Reinsurance vs. Double Insurance

In the previous article, we understood what reinsurance is. We also studied the various types of reinsurance contracts that are commonly signed by insurance companies.

The problem is that many a times people get confused between reinsurance and double insurance, since there are more than one insurance companies involved in both the cases. However, it needs to be understood that reinsurance and double insurance are both very different. In this article, we will have a closer look at the differences between the two concepts.

• Definition: Reinsurance is a contract between an insurance company and another insurance company. This is done to insure that all the risk is not concentrated in the hands of a single insurance company. On the other hand double insurance is a situation when the policyholder gets the same risk and subject matter covered by more than one insurance companies.

  The sum total of all the policies must be greater than the value of the underlying property in case of double insurance. For instance, if the value of a car is $1000, two insurance policies worth $500 and $400 will not be termed as double insurance. This is because, the sum assured is lower than the value of the property. On the other hand, if the sum assured for two policies is $800 and $700, then the total sum assured is $1500 as opposed to the underlying value of $1000. Since the sum assured exceeds the value of the property, such an arrangement will be called double insurance.

  It needs to be understood that in the case of reinsurance, the insurance company is covered against the possibility of a loss. On the other hand, in case of double insurance, the policyholder is covered against the possibility of loss.

• Principle of Indemnity: The principle of indemnity states that a person should not be able to make a profit from insurance. Insurance is only to recover the loss and not to make a profit. Otherwise people will start damaging their own possessions in order to profit from it. Reinsurance is in line with the principle of indemnity whereas on the other hand, double insurance is against the principle of indemnity.

  This is because in case of reinsurance, the same risk is covered by the reinsurer. For instance, if an insurance company has sold $1000 worth insurance on a car, it is again reinsuring the same risk with another insurance company. Hence, in the event of a loss, the insured will receive only $100 which will cover the loss and not allow the customer to make a profit.

  In case of double insurance, a person has insured the same $1000 vehicle with two insurance companies. Hence, in the event of a loss, the total pay-out should be restricted to $1000 only. The person cannot claim $1000 from two parties and benefit from the insurance claim. In case of double insurance, two insurance companies will have to deal with each other and make a combined payment to the policyholder.

• Dependency: In case of reinsurance, the second contract is contingent on the existence of the first contract. This means that reinsurance cannot be claimed if the original insurance contract is not in effect! This ensures that the insurance company cannot profit from a claim made on the behalf of others.

  In case of double insurance, two or more insurance contracts are independent of one another. Hence, even if the user decides to cancel one of the insurance contracts, such an action will have no effect on the other contract. The policyholder can still continue to claim on one of the policy if the other one doesn’t exist.

• Life Insurance: Since no one can place a value on human life, the concept of double insurance doesn’t really apply to life insurance. Hence, policyholders are allowed to take as many insurance contracts as companies are willing to sell them. In the event of their death, all companies will have to pay up the entire sum assured. There will be no splitting of sum assured in this case, since the principle of indemnity doesn’t apply.
• Purpose: Reinsurance serves the purpose of diversifying risk. It is a tool used by large insurance companies to park a certain part of their risk with insurance companies in other nations. On the other hand, double insurance is not a mechanism to diversify risk. In many cases, it is an attempt to defraud the insurance company and profit from claims. In order to prevent fraudulent claims, insurance companies have to constantly share data with each other regarding the underlying asset and the sum assured that has been granted against it.

The bottom line is that reinsurance and double insurance are very different from each other. The only similarity they have is that more than one insurance company is involved in both the cases.

Authorship/Referencing - About the Author(s)

The article is Written 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.