Reinsurer's work

Reinsurance – origin, purpose and how it works

Origin

The first reinsurance contract was signed in the 14th century in Genoa, covering part of the risk of shipping goods transported from Genoa to Flanders.

In the world of insurance and reinsurance it’s all about diversifying risks between many carriers. Primary insurers commit to compensating losses of their clients under certain conditions and against a premium. To protect against larger losses in their portfolio, they transfer part of these risks to reinsurers, and pay a premium in return. This transaction is called "cession”, with the primary insurance acting as the ceding company.

Purpose

Insurance companies use reinsurance for the following reasons:

• To increase their underwriting capacity by sharing risk with a reinsurer. This gives them the possibility to write more business than their capital base would allow for.
• To protect their balance sheet against larger losses and reducing the amount of capital needed to provide coverage.
• To ensure compliance with regulatory requirements.

Reinsurers protect themselves likewise, giving part of the risks they assumed to other reinsurers. This transaction is called "retrocession".

How Reinsurance works

Depending on the nature of the underlying risk, there are two main types of reinsurance: treaty and facultative.

We talk about treaty reinsurance if an entire book of risks is covered in one reinsurance contract. This usually applies for homogeneous portfolios with risks of similar type, size and underlying terms and conditions.

For particularly large risks with a set of individual factors to consider, facultative reinsurance is applied. This means that these risks are reinsured individually, because they are too large and too specific to be gathered under one contract.

Both insurers and reinsurers have to manage the risks they take by applying appropriate terms and conditions as well as demanding the appropriate price for the risk they take. Therefore, a core part of what they do is proper risk management, consisting of risk assessment and analysis. Based on these techniques, they decide about price of assumed risks, how much of it they retain or possibly cede to others.