Reinsurance is a procedure in which an insurance company enters into a contract with another insurance company. The later insurance company is known a Reinsurance company. Under this contract, the insurance company has the right to transfer all or part of its risk to reinsurance company. As a result of this contract, the insurer and the re insurer gets bound with an reinsurance agreement. The conditions of payment of losses in the form of claim to the insurance company by the re insurer is stated in this agreement. Thus Reinsurance is basically risk sharing in specified proportion by two or more parties.
Objective of reinsurance:
The main objectives of reinsurance is as follow:
1)To protect the insurance company against the unforeseen circumstances resulting in loss.
2)To minimize the fluctuations in claim payments of the insurance company.
3)To reduce the underwriting errors resulting in losses due to higher risk.
4)To provide technical advice to the insurance company.
The Reinsurance contract is signed between two companies
a) The ceding company: The company which originally issues the policy by undertaking the risk.
b) The Assuming company: The company to which the ceding company transfers the risk.
Benefits of reinsurance:
1) Reinsurance reduces the net liability of the ceding company on individual risk and thus provides protection from multiple losses.
2) The claim settlement in the insurance company is quiet uncertain. The company has to pay huge amount of claim at any point of time and in such a case if the company has shortage of funds or greater liability than that of accumulated funds, then the company has no option but to face bankruptcy. Thus reinsurance provide financial stability to the insurance company without affecting it adversely.
Reinsurance from Re-insurer's point of view:
The re insurer looks at the following points while considering the proposal for reinsurance:
1) The risk type offered by the insurer to the party.
2) The category of the client whose insurance is being considered by the insurer.
3) The objective for which the insurance is required.
4) Whether the amount offered by the insurer is adequate or excess.
5) The financial position of the insurance company.
6) The methods adopted by the insurance company to evaluate risk.
7) The details of the plan offerd by the insurer.
8) The capability and competence of the management of the insurance company.
Types of Reinsurance:
1) Proportional Reinsurance:
The proportional reinsurance is a kind of reinsurance in which the risk is shared between the two companies in proportion. The ceding company dictates the reinsurance company to take a definite percentage of share under each policy. The premiums and losses shared by the insurer and the re insurer in same proportion. The ratio of share of premium and losses by two or more companies is definite say 50:50 or 75:25. Under this type of reinsurance, a definite percentage of premiums are being received by the re insurer and the same percentage of claim is by the assuming company. Since the insurance company, by transferring some part of its risk, provides business to the reinsurance company. The reinsurance company in turn pays ceding commission to the insurance company. In this type of insurance, it is decided by the ceding company that what percentage of insurance is to be done by the insurer through its own account and the balance amount to be transferred to the re insurer. The insurance company may opt for proportional reinsurance if he is not capable to prudently retain its risk which it is capable of producing.
2) Non Proportional Reinsurance:
This type of reinsurance is done on Non-Proportion basis. The reinsurance cover is seeked by the insurer on the actual claim on each and every risk. The insurer seeks the reinsurance cover as and when the claim arises. The response of reinsurance arises only when the claim occurred by the insurer exceeds the retention limit. The non proportional reinsurance is done strictly on the basis of retention limit. This retention limit is decided by the ceding company and if the loss exceeds the retention limit then the loss over the retention limit will be reimbursed by the re insurer. Thus the existence of non proportional reinsurance comes into picture only if there loss suffered by the ceding company is above the retention limit decided by the insurer earlier. This type of insurance does not protect the insurance company from risk exposure but protects the loss incurred by the insurer.
3) Facultative Reinsuracne:
This type of reinsurance is also known as optional reinsurance. The re insurer has the right to accept or decline the proposal offered by the insurer. Every risk is covered under this type of reinsurance on individual basis. This type of insurance minimizes the risk exposure of the ceding company. However this type of reinsurance is non obligatory to both the companies. Neither the ceding company is obliged to transfer the risk nor the assuming company is obliged to accept the risk. Each risk is underwritten individually in this type of reinsurance thus increasing the cost and expenses of underwriting. The commission paid by the re insurer depends upon the expenses incurred by the insurer for providing the business as well as management expenses.
This type of reinsurance is adopted when a group of same risks are taken into consideration. According to term of the policy, the re insurer will accept all or part of risk of insurance company for certain sections. This is an obligatory type of reinsurance. The ceiling company is obliged to cede its business and the re insurer is obliged to accept the risk. Under this type of reinsurance, the ceding and the assuming company enters into a treaty under which re insurer has to accept all the insurance policies coming under the scope of contract for reinsurance. Under this type of reinsurance, each and every risk is not evaluated on individual basis. Even the underwriting expenses are less because re insurer accepts the ceding company's underwriting decision.
Source: Application of insurance
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