Reinsurance & Co-Insurance

Reinsurance is insurance for insurers. An insurance company (the cedant or ceding company) transfers part of the risk it has accepted from policyholders to another insurer (the reinsurer). The policyholder usually has no direct relationship with the reinsurer — the original insurer remains fully liable to the policyholder, a principle known as privity of contract.

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Must-know for the exam

Reinsurance is 'insurance for insurers': the cedant remains fully liable to the policyholder, who usually has no contract with the reinsurer (privity of contract).
The main purposes of reinsurance are: increased capacity, catastrophe protection, stability of results, spreading of risk, and financing/solvency support.
Co-insurance = several insurers share ONE original risk DIRECTLY (each liable to the policyholder for its share); reinsurance = ONE insurer passes risk to another insurer behind the scenes.
Facultative reinsurance covers a single individual risk and the reinsurer may accept or decline it; treaty reinsurance is an obligatory standing agreement covering a whole class automatically.
Proportional reinsurance shares premiums and claims in the same proportion as the sum insured; non-proportional pays only losses above an agreed retention.
Quota share cedes a fixed percentage of every risk; surplus lets the insurer keep a chosen retention and cede only the surplus above it, up to a number of 'lines'.
Surplus capacity = retention + (number of lines × retention). A $200,000 retention with a 4-line treaty gives $1,000,000 of capacity.
Excess of loss ('X excess of Y') means the reinsurer pays the loss above the cedant's retention Y, up to limit X; stop loss protects the insurer's total annual loss ratio.
Cession = risk passed on; retention = risk kept; retrocession = a reinsurer reinsuring its own accepted risk with another reinsurer (retrocessionaire).
Reinsurance operates on utmost good faith and often a 'follow the settlements' clause; on proportional treaties the reinsurer pays the cedant a ceding commission.

Why Reinsurance Exists

Reinsurance exists for several practical reasons. Increased capacity: it lets an insurer accept risks larger than its own capital and licensing limits would otherwise allow, because it can pass on the excess. Catastrophe protection: it shields the insurer from an accumulation of losses from a single event such as a flood, earthquake or major fire affecting many policies at once.

Stability of results: by smoothing out the peaks caused by large or unexpected claims, reinsurance helps the insurer report steadier year-to-year profits. Spreading of risk: a risk accepted by one insurer is subdivided among many reinsurers around the world, so no single carrier is over-exposed. Reinsurance also provides financing / solvency support, easing the strain that rapid growth in new business places on an insurer's capital.

Co-Insurance vs Reinsurance

Co-insurance and reinsurance are two different ways of sharing a large risk, and they are frequently confused in the exam.

In co-insurance, several insurers each accept a share of the same original risk directly, in a horizontal split. Each co-insurer issues its own portion (or one leader issues a single policy on behalf of all) and is liable to the policyholder only for its agreed percentage — for example three insurers taking 50%, 30% and 20% of a $10 million factory. The policyholder deals with the co-insurers (usually through a leading office) and knows who carries each share.

In reinsurance, only one insurer issues the policy and is liable to the policyholder for the whole amount. That insurer then privately passes part of the risk to a reinsurer behind the scenes. The policyholder normally does not know, and does not need to know, that reinsurance exists. So the simple test: co-insurance is a direct, horizontal sharing among insurers of the customer; reinsurance is a vertical passing-on of risk by one insurer to another insurer of insurers.

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Reinsurance is protection for the insurer, not for the policyholder.
Reinsurance smooths results; it does not guarantee profit.
Under co-insurance the customer knows and deals with each insurer's share; under reinsurance only one insurer faces the customer.
The policyholder claims against their own insurer only, not the reinsurer.
Facultative = optional, single risk; treaty = obligatory, whole class.
Selecting individual risks describes facultative, not treaty, reinsurance.
The percentage quoted (60%) is the ceded share; the retention is the remainder (40%).
Remember to add the retention to the 4 ceded lines — total capacity is 5 × retention, not 4.

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Exam-style questions

A 'follow the settlements' (follow the fortunes) clause in a reinsurance treaty generally means the reinsurerAnswer explained →Under a '$1,000,000 excess of $250,000' cover, a loss of $1,600,000 occurs. How is the loss split between insurer, reinsurer and any uninsured amount?Answer explained →Stop loss (aggregate excess of loss) reinsurance protects the insurer againstAnswer explained →An insurer retains $200,000 on a surplus treaty and writes a risk with a sum insured of $800,000. A claim of $400,000 occurs. How much does the insurer bear from its own retention?Answer explained →Which of the following correctly matches the arrangement to its description?Answer explained →

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BCP — Basic Insurance Concepts & Principles