Reinsurance is insurance for an insurance company. A reinsurance contract generally has two parties: the insurance company (“cedent”) and the reinsurance company (“reinsurer”).
An insurance company purchases reinsurance to minimize risks by limiting potential losses on its policies.
What’s an Example?
Insurance Company A is a small Florida-based property & casualty insurance company that provides homeowners insurance on Florida single-family homes. The company wrote 30,000 homeowners insurance policies and earned direct premium of $75,000,000 for the 2023 calendar year.
The company generally has enough capital and revenue to cover a regular stream of insurance claims submitted by its customers. However, what would happen if a hurricane swept through Florida and caused significant damage to over 70% of the homes within the state?
If, for example, Insurance Company A received claims from 21,000 of its 30,000 policyholders, would it have sufficient funds to pay those claims? Likely not…
For this reason, Insurance Company A should purchase reinsurance coverage. By buying a quota-share reinsurance policy, the company can share its risk with a third-party reinsurance provider. If Company A faces substantial claims, the reinsurance coverage will limit its losses and maintain its solvency.