Functions of Reinsurance

There are many reasons why an insurance company would choose to reinsure a part of its responsibility for the benefit of its policy holders and investors

1. Risk transfer

Reinsurance allows a ceding (transferring) company to assume greater individual risks than its size would otherwise allow. It allows an insurer to offer higher limits of protection that its own assets would allow. For e.g. if an insurer could underwrite only 50 lakhs on any given policy, he can reinsure (or cede) the amount in excess of 50 lakhs.

2. Increased capacity

An insurance company's writings are limited by its solvency margin. When that limit is reached an insurer can either stop writing new business or increase its capital base or reinsure. The latter i.e. reinsurance is often done as it is an efficient way of not having to turn the clients away or raise additional capital.

Catastrophe protection

Reinsurance provides protection against catastrophic losses. Insurers use reinsurance to protect against catastrophes in two ways. The first is to protect against catastrophic loss resulting from a single event such as total fire loss of a large manufacturing plant. Secondly, protection is sought on smaller claims, which could result from a single event affecting many policy holders simultaneously, such as an earthquake. Financially, the insurer is able to pay losses individually, but when the losses are aggregated the total may be more for him to bear.

Specialised services

Reinsurers often provide insurers with variety of other services. Some reinsurers often provide guidance to insurers in underwriting claims, reserving and handling investments and even on general management. These services are particularly important for smaller companies.