What purpose does reinsurance serve for insurance companies?

Whether it be made compulsory by the public authorities or proves to be compulsory otherwise, insurance allows the policyholders, individuals or companies, to be supported by another for a part or all of their risks. Insurance companies themselves are likely to use this kind of service. Similarly, they can seek to protect themselves against the risk of accident or claims, or increase their underwriting capabilities by taking out reinsurance cover.

What is reinsurance?

  • A vertical risk distribution technique

It is a technique of "vertical" distribution of risks insured by insurance companies. The insurer contractually transfers part its insured risks to a third party in a vertical relationship. Classically, in the event of a claim, the reinsurer does not intervene as a primary actor, unlike the insurer (or cedant to the reinsurance contract). The latter therefore intervenes in the first line under the insurance contract. The reinsurer then intervenes in the second line to indemnify the cedant within the limits of the reinsurance agreement.   Vertical distribution, therefore, as opposed to the technique known as horizontal distribution of insured risks: the mechanism of co-insurance. In the latter case, the insurer uses the services of one or more third-party insurers under a co-insurance contract to cover one or more specific risks together. They are placed on an equal footing and the entire insurance process resulting from this contract will remain governed by the Insurance Code.

  • The insurer’s insurance

The technique of reinsurance is presented as being "the insurance of the insurer". Technically, an insurer, or "ceding company" to the reinsurance contract, cedes all or part of one or more insured risks to a third party insurance company: the reinsurer. The reinsurer may be a professional whose exclusive activity is the reinsurance of insurance companies, or a "general public" insurance company, offering this type of product.

Through the reinsurance mechanism, the reinsurer undertakes, in return for the payment of a premium, to compensate the ceding company for the losses incurred as a result of the realization of the reinsured risk in the proportions ceded to the reinsurance contract. The ceding company is the only one liable to the policyholder. And it is likewise the only one bound to the reinsurer by the reinsurance contract. Finally, and as a consequence, the insured under the insurance policy and the reinsurer have no contractual relationship. Unlike an insurance or co-insurance contract, a reinsurance contract is subject to contract law.

Why use the reinsurance mechanism?

There are situations that can threaten the survival of insurance companies. The notion of loss is at the heart of the reinsurance mechanism. A claim can, for example, endanger the financial balance of an insurer. Let's imagine for example major claims from large individual risks involving very large sums insured. Reinsurance serves to reduce the exposure of insurance companies to such risks.

What are the benefits of reinsurance for insurers?

The use of reinsurance is a real steering and management tool for insurance companies. Directive 2009/138/EC of the European Parliament and of the Council of November 25, 2009, known as Solvency II, introduces the concept of "Solvency Capital Requirement" (SCR) into the European and French legal framework. The text defines it as "the economic capital that insurance and reinsurance undertakings must hold in order to limit the probability of bankruptcy to one case in two hundred, or alternatively, so that the said undertakings remain in a position, with a probability of at least 99.5%, to meet their commitments to policyholders and beneficiaries within the following twelve months. Among other elements that are taken into account in the determination of the SCR is the reinsurance policy of insurance companies. Which shows just how important reinsurance is!  

Reinsurance allows the cedent insurer to increase their underwriting capabilities. It offers an additional guarantee of security to the underwriters of insurance contracts by participating in the permanent respect of the solvency margins of the insurance companies. Reinsurance also makes it possible to alleviate the cash flow needs of ceding companies, in particular through the mechanism of "cash calls". These are calls for funds made by the cedant to the reinsurer when it has to settle a major claim, the threshold of which must be specified in the reinsurance agreement. Reinsurance also facilitates the opening of new lines of business at the level of ceding companies and therefore their economic and technical development. It provides them with the security and expertise that they may need to prudently conquer new markets. Because of the scope of the reinsurance business, it contributes to good risk monitoring and provides ceding companies with international expertise. The activity of reinsurers is carried out on multiple and varied geographical territories. French reinsurers, for example, work with ceding companies on five continents.

Each insurance company is entitled to benefit from the protection provided by the reinsurance mechanism within the framework of its activity.

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