DEFINITION of Ceded Reinsurance Leverage
Ceded Reinsurance Leverage is the ratio of ceded insurance balances to policyholders’ surplus. Ceded reinsurance leverage represents the extent to which an insurance company relies on ceding risk to reinsurers. This includes ceded premiums, net balances for unpaid losses and unearned premiums.
BREAKING DOWN Ceded Reinsurance Leverage
Companies use reinsurance as a way to shift risk off of their portfolios, which they do in exchange for a portion of the premiums they earn from writing policies. Ceding risk to reinsurers is a fairly common occurrence in the industry, as it allows insurance companies to reduce their exposure to a potential surge in claims by shifting some of the obligation to another company.
How Insurers Manage Risk
Ceded reinsurance leverage is used as a barometer on how much an insurance relies on shifting policy risks to others. A high ratio indicates that the company relies heavily on others to help defray risk, a situation that carries with it its own risks. If reinsurance companies demand more money for assuming risks, the insurance company may find itself exposed to a larger risk than usual.
Another threat to the future health of an insurance company relates to how many reinsurers a company uses when transferring risk. A heavy concentration of ceded insurance in a small group of insurers can lead to a situation in which companies may be unable to collect from reinsurance companies, either because those companies are unwilling to fulfill their obligations or because they are unable to. If the insurance company only offers policies in a single state and in a single line, it could face serious risks.
Having a high ceded reinsurance leverage does not mean that an insurance company is headed to impairment. While there is a risk that the reinsurance companies used could find themselves unable to fulfill their obligations, using reinsurance companies that have either good credit ratings or can provide letters of credit may keep underwriting risks low.
Reinsurance allows insurers to remain solvent by recovering some or all of amounts paid to claimants. Reinsurance reduces net liability on individual risks and catastrophe protection from large or multiple losses. It also provides ceding companies the capacity to increase their underwriting capabilities in terms of the number and size of risks.
By covering the insurer against accumulated individual commitments, reinsurance gives the insurer more security for its equity and solvency and more stable results when unusual and major events occur. Insurers may underwrite policies covering a larger quantity or volume of risks without excessively raising administrative costs to cover their solvency margins.