What Is Portfolio Reinsurance?
Portfolio reinsurance is a type of contract in which an insurer has a large block of insurance policies reinsured. Portfolio reinsurance, also known as assumption reinsurance, may involve shifting risk from the insurer to the reinsurer for a particular type of policy (such as life insurance), all policies within a geographic area, or for a book of business.
Understanding Portfolio Reinsurance
Portfolio reinsurance, like all forms of reinsurance, is a way for insurance companies to mitigate risk and in some cases lower their taxes. It always involves an insurance company buying insurance on policies they have already written. The company buying the reinsurance is called the ceding company or the cedent. Insurance companies balance the risk that they take on when underwriting policies with the premiums that those policies bring in. The more risk that the insurer takes on, the greater its chance for insolvency, especially if the policies it underwrites are for a narrow set of insurance types or in a small geographic area. Insurers transfer some of this risk to a reinsurer through the purchase of a reinsurance policy, with the reinsurer accepting some or all of the policy risk in exchange for a fee.
Portfolio Reinsurance Allows More Risk
Say, for example, after a natural disaster like a hurricane or flood drains an insurers loss reserves, the company seeks to protect itself from insolvency by reinsuring its policies. By transferring risk to the reinsurer, an insurance company then increases claim limits, which attracts more business.
Insurance companies balance the benefits of increased business versus the risk of higher claims, which is an ongoing process.
In some cases, an insurance company stops providing a particular type of insurance policy or serving a specific geographic area. It does this because of the focus of its business changes, or because the policies are not profitable enough to keep operations open. The insurer has the option of not underwriting any new policies and letting the active policies lapse without renewing them, but this requires the insurer to continue operations and remain exposed to the perils that it has insured. Alternatively, the insurer can purchase a reinsurance contract in which it transfers the entire set of risks to the reinsurer and subsequently ceases operations.
When an insurance company closing up shop purchases portfolio reinsurance, it transfers all outstanding premiums and loss reserves to the reinsurer. No new policies are transferred because none is being created, and no renewal policies are transferred because the insurer is exiting the market and letting the policies lapse.