What Is a 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 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.
- A reinsurer provides insurance to insurance companies.
- The risks of an insurance company are spread out by purchasing insurance from reinsurers.
- Doing business with a reinsurer allows an insurance company to do more business itself by being able to take on more risk than its balance sheet would otherwise allow.
- Insurance companies pay reinsurers premiums in the same manner that individuals pay insurance companies premiums.
- The transfer of risk from an insurance company to an insurer is known as cession.
- Reinsurance companies can also buy reinsurance themselves, a term known as retrocession.
Understanding a 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 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, General 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 a primary insurer could payout 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. Historically, there have been many instances where a number of insurance companies have gone out of business after a catastrophe because they were not solvent enough to pay out the insurance on their policies.
Reinsurance is a large business, where, in 2018, the top 10 reinsurance companies in the world made up two-thirds of written premiums in the reinsurance market, excluding life insurance. The two largest reinsurance companies in the world, Munich Re (MURGF) and Swiss Re (SSREF), accounted for 30% of that.
In general, the main reasons an insurance company would seek to purchase reinsurance are to grow the insurance company's business, bring stability to the underwritten policies, raise capital via financing, seek catastrophe protection, divestiture from a specific type of insurance business, gain expertise, and distribute risk.
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; 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. Reinsurance companies often buy reinsurance themselves, a term known as retrocession.
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
Reinsurers offer four main types of policies: facultative, treaty, proportional, and non-proportional.
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.
Treaty Reinsurance: Treaty reinsurance is used when one reinsurance contract can cover a large pool of similar risks.
Proportional Reinsurance: This type of reinsurance allows primary insurers and reinsurers to share a proportional share of premiums and risks.
Non-proportional Reinsurance: With non-proportional reinsurance, the reinsurer covers losses based on their size.