Welcome to
Introduction to Reinsurance
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COMING UP

In this module, you will:

1

Understand what reinsurance is and its purpose

2

Learn about the two basic forms of reinsurance

INTRODUCTION

A short definition of reinsurance might be: Reinsurance is insurance for the insurer.

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Why do insurance companies need insurance?

Basically, insurance companies need to avoid both single large risks as well as the cumulation of too many small risks, which could endanger the existence of the company.

Insurance companies need to remain stable, because the promise to pay after an unfortunate event is the main ingredient of all products they offer.

What can reinsurance do for the insurer?
  • Reduce its risk of bankruptcy
  • Ensure more balanced business results: smooth fluctuations in results
  • Increase the insurer’s underwriting capacity: instead of raising its equity capital as a way of writing more insurance contracts, the primary insurer obtains reinsurance cover
  • Homogenise the risk portfolio of the insurer
  • Take away peak risks from the balance sheet of the insurer
  • Provide financing assistance
  • Provide services and expertise
  • Help to introduce new products
What is the economic value of reinsurance?
  • Diversification reduces the effect of large losses on an insurance portfolio
  • Large numbers of similar risks enhance the predictability of loss scenarios and therefore, smoothen results
  • Reinsurance enables insurers to realise business opportunities which could not be assumed otherwise because of lacking liquidity
  • Reinsurance provides the insurance market with insurance capital

FORMS OF REINSURANCE

FACULTATIVE (INDIVIDUAL) REINSURANCE

Definition: Facultative reinsurance is the reinsurance of an individual risk.

Select each number to view the aspects of facultative reinsurance.

Aspects of facultative reinsurance

Facultative reinsurance always involves an individual insurance policy or policies which constitute(s) one risk. If the primary insurer is unable or unwilling to bear all the risk itself, it passes on a part of this risk via facultative reinsurance.

The primary insurer is free to decide whether it wants to offer a risk to the reinsurer, and the reinsurer, in turn, is free to decide whether it wishes to accept this offer.

WHY FACULTATIVE REINSURANCE?

Facultative reinsurance is used where only a few risks require reinsurance coverage or where these risks do not meet the conditions of the obligatory (treaty) reinsurance agreements.

Facultative reinsurance is a good tool for insurers who are experiencing:

Insurance portfolio peaks
Difficult or unusual risks

Include chemical/pharmaceutical companies, mining operations, or the risk of accidents associated with extreme sports.

Select the icon to view some examples of peak rises.

Examples of peak risks in the market include BMW in Germany, Rhône Poulenc in France, ABB in Switzerland, Fiat in Italy or Boeing in the US.

CHECK YOUR UNDERSTANDING

Which among these risks are suitable for facultative reinsurance?

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OBLIGATORY (TREATY) REINSURANCE

Definition: Treaty reinsurance is the reinsurance of entire insurance portfolios.

Select each number to view the aspects of obligatory reinsurance.

Aspects of obligatory reinsurance

Treaty reinsurance is provided for a defined insurance portfolio comprising all insurance contracts in force at the time the reinsurance treaty is arranged, or insurance contracts accepted thereafter.

The primary insurer and the reinsurer set out in the treaty arrangement what risks constitute the subject-matter of the reinsurance. This is done in the so-called treaty terms and conditions. The primary insurer is obliged to cover these risks under the reinsurance treaty, and the reinsurer is obliged to accept them along the terms agreed on in the reinsurance treaty.

WHY OBLIGATORY REINSURANCE

Treaty reinsurance is normally only worthwhile in cases where the portfolio of risks comprises a sufficient number of risks to be reinsured. As a rough guide, the portfolio should consist of at least 50-100 risks.

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    Note

For each facultative reinsurance arrangement, the primary insurer and reinsurer enter into a separate contract. In case of a large number of risks, this process can be time-consuming and therefore expensive.

Consequently, facultative reinsurance is predominantly used where treaty reinsurance is not available. It may, however, also be used if the treaty reinsurance capacity is not sufficient for a particular risk.

CHECK YOUR UNDERSTANDING

If you were to reinsure these risks, would you either choose a facultative or an obligatory treaty type?

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SUMMARY

You are at the end of this module. Let’s recap what we have gone through so far.

  • Reinsurance is insurance for the insurer. It protects insurance companies from risks and provides it the support it requires, both financially and functionally.
  • Facultative reinsurance is the insurance of a single risk.
  • Treaty reinsurance is the reinsurance of entire insurance portfolios.