Spot Reinsurance

Spot Reinsurance

Investopedia / Laura Porter

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.

Key Takeaways

  • Spot reinsurance is an insurance contract that spreads the risk associated with a single event from an insurance company to a reinsurer.
  • Insurance companies can get spot reinsurance when a portion of their portfolios involves more risk than the entire portfolio.
  • Facultative reinsurance lets the reinsurance choose the risks they agree to cover while treaty reinsurance requires the reinsurer to cover specific risks.
  • Insurers can purchase spot reinsurance for policies using a limit other than what is granted for their entire portfolio.
  • Insurance companies can purchase spot reinsurance for policies using a limit other than what is granted for their entire portfolio.

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.

While the increased cost is a burden, a facultative reinsurance arrangement may allow the insurer to take on clients that it may otherwise not be able to accept.

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.

What Are the Two Types of Reinsurance?

Facultative and treaty reinsurance are the two main types of reinsurance contracts available to insurance companies.

Facultative reinsurance provides coverage by the reinsurer on a single or set of specified risks negotiated in the contract.

Treaty reinsurance covers some or all of the risks that an insurance company may incur. This is normally for a set period of time or on a contract basis.

What Is the Largest Reinsurance Company?

The largest reinsurance company in the world is Munich Reinsurance, which is based in Germany. The company recorded $43.1 billion in net premiums for the full year in 2020. This was followed by Swiss Reinsurance with $34.29 billion in premiums and Hannover Rück with $26.23 billion in premiums.

What Is the Difference Between Insurance and Reinsurance?

Insurance and reinsurance both provide coverage against losses that stem from certain risks. But the main difference between the two is who is covered.

Insurance covers individuals, corporations, and other entities against losses incurred by an event, such as a fire or natural disaster. Or it may act as an indemnity against losses caused by another individual like a driver in a car crash.

Reinsurance, on the other hand, protects insurance companies against losses. A reinsurer assumes some or all of the risks associated with a single risk or a set of risks assigned to policies in exchange for some or all of the policy premiums.

How Do Reinsurers Make Money?

Reinsurance companies provide coverage to other insurers for policies they believe have predictable risks. This means that reinsurers are more prone to cover policies that come with risks that aren't speculative.

For example, a reinsurer may be less likely to assume the risks associated with a car insurance policy that covers a high-risk driver. Instead, they're more likely to reinsure policies or drivers with clean driving records.

In exchange for coverage, the original insurer cedes a portion or all of the premiums associated with the policies assigned to the reinsurance contract.

Article Sources
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  1. Statista. "Largest reinsurers worldwide in 2020, by net premiums written." Accessed Dec. 30, 2021.

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