What Is Reinsurance Credit?
Reinsurance credit is an accounting entry made by an insurer for premiums ceded to reinsurers and losses recovered from reinsurers. Reinsurance credit procedures allow an insurance company to treat money owed by reinsurers for covered losses as assets.
When an insurance company enters into a reinsurance contract, it is agreeing to shift some of the risk from the policies that it has underwritten to the reinsurer, and in turn, will provide the reinsurer with a portion of the premium that it earns on those policies. It is an accounting move made by insurance companies that helps them not to lose money if customers do not pay their bills.
- A reinsurance credit entry enables insurers to account for money owed by reinsurers for covered losses as assets.
- The reinsurance credit entry can be treated as a reduction in the insurer's liability only when the reinsuring agency meets a specific set of requirements, such as being licensed to work in the state and having a good credit rating.
- Because the number of reinsurers in a given market and sector is generally small, insurance agencies typically have exposure to only a limited number of names.
How Reinsurance Credit Works
This is the risk associated with the reinsurer becoming insolvent, and thus becoming unable to fulfill its portion of the reinsurance agreement. If the reinsurer is unable to cover the claims that it is contractually obligated to, the insurance company may find itself with a much larger liability than anticipated.
Insurance companies take into account this credit risk through reinsurance credits. These are accounting entries that allow it to show that it still has potential exposure to loss (non-admitted balance), though ideally the loss would be covered by the reinsurance company.
Using reinsurance allows an insurer to underwrite more policies because its overall risk profile is reduced, but also opens up the insurer to reinsurance credit risk.
The credit risk may vary according to the reinsurer that the ceding company is working with, as each reinsurer may have a different level of creditworthiness from the other. Typically, insurance companies will set up internal controls to make sure that the reinsurers that they work with have sufficient capital to remain solvent if claims are filed.
A reinsurance credit entry allows the insurer to either list reinsurance as an asset or as a reduction in liability only when the reinsurer meets a basic set of requirements as put forth by the insurance company.
These requirements include the reinsurer being licensed to provide reinsurance in the state that the insurer is operating in, the reinsurer filing the appropriate regulatory documentation, and the reinsurer submitting to financial reviews.
According to a paper published on Actuaries.org, insurers must deal with industry concentration and single-name concentration when it comes to reinsurance. Why? The paper states: "The number of reinsurers is small (when compared to the number of bond issuers) and so a typical insurer—however prudent—is likely to have concentrated exposure to individual names."