Reinsurance happens
when multiple insurance companies form consortium to share risk by purchasing
insurance policies from other insurers to limit their own loss in case of
disaster or natural calamities.
Reinsurance is known as "insurance for
insurance companies” so that no insurance company has too much exposure to any
uncertain event or disaster. The company that purchases the reinsurance
policy is called a "ceding company" or "cedent".
Reinsurance started in
early 14th century primarily for marine and fire insurance. Since
then, it has grown to cover every aspect of the modern insurance market.
There are 2 types of reinsurance:
- Treaty reinsurance and
- Facultative reinsurance
Consider a ship
carrying goods, sinks in the water causing loss of millions of rupees. Now
think if one insurance company had sold all the homeowners insurance, the
chance of it being able to cover the losses would be impossible. Here comes the
concept of reinsurance. Instead, the insurance company spreads parts of the
coverage to other insurance companies (reinsurance), thereby spreading the cost
of risk among many insurance companies. This saves the insurance company from
being bankrupt or being financially ruined. When reinsurance occurs, the premium paid by the insured is typically shared by all of the
insurance companies involved.
An insurer purchase reinsurance for four major reasons:
- To limit liability on a specific risk,
- To stabilize loss incurred,
- To protect themselves and the insured against catastrophes,
- To increase their capacity.
Regards
Author: Sakshi Lunia
Kautilya,
IBS Mumbai
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