Explanation on Reinsurance Broking
EXPLANATION ON REINSURANCE BROKING
Reinsurance is insurance that is purchased by an insurance company (the "ceding company" or "cedant" under the arrangement) from one or more other insurance companies (the "reinsurer") as a means of risk management, sometimes in practice including tax mitigation and other reasons described below.
The ceding company and the reinsurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay a share of the claims incurred by the ceding company. The reinsurer is paid a "reinsurance premium" by the ceding company, which issues insurance policies to its own policyholders.
The reinsurer may be either a specialist reinsurance company, which only undertakes reinsurance business, or another insurance company.
For example, assume an insurer sells 1000 policies, each with a $1 million policy limit. Theoretically, the insurer could lose $1 million on each policy – totaling up to $1 billion. It may be better to pass some risk to a reinsurer as this will reduce the ceding company's exposure to risk.
There are two basic methods of reinsurance:
Facultative Reinsurance, which is negotiated separately for each insurance contract that is reinsured. Facultative reinsurance is normally purchased by ceding companies for individual risks not covered, or insufficiently covered, by their reinsurance treaties, for amounts in excess of the monetary limits of their reinsurance treaties and for unusual risks. Underwriting expenses, and in particular personnel costs, are higher for such business because each risk is individually underwritten and administered. However as they can separately evaluate each risk reinsured, the reinsurer's underwriter can price the contract to more accurately reflect the risks involved.
Treaty Reinsurance means that the ceding company and the reinsurer negotiate and execute a reinsurance contract. The reinsurer then covers the specified share of all the insurance policies issued by the ceding company which come within the scope of that contract. The reinsurance contract may oblige the reinsurer to accept reinsurance of all contracts within the scope (known as "obligatory" reinsurance), or it may require the insurer to give the reinsurer the option to reinsure each such contract (known as "facultative-obligatory" or "fac oblig" reinsurance).
There are two main types of treaty reinsurance, proportional and non-proportional, which are detailed below. Under proportional reinsurance, the reinsurer's share of the risk is defined for each separate policy, while under non-proportional reinsurance the reinsurer's liability is based on the aggregate claims incurred by the ceding office.
Reinsurance brokers are used by Insurance companies, Underwriting managers, Medical Schemes, Life Assurers, Cell Captives, etc. to facilitate placement of Reinsurance into the Reinsurance market (both locally and internationally). Reinsurance brokers act as wholesalers in the transaction, as they cannot deal with the man on the street, due to the fact that there always needs to be an initial risk carrier between the reinsurance broker and the policyholder.
Reinsurance brokers assist Insurers and the like, by spreading their risk into the Reinsurance market, which assists the Insurance Company with capacity, as well as the spreading of volatility.
In order for an insurance transaction to be called Reinsurance, the Insurer needs to be the one initially carrying the risk, after which, the Insurer may decide what his specific appetite is towards the underlying risk. Once this is decided, if he wishes to spread the risk amongst Reinsurers, he would typically make use of a Reinsurance Broker.
Reinsurance brokers offer advice only to risk carriers in terms of structuring a Reinsurance programme to cater for the underlying risk, taking the Insurers risk appetite into consideration.
Reinsurance brokers only deal with Insurance Risk Carriers who in turn offer advice to individual policyholders, i.e. the man on the street. Reinsurance Brokers are therefore in no way tied in or linked to direct policyholders, nor do they offer advice to individuals, but rather to the Insurers themselves.