What is reinsurance?

What is reinsurance?

Did you know that insurance companies also buy insurance for the policies they sell to you? In much the same way that you buy insurance to mitigate the risks of your business, insurance companies also buy insurance to make sure they are able to meet their obligations to their clients when claims occur. The process of an insurance company purchasing insurance on the policies they sell is called reinsurance.

Insurance companies work by taking a fee known as the insurance premium from clients, and pooling those premiums together – when one client suffers a loss, money is taken from the collective pool to compensate. Reinsurers work in a similar way, but their clients are the insurance companies themselves.

An insurance company (known as the ceding party in this context) chooses to pay premiums to a reinsurer (usually, a fraction of the premium it receives from its own clients). In return, the reinsurer agrees to reimburse part of the ceding party’s obligations should a claim occur. As with regular insurance, reinsurance is often purchased through a broker.

Reinsurance assists insurers to reduce the impacts of large claims and in turn allows them to assist more clients than they would normally have been able to.

Reinsurance is a complicated topic, but at the most basic level there are two types of re-insurance.

1. Treaty Reinsurance – this type of reinsurance generally covers an agreed share of the policies issued by an insurance companies within a defined scope.

2. Facultative Reinsurance – this type off reinsurance is negotiated on a policy by policy basis and is        mostly used for policies that are excluded from the company’s treaty reinsurance 

In Australia, reinsurers are regulated by APRA in much the same way as insurance companies. Among other things, APRA requires that insurance companies have a detailed reinsurance management plan to ensure all insurers are responsibly managing their potential liabilities. APRA also provides guidelines to insurers around the amount of reinsurance they should have.