Question

Reinsurance is considered as a significant process which provides necessary securities to insurer which safeguards them from financial problems that arises from any future unexpected events.” Comment on the statement and explain the meaning and benefits of the term “Reinsurance.” Also read the following statements and identify the relevant reinsurance type/contract for each case.         

1. Under this contract, the pro rata basis is being used to share the premium and losses by the reinsurer and insurer.

Answer 1

Reinsurance is considered as a significant process which provides necessary securities to insurer which safeguards them from financial problems that arises from any future unexpected events.”

In light of above statement, reinsurance can be termed as insurance for insurers or stop-loss insurance. Reinsurance is the practice whereby insurers transfer portions of their risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a large obligation resulting from an insurance claim.

The party that diversifies its insurance portfolio is known as the ceding party. The party that accepts a portion of the potential obligation in exchange for a share of the insurance premium is known as the reinsurer.

How Reinsurance Works

• Reinsurance allows insurers to remain solvent by recovering some or all amounts paid to claimants. Reinsurance reduces the net liability on individual risks and catastrophe protection from large or multiple losses.
• The practice also provides ceding companies, those that seek reinsurance, the capacity to increase their underwriting capabilities in terms of the number and size of risks.

Benefits of Reinsurance

1. Reinsurance boosts Insurance Business: The major advantage of reinsurance is that it assists in the boom of insurance business. It enables every insurer to accept insurance business as the total risk will be distributed among other reinsurers.
2. Reinsurance reduces the risks: The prime principle of insurance is to reduce risk. If there is no reinsurance, the insurer may not be willing to take up risks, particularly when the risk exceeds beyond his capacity to manage.
3. Reinsurance Limits the Liability: Reinsurance motivates the insurers to undertake and spread the risks. Hence the liability of insurer is limited to the maximum.
4. Reinsurance Stabilizes premium Rates: The premium rates of insurance are stabilized by reinsurance. Generally, the premium rates are calculated on the basis of the loss experienced by the insurer in the past, due to the risk concerned. Reinsurance takes into account of all these data and fixes the premium rate according for various types of risks under mutual agreement.
5. Reinsurance Reduces Competition: The competitions between inter company is reduced as everyone work in a cooperative manner and with the helping tendency in the insurance business.

Answer to identification of type of reinsurance:

Under this contract, the pro rata basis is being used to share the premium and losses by the reinsurer and insurer. - This is Participating or Pro Rata Based Reinsurance Agreement (Under Quota share)

PARTICIPATING OR PRO-RATA: Where the proportion of amounts payable by the insurer and the reinsurers in respect of a loss is determined and agreed beforehand, i.e., before a loss. Here the premium received by the insurer is also distributed in between himself and the reinsurers in the same proportion. Examples are facultative, quota share, surplus or pool.