What Is Reinsurance? : Types, Functions, How It Works, Advantages & More

August 31, 2023

What Is Reinsurance

Have you ever wondered what is reinsurance all about? If yes, then you have stepped into the right place because that’s what I will be talking about today! Reinsurance, very commonly, is known as insurance dedicated to insurance firms. 

It is basically a contract or agreement between an insurer and a reinsurer. This contract states that the insurance firm is capable of transferring certain insured risks to the reinsurance firm. The latter is also popular as a cedent or cedent partner. 

Further, the reinsurance company assumes just a part or whole of the insurance policies that this ceding party issues. 

What Reinsurance Actually Does? 

What Reinsurance Actually Does

Reinsurance lets an insurer remain solvent and recover either full or partial amounts he has paid to claimants. It mainly decreases the net liability on personal risks and protects an entity or individuals from enormous losses. This practice also offers ceding firms the opportunity to maximize their underwriting abilities in risk numbers and sizes. 

Ceding industries, those seeking reinsurance, are nothing but insurance firms that move their risks to other insurers. 

Types Of Reinsurance 

Types Of Reinsurance

If you have got an idea of what is reinsurance and what does it actually do, let me quickly take you to the next part of the article. Here, you will discover some of its most common types that have an influence on both the reinsurer and insurer. 

1. Treaty Reinsurance

Let me begin with a less common reinsurance type. Treaty reinsurance refers to acquired insurance from a different insurer via an insurance business. This form of reinsurance offers additional protection for the equities of the ceding insurer. Also, when it comes to providing more stability, nothing matches the supremacy of treaty reinsurance. 

Let’s understand this with an example. This insurance can literally be any policy that some insurance firm writes off. Treaty reinsurance can be a sum-total or a bundle of all policies noted down by the insurance firm.

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2. Facultative Form Of Reinsurance

Facultative has to be the most important type of reinsurance where the primary insurer buys facultative reinsurance for covering single or multiple risks. To understand “what is reinsurance,” you will first have to know the details of facultative reinsurance. It covers most of the single transaction and is a single-time contract. 

Both the reinsurer and the ceding company have to create a facultative certificate stating that the reinsurer absorbs some risk.  

3. Reinsurance Of Risk Attaching

“Risk attaching” is generally a treaty where the Reinsurer simply pays for losses to the Ceding party. These might arise from new or renewed policies or in force at the time of the reinsurance period. The risk-attaching reinsurance generally does not take the date of loss in regard. 

Take, for example, somebody who claimed a policy in January. Now, the insurance firm will settle the total bill only on a specific date. 

4. Proportional Reinsurance

This type of reinsurance is a kind of treaty reinsurance where it might ask the reinsurer to share the loss percentage. It is usually categorized under the arrangement of proportional reinsurance or, as professionals call it, “Pro Rata type of insurance.” It is the same as what is reinsurance for the commoners. 

Suppose any firm claims insurance worth Rs 1 Lakh. Here, the reinsurer will have to share just a part of the claim, not the total amount. Thus, it is possible that the reinsurance firm will pay the claim’s preset percentage only. 

5. Reinsurance That’s Non-Proportional

Also called the “excess of loss,” this reinsurance type obliges the reinsurer for a payout only when the insurer’s claim reaches a specific limit. This sum is generally called a priority or retention in layman’s language. 

For example, an insurance agency wants a reinsurance agreement. Now, this should cover every loss of more than Rs 1 lakh that is caused by a natural disaster. Or they might also cover a loss of Rs 50,000 twice until the overall loss is covered. 

What Are The Functions Of Reinsurance? 

What Are The Functions Of Reinsurance

It is obvious that the key function of reinsurance is to lower the risk regarding insurance claims. But that’s not all! Just like I answered ‘What is reinsurance’ and its types, now I will be laying off some of its common functions: 

Smoothing Down The Income

With the help of reinsurance, an insurance firm delivers more predictable outcomes by tackling huge losses. This brings down the amount of cash needed to provide coverage. Since the risks are evenly spread, the reinsurer can cover a large portion of the insurance firm’s losses. 

Transmitting Risk Factors 

It is due to reinsurance that the risk gets automatically transferred to the reinsurer. Hence, the primary insurance firm can get a sense of relief as they can focus on other streamlined activities. 

Making Portfolios Bigger

Reinsurance also functions as a substitute that expands the portfolio of an insurance company. Since much of the risk is undertaken, there is much dedication for the companies to actually take initiatives and expand their portfolio. 

Providing Expertise

When there is a specific risk involved, the insurance firm might want to make use of the reinsurer’s experience. In order to protect their personal interests, reinsurers want to implement this knowledge when it comes to underwriting. This one is dedicated to facultative reinsurance. 

Claim Settlement Assurance

Involving a reinsurer also provides the company an assurance that its claims will be settled. The functions of what is reinsurance for common policyholders have no boundaries as it keeps them insured, no matter what!

Reinsurance Advantages One Must Know About 

Reinsurance Advantages One Must Know About

Yes, much has been talked about risk-taking lately. But it’s time to understand some of its other advantages. So, what is the delay? Let’s just quickly get started! 

1. Safeguarding Insurance Funds

In reinsurance cases, the reinsurer protects insurance funds which are generally kept safe for unforeseen claims. Thus, it assists the insurance firm in managing its funds in a streamlined manner. 

2. Limits The Liability Quantum

The risk is shared; thus, the reinsurance aids in decreasing the number as well as the size of liabilities. Most of which the insurance industry has to bear generally. 

3. Appreciates New Underwriters

Reinsurance is another way of encouraging insurance firms to hire underwriters. This further results in increasing business expansion and prosperity. 

4. Stabilizes Profits

Profits and their stability are directly proportional to the question “what is reinsurance.” With a reinsurer’s help, the profit of any insurance company gets highly stable. 

5. Increases The Insurer’s Goodwill

A reinsurer assists in developing the goodwill and reputation of the insurance company. If the claim settlement gets better, there are chances of the business excelling in the near future. 

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Wrapping Up… 

As mentioned above, insurance firms cater to the insurance needs of an individual, but reinsurers help these firms protect their risks of catastrophic loss. Any reinsurance company operates through the procedures like cession and generally minimizes the insurance risk. 

So, that was all about ‘what is reinsurance’ and its multiple aspects. I hope this comprehensive guide was competent enough to take you through the important details which might come to use later. If yes, don’t forget to comment below and keep me encouraged to write on similar topics.

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Mony Shah

With an adept skill of curating content on multiple genres, Mony has harnessed success as a Content Writer quickly. Find her sharing profound thoughts and opinions on finance, insurance and lifestyle niches.

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