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Reinsurance is often called "insurance for insurers." It involves a contract whereby one insurer (the reinsurer) agrees, for a portion of the premium, to indemnify another insurer (the ceding company or primary insurer) for losses paid by the ceding company under insurance policies it has issued to its policyholders. Notwithstanding the heavy regulation of insurance and the products that are issued by primary insurers, reinsurance is largely an unregulated business.
Reinsurance plays a very vital role in the management of any primary insurer's business. It assists the primary insurer in redistributing the risk of loss incurred under its policies, and it also redistributes the premiums received by the primary insurer. First, it assists the insurer in financing its activities by providing additional underwriting capacity. Second, it provides for stability, allowing the primary insured to plan for long-term growth and development. Third, it provides for catastrophe protection, allowing the primary insurer to avoid ruinous results arising because of epidemics and calamities. Finally, it provides a means for which the primary insurer can outsource certain functions for matters that are outside its core business, such as, for example, product development and loss prevention.
This type of reinsurance, often called indemnity reinsurance, is to be distinguished from other types of reinsurance that are utilized in the sale or transfer of a book of business, namely assumption reinsurance or portfolio reinsurance. These types of reinsurance are used in mergers and acquisitions whereby one insurer will transfer its policy obligations and reserves to another.
One type of excess reinsurance is catastrophe coverage. It provides coverage on an occurrence basis (rather than per-risk). It is a commonly used coverage for health insurers and HMOs. Another common form of excess coverage is aggregate excess of loss coverage. These arrangements provide coverage in the event that losses in the aggregate exceed a certain amount or exceed a certain loss ratio for a given period.
Reinsurance is available through professional reinsurance companies that specialize only in reinsurance and derive a majority of their premium income from reinsurance transactions. Access to professional reinsurers is usually available through reinsurance intermediaries, which broker transactions between primary insurers and the reinsurance market.
Though largely unregulated, reinsurance contracts have evolved into fairly standard agreements with common provisions. The agreements often state a specific commencement date and time of attachment, and termination typically is provided for on a run-off basis. The types of expenses are generally well-defined, as well as those that are to be excluded from coverage. They will specifically describe the types of business that may be written, the maximum limits, and the types of insureds that will be covered.
This column is written for informational purposes only and should not be construed as legal advice.