What is reinsurance

The loss reserve is made up of funds set aside to pay future claims. The reduction in these two accounts is commensurate with the payments that can be recovered from reinsurers, known as recoverables.

By statute or administrative practice, all states but with considerable variation recognize and grant credit on the financial statement for the reduced financial responsibility that reinsurance transactions provide. An alien company can also participate in the U.

For many years, few people outside the insurance industry were aware that such a mechanism as reinsurance existed. The public was first introduced to reinsurance in the mids, during what has now become known as the liability crisis. A shortage of reinsurance was widely reported to be one of the factors contributing to the availability problems and high price of various kinds of liability insurance.

These investigations culminated in a widely read report, "Failed Promises: Insurance Company Insolvencies," published in February The publicity surrounding the investigations and the poor financial condition of several major life insurance companies prompted proposals for some federal oversight of the insurance industry, particularly insurers and reinsurers based outside the United States.

However, no federal law was enacted. While a large portion of the insurance industry opposes federal regulatory oversight, many U. A critical tool for evaluating solvency is the annual "convention" statement, the detailed financial statement submitted by all insurance companies to the NAIC.

In , for the first time, the annual statement required insurers ceding liability to unauthorized reinsurers those not licensed or approved in a designated jurisdiction to include the amount of incurred but not reported IBNR losses in addition to known and reported losses.

IBNR losses are losses associated with events that have already occurred where the full cost will not be known and reported to the insurer until some later date. This requirement reflects regulators' concern that all liabilities are identified and determined actuarially, including IBNR losses, and that IBNR losses are secured by the reinsurer with additional funds or a larger letter of credit than otherwise would have been required.

In the mids, some reinsurance companies that had entered the reinsurance business during the period of high interest rates in the early s left the market, due to insolvency or other problems. Those that fail to pay attention to the riskiness of the business they are underwriting may end up undercharging for coverage and going bankrupt as a result. Consequently, some of the insurers that reinsured their business with these now-defunct companies were unable to recover monies due to them on their reinsurance contracts.

The rule helps regulators identify problem reinsurers for regulatory actions and encourages insurers to purchase reinsurance from companies that are willing and able to pay reinsured losses promptly. Concern about reinsurance recoverables led to other changes in the annual financial statement filed with state regulators, including changes that improve the quality and quantity of reinsurance data available to enhance regulatory oversight of the reinsurance business.

Reinsurers subsequently reassessed their position, which in turn caused primary companies to reconsider their catastrophe reinsurance needs. When reinsurance prices were high and capacity scarce because of the high risk of natural disasters, some primary companies turned to the capital markets for innovative financing arrangements.

Catastrophe Bonds and Other Alternative Risk Financing Tools: The shortage and high cost of traditional catastrophe reinsurance precipitated by Hurricane Andrew and declining interest rates, which sent investors looking for higher yields, prompted interest in securitization of insurance risk. Funds to pay for the transaction should money be needed, are held in U. Surplus notes are not considered debt, therefore do not hamper an insurer's ability to write additional insurance.

In addition, there were equity puts, through which an insurer would receive a sum of money in the event of a catastrophic loss in exchange for stock or other options. Commercial banks and other lenders have been securitizing mortgages for years, freeing up capital to expand their mortgage business. Insurers and reinsurers issue catastrophe bonds to the securities market through an issuer known as a special purpose reinsurance vehicle SPRV set up specifically for this purpose.

These bonds have complicated structures and are typically created offshore, where tax and regulatory treatment may be more favorable. SPRVs collect the premium from the insurance or reinsurance company and the principal from investors and hold them in a trust in the form of U. With non-proportional reinsurance, the reinsurer is liable if the insurer's losses exceed a specified amount, known as the priority or retention limit.

As a result, the reinsurer does not have a proportional share in the insurer's premiums and losses. The priority or retention limit is based on one type of risk or an entire risk category. Excess-of-loss reinsurance is a type of non-proportional coverage in which the reinsurer covers the losses exceeding the insurer's retained limit.

This contract is typically applied to catastrophic events and covers the insurer either on a per-occurrence basis or for the cumulative losses within a set period. Under risk-attaching reinsurance, all claims established during the effective period are covered regardless of whether the losses occurred outside the coverage period.

No coverage is provided for claims originating outside the coverage period, even if the losses occurred while the contract was in effect.

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Honouring Exemplary Boards. Deep Dive Into Cryptocurrency. Facultative Reinsurance: With this kind of reinsurance, a reinsurer offers coverage on each particular policy as a single transaction. Since the policies are not grouped together here, it offers the reinsurer greater scope to carefully analyze their risks and then undertake as to 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.

Reinsurance is helpful for the insurance industry in several ways. Read on to learn more about how reinsurance helps the industry. Reinsurance enables insurance companies to stay solvent by restricting their own 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. The main benefit of reinsurance lies in the insurer restricting losses to their own balance sheets.

This situation is likely to arise in times of natural calamities when too many claims are raised at the same time, and insurers might be required to settle them all.