Assumption Reinsurance Vs. Indemnity Reinsurance

In the previous few articles, we have studied a lot about reinsurance. We are now aware of the various issues related to the field of reinsurance. However, up until now, we have assumed that reinsurance can be of only one type. This is not true.

There are several different types of classifications that are possible in the reinsurance industry. One of the important ways to classify reinsurance is whether it is of the assumption type or whether it is of the indemnity type.

In this article, we will explain the concept of assumption reinsurance as well as indemnity reinsurance and try to highlight the differences between the two.

What is Assumption Reinsurance?

Assumption reinsurance can be thought of as the process of legally replacing the ceding insurer with another similar insurance company. These types of transactions are called assumption reinsurance because the new reinsurance company assumes the risks related to the entire portfolio. This means that the liability of a ceding insurer is permanently transferred to a reinsurance company. Hence, in such cases, the liability of the original ceding company towards the policyholder is completely extinguished.

Assumption reinsurance is generally used by companies when they are trying to exit a geographical market or a certain line of business. In such cases, the company wants to purge itself of any liabilities so that it can free up the required capital and then use the same for other purposes.

There are certain characteristic features that can be used to identify a case of assumption reinsurance.

  • In an assumption reinsurance scenario, the ceding insurance company is under a legal obligation to inform the original policyholders and obtain consent from them. In the absence of such consent from a large majority of policyholders, such a transaction cannot go through.

  • If a large number of policyholders of the ceding insurer object to the transfer of this kind of business to the reinsurer, then the ceding insurer may have to hold on to their business. Alternatively, they may have the authority to manage this business via coinsurance.

  • Assumption reinsurance requires a large number of regulatory approvals from the concerned regulatory bodies. This is because of the fact that the policyholders will no longer have any recourse to the original ceding insurance company they signed a contract with.

  • In the case of an assumption reinsurance contract, the ceding insurance company is no longer required to maintain any further administrative records of the policy or the policyholders. Hence, it saves the ceding insurance company on the costs and efforts related to administration as well.

In short, assumption reinsurance is used when the ceding insurance company wants to completely break its relationship with a policyholder. It can be considered to be a case of a ceding insurance company selling off its clients to a reinsurance company.

What is Indemnity Reinsurance?

Indemnity reinsurance is very different from assumption reinsurance. Indemnity reinsurance has been named so because it indemnifies the ceding insurance company against claims which may arise from the policies that they have underwritten. However, such indemnification is not permanent and lasts only for a certain period of time.

It is important to note that an indemnity reinsurance contract is completely separate from the original insurance policy. The ceding insurance company remains completely liable to the original policyholders. In the backend, they create a financial relationship with a third party to share their economic fortunes. This means that in the event of a loss, two things will happen.

Firstly, the ceding insurance company will become liable to the policyholder.

Secondly, the reinsurance company will become liable to the ceding insurance company.

Even though these transactions are linked, legally and financially they are considered to be separate. This means that the ceding insurer cannot deny payment of a claim to the primary insured if they do not receive the money from the reinsurance company. The underwriting standards and cash flows of both contracts can be considered to be completely different from each other.

  • In such cases, since indemnity reinsurance does not have a direct impact on the fortunes of the original policyholder, there is no legal compulsion for the ceding insurance company to inform the policyholder or obtain their consent in any manner. It is possible for a ceding insurer to obtain an indemnity-based reinsurance cover without even informing the original policyholder.

  • There are very few regulatory approvals required for an indemnity-based reinsurance contract to go through. It is for this reason that these are the most common types of contracts which are used in the market. In fact, when the term reinsurance contract is mentioned, the average person automatically assumes that it is an indemnity-based contract.

  • In the case of indemnity-based reinsurance, the ceding insurance company is not passing on the entire policy to the reinsurer. Hence, it is possible for the ceding insurance company to slice the policy to some extent. This allows them to retain some of the risks related to the policy while passing on the rest to the reinsurance company. There are many complex forms of indemnity-based reinsurance contracts available in the market which allow reinsurance companies to transfer risks in different forms.

The bottom line is that theoretically assumption reinsurance and indemnity reinsurance are both options that a ceding insurer can use. However, with the evolution of the reinsurance market, most of the contracts underwritten all over the world belong to the indemnity reinsurance category.

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