Reinsurance is essentially insurance for insurance companies. With a reinsurance arrangement, a “ceding” insurer transfers a portion of its risk portfolio to a reinsurer, who agrees to cover the ceding insurer’s losses as specified by the terms of the contract.
What Are the Purposes of Reinsurance?
Reinsurance helps ensure the solvency of insurance companies in the event of an unusual occurrence, such as a major hurricane, that causes catastrophic losses. By spreading the risk of catastrophic losses among multiple insurers, the ceding insurer is able to accept risks that would otherwise be beyond its underwriting capacity. Reinsurance also allows the insurer to reduce the amount of capital reserves it is legally required to hold for the protection of policyholders.
Assumption Reinsurance vs. Indemnity Reinsurance
There are two basic types of reinsurance: assumption reinsurance and indemnity reinsurance. With assumption reinsurance, the reinsurer essentially steps into the shoes of the ceding insurer with regard to the reinsurance policy. The assumption reinsurer assumes all of the ceding insurer’s liabilities and responsibilities to maintain required reserves against potential claims. The assumption reinsurer receives all premiums directly and becomes directly liable to the policyholders.
With indemnity reinsurance – which is much more common – the indemnity reinsurer agrees to indemnify, or reimburse, the ceding insurer for a specified amount of the claims and expenses attributable to the reinsured risks. Indemnity reinsurance is usually available on either a “pro rata” or “excess of loss” basis.
Pro Rata Reinsurance
In a pro rata or proportional reinsurance contract, the reinsurer agrees to indemnify the ceding insurer for a percentage of any losses in exchange for a corresponding portion of the premiums. Depending on the particular arrangement, the reinsurer may indemnify the ceding insurer for a certain percentage, say 60 percent, of the losses for all policies of a particular type written by the ceding insurer. This is known as a quota share reinsurance arrangement. Another option is a surplus share arrangement, in which the ceding insurer retains a fixed amount of liability for the underwritten amount and cedes the remaining liability to the reinsurer. For instance, a ceding insurer that underwrites policies for $500,000 in coverage may retain $100,000 in liability, and the reinsurer will be responsible for the remaining $400,000.
Excess of Loss Basis
When reinsurance is purchased on an excess of loss basis, the reinsurer indemnifies the ceding insurer for all or a stated portion of losses that exceed a specified threshold. For instance, if a contract states that the reinsurer is responsible for all losses over $600,000, and the losses amount to $900,000, the ceding insurer is responsible for the first $600,000 and the reinsurer is responsible for the excess amount of $300,000.
There are several forms of excess of loss reinsurance, including per risk, per occurrence and aggregate excess of loss reinsurance. With per risk reinsurance, the reinsurer indemnifies the ceding insurer against losses above a specified amount (subject to a stated limit) for each risk covered by the reinsurance agreement. With per occurrence reinsurance, the ceding insurer is indemnified for losses above a certain threshold (subject to a specified limit) for each occurrence. With aggregate excess of loss reinsurance, the reinsurer will indemnify the ceding insurer for excess losses during a specific period.
A Policyholder’s Rights against a Reinsurer
Since a reinsurance contract is between the reinsurer and the ceding insurer, the reinsurer generally has no obligations to the original policyholder, absent policy language indicating the reinsurer is directly liable to the original insured. Correspondingly, the policyholder generally has no rights against the reinsurer. However, courts have allowed a policyholder to proceed directly against a reinsurer under certain limited circumstances, including when a reinsurance agreement contains a cut-through clause that allows the original insured to bring a direct action against the reinsurer in certain situations.
If you are involved in a dispute with your business insurance company, contact us. We have the expertise, experience and tenacity to make insurance companies keep their promises to you and your business.