BASIC PRINCIPLES OF REINSURANCE
(Clear, logical, exam-oriented version — rewritten from scratch)
🔷 1.1 WHAT IS REINSURANCE? (Core Definition)
Reinsurance is insurance for insurers.
A primary insurer (cedant) transfers part of the risk it has assumed from
policyholders to another insurer (reinsurer), in exchange for a portion of
premium.
Clean definition (exam-safe):
“Reinsurance is a contractual arrangement whereby an insurer transfers part
of the risks it has accepted to another insurer (reinsurer) in return for a
premium.”
Purpose (in one line):
To protect insurers from accumulation, large losses, and volatility,
enabling them to write more business than their net resources alone would
allow.
🔷 1.2 WHY INSURERS NEED REINSURANCE (FUNCTIONS)
Reinsurance exists because insurers cannot:
predict losses perfectly
hold unlimited capital
accept unlimited risks
survive extreme events alone
Hence insurers use reinsurance for five fundamental objectives:
1️⃣ Capacity Expansion
An insurer can write bigger risks than its net retention allows.
Example:
Retention per risk = ₹5 lakh
Customer wants SI = ₹50 lakh → insurer keeps ₹5 lakh, reinsurer takes ₹45
lakh.
Effect: Increases underwriting capacity.
2️⃣ Stabilisation of Results (Volatility Control)
Reinsurance reduces fluctuations in yearly profit/loss by absorbing large or
irregular losses.
Especially helpful in:
motor
health
property
catastrophe-prone regions
Effect: Smooths earnings.
3️⃣ Protection Against Large Individual Losses
Per-risk XL and Facultative reinsurance protect against losses from:
one building fire
one factory explosion
one high-value asset
one aviation loss
Effect: Protects solvency.
4️⃣ Protection Against Catastrophic Accumulations
When multiple risks get hit by ONE event:
cyclone
flood
earthquake
riot
industrial explosion
Catastrophe XL protects against event-based accumulation.
Effect: Prevents financial collapse.
5️⃣ Financial Relief
Reinsurance helps insurers:
reduce strain on capital
improve solvency margin
finance growth
reduce need for expensive capital infusion
Effect: Strengthens financial position.
🔷 1.3 HOW THE REINSURANCE MARKET WORKS
Participants
1. Cedant / Primary Insurer
The company that issues policies to the public and cedes risk.
2. Reinsurer
The company that accepts risk from cedants.
3. Retrocessionaire
A reinsurer who passes part of its accepted risk to another reinsurer.
4. Intermediaries (Brokers)
Specialists who place reinsurance globally.
Market Structure (Flow Diagram)
Policyholder → Insurer (Cedant) → Reinsurer → Retrocessionaire
Premium flows rightward
Claims flow leftward.
🔷 1.4 TYPES OF REINSURANCE CONTRACTS
Reinsurance arrangements fall into three broad classes:
A) Facultative Reinsurance
Risk-by-risk basis
Each policy separately offered to reinsurer
Reinsurer may accept or decline; Insurer may choose to reinsure or
retain
Used for large, unusual, hazardous risks
Highest underwriting scrutiny
Example: Ship, refinery, satellite, chemical plant.
B) Treaty Reinsurance
Automatic, continuous protection for a class of business
Cedant must cede; reinsurer must accept
Applies to all risks that meet treaty definition
More efficient than facultative
Two major types:
1. Proportional Treaty
2. Non-Proportional Treaty
C) Retrocession
Reinsurer reinsures itself.
Purpose:
Spread accumulation
Manage capital
Stabilise losses
🔷 1.5 REINSURANCE VS INSURANCE (Exam Table)
Point Insurance Reinsurance
Who buys? Individuals/businesses Insurers
Object Protect insured Protect insurer
Contract with
Basis Contract of indemnity to insurer
policyholder
Regulation Domestic Global markets
Underwriti
Retail/SME/Corporate Large-scale risk evaluation
ng
Based on treaties, GNPI,
Premium Based on exposure
burning cost
🔷 1.6 BENEFITS OF REINSURANCE TO THE INSURER
Primary benefits:
Increased acceptance capacity
Catastrophe protection
Stabilisation of results
Protection of solvency margin
Financial flexibility
Access to reinsurer expertise
Secondary benefits:
Underwriting support
Pricing guidance
Claims handling experience
Entry into new lines of business
🔷 1.7 FORMS OF REINSURANCE (TYPES)
1️⃣ Proportional Reinsurance
Cedant and reinsurer share:
premium
losses
expenses
in the SAME proportion
Types:
Quota Share
Surplus
2️⃣ Non-Proportional (Excess of Loss)
Reinsurer pays only when loss exceeds a threshold (retention).
Types:
Per Risk XL
Per Event / CAT XL
Aggregate XL
Stop Loss
3️⃣ Facultative
Individual, optional, case-by-case.
🔷 1.8 IMPORTANT REINSURANCE PRINCIPLES
1. Principle of Indemnity
Reinsurer indemnifies the insurer; reinsurer never indemnifies the insured
directly.
2. Utmost Good Faith
Insurer must disclose:
high exposures
hazards
unusual loss patterns
3. Follow the Fortunes / Follow the Settlements
Reinsurer follows insurer’s reasonable claim settlements.
4. Principle of Participation
Reinsurer participates in premiums and losses based on treaty terms.
🔷 1.9 HOW REINSURANCE IMPROVES SOLVENCY
Reduces required capital
Shares large losses with reinsurer
Reduces volatility
Improves solvency ratio
Enables writing more premium with same equity
🔷 1.10 PRACTICAL REAL-WORLD EXAMPLES
Example 1: Capacity Creation
Insurer retention = ₹10 lakh
Proposal = ₹2 crore
Surplus treaty available = 19 lines
Capacity = 19 × 10 + 10 = ₹2 crore
→ Entire risk accepted.
Example 2: Catastrophe Accumulation
Retention per risk = ₹5 lakh
100 houses hit by cyclone
Total retention = 100 × 5 = ₹5 crore
Cat XL attachment = ₹3 crore
Limit = ₹10 crore
→ Insurer pays 3 crore; reinsurer pays up to 10 crore.
🔥 1.11 EXAM TRAPS (Important)
⚠️Trap 1:
Reinsurance protects insurers from accumulation of retained losses, not
total losses.
⚠️Trap 2:
Treaty reinsurance is automatic, facultative is optional.
⚠️Trap 3:
Reinsurer indemnifies insurer not insured.
⚠️Trap 4:
Proportional = share premium & losses
Non-proportional = reinsurer pays only above retention
⚠️Trap 5:
Capacity expansion is a primary function of reinsurance — often asked.
🔑 1.12 KEYWORD GLOSSARY (Chapter Summary)
Term Meaning
Primary insurer who transfers
Cedant
risk
Reinsurer Company accepting ceