Reinsurer: Definition, Types, Top Companies, Vs. Primary Insurer

What Is a Reinsurer?

The term reinsurer refers to a company that provides financial protection to insurance companies. Reinsurers handle risks that are too large for insurance companies to handle on their own and make it possible for insurers to obtain more business than they would otherwise be able to. Reinsurers also make it possible for primary insurers to keep less capital on hand needed to cover potential losses.

Understanding a Reinsurer

A primary insurer is the insurance company from which an individual or business purchases a policy. This entity transfers risk to a reinsurer through a process called cession. Just as insurance policyholders pay premiums to insurance companies, insurance companies pay premiums to reinsurers. The price of reinsurance, like the price of insurance, depends on the amount of risk.

Reinsurers help spread out the risk of insuring natural disasters like earthquakes and hurricanes. Such an event could result in more claims than a primary insurer could pay out without going bankrupt. That's because there would not only be a high dollar amount of claims but they would all be made in the same time period.

By transferring part of the risk of insuring (and thus, part of the premiums) against these events to several reinsurers, individuals and businesses can purchase insurance for these perils. This allows insurance companies to stay solvent. Historically, there have been many instances where a number of insurance companies went under after a catastrophe because they were not solvent enough to pay out the insurance on their policies.

Some of the main reasons that an insurance company would purchase reinsurance include:

• Growing its business
• Bringing stability to the underwritten policies
• Raising capital via financing
• Seeking catastrophe protection
• Divesting from a specific type of insurance business
• Gaining expertise,
• Distributing risk

Special Considerations

Reinsurance is a large business and most consumers aren't really aware of this part of the insurance industry. The following table is a list of the top 10 reinsurance companies, according to rating agency A.M. Best.

Setting Up Reinsurance

The reinsurance transaction is not a simple one, as there are many factors to consider in selecting a reinsurer. For instance, the rating agencies don’t treat all reinsurers the same because their capital models vary based on the financial strength ratings of the reinsurer. 

Best practices for buying reinsurance should include a risk charge based on the reinsurer’s credit quality, mortality risk exposure, and the ceding company’s concentration of risk reinsured to the reinsurer.

Many policies are spread amongst multiple reinsurers. In this case, the transaction would involve a lead reinsurer that would negotiate the terms of the policy that other reinsurers would participate in. The lead reinsurer would set the terms and any modifications after signing, but they do not have to take on the largest portion of the risk. The other reinsurers are known as followers.

Types of Reinsurance Offered by Reinsurers

There are two main types of policies that fall under the reinsurance umbrella:

• Facultative Reinsurance: This insurance is used when a single insurance contract is so large that it requires its own reinsurance, such as a large life insurance policy for an extremely wealthy individual. As such, the reinsurer is responsible for underwriting the individual risk involved. This type of reinsurance allows the reinsurer to reject all or parts of the policy that they take on.
• Treaty Reinsurance: Treaty reinsurance, which is also called obligatory insurance, is used when one reinsurance contract can cover a large pool of similar risks. Unlike facultative reinsurance, this type of coverage ensures that the reinsurer takes on everything automatically rather than being able to reject portions of the policy until both parties terminate the agreement.

Both facultative and treaty reinsurance are broken down into two different policy structures. These categories are proportional and non-proportional. Under proportional reinsurance, both the primary insurer and the reinsurer agree to share a proportional share of premiums and risks. Non-proportional reinsurance, on the other hand, allows the reinsurer to cover losses based on their size.