.
A good finance team checks the reinsurer's financial strength, because the cover is only worth what the reinsurer can pay. It also confirms that the wording of the reinsurance matches the wording of the original policy, so that every claim the insurer pays is recoverable.
In practice
Real-world examples.
Example
An insurer is asked to cover a new $80,000,000 factory but its comfortable limit on a single risk is $20,000,000. It buys spot reinsurance for the remaining $60,000,000 so that it can accept the policy. Without the cover, the insurer would have had to decline the business and lose a long-standing client to a larger competitor. The reinsurance premium is deducted from the income it keeps on the deal, so the insurer's profit on the policy is smaller but far safer.
Example
A marine insurer is offered cover on a single cargo vessel carrying unusually valuable goods. It places spot reinsurance on that voyage alone, because its normal reinsurance programme does not fit the risk.
Example
A small specialist insurer writes a one-off policy for a film production with a large number of stunts. It buys spot cover for the production so that one serious accident cannot threaten its balance sheet. The extra premium is a cost, but it is far smaller than the loss it protects against.
Case study
Seen in the real world.
Lakeland Mutual is an illustrative, fictional insurer that normally writes small commercial policies. A property developer asked it to insure a $45,000,000 warehouse complex, far larger than anything on its books.
The underwriting director set a maximum retention of $5,000,000 on the risk and approached three reinsurers to cover the remaining $40,000,000. After inspecting the site and reviewing fire protection, one reinsurer agreed to take $25,000,000 and another $15,000,000.
Lakeland kept the customer, collected the premium, and passed on a share of it to the reinsurers, who each took the share of risk they had agreed to carry. The illustrative lesson is that spot reinsurance lets a small insurer compete for large business, provided it checks that its reinsurers are financially strong and the terms match the original policy. Lakeland also set up a simple register of every spot placement, showing the reinsurer, the limit and the expiry date.
Watch out
Common mistakes.
- Assuming spot reinsurance covers an entire portfolio, when it is arranged for one particular risk.
- Forgetting to match the reinsurance terms to the original policy, which can leave gaps in the cover.
- Choosing a reinsurer on price alone, without checking that it can actually pay a large claim.
Questions
People also ask.
Is spot reinsurance the same as facultative reinsurance?
They are very close, as facultative reinsurance is negotiated risk by risk, and spot cover is often used to describe that same one-off arrangement.
Why not use a standard treaty for large risks?
A treaty covers a defined class of business with set limits, and a single oversized risk may fall outside those limits or use them up, leaving the rest of the book without protection.
Who pays the claim if the original insurer cannot?
The policyholder still claims from the original insurer, which then recovers the reinsured share from the reinsurer, so the insurer remains responsible to the customer, whatever happens between it and the reinsurer.
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