What Is Prospective Reinsurance?
Prospective reinsurance is a reinsurance contract in which coverage is provided for future losses on insurable events. Prospective reinsurance differs from retroactive reinsurance, which covers losses from insurable events that may have occurred in the past.
- Prospective reinsurance is a type of reinsurance contract that covers potential future losses, versus retroactive reinsurance, which covers losses that happened previously.
- With prospective reinsurance, a ceding company is paid back for insured losses that could happen in the future; with retroactive reinsurance, the ceding company is paid for insured events that have already happened.
- While the two types of reinsurance are often accounted for separately, some reinsurance contracts include both prospective and retroactive coverage, as insurers need to account for both past and future risks.
Understanding Prospective Reinsurance
Some reinsurance contracts contain both prospective and retroactive coverage because insurance companies have to account for two distinct types of risks. The first type of risk involves future events. The insurer has to consider the probability that a future event that is covered under a policy will result in a loss being reported. For example, the possibility that a fire will result in a loss on a fire insurance policy.
The second type of risk is the liability associated with insurable events that have occurred in the past, and that a claim will be filed against the company in the future. As long as an insurance policy is active, it will be subject to claims until the premium has been fully earned.
How Prospective Reinsurance Works
A prospective reinsurance contract is one in which the reinsurer agrees to reimburse the ceding company for losses that may result from future events. For example, consider a life insurance policy, an insurance policy that pays out the insured when the insured dies. The coverage event is triggered when the insured dies, which is something that can only happen in the future.
Another example is health insurance in which the insured may become ill in the future. Prospective reinsurance arrangements cover a ceding company’s losses that occur on or after the reinsurance treaty’s effective date.
Estimating prospective risk and risk funding has been a fundamental part of actuarial practice in the insurance business since the beginning of the profession. Estimating future costs based on sound actuarial practice is essential to the integrity of the insurance and risk financing system and is a key to fulfilling the promise embodied in the insurance contract.
The study of emerging risks is also a major part of prospective reinsurance modeling. By studying emerging risks, reinsurers are better able to advise insurance company clients on exclusions, policy wording, claims handling, and overall management of these risks.
Larger reinsurance groups are quite active in developing white papers and analyses on emerging risks for their clients and the industry as a whole. Many reinsurance companies will have experts attend client seminars to provide the claims personnel of clients with state-of-the-art industry knowledge.
Retroactive vs. Prospective Reinsurance
By contrast, retroactive reinsurance provides payment to the ceding company for insured events that have already occurred. For example, a long-term disability policy will pay the policyholder for injuries that were sustained in the past. A reinsurance policy covering this type of peril will thus be paying the ceding company for a peril that has already occurred.