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What is 'Reinsurance'

Reinsurance, also known as insurance for insurers or stop-loss insurance, is the practice of insurers transferring portions of risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a large obligation resulting from an insurance claim. The party that diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of the potential obligation in exchange for a share of the insurance premium is known as the reinsurer.

BREAKING DOWN 'Reinsurance'

Reinsurance allows insurers to remain solvent by recovering some or all of amounts paid to claimants. Reinsurance reduces net liability on individual risks and catastrophe protection from large or multiple losses. It also provides ceding companies the capacity to increase their underwriting capabilities in terms of the number and size of risks.

Benefits of Reinsurance

By covering the insurer against accumulated individual commitments, reinsurance gives the insurer more security for its equity and solvency and more stable results when unusual and major events occur. Insurers may underwrite policies covering a larger quantity or volume of risks without excessively raising administrative costs to cover their solvency margins. In addition, reinsurance makes substantial liquid assets available for insurers in case of exceptional losses.

Types of Reinsurance

Facultative coverage protects an insurer for an individual or a specified risk or contract. If several risks or contracts need reinsurance, each is negotiated separately. The reinsurer has all rights for accepting or denying 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 the insurer may incur.

Under proportional reinsurance, the reinsurer receives a prorated share of all policy premiums sold by the insurer. When claims are made, the reinsurer bears a portion of the losses based on a pre-negotiated percentage. The reinsurer also reimburses the insurer for processing, business acquisition, and writing costs.

With non-proportional reinsurance, the reinsurer is liable if the insurer'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 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 insurer's retained limit. This contract is typically applied to catastrophic events, covering the insurer 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.

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