What Is Portfolio Reinsurance?
Portfolio reinsurance, also known as assumption reinsurance, is a type of transaction in which one insurance company transfers a large number of its existing insurance policies to another. It is typically employed when the company seeking portfolio reinsurance wishes to cease operating within a particular segment of the insurance market.
- Portfolio reinsurance is a type of insurance transaction involving two or more insurance companies.
- The purchaser of portfolio reinsurance provides the reinsurer with the insurance premiums received from the policies being reinsured.
- In exchange, the reinsurer assumes the risk for any future claims associated with those policies.
How Portfolio Reinsurance Works
Insurance companies must closely monitor the profitability of their insurance contracts. If the claims they pay consistently exceed the premiums they collect, then the insurer may struggle to fund its ongoing operations.
One of the ways that companies in that situation can reduce their risk of insolvency is by shifting some of their policies over to other insurance companies, called reinsurers. In doing so, the company purchasing reinsurance would pay the reinsurer a percentage of the premiums received. In exchange, the reinsurer would accept responsibility for a percentage of any future claims arising from the contract.
Portfolio reinsurance is simply a more extensive version of this basic transaction. Instead of reinsuring specific contracts, portfolio reinsurance involves reinsuring a large block of contracts—typically with the intention of no longer writing such contracts in the future. For instance, if an insurance companies decides to no longer offer home insurance policies, they might obtain portfolio reinsurance for all of their home insurance policies and then cease offering home insurance in the future.
Real World Example of Portfolio Reinsurance
Dorothy is an entrepreneur who recently acquired an insurance company specializing in home and auto insurance. After carefully reviewing the firm’s outstanding insurance policies, she determines that some of the regions in which the firm operates are consistently generating sub-standard profit margins.
In an effort to improve her firm’s financial strength, Dorothy decides to divest herself of the unprofitable contracts and cease operating in those regions. To accomplish this, she negotiates with several reinsurers and reaches an agreement with one of them to transfer 100% of the outstanding liabilities associated with those claims. In exchange, the reinsurer receives all of the premiums associated with those contracts in the future.
After completing this portfolio reinsurance transaction, Dorothy transfers all outstanding premiums and loss reserves to the reinsurer. Going forward, no new policies will be transferred to the reinsurer, because none will be created. Similarly, no renewal policies will be transferred since Dorothy’s firm will exit that geographic market and let their past policies lapse.