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Reinsurance

Exposure to risk is an occupational hazard for insurance companies, which they minimize through underwriting and the assessment of appropriate premiums. However, sometimes the potential for excessive loss from claims is still too great. In these cases insurers can use reinsurance as a way to protect themselves from massive claims. Reinsurance is insurance for insurers.

A primary insurer can purchase coverage from a reinsurance company to transfer a portion of their risk from a policy or group of policies, buffering them from massive claims that might push them into bankruptcy. This reduces the impact of large claims on one company and spreads the risk across several institutions. Reinsurance is available for all types of insurance policies including: life, health, accidental death, property, commercial and aviation. In exchange for taking on risk from the primary insurer or “ceding party”, the reinsurer shares in the premiums and profits.

Reinsurance gives primary insurers additional capacity to offer policyholders higher insurance limits than their own balance sheets would allow. It is commonly used for catastrophic loss protection for natural disasters such as a hurricanes, earthquakes, major floods or wildfires. Terrorist attacks, such as the 911 attacks on the World Trade Center and the Pentagon which resulted in massive life, property and aviation claims, are other risks protected by reinsurance. Reinsurance companies can themselves purchase reinsurance for policies to further spread the risk of catastrophic loss. This is called retrocession.

There are different types of reinsurance. Proportional reinsurance involves a reinsurer taking over a percentage of each policy that an insurer writes. The reinsurer earns that percentage of the premiums and accepts that percentage of the losses resulting from claims against those policies. In non-proportional reinsurance, or stop loss insurance, the reinsurer only pays if the loss exceeds a set limit. Catastrophic excess of loss reinsurance provides protection if there are multiple losses from one event, such as a natural disaster. Reinsurance contracts between an insurer and a reinsurer can be continuous (ongoing with set notice periods) or term (where they expire after a given time).

A policyholder will probably not know if their insurer has reinsured a portion of their coverage. In the event of a claim, the insurer is still liable to compensate policyholders for insured losses.

Sometimes a reinsurer may refuse to reimburse an insurer if they disagree with their decision to settle a particular claim, or the reinsurer may have over committed funds or underestimated risks and be unable to settle a reinsurance claim. Insurers research the solvency of their reinsurers carefully.

By spreading risk among several insurance institutions, reinsurance enables insurers to write larger policies, reduce the impact of huge claims and minimize the risk of bankruptcy.