What is Reinsurance?
Reinsurance is a contract between two in which one insurance company transfers either all or a portion of its risk of insurance to another company known as a reinsurer. The company that transfers the risk in the reinsurance arrangement is called the ceding insurer, and the company that acquires the risk in the arrangement is called the assuming reinsurer. The insurance company looks for security from the reinsurer. Generally, the reinsurer pays only a part of the losses incurred in an insurance contract, but in some cases, the reinsurer pays the full amount of the insurance contract.
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Reinsurance is quite similar to insurance and involves risk distribution (the payment of insurance premium by many to cover the losses of the few), risk transfer (the shifting of the risk from one party to another) and diversification of risk (the sharing of risk from one insurer to several insurers) among a large number of insurance companies.
Application Areas of Reinsurance
An insurer can issue policies with higher limits by procuring reinsurance, which otherwise is not possible for insurance companies. Since reinsurance is practised by insurance companies, it involves transferring some part of a risk to another insurance company.
Smoothening the flow of income
By sharing the risk, the company has more funds available for investment purposes. This ensures a smooth flow of income. Moreover, the need of capital of insurance companies for providing coverage is reduced.
Ensuring surplus relief
An insurer can provide insurance policies only up to the limits of the company’s solvency margin. Once the solvency margin is achieved, an insurance company has to either stop obtaining new business or increase its capital flow. However, by getting reinsurance, it can keep on expanding its business.
In the insurance industry, it is a general practice to settle every claim. However, sometimes, it is only the reinsurer who possesses the necessary expertise for handling particular claims or unique classes of insurance such as classes belonging to insurance related to engineering.
Reinsurance is also applicable when the premium rate of insurance policies has to be calculated. Only reinsurers possess the necessary experience needed to determine the premiums required for deciding big risks. Moreover, reinsurers get to decide the method of calculating the risks as they are taking over the responsibility for the payment of a bigger part of indemnity.
Providing ideas and advice
A favourable balance needs to be ascertained in reinsurance between the expenses of reinsurers and those of the insured. In order to supplement this endeavour, ideas and specific programmes need to be implemented for data collection. This is beneficial in simplifying and improving the insurer’s administration. Moreover, reinsurance advice is given by reinsurers for compiling reinsurance programmes in relation with different kinds of reinsurance.