What is a Reinsurer?
A reinsurer is an insurance company that sells insurance to life insurance companies and companies that sell other types of insurance products. The purpose of reinsurance is to mitigate risk for the primary insurer.
Distributing risk with reinsurance
Reinsurance allows an insurance company to spread their risk out more broadly. For the purposes of this conversation, the company that sells insurance policies to consumers and buys reinsurance gets called the primary insurer.
The primary insurer wants to ensure that a single catastrophic event or a series of losses in quick succession wouldn’t make them insolvent. To do that, they buy insurance on their insurance policies. This is called reinsurance.
When a primary insurer buys reinsurance, they cede some of their risk to the reinsurer. That cessation functions just like other forms of insurance: the primary insurer purchases an insurance contract from the reinsurer. They then pay premiums to the reinsurer to keep the coverage in place. The primary insurer usually comes up with the money for the premiums to the reinsurer using the revenue generated from their own insureds’ premium payments.
Why reinsurers exist
Federal and state law subjects insurance companies to a lot of regulation. Specifically, one of the biggest rules across the board is that an insurer can’t issue a policy if it doesn’t have sufficient capital to be able to pay out the claim.
This ensures that whenever consumers need to make a claim against a policy, the insurer has the ability to pay it in full while staying solvent. That way, they can fulfill their obligation to the individual making the claim while maintaining coverage for all of their other insureds.
The issue, though, is that this regulation limits how much insurers can grow. If the buck stopped with the insurers, they would max out on policies they could issue in line with the amount of available capital they had at any given time.
But thanks to reinsurance, insurers are able to comply with regulation and continually grow their business. By distributing some of their claims to reinsurers, they can limit their liabilities — and, consequently, the available capital requirement. This way, they can continually show regulators that they’re in good financial standing while growing their business by writing new insurance policies.
Treaty vs. facultative reinsurance
Reinsurers sell two main types of reinsurance:
Treaty reinsurance. These reinsurance policies establish an agreement (i.e., treaty) to cover any existing and new insurance policies within a certain pool. This is a little like group life insurance, where a single policy covers multiple individual instances with preset terms governing the coverage.
Facultative reinsurance. Primary insurers buy this type of coverage for particularly high-risk policies. They might purchase facultative reinsurance for an individual life insurance policy with an especially large death benefit, for example. With this type of reinsurance, the reinsurer has the opportunity (i.e., faculty) to examine the risks associated with the individual policy before deciding to issue reinsurance to the primary insurer.
Other forms of reinsurance
To further distribute risk, some reinsurance companies buy reinsurance for their own policies. Industry professionals call this retrocession.
While many reinsurance policies involve one primary insurer purchasing coverage from one reinsurer, some agreements limit liability for any one reinsurer by distributing coverage across multiple reinsurers. In these instances, the policy generally names a lead reinsurer, with the other reinsurers named as followers.