Reinsurance is a contract under which a company, the reinsurer, agrees to indemnify an insurance company, the ceding company, against all or part of the primary insurance risks underwritten by the ceding company under one or more insurance contracts.
Reinsurance differs from insurance primarily in terms of its inherent complexity, which is linked to its broader range of activities and international nature. Reinsurance can provide a ceding company with several benefits, including a reduction in net liability on individual risks and catastrophe protection from large or multiple losses. Reinsurance also provides ceding companies with the necessary capacity to increase their underwriting capabilities, in terms of both the number and size of risks. Reinsurance does not, however, discharge the ceding company from its liability to policyholders. Reinsurers themselves may feel the need to transfer some of the risks involved to other reinsurers (known as retrocessionnaires).
Reinsurance provides three essential functions:
- it offers the direct insurer greater security for its equity and solvency, as well as stable results when unusual and major events occur, by covering the direct insurer above certain ceilings or against accumulated individual commitments;
- it allows insurers to increase their available capacity - i.e. the maximum amount they can insure for a given loss or category of losses, by enabling them to underwrite policies covering a larger number of risks, or larger risks, without excessively raising their administrative costs and their need to cover their solvency margin and, therefore, their shareholders' equity;
- it makes substantial liquid assets available to insurers in the event of exceptional losses.
In addition, reinsurers also provide advisory services to ceding companies by:
- defining their reinsurance needs and devising the most effective reinsurance program to better plan their capital needs and solvency margin;
- supplying a wide array of support services, specifically in terms of technical training, organisation, accounting and information technology;
- providing expertise in certain highly specialised areas such as the analysis of complex risks and risk pricing;
- enabling ceding companies to build up their business even if they are temporarily under-capitalised, particularly in order to launch new products requiring heavy investment.
Watch this short animated video produced by the Chartered Insurance Institute (CII) illustrating the basic features of Reinsurance: https://www.youtube.com/watch?v=gAaZNPOQ0D4