Reinsurance: Insurance for insurance companies

Reinsurance is a process whereby one entity (the reinsurer) takes on all or part of the risk covered under a policy issued by an insurance company in consideration of a premium payment. In other words, it is a form of insurance cover for insurance companies.

The guiding principle of the regulatory framework in India is maximising retention within India, so each Indian insurance company must maintain the maximum possible retention commensurate with its financial strength, quality of risks, and volume of business. Indian insurance companies are required to mandatorily cede a certain percentage of the sum assured on each policy for different classes of insurance written in India to Indian reinsurance companies as defined under the provisions of the Insurance Act. Apportionment of obligatory cession for the financial year 2023-24 has remained consistent with the previous year’s requirement of 4 per cent. The requirement to place the entire obligatory cession only with the General Insurance Corporation of India also continues to be applicable.

As per Regulation 3, Clause (C) of sub-Regulation (2), Every Indian Re-insurer including Foreign Re-insurance Branches (FRBs) shall maintain a minimum retention within India of 50% of Indian reinsurance business underwritten. Any retrocession to an IIO (International Financial Service Centre Insurance Office’ (IIO)) up to 20% of Indian reinsurance business underwritten shall be reckoned towards the required minimum retention of 50%.

 An Indian insurance company is also strictly prohibited from fronting for a foreign insurance company or reinsurance company. Fronting’ is defined as a process of transferring risk in which an Indian insurance company cedes or retrocedes most or all of the assumed risk to a reinsurance company or a retrocessionaire.

Ceded reinsurance and retention of risk:

Reinsurance ceded is an insurance industry term that refers to the portion of risk that a primary insurer passes to another insurer. That other insurer is often a reinsurance specialist. This practice allows the primary insurer to limit the overall risk exposure that it takes on with its clients. The Indian Reinsurer shall retrocede at least 50% of the obligatory cessions received by it to the ceding insurers after protecting the portfolio by suitable excess of loss covers. Such retrocession shall be at original terms plus an overriding commission to the Indian reinsurer not exceeding 2.5%. The retrocession to each ceding insurer shall be in proportion to its cessions to the Indian reinsurer.

Treaty Reinsurance: When an insurance company enters into a reinsurance contract with another insurance company, then the same is called treaty reinsurance. Within this type of reinsurance, the reinsurer agrees to provide blanket coverage for all the policies written as well as those that have not been written by the insurer company for a specified duration of time. It can often prove risky for the reinsurer in case they have not studied all the policies issued by the insurer in depth.

Facultative Reinsurance: Facultative reinsurance is coverage purchased by a primary insurer to cover a single risk—or a block of risks—held in the primary insurer’s book of business. With this kind of reinsurance, a reinsurer offers coverage on each particular policy as a single transaction. Since the policies are not grouped here, it offers the reinsurer greater scope to carefully analyze their risks and then undertake whether they wish to cover a part of the policy or the entire policy.

Most reinsurance policies are made on a proportional basis, wherein the reinsurer agrees to receive a certain proportion of the premiums collected for the policies it has undertaken the risks for.

Why reinsurance?

The main benefit of reinsurance is to protect a company from insolvency. During a natural disaster or any other calamity strike, a large number of the policyholders will claim their policies, unlike only a few policyholders are expected to lodge claims within a particular timeline. To pay a large number of policyholders, it is quite likely that an insurance company might go insolvent. Reinsurance enables insurance companies to stay solvent by restricting their losses. Sharing the risks with a reinsurer enables companies to honour the claims raised by people without being worried about too many people raising claims at the same time. Several other reasons for reinsurance include: i) expanding the insurance company’s capacity to offer further coverage as part of the existing risks transferred to a reinsurance company; ii) stabilizing underwriting results (Insurance companies rely on reinsurance to stabilize underwriting results by leveling claims volatility; protect capital and surplus); iii) withdrawing from a line or class of business; iv) spreading risk; and v) acquiring expertise from a reinsurance company.

Disadvantage:

If reinsurance becomes more expensive or harder to get, insurers may be forced to increase prices for their policies. This can result in higher premiums for policyholders. Reinsurance can also impact the amount of risk that insurers are willing to take on with their policyholders.

Disclaimer: The content on this page is generic and shared only for informational and explanatory purposes. It is based on industry experience and several secondary sources on the internet; and is subject to changes. Please read the related product brochures for exclusions, terms and conditions, warranties, etc. carefully before concluding a purchase.

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