Reinsurance is insurance that is purchased by an insurance company (the ceding company) from one or more other insurance companies (the reinsurer) as a means of managing their exposure to risk. The ceding company and the reinsurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay a share of the claims incurred by the ceding company. The reinsurer is paid a reinsurance premium by the ceding company, which issues insurance policies to its own policyholders.
- The goal is to reduce exposure to loss by passing part of the risk of loss to a reinsurer or a group of reinsurers.
- Reinsurance can make an insurance company’s results more predictable by absorbing larger losses and reducing the amount of capital needed to provide coverage.
- Income smoothing is another driver as the losses of the cedant are essentially limited. This fosters stability in claim payouts and caps indemnification costs.
- Surplus relief is sometimes a goal. An insurance company’s ability to write business is limited by its balance sheet (the solvency margin). When that limit is reached, an insurer can stop writing new business, increase its capital, or buy surplus relief from a reinsurer.
- The insurance company may be motivated by arbitrage in purchasing reinsurance coverage at a lower rate than they charge the insured for the underlying risk.
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