What is Reinsurance

Understanding Reinsurance

Reinsurance represents a specialized facet of insurance conducted among professionals, where many of the principles and practices governing insurance business also apply to reinsurance. However, certain principles take on different significance in the realm of reinsurance.

In essence, reinsurance involves an insurer, known as a reinsurer, assuming all or a portion of the risk of loss from another insurer, referred to as the ceding company.

Parties Involved in a Reinsurance Agreement

The parties engaged in a reinsurance contract are typically the insurance company and the reinsurer. Insurance companies often find themselves exposed to numerous risks at any given time through policies they issue, which are legal contracts between the policyholder and the insurance company. When an insurance company opts to mitigate its risks via reinsurance, it transfers a portion of these risks to a reinsurer through a reinsurance contract.

It is crucial to note that the policyholder is not party to the reinsurance contract. The contractual relationship exists solely between the insurance company and the reinsurer, thereby absolving the reinsurer of any obligations to the policyholder, who retains rights exclusively against the insurance company.

Fundamental Principles of Reinsurance

In many jurisdictions worldwide where reinsurance is practiced, the legal principles governing reinsurance align closely with those governing insurance. From the standpoint of the reinsured, the party purchasing reinsurance coverage, several key principles come into play:

1. Utmost Good Faith: Reinsurance agreements demand a higher level of transparency compared to typical commercial contracts. As such, the party seeking reinsurance coverage (the insurance company) is obligated to disclose all material facts to accurately delineate the risks covered by the contract.
2. Insurable Interest: Similar to insurance, the concept of “insurable interest” is pivotal in reinsurance. The reinsured must demonstrate a financial stake in the subject matter of the reinsurance to validate the contract. Failure to establish insurable interest renders the reinsurance contract void.
3. Indemnity: The principle of indemnity stipulates that the insured or reinsured should not profit from the insurance or reinsurance coverage but rather be compensated solely for their actual loss. Therefore, settlement is contingent upon the terms of the contract and the genuine extent of loss incurred.