What is Reinsurer
A reinsurer is 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 (that is, underwrite more policies) than they would otherwise be able to. Reinsurers also make it possible for primary insurers to keep less capital on hand to cover potential losses.
BREAKING DOWN Reinsurer
A primary insurer, which is the insurance company from which an individual or business purchases a policy, 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 premiums primary insurers pay to reinsurers may be reduced by any commission the reinsurer pays to the insurer. The price of reinsurance, like the price of insurance, depends on the amount of risk. Reinsurers often have the word “Re” in their names (e.g., Allianz Re, Cologne Re, Swiss Re).
Reinsurers also help spread out the risk of insuring natural disasters like earthquakes and hurricanes. Such an event could result in more claims than the primary insurer could pay out without going bankrupt, since 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 (and part of the premiums) of insuring against these events to several reinsurers, individuals and businesses are able to purchase insurance for these perils and insurance companies are able to stay solvent.
The reinsurance transaction is not a simple one, as there are many factors to consider in selecting a reinsurer. For instance, the ratings agencies don’t treat all reinsurers the same; their capital models vary based on the financial strength ratings of the reinsurer. Best practices for buying reinsurance should include 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.
Five Types of Reinsurance
Reinsurers offer five main types of policies: facultative, treaty, proportional, non-proportional and retrocession. Facultative reinsurance 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. Treaty reinsurance is used when one reinsurance contract can cover a large pool of similar risks. Proportional reinsurance allows primary insurers and reinsurers to share a proportional share of premiums and risks. With non-proportional reinsurance, the reinsurer covers losses based on their size. Retrocession allows reinsurers to purchase reinsurance.