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Characteristics - Reinsurance - Concept of Insurance, Principles of Insurance, B com | Principles of Insurance

When an insurer transfers a part of his risk on a particular insurance by insuring it with another insurer or other insurers, it is called “Re-insurance”.

 

Reinsurance is insuring the same risk

Reinsurance means insuring again by the insurer of a risk already insured. Every insurer has a limit to the risk that he can bear. If at anytime a profitable venture comes his way, he may insure it even if the risk involved is beyond his capacity which is his retention limit. In such cases, in order to safeguard his interest, he may reinsure the same risk for an amount in excess of his retention limit with other insurers, so that the loss due to risk is spread over many insurers.

 

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What is the purpose of reinsurance?
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Contract between two insurers

Reinsurance is, therefore, a contract between two insurers and the original contract or the insured is not at all affected by it. Now there are two contracts on the subject matter. The first contract is between the original insurer or direct insurer and the owner of the subject matter or the original insured.

The other contract (reinsurance contract) is between the original insurer and the reinsurer. In the case of loss on the subject matter, the original insurer collects the insured sum from the reinsurer and then settles the loss value in full to the original insured.

 

Example of Reinsurance

An example will make the concept of reinsurance more clear:

Mr. X, a factory owner, approached an insurance company ‘A’ for an insurance of an amount of Rs. 40 crores. Company ‘A’ has two options before it. It can reject the risk or accept the entire risk and share a part of the risk with other insurer.

In case, the company ‘A’ decides to assume the risk, by retaining Rs. 20 crores worth of insurance with it and seeking assistance of other insurer for the excess of his own limit. i.e., for the balance of Rs. 20 crores. The excess for which the company ‘A’ is approaching the other insurer is called “Reinsurance”.

 

Definition of Reinsurance

Definition by W.A. Dinsdale:

When the amount of any risk or risks from one hazard is such that it is beyond the limits, which it is prudent for one insurer to carry, it is necessary to effect reinsurance.


Definition by Federation of Insurance Institute, Mumbai

Reinsurance is an arrangement whereby an insurer so has accepted all insurance, transfers a part of the risk to another insurer so that his liability on any one risk is limited to a figure proportionate to his financial capacity.

 

 


Definitions of Terms used in Reinsurance

Before going deep into the concept of reinsurance, it is necessary to understand the meaning of the various terms used in it.

1. Direct Insurer

An insurance company which accepts the risk from the proposer and which is solely responsible to the policyholder for the obligations undertaken.

2. Reinsurer

The insurance company which provides reinsurance cover to the ceding company is called the Reinsurer. The offer made by the ceding company is accepted by the Reinsurer. The Re-insurer may be

  • a direct insurer, who in addition to accepting direct business, also accepts reinsurance business; or

  • a professional reinsurer who accepts only reinsurance business but does not transact direct business.

3. Ceding company

Insurance company that places reinsurance business of the original risk with a reinsuring company; or the original insurer; the insurer who obtains a guarantee (on fire policy).

4. Cession

This is the amount reinsured with the reinsurance i.e., ceded to the reinsurer.

5. Reinsurance policy

The contract of reinsurance; in fire insurance, it is called guarantee policy.

6. Retention

This is the amount retained by the ceding company for its own account i.e., maximum it is prepared to lose on anyone loss. It is also known as ‘net limit‘ or ‘net holding‘ or ‘net line‘.

7. Surplus

This refers to the difference between the sum insured under the policy issued by the ceding company and its retention.

8. Reinsurance Commission

It refers to the amount paid by the reinsurer to the insurer (ceding office) as a contribution to the acquisition and administration costs. Usually, it is a fixed percentage of premium received by the reinsurer.

 

Characteristics of Reinsurance

1. Reinsurance is a contract between the two insurance companies.

2. The original insurer agrees to transfer part of his risk to other insurance company on the same terms and conditions.

3. The fundamental principles of insurance such as insurable interest, utmost good faith, indemnity, subrogation and proximate cause also apply to reinsurance.

4. In the event of fire, the insured is entitled to get the amount of claim only from the original insurer and not from reinsurer.

5. Original insurer cannot insure the risk with a re-insurer, more than the sum assured, originally by the insured.

6. The original insurer should intimate to the reinsurer about the alteration, if any, made in terms and conditions with the insured.

 

Objectives of Reinsurance

The following are the main objectives of reinsurance:

1. Wide distribution of risk to secure the full advantages of the law of averages;

2. Limitation of liability of an amount which is within the financial capacity of the insurers; .

3. Stability in underwriting over a period; and

4. A safeguard against serious effects of conflagrations. Apart from these, sometimes an insurer may undertake the insurance of certain risks at a higher rate of premium and may reinsure part of these or the whole of it with some other insurers at a lower rate with the objective of earning of profit out of it i.e., making profits by way of retaining the difference between the two premiums.

