Have you ever heard of reinsurance? If not, then maybe it’s time you did. Why, you may ask? Well, for starters, it helps protect the insurer against huge claims and hence reduces the overall risk involved.
What Is Reinsurance?
If you have taken an insurance policy, you can pass on some part of the risk involved by opting for reinsurance. In this process, the reinsurer covers everything or just a part of the risk covered under a policy issued by an insurance company.
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Why Is It Done?
One of the primary reasons for opting for reinsurance is that it helps manage risk. The insurance business is mainly based on an assumption that only a fraction of policies issued will be claimed at a time. Actually, if we compare the amount, the total sum that is assured to all insurers is much greater than the net worth of the company.
In order to help the company pay off insurance claimed after providing for all losses, the collected premiums are expected to help. But, there can also be a situation where a large number of claims are made, which can’t be covered just by premiums collected. In this case, there is a high risk of insolvency for the insurance company involved.
In case this situation actually arises, the company’s net worth will automatically get wiped off in an attempt to pay all its customers. That explains the need for reinsurance. It’s like an umbrella that protects the insurance companies.
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How Does It Work?
When you take an insurance plan, you pay a premium to the insurance company. Similarly, in case of reinsurance, the insurance company is supposed to pay premiums to the reinsurance company. So, in case the insurance company is incapable of paying the claims of some of its customers, the reinsurer pays them on the company’s behalf.
The reinsurer can either be a company that’s exclusively in the business of reinsurance or another insurance company where the companies are willing to share the risk with each other.
What Are The Types Of Reinsurance?
There are two types of reinsurance. Here they are:
- Facultative Coverage: This type of reinsurance aims at protecting the insurer for an individual or a specified risk or contract. Being an individual risk-based coverage, if several risks or contracts need reinsurance, each is negotiated separately. In this case, the rights to accept or deny a facultative reinsurance proposal rest with the reinsurer. When do we take this type of coverage? For policies that have a very high insurable value and the insurance company does not have the capacity to provide it on its own.
- Treaty Coverage: In this case, there exists a pre-negotiated agreement between the insurance company and the reinsurer. As a part of that agreement, the reinsurance company accepts all risks of a particular type from the ceding insurance company.
- Excess-of-loss Coverage: This is a non-proportional coverage where the reinsurer covers the losses exceeding the insurer’s retained limit. Excess-of-loss coverage reinsurance is generally applied in case of catastrophic events to cover the insurer either on a per-occurrence basis or for the cumulative losses within a set time period.
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