key term - Reinsurance

Definition

Reinsurance is a type of insurance that insurance companies purchase to protect themselves from large claims or catastrophic events. It is a risk-transfer mechanism where an insurance company transfers a portion of its risk to another insurance company, known as the reinsurer, in exchange for a premium payment.

5 Must Know Facts For Your Next Test

1. Reinsurance helps insurance companies manage their risk exposure and increase their underwriting capacity, allowing them to take on more business.
2. Reinsurance can be proportional, where the reinsurer shares a percentage of the risk and premium, or non-proportional, where the reinsurer covers losses above a certain threshold.
3. Reinsurance is particularly important for insurance companies that underwrite large, complex, or catastrophic risks, such as natural disasters, pandemics, or terrorism.
4. The reinsurance market is global, with major reinsurance hubs in places like Bermuda, London, and Switzerland.
5. Regulators require insurance companies to maintain a certain level of reinsurance coverage to ensure their financial stability and ability to pay claims.

Review Questions

• Explain the purpose and benefits of reinsurance for insurance companies.
  • The primary purpose of reinsurance is to help insurance companies manage their risk exposure and increase their underwriting capacity. By transferring a portion of their risk to a reinsurer, insurance companies can take on more business, diversify their risk, and protect themselves from large claims or catastrophic events. Reinsurance also allows insurers to free up capital, which can be used to expand their operations or invest in other areas. Additionally, reinsurance can help insurance companies maintain their financial stability and meet regulatory requirements, ensuring they have the resources to pay out claims when needed.
• Describe the different types of reinsurance arrangements and how they work.
  • There are two main types of reinsurance arrangements: proportional and non-proportional. In a proportional reinsurance agreement, the reinsurer shares a percentage of the risk and premium with the ceding company. This means the reinsurer will pay a corresponding percentage of any claims that arise. Non-proportional reinsurance, on the other hand, covers losses above a certain threshold or attachment point. The reinsurer will only pay claims that exceed this predetermined level, providing coverage for the insurance company's larger, more catastrophic risks. The choice of reinsurance structure depends on the insurance company's specific needs and the nature of the risks being covered.
• Analyze the importance of the global reinsurance market and its role in the insurance industry.
  • The global reinsurance market plays a crucial role in the insurance industry by providing a mechanism for risk transfer and diversification. Major reinsurance hubs, such as Bermuda, London, and Switzerland, facilitate the flow of risk and capital around the world, allowing insurance companies to access a broader pool of resources to manage their exposures. This global interconnectedness enhances the overall stability and resilience of the insurance industry, as risks can be spread across multiple jurisdictions and reinsurers. Additionally, the reinsurance market is subject to regulatory oversight, which helps ensure the financial solvency of reinsurers and their ability to fulfill their obligations to ceding companies. The global nature of the reinsurance market is particularly crucial for addressing large-scale, catastrophic risks that can have far-reaching implications.

Related terms

Primary Insurance: The original insurance policy purchased by an individual or business, which is then backed by the reinsurance policy.

Ceding Company: The insurance company that transfers a portion of its risk to the reinsurer by purchasing a reinsurance policy.

Reinsurer: The insurance company that accepts the risk transferred by the ceding company in exchange for a premium payment.