Reinsurance

In addition to its basic role in risk management, reinsurance is sometimes used to reduce the ceding company's capital requirements, or for tax mitigation or other purposes.

In the past 30 years there has been a major shift from proportional to non-proportional reinsurance in the property and casualty fields.

Reinsurance can make an insurance company's results more predictable by absorbing large losses.

In addition, the reinsurer will allow a "ceding commission" to the insurer to cover the costs incurred by the ceding insurer (mainly acquisition and administration, as well as the expected profit that the cedent is giving up).

Under a quota share arrangement, a fixed percentage (say 75%) of each insurance policy is reinsured.

Under a surplus share arrangement, the ceding company decides on a "retention limit": say $100,000.

For example, it may only be able to offer a total of $100 million in coverage, but by reinsuring 75% of it, it can sell four times as much, and retain some of the profits on the additional business via the ceding commission.

The ceding company may seek surplus reinsurance to limit the losses it might incur from a small number of large claims as a result of random fluctuations in experience.

If they issue a $200,000 policy, they would give (cede) half of the premiums and losses to the reinsurer (1 line each).

In this example, the insurer also retains any loss over $5 million unless it has purchased a further excess layer of reinsurance.

In per risk, the cedent's insurance policy limits are greater than the reinsurance retention.

These contracts usually contain event limits to prevent their misuse as a substitute for Catastrophe XLs.

For example, an insurance company issues homeowners' policies with limits of up to $500,000 and then buys catastrophe reinsurance of $22,000,000 in excess of $3,000,000.

Aggregate covers can also be linked to the cedent's gross premium income during a 12-month period, with limit and deductible expressed as percentages and amounts.

Facultative reinsurance contracts are commonly memorialized in relatively brief contracts known as facultative certificates and often are used for large or unusual risks that do not fit within standard reinsurance treaties due to their exclusions.

The reinsurer's liability will usually cover the whole lifetime of the original insurance, once it is written.

However the question arises of when either party can choose to cease the reinsurance in respect of future new business.

A continuous contract has no predetermined end date, but generally either party can give 90 days notice to cancel or amend the treaty for new business.

It is common for insurers and reinsurers to have long-term relationships that span many years.

Using game-theoretic modeling, Professors Michael R. Powers (Temple University) and Martin Shubik (Yale University) have argued that the number of active reinsurers in a given national market should be approximately equal to the square-root of the number of primary insurers active in the same market.

Because of the governance effect[clarification needed] insurance/cedent companies can have on society, reinsurers can indirectly have societal impact as well, due to reinsurer underwriting and claims philosophies imposed on those underlying carriers which affects how the cedents offer coverage in the market.