What is Reinsurance
It is understood that in insurance the fund of the policyholders is managed by insurance companies and the losses incurred by a few are shouldered by many. Therefore, more the number of risks, lessen the possibility of loss incidence. In other words, wider the geographical spread of the business, better the result. The same basic principle applies to reinsurance also. Reinsurance is effected by an insurance company to increase market capacity by spreading the risk over the international market. This is also affected to reduce any particular risk which the underwriters feel undesirable and must get rid of all or part of it. In order to do this, the insurance company takes the place of an insured and offloads its excess risks on another insurer. This is called reinsurance.
What is Reinsurance
Different methods of reinsurance
What are the different methods of re-insurance?
Reinsurance can be effected broadly by two methods:
(a) Facultative; and
Facultative reinsurance is effected only in special cases. Generally, protection is obtained by a reinsurance treaty. Under treaty arrangement, the ceding company agrees to cede during a specified period when the reinsurer agrees to accept up to a specified amount.
The treaty is called “quota share” when the ceding company and re-insurer share each and every risk proportionately, on the original terms and conditions. In a quota share treaty, the reinsurer, in effect follows the fortune of the reinsured. The treaty is called “surplus treaty”, when the ceding company by arrangement with the re-insurer cede only that portion of each and every risk which it does not like to retain in his own account.
The “surplus” means the surplus over the amount of a risk retained. by the company in its own account. The retention of a company is determined by maximum loss exposure of the risks undertaken, during the currency of the policy and the financial capacity of the company to bear such loss. Facultative reinsurance is placed on an individual risk basis. Full information of each and every risk are required to be placed before the re-insurer, and the reinsurer, on receipt of this information decides whether to accept or decline the risk offered.
The placement of facultative reinsurance is, therefore, uncertainty ridden and not usually preferred. However, when a reinsurance treaty is in existence, facultative reinsurance is effected to get rid of either excess over treaty limit or the part of or whole of an undesirable risk.
An ‘excess of loss’ treaty is arranged when original underwriter bears all claims arising up to a specified amount and only when his ultimate net loss (after taking into account all recoveries) exceeds this amount, he can recover from his re-insurer up to a specified maximum. In this case, there is a proportional sharing of risks between the ceding company and the reinsurer. The re-insurer is absolutely liable for all ultimate net loss in excess of the certain specified amount. The liability of re-insurer is, however, not unlimited, an upper limit is always fixed.
“Stop-loss” treaty reinsurance can also be arranged, whereby the reinsurer is not responsible for any individual loss, big or small until the loss ratio for the year reaches an agreed percentage of the premium. When the loss ratio for the year exceeds this agreed percentage, the reinsurer is responsible for all losses following beyond this percentage. The reinsurers liability continues until the loss ratio reaches an agreed upper limit. For the purpose of stop loss, reinsurance is to limit the loss ratio to an agreed percentage of the premium income.
Whatever may be the method of reinsurance, it is to be understood that the more a country seeks reinsurance from abroad, it is importing service from abroad and there is the outflow of foreign exchange. On the other hand, every time a country gives reinsurance cover to foreign risks, is exporting its services abroad. Reinsurance cessation to or acceptance: -om outside the country, therefore, have the same impact as our export-import have on our balance of trade. Therefore, it is generally argued from a national economic point of view that the price of import of ‘re-insurance has to be minimum possible.