Reinsurance
Also known as: reinsurance cover, risk cession
Reinsurance is, put simply, insurance for insurance companies. When an insurer issues a policy, it keeps a portion of that risk on its own books and cedes the rest to a reinsurer in exchange for a share of the premium. This spreads large or correlated losses across the global capital markets so that no single hailstorm, hurricane, or liability verdict can threaten the primary carrier's solvency. Regulators and rating agencies watch a carrier's reinsurance program closely because it directly affects how much business the company can safely write relative to its surplus.
Small-business buyers rarely purchase reinsurance directly, but it quietly shapes the coverage they can buy. Reinsurance capacity is why an insurer can offer a high aggregate limit or an umbrella on a risk far larger than its own balance sheet. When reinsurance costs spike after a bad catastrophe year, those increases flow downstream into higher primary rates and tighter underwriting — a dynamic often called a 'hard market.' Understanding this helps a buyer see why premiums for property or liability can jump even when their own loss history is clean.
A practical nuance is the distinction between the two main structures: facultative reinsurance, negotiated one risk at a time, and treaty reinsurance, which automatically covers an entire class of policies. Reinsurance also comes in proportional forms (the reinsurer shares premium and losses by a fixed percentage) and non-proportional or excess-of-loss forms (the reinsurer pays only above an attachment point). Because it is a wholesale transaction between sophisticated parties, reinsurance is largely unregulated at the policy level, yet it is one of the most important stabilizers of the entire insurance system.
Real-world scenario
Summit Contractors Group Captive is a member-owned insurer that writes workers' compensation for 42 midsize construction firms. It collects $9,600,000 in annual premium (the average member pays about $228,000), but a single catastrophic claim could wipe out its $4,300,000 of surplus. To cap that risk, Summit keeps the first $350,000 of every claim and buys treaty reinsurance for losses above that attachment point, up to a $5,000,000 per-occurrence limit and a $12,000,000 annual aggregate.
For that excess-of-loss protection Summit cedes $1,530,000 of premium to its reinsurer. When a scaffolding collapse severely injures a framer, the claim develops to an ultimate value of $2,900,000 plus $210,000 in defense and adjustment expense. Summit funds the first $350,000 from its own reserves, and the reinsurer reimburses the remaining $2,760,000.
Because that loss eroded part of the coverage tower, Summit pays a $110,000 reinstatement premium to restore the limit for the rest of the year. A second, smaller claim settles at $1,150,000, of which the reinsurer pays $800,000. Without reinsurance, those two events alone would have cost the captive roughly $4,260,000 against just $4,300,000 of surplus — leaving it nearly insolvent instead of comfortably solvent.
How it affects your premium
Reinsurance pricing (the ceded premium a primary insurer or captive pays) is driven less by any one policyholder and more by the shape and volatility of the ceding company's whole book:
- Attachment point and retention — the lower the attachment point where the reinsurer starts paying, the more claims it touches and the higher the ceded rate; raising your retention lowers the price.
- Limit and aggregate profile — higher per-occurrence limits, larger annual aggregates, and the number of free reinstatements all increase cost.
- Loss experience and development — the ceding company's historical loss ratio and how long its claims take to develop directly shape the rate.
- Line of business volatility — long-tail casualty and catastrophe-exposed property command far higher reinsurance rates than short-tail, low-severity lines.
- Reinsurance structure — quota-share (proportional) treaties are priced on a ceding-commission basis, while excess-of-loss treaties are priced on rate-on-line; each responds to different drivers.
- Market cycle and capacity — a "hard" reinsurance market after major catastrophes tightens terms and raises rates industry-wide, independent of your own results.
- Concentration and correlation — geographic or class-of-business concentration that could produce many simultaneous claims raises the reinsurer's modeled loss and your premium.
Common misconceptions
Myth: Reinsurance is just insurance for big companies.
Reality:
Reinsurance is insurance that insurers buy — carriers, captives, and risk pools transfer part of their assumed risk to a reinsurer. An ordinary business buys direct insurance, not reinsurance.
Myth: If my insurer has reinsurance, my claim gets paid faster or my limits are higher.
Reality:
Reinsurance is a contract between your insurer and the reinsurer; it does not create any duty to you and does not change your policy limits. You still file with, and are paid by, your own carrier.
Myth: Reinsurance and facultative reinsurance are the same thing.
Reality:
Treaty reinsurance automatically covers a whole book of business, while facultative reinsurance is negotiated risk-by-risk for a single large or unusual account. Most insurers use both.
Myth: Buying reinsurance means my insurer is financially weak.
Reality:
The opposite is usually true — prudent reinsurance protects policyholder surplus and stabilizes results, and rating agencies view a well-structured program as a sign of disciplined risk management.
Frequently asked questions
Does reinsurance affect me as a policyholder?
Not directly. Your contract is with your insurer, which remains fully responsible for paying your claim even if its reinsurer fails to pay. Reinsurance mainly protects the insurer's solvency, which indirectly benefits everyone it covers.
What is the difference between treaty and facultative reinsurance?
Treaty reinsurance automatically covers an entire class or book of business under one agreement, while facultative reinsurance is arranged individually for a specific large or hard-to-place risk.
Why would a captive or self-insured group buy reinsurance?
To cap the cost of any single catastrophic claim above a chosen retention, protecting the group's surplus. Without it, one severe loss could exceed the reserves the members have set aside.
What is a ceding commission?
It is money the reinsurer pays back to the ceding insurer — see ceding commission — to reimburse acquisition and administrative costs on the premium that was ceded, most common in proportional (quota-share) treaties.
Can a reinsurance agreement ever be terminated early or settled?
Yes. Parties can negotiate a commutation, a lump-sum settlement that closes out future obligations, or let the treaty run off; terms often mirror the underlying policies under a follows-form basis.
Sources cited
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