VATINS3220 - Types of insurance: reinsurance: example

An insurance company insures North American risks and may potentially be liable to claims amounting to, say, $500m. It may be happy to retain part of this risk itself, but feels that it needs protection against the balance of the risk. Accordingly, it may reinsure all policies with a risk of between $10m and $50m with one re-insurer, policies with a risk of between $50m and $100m with another and so on.

There are several other basic types of reinsurance programme, some offering cover for various proportions of the insurer’s risks. Reinsurance is most often achieved via agreements (called ‘treaties’) with the re-insurers which set out the basis on which the reinsurance cover operates, although some risks are reinsured on an individual basis. This is called ‘facultative’ reinsurance.

The structure of the reinsurance does not affect the liability of the supplies. It is important to realise that, with reinsurance, the original risk remains with the insurer who is liable for any claims arising from the original policy.

Reinsurance business should not be confused with the transfer of an insurance business with all risks and liabilities being taken on by a new company. In reinsurance transactions no obligations to the insured under the primary contract are transferred to the re-insurers.

A reinsurer may decide not to hold the full amount ceded by an insurer and, therefore, in turn reinsures, or retrocedes part of the insurance that is ceded to the reinsurer, i.e. reinsurance of reinsurance. Thjs retrocession serves to ‘lay off’ risk.