Reinsurance is insurance for insurers. Insurance is an agreement between a provider and a client stipulating that compensation will be paid in the event of particular occurrences and, in exchange for that protection, the client pays a premium. Reinsurance protects insurers against excessive losses, helping to ensure their sustainability and prevent bankruptcy and failure as a business.
In preparation for a known-risk time such as a major accident claim or a coming storm, insurance companies might purchase reinsurance. Reinsurance limits a company’s claim losses to a specific amount. This limiting on a case can often help a company prevent exceeding the insurance premiums collected in a year. Instead of having the required capital on hand to cover claims, an insurance company may also hold the value in reinsurance.
Reinsurance fits into two main categories, treaty or facultative:
- Treaty reinsurance covers some or all of an insurer’s risks for an agreed-upon period of time.
- Facultative reinsurance covers against a specific risk case.
Either treaty or facultative reinsurance may be proportional, in that the insurer may have to cover a portion of the costs (usually a percentage). Proportional insurance and reinsurance are also called pro-rata. Non-proportional reinsurance only begins when losses exceed an agreed upon amount. Once this amount is exceeded the reinsurance covers all additional losses. Non-proportional reinsurance is also called excess of loss insurance as that is what it protects against: losses to greater than the company agrees to bear.