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1/2 M97/February 2018 Reinsurance
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Chapter

Introduction

As a starting point, it is useful to have a benchmark description of what reinsurance actually means in
practice. In their book Reinsurance in Practice, Robert and Stephen Kiln describe reinsurance as:
• the business of insuring an insurance company or underwriter against suffering too great a loss from
their insurance operations; and
• allowing an insurance company or underwriter to lay off or pass on part of their liability to another
insurer on a given insurance which they have accepted.

This description remains true today, although reinsurance has changed significantly in recent years. With
Reinsurance has
changed significantly the globalisation of financial markets and the development of alternative products to those viewed as
in recent years traditional reinsurance, reinsurance in developed markets has expanded beyond the insurer’s use of
conventional methods of passing on part of its contractual underlying risk – towards the adoption of a
range of tools that provide a variety of options without departing from the concept of risk transfer.
Within this chapter and throughout the remainder of the study text we will touch on these other
elements as we explore the traditional concepts of reinsurance alongside alternative risk transfer (ART)
strategies, in order to obtain a broader appreciation of the wider aspects of the reinsurance market and
the covers that are now available.
Reinsurance serves a number of purposes. Its main purpose is a means used by an insurance company
or an underwriter (for instance, a syndicate at Lloyd’s) to reduce – from the point of view of possible
material losses – the financial consequences resulting from the risks that it has accepted as an insurer.
An insurer acting as a buyer of reinsurance cover is generally known as a ‘reinsured’, but may also be
called a ‘ceding company’or a ‘cedant’. Overall, the losses are not reduced, but the reinsured benefits
from the smoothing effect that the transfer of any part of the risk has on the material consequences of
the loss.

Key terms
This chapter features explanations of the following terms and concepts:
Authorisation Captive insurance Catastrophic loss Cedant Reference copy for CII Face to Face Training
companies
Contractual promise Lloyd’s syndicates Material losses Mutual funds
Portfolio and asset Reinsurance broker Reinsurance pools Risk retention
management
Risk transfer Sidecars Takaful insurance Uncertainty of loss

Underwriting capacity

A Purpose of reinsurance

Consider this…
What do you think is the purpose of reinsurance?

When considering the purpose of reinsurance, it helps to remember why consumers purchase insurance.
The purpose and the motivation for purchasing reinsurance are inseparable. This relationship is best
The purpose and the
motivation for understood if considered from the viewpoint of both the insurer and reinsurer. An example would be the
purchasing transfer of risk. While clearly the purpose of reinsurance, this is also a motivating point for both insurers
reinsurance are
inseparable and reinsurers. If the cost of reinsurance is low then insurers look to optimise their transfer of risk by
buying more protection and lowering retention limits.
It is self-evident, although worth emphasising, that the value of the reinsurance purchased by the
insurer is dependent on the reinsurer being able to meet its financial obligations when a valid claim is
submitted for payment. The steps that insurers take to ensure that the security offered by the reinsurer is
fit for purpose are considered in more detail in chapter 6, section C.

Question 1.1
What is an insurer’s likely course of action if the cost of reinsurance is high?