Reinsurance (Chapter 7)

Reinsurance is a form of insurance. A reinsurance contract is legally an insurance contract. The reinsurer agrees to indemnify the cedant insurer for a specified share of specified types of insurance claims paid by the cedant for a single insurance policy or for a specified set of policies. The terminology used is that the reinsurer assumes the liability ceded on the subject policies. The cession, or share of claims to be paid by the reinsurer, may be defined on a proportional share basis (a specified percentage of each claim) or on an excess basis (the part of each claim, or aggregation of claims, above some specified dollar amount). The nature and purpose of insurance is to reduce the financial cost to individuals, corporations, and other entities arising from the potential occurrence of specified contingent events. An insurance company sells insurance policies guarantying that the insurer will indemnify the policyholders for part of the financial losses stemming from these contingent events. The pooling of liabilities by the insurer makes the total losses more predictable than is the case for each individual insured, thereby reducing the risk relative to the whole. Insurance enables individuals, corporations and other entities to perform riskier operations. This increases innovation, competition, and efficiency in a capitalistic marketplace. The nature and purpose of reinsurance is to reduce the financial cost to insurance companies arising from the potential occurrence of specified insurance claims, thus further enhancing innovation, competition, and efficiency in the marketplace. The cession of shares of liability spreads risk further throughout the insurance system. Just as an individual or company purchases an insurance policy from an insurer, an insurance company may purchase fairly comprehensive reinsurance from one or more reinsurers. A reinsurer may also reduce its assumed reinsurance risk by purchasing reinsurance coverage from other reinsurers, both domestic and international; such a cession is called a retrocession. Reinsurance companies are of two basic types: direct writers, which have their own employed account executives who produce business, and broker companies or brokers, which receive business through reinsurance intermediaries. Some direct writers do receive a part of their business through brokers, and likewise, some broker reinsurers assume some business directly from the ceding companies. It is estimated that more than half of U.S. reinsurance is placed via intermediaries. The form and wording of reinsurance contracts are not as closely regulated as are insurance contracts, and there is no rate regulation of reinsurance between private companies. A reinsurance contract is often a manuscript contract setting forth the unique agreement between the two parties. Because of the many special cases and exceptions, it is difficult to make correct generalizations about reinsurance. Consequently, as you read this chapter, you should often supply for yourself the phrases “It is generally true that: : :” and “Usually: : :” whenever they are not explicitly stated. This heterogeneity of contract wordings also means that whenever you are accumulating, analyzing, and comparing various reinsurance data, you must be careful that the reinsurance coverages producing the data are reasonably similar. We will be encountering this problem throughout this chapter.