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Reinsurance is insurance protection that is purchased by one insurance company (also called an insurer and sometimes called a "cedant" or "cedent") from another insurance company (called a reinsurer) as a means of managing the risks on its books. The reinsurer and the insurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay the insurer's losses under the agreement. The reinsurer is paid a (reinsurance) premium by the insurer for the protection bought. The insurer issues its own insurance policies to its policyholders. The main reason for an insurer to purchase reinsurance protection is to transfer some of its risk to the reinsurer.
For example, assume an insurer sells one hundred policies, each with a $100,000 policy limit. At worst case, the insurer could lose $100,000 on each policy – totaling up to $10 million. It may be better to pass some risk to a reinsurance company (reinsurer) as this will reduce the insurer's exposure to risk.
When an insurer purchases reinsurance, it can issue policies with higher sums insured or limits than it would otherwise be allowed. This affords it the opportunity to take on more risk because some of that risk is now transferred to the reinsurer and grow its business.
There are different types of reinsurance protection. The insurance company decides on what is appropriate for it to create a more balanced and homogenous portfolio of insured risks. This would lend greater predictability on the performance of the portfolio whereby positive results on net basis (after reinsurance) would be achieved and smoothing of the income results/profits. While income smoothing is one of the objectives of reinsurance arrangements, the mechanism is by way of creating and maintaining balance in the portfolio of risks taken on the books of the insurer.
List of Classes for which Reinsurance is bought:-
Reinsurance is acquired via insurers since ordinary policyholders cannot claim on reinsurers as there is no direct contractual relationship between them.
There are two methods of Reinsurance:-
- Proportional – Same share of risk, premium and loss as well as an equal share of premiums and losses
- Non-proportional – The insurer retains what it can handle and offers the rest to the reinsurer.