A ceding company is an insurance company that passes the part or all of its risks from its insurance policy portfolio to a reinsurance firm. Passing off risk in this manner allows the ceding company to hedge against undesired exposure to loss and frees up capital to use in writing new insurance contracts.
Breaking Down Ceding Company
The ceding company retains liability for the reinsured policies, so although claims should be reimbursed by the reinsurance firm, if the reinsurance company defaults, the ceding company may still have to make a payout on reinsured policy risks. Insurance is a highly regulated industry which requires insurance companies to write certain semi-standardized policies and maintain sufficient capital as collateral against losses. Insurance companies can use reinsurance to allow them more freedom in controlling their operations. For instance, in cases where the insurance company does not wish to carry the risk of certain losses in a standard policy, these risks can be reinsured away. An insurer can also use reinsurance to control the amount of capital it is required to hold as collateral.
Why Ceding Companies Rely on Reinsurance
Ceding a portion of the risk to a reinsurer allows an insurance company to more effectively and efficiently manage its overall risk exposure. Reinsurance can be written by a specialist reinsurance company, such as Lloyd’s of London or Swiss Re, by another insurance company, or by an in-house reinsurance department. Some reinsurance can be handled internally, such as with automobile insurance, by diversifying the types of clients that are taken on. In other cases, such as liability insurance for a large international business, specialty reinsurers may be used because diversification is not possible.
Reinsurance Available to Prospective Ceding Companies
- Facultative reinsurance coverage protects a cedent insurance company for a certain individual or a specified risk or contract. If several risks or contracts need facultative reinsurance, each is negotiated separately. The reinsurer has all rights to accept or deny a facultative reinsurance proposal.
- A reinsurance treaty is effective for a set time period rather than on a per-risk or contract basis. The reinsurer covers all or a portion of the risks that a cedent insurance company may incur.
- Under proportional reinsurance, the reinsurer receives a prorated share of all policy premiums sold by the cedent. When claims are made, the reinsurer covers a portion of the losses based on a pre-negotiated percentage. The reinsurer also reimburses the cedent for processing, business acquisition, and writing costs.
- With non-proportional reinsurance, the reinsurer is liable if the cedent's losses exceed a specified amount, known as the priority or retention limit. As a result, the reinsurer does not have a proportional share in the ceding insurer's premiums and losses. The priority or retention limit may be based on one type of risk or an entire risk category.
- Excess-of-loss reinsurance is a type of non-proportional coverage in which the reinsurer covers the losses exceeding the ceding insurer's retained limit. This contract is typically applied to catastrophic events, covering the cedent either on a per-occurrence basis or for the cumulative losses within a set time period.
- Under risk-attaching reinsurance, all claims established during the effective period are covered, regardless of whether the losses occurred outside the coverage period. No coverage is provided for claims originating outside the coverage period, even if the losses occurred while the contract was in effect.