Spot Reinsurance

What Is Spot Reinsurance?

The term spot reinsurance refers to an insurance contract that spreads the risk from an insurance company to a reinsurer for a single event. A spot reinsurance contract involves transferring the coverage from the original insurer to the reinsurer. As such, it is a form of insurance for insurance companies. An insurance company may obtain spot reinsurance when a subsection of its total portfolio involves considerably more risk than its portfolio as a whole.

Understanding Spot Reinsurance

Reinsurance is a form of insurance that protects insurance companies. Many insurance companies may band together to share the risk by buying policies from other insurers. This allows them to mitigate the risk of loss in the event of a major disaster or event that would result in a high payout.

In exchange for sharing the risk (and reducing their own exposure), insurance companies give up part of the premiums paid by their policyholders when they enter into reinsurance agreements. By doing this, they effectively pay another insurer to take some of the underwriting risks off their books.

A reinsurance agreement may cover an entire line of business or specific policy types. Under spot reinsurance contracts, the reinsurer agrees to take on some or all of the risks associated with a single event or occurrence from a catastrophic loss like floods, fires, and natural disasters, especially when policies carry a considerable degree of risk.

Reinsurance may allow the reinsurer to be selective when it comes to the perils it accepts. This is known as facultative reinsurance. Or, it may require the insurer to automatically accept a peril. That is known as treaty reinsurance. We go into detail about these two types of reinsurance below.

Special Considerations

Reinsurance exists because there are certain risks that are just too high for one company to assume. As such, insurance companies often seek out reinsurers to help spread the risk. Reinsurers are large insurance companies that are in the business of providing financial protection to insurance companies, which means they don't provide financial services or protection to individuals. As noted above, spot reinsurance allows insurance companies to share the risk stemming from a single event with a reinsurer.

Facultative Reinsurance vs. Treaty Reinsurance

Facultative reinsurance is one of the simplest ways for insurance companies to get reinsurance coverage. This type of agreement allows a reinsurer to be selective by choosing a single risk profile or they may choose a specific set of risks. Reinsurance companies normally underwrite the policies they choose to reinsure on their own.

For example, an insurance company may underwrite flood insurance policies across a wide geographic area but may choose to take on only a small number of policyholders. This small number may push the company’s aggregate risk over its limit, leading it to reinsure those policies.

Treaty reinsurance, on the other hand, allows the insurance company to cede all the risks associated with a set of policies to the reinsurer. The reinsurer doesn't underwrite any of the policies on its own and agrees to indemnify the ceding company of all of the risks.

Facultative reinsurance contracts can be more expensive than treaty reinsurance. This is because treaty reinsurance covers an entire book or category of risks. It is an indication that the relationship between the insurer and the reinsurer is more long-term than if the reinsurer dealt only with one-off transactions covering single risks.

Purchasing Spot Reinsurance

Insurance companies can purchase spot reinsurance to cover policies using a limit other than what is granted for their portfolio as a whole. This type of insurance may be purchased to cover a specific peril or set of policies in a certain location, or it can be tailored to be as specific as covering a single policy.

For example, a company that underwrites auto insurance policies may purchase spot reinsurance to cover a single driver who is identified as much riskier than the other drivers that it insures. By separating the risk associated with the more accident-prone driver, the insurer reduces the odds that its general portfolio of policies will bump up against its coverage limit.