 

Important Concept

What is Retrocession?

Means reinsurance of reinsurance. A reinsurer may like to get his interest protected by further reinsurance and so on.


What is Retention?

This refers to the amount of risk retained by the ceding company. The balance is usually reinsured. The amount of retention is dependent on the financial strength of the ceding company for that class of business. It is the refined figure of another term known as LIMIT.

Normally “Limit1’ is a rough guide of the ceding company and depending on the quality and nature of the risk the ceding co. may decide to enhance or reduce the limit for the purpose of actual retention.

Question for Characteristics - Reinsurance - Concept of Insurance, Principles of Insurance, B com
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What is the term used to describe the contract between two insurance companies where the original insurer transfers part of their risk to another insurer?
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What is Line?

A line is equivalent to retention, i.e., the amount retained by the ceding co… A reinsurance arrangement is usually expressed in terms of “line” meaning that if a ceding company has a ten- line or twelve-line reinsurance arrangement (TREATY) it can automatically cede or reinsure up to ten times or twelve times of the amount retained.


Who is a Primary Insured / Assured?

This refers to the primary insured (assured) originally insuring the risk at the first instance. He is one of the parties to the insurance contractand not in the reinsurance contract.


What is Reciprocity?

This is a widely used term in the transaction of the business of reinsurance, indicating a situation involving the desire for the satisfaction of mutual interest.

Normally, the direct insurers, at one time or the other, do transact reinsurance business also in addition to the insurance business.

The document Characteristics - Reinsurance - Concept of Insurance, Principles of Insurance, B com | Principles of Insurance is a part of the B Com Course Principles of Insurance.
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FAQs on Characteristics - Reinsurance - Concept of Insurance, Principles of Insurance, B com - Principles of Insurance

1. What is reinsurance and how does it relate to the concept of insurance?
Reinsurance is a process in which an insurance company transfers a portion of its risk to another insurance company. It is essentially insurance for insurance companies. When an insurer sells policies to individuals or businesses, it assumes the risk of paying claims if an insured event occurs. Reinsurance helps insurance companies manage their risk exposure by allowing them to transfer a portion of the risk to other insurers.
2. What are the principles of insurance and how do they apply to reinsurance?
The principles of insurance include principles of utmost good faith, insurable interest, indemnity, subrogation, and contribution. These principles also apply to reinsurance. Reinsurance contracts are based on the principle of utmost good faith, which means both parties must disclose all relevant information honestly and accurately. Insurable interest is required for reinsurance, just as it is for insurance contracts. Reinsurance also follows the principle of indemnity, which means that the reinsurer will only compensate the insurer for the actual loss suffered. Subrogation and contribution principles also apply to reinsurance, allowing the reinsurer to seek recovery from other parties or share the loss with other reinsurers.
3. How does reinsurance help insurance companies manage their risk?
Reinsurance helps insurance companies manage their risk by transferring a portion of their risk exposure to other insurers. By doing so, insurance companies can reduce their potential losses in the event of a catastrophic event or a high number of claims. Reinsurance allows insurers to protect their financial stability and ensure they have sufficient funds to pay claims. It provides a safety net for insurance companies, enabling them to continue operating even in the face of significant losses.
4. What are the characteristics of reinsurance?
Reinsurance has several characteristics that make it distinct from primary insurance. Firstly, reinsurance involves the transfer of risk from one insurer to another. It is a contractual agreement between insurers. Secondly, reinsurance can be either proportional or non-proportional. Proportional reinsurance involves sharing the risk and premium income between the insurer and the reinsurer based on predetermined percentages. Non-proportional reinsurance, on the other hand, provides coverage for specific events or losses that exceed a certain threshold. Thirdly, reinsurance can be facultative or treaty. Facultative reinsurance covers individual policies or risks, while treaty reinsurance covers a portfolio of policies. Lastly, reinsurance plays a crucial role in spreading risk globally, allowing insurers to diversify their risk exposure across different geographic regions.
5. How does reinsurance benefit policyholders?
Reinsurance indirectly benefits policyholders by ensuring that insurance companies have the financial capacity to pay claims. When an insurance company faces a high number of claims or a catastrophic event, reinsurance provides the necessary support to cover these losses. This helps policyholders by ensuring they receive the compensation they are entitled to, even in challenging circumstances. Reinsurance also promotes a stable insurance market by reducing the likelihood of insolvency for insurers, which ultimately benefits policyholders by maintaining the availability and affordability of insurance coverage.
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