Reinsurance Programs - Meaning, Need and its Benefits

In the previous articles, we have already studied about what reinsurance is. However, we have assumed that most ceding insurance companies buy only one reinsurance policy in order to cover their risks. However, this is not the case in reality.

In real life, ceding insurance companies have very complex portfolios. As a result, they need a combination of several reinsurance policies in order to meet their needs. The combination of these reinsurance policies is called a reinsurance program.

Different ceding insurers use different types of combinations for various purposes. In this article, we will have a closer look at what a reinsurance program is as well as the various benefits of having a reinsurance program instead of a single reinsurance policy.

What is a Reinsurance Program?

As mentioned above, a reinsurance program is a combination of various reinsurance policies. It is possible for different reinsurance policies to be offered by different reinsurance companies. It is also possible for different reinsurance policies to be offered by the same reinsurance company but belong to different types.

For example, some of the policies offered may be quota share policies. On the other hand, some of the other policies offered may be proportional insurance policies. It is also important to realize that some of these policies may be overlapping. Hence, ceding insurance companies often hire experts who help them create their reinsurance program.

Why is a Reinsurance Program Required?

It is important for companies to have a reinsurance program because it offers them several benefits. Some of the important benefits have been listed below:

1. Better Classification of Risks: When ceding insurance companies create a reinsurance program, they are forced to have a closer look at their risks and then classify the same. The end result is that insurance companies end up grouping risks together in a way that ensures maximum diversification. They are also forced to evaluate which risks they want to keep on their balance sheet and which they want to outsource. Such classifications help insurance companies continue in line with their strategic vision.

2. Better Coverage: A reinsurance program often helps the ceding insurance company get wider coverage. If an insurance company only deals with one reinsurer, then they are restricted by the services which are provided by that reinsurer as well as the geographies in which those reinsurers provide such services.

   On the other hand, when a ceding insurance company deals with multiple reinsurers, they are able to obtain wider coverage at a lower price.

3. Lower Costs: Ceding insurance companies often take out multiple reinsurance policies because it makes financial sense to do so.

   For example, if a company only takes a single insurance policy with a single type of cover, they pay the same price for different risks. However, the ceding insurer may know that some risks are more likely to materialize as compared to others. Hence, they may want to take a better policy for such risks. However, for the other risks, they may be willing to experiment with a higher threshold limit and deductibles.

   Different policies provide different levels of coverage. The sum total of these policy premiums often works out cheaper. This creates a cost advantage by letting go of unnecessary coverage. Also, reinsurance companies tend to give better quotations if they know that multiple reinsurance companies are providing service to the company. This is because they need to remain competitive.

4. Shared Risks: If a ceding insurance company uses only one reinsurance company to insure all its risks, then they are creating another huge counterparty risk. If a catastrophe strikes and the reinsurer faces a large number of claims simultaneously, then there is a good chance that the reinsurance company itself may go bankrupt and as a result, may not be able to pay claims to the ceding insurance company. This may seem like an unlikely scenario. However, it is possible.

   Even large insurance companies such as AIG have faced the possibility of bankruptcy. It needs to be understood that by choosing multiple reinsurance companies, the ceding insurer is spreading out its risks.

   Even if one particular reinsurance company is facing financial distress, it may not lead to a complete bankruptcy of the ceding insurer since they will still be able to obtain cash flows from the remaining reinsurance companies.

5. Best of Breed Services: Last but not the least, different reinsurance companies are experts at providing different types of services. There are some reinsurance companies that are an expert at providing property-related reinsurance whereas others can provide better life-related reinsurance.

   By using multiple reinsurance companies, the ceding insurance company can benefit from the vast knowledge and experience these companies have gained in their respective fields. It will allow the ceding insurance company to pay the minimum premium since the best companies in each field will be able to price the risks more accurately than their competitors.

   The expertise of the reinsurance companies need not be limited to types of reinsurance. It could also be related to different geographies. For instance, some reinsurance companies may have a higher experience in dealing in developing countries as compared to others.

The bottom line is that ceding insurance companies prefer having reinsurance programs for multiple reasons. Over the years, they have realized that having a diversified portfolio is better than putting all your eggs in one basket.

Authorship/Referencing - About the Author(s)

The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.