9.

0 REINSURANCE
A reinsurance transaction is an agreement made between two parties, called ceding company and reinsurer,
whereby the ceding company agrees to cede, and the reinsurer agrees to accept, a certain share of risk upon
terms as set out in the agreement.

➡ This means:
Reinsurance is a deal between two companies:

 Ceding company (the original insurer) — agrees to pass on part of the risk.

 Reinsurer — agrees to take that part of the risk.

Reinsurance is the insurance of insurance.

➡ This means:
Insurance companies themselves can buy insurance — and that’s called reinsurance.

According to German Commercial Law, “Reinsurance is the insurance of the risk assumed by the insurer”.

➡ This means:
When an insurer takes a risk from a customer, that risk can itself be insured by another company — this is
reinsurance.

Reinsurance is always a contract of indemnity, even in life and personal accident insurance, because it
protects the insurer from a diminution of his property, caused by insurance policy obligations.

➡ This means:
Reinsurance is always about compensating actual loss (contract of indemnity).
Even if it’s for life insurance or accident insurance, it’s still meant to protect the insurance company from losing
its money or resources when it has to pay claims to policyholders.

Whereas insurance is a contract between the insurer and the insured, reinsurance is a separate contract
between the insurer and the reinsurer. Each of these contracts is independent of the other.

➡ This means:
Normal insurance is between customer and insurance company.
Reinsurance is a different contract between the insurance company and a reinsurer.
Both contracts are separate — one does not control the other.

Difference between reinsurance and coinsurance

In coinsurance risk is shared among several insurance companies, each one of them having direct contractual
relationship with the insured for the portion of the risk accepted by that company.

➡ This means:
In coinsurance, many insurance companies share one risk. Each company deals directly with the customer for
its share.

In reinsurance, the contract is between insurance company (called ceding company or cedant or reinsured)
and the reinsurer. The insured is not involved in this contract.

➡ This means:
In reinsurance, the deal is only between the original insurer and another insurer (reinsurer). The customer
doesn’t take part in this arrangement.
 9.1 NEED FOR RE-INSURANCE
1. It provides additional underwriting capacity to the insurer thereby helping them to expand the
volume of business it writes at a faster rate than otherwise would be possible without a
corresponding increase in its capital base.

➡ This means:
Reinsurance gives an insurance company extra power to issue more policies (underwriting capacity).
Because of this, the company can grow its business faster than it normally could — and it can do this
without adding a lot more money to its own funds or capital.

2. It helps a direct insurance company to spread the risks internationally thereby reducing the
exposure to catastrophic perils in the particular location where the insurer is situated.

➡ This means:
Reinsurance allows the insurance company to share its risks with other companies in different
countries.
This way, if a big disaster (like an earthquake, flood, or cyclone) happens in its own area, the
company doesn’t have to bear all the losses — the risk is spread out, so its losses are smaller.

3. Thus, Important benefits of reinsurance are:

→ Reduced volatility of underwriting results

→ Access to capital (of the reinsurer) which otherwise would not be possible to attain
➡ The insurance company can use the financial strength of the reinsurer, even though it doesn’t
own that money, which helps in paying big claims.

→ Access to reinsurers’ expertise and services especially in the areas of product development,
pricing, underwriting and claims management
➡ The insurance company can get advice and support from the reinsurer — such as creating new
insurance products, deciding premium amounts, checking and accepting risks, and handling claims
better.

9.3 RATING AGENCIES

➡ This means:
Reinsurers act as a backup for insurance companies, so they must be financially very strong to pay
claims when needed.

To assess & certify this, there is a need for organizations with unimpeachable credentials &
academic rigour.

➡ This means:
We need trusted and highly respected organizations to check and confirm the financial strength of
reinsurers.
Some of the well-known names in the field of financial ratings are listed below.

International rating agencies:

 Standard & Poor

 A.M. Best

 Moody’s

Indian rating agencies:

 CARE (Credit Analysis & Research Ltd.)

 Duff & Phelps Credit Rating India Pvt. Ltd. (DCR India)

 CRISIL (Credit Rating Information Services of India Ltd.)

 ICRA (Investment Information & Credit Rating Agency of India)

➡ This means:
These are the famous companies that give ratings to insurers and reinsurers based on their financial
strength.

The IRDA regulation in this regard requires minimum BBB rated Reinsurer (By Standard & Poor or
equivalent), with whom an Indian Insurer can place business.

➡ This means:
As per IRDA rules, Indian insurance companies can only work with reinsurers who have at least a BBB
rating (given by Standard & Poor or any similar rating agency).

Typically, a Rating Agency expresses forward-looking opinions about relative creditworthiness of

➡ This means:
Rating agencies give future-looking opinions on how likely a company is to pay back its debts and
meet its promises.

Creditworthiness is a multi-dimensional phenomenon. The likelihood of default is seen as the

➡ This means:
Creditworthiness (trust in a company’s ability to pay) has many sides, but the most important is —
will the company fail to pay (default) or not?

The secondary dimensions of creditworthiness are: payment priority, recovery, and credit stability.

➡ This means:
Other important factors are:

 Payment priority — who gets paid first if money is limited.

 Recovery — how much money can be recovered if the company fails.

 Credit stability — how steady and reliable the company’s credit position is over time.

Briefly, a credit rating is an indicator of a company’s overall capacity and willingness to meet its
financial obligations.
➡ This means:
In short, a credit rating shows how able and willing a company is to pay its debts and meet its
financial promises.

9.4 PRINCIPLES OF REINSURANCE

1. Principle of utmost good faith

2. Principle of indemnity

3. No reinsurance without retention

1. Utmost good faith

The relation between the insurer and the reinsurer is based on the principle of “utmost good faith.” In
case of facultative reinsurance insurer have to provide details of risk related information. In case of
automatic reinsurance principle of utmost good faith is also important.

➡ This means:
The insurer (ceding company) and the reinsurer must be completely honest with each other and
share all important facts about the risk.

 In facultative reinsurance (case-by-case reinsurance), the insurer must give full details about
the risk.

 In automatic reinsurance, honesty is still equally important.

2. Principle of indemnity

The principle of indemnity of the insured risk applies automatically on reinsurance. A reinsurer
automatically follows the legal and technical future of the reinsured writing and underwriting a risk.
Indemnity limit in reinsurance can be more than the sums insured if there are additional legal
expenses against the insurer that are incurred while contesting a claim.

➡ This means:
Reinsurance also works on compensation for actual loss (indemnity).

 The reinsurer agrees to pay the insurer for losses according to the same rules the insurer
follows with its customer.

 The reinsurer “follows the fortunes” of the insurer — meaning it accepts the insurer’s
decisions on underwriting and claims.

 Sometimes, the payment from the reinsurer can be more than the policy sum insured — for
example, if the insurer had to pay extra legal costs while fighting a claim in court.

3. No reinsurance without retention

The insurer must retain a part of the risk before reinsuring. Though there cannot be reinsurance of
the complete risk, there can be complete retention of a risk. Those risks that are within the retention
capacity of an insurer must be retained completely. Reinsurers always try to attach a global spread of
risks. When reinsurers are in global market they are not excessively affected by local market bad
losses and are capable of meeting liabilities.

➡ This means:
The insurer must keep some portion of the risk with itself before passing the rest to the reinsurer.

 The insurer cannot reinsure 100% of the risk (because then it’s avoiding all responsibility).

 But the insurer can keep the full risk if it’s within its capacity.

 Reinsurers usually want a variety of risks from all over the world so that losses in one place
don’t hurt them too much, and they can still pay claims anywhere.