What is reinsurance and how does it help in maintaining the stability of the insurance industry?

Jan 04, 2019 | 6 months ago | Read Time: 3 minutes | By iKnowledge Team

Reinsurance means an insurance for insurance companies. Insurance companies cover the risks for individuals and businesses. Reinsurance covers the risk of excessive claims due to different reasons for insurance companies.

Insurance is an agreement between two parties where one party agrees to compensate the other party in case of specified loss or damage. For term life insurance, the benefits are paid out when the policyholder dies. For other general insurance policies such as crop insurance, motor insurance, travel insurance, fire insurance, the sum assured is paid out when the specified loss or damage occurs.

An insurance company works on the concept of collective risk. It collects premium from a number of parties on the assumption that only a certain percentage of the population will lodge claims in a particular year. These depend on actuarial calculations which determine the risk that the company agrees to underwrite.

In some cases, the insurance company estimates a higher than normal payout, and spends a portion of the premium to get reinsurance.

But what is reinsurance?

Reinsurance is insurance but for insurance companies. It is a type of insurance that an insurance company takes to mitigate and reduce their exposure to a particular risk. If a general insurance company takes reinsurance against loss due to floods in the monsoons in India, and if it incurs claims on that account, it can claim from the reinsurance company.

In reinsurance, the party that is sharing the loss is called the ceding party. The party that is covering the loss is called the reinsurer.

Types of reinsurance:

There are two types of reinsurance:

  1. Treaty reinsurance: Under this type of reinsurance, the reinsurer agrees to cover all risks of the insurance company for a specified period. These apply to policies written and to those that have not been written. Treaty reinsurance can be risky for the reinsurer especially if they have not assessed the risks carefully.
  2. Facultative reinsurance: Under facultative reinsurance, the reinsurer underwrites the risk for each policy as a single transaction. The policies are not grouped together. This works out in the favour of the reinsurer since they can evaluate the risk for each policy separately and then insure a part or whole of the policy.

Treaty reinsurance and facultative reinsurance can be either proportional or non-proportional.

Under proportional reinsurance, the reinsurer agrees to receive a portion of the premium collected for the policies whose risk it assumes. If the proportion is 60%, it would mean that 60% of the premiums collected by the ceding party have to be paid to the reinsurer to insure the risk. Most of the treaty reinsurance policies are proportional reinsurance policies.

Non-proportional reinsurance is also called “excess of loss” type of insurance. This is activated when the losses from a particular policy or a particular loss or damage exceed a particular amount.

How does reinsurance maintain the stability of the insurance industry?

 Reinsurance helps insurance companies to restrict the loss to their balance sheets, and in that sense, helps them to stay solvent. By sharing the risk with a reinsurer, insurance companies ensure that they can honour all the claims related to a particular risk. Reinsurance helps insurers to manage their risks and to better their underwriting practices, especially since reinsurers can opt for facultative reinsurance and cherry pick insurance policies.

The main reason for opting for reinsurance is to limit the financial hit to the insurance company’s balance sheet when claims are made. This is particularly important when the insurance company has exposure to natural disaster claims because this typically results in a larger number of claims coming in together. A major disaster such as a cyclone, earthquake or flood can cause a large number of claims from a certain area. If the insurance company has a reinsurance contract, it will get some portion of the claim reimbursed from the reinsurance company, and thus will avoid huge losses.

Just the way that reinsurers help an insurance company to maintain their financial status and restrict their losses, similarly, selecting a good term plan can help your family be financially secure. Opting for a flexible term plan like Aegon Life’s iTerm Insurance Plan  will help you to take a high coverage for at a cost-effective rate. The iTerm plan comes with an inbuilt accidental death rider and other riders that provide assistance on terminal illnesses and extended cover for critical illness. The plan is flexible and it is easy to increase the sum assured during the policy depending on your life stage. The ability to purchase the plan online helps in keeping costs low.

A vibrant reinsurance market helps insurance companies maintain their financial stability, which helps them continue serving customers reliably.

II/Dec 2018/4741


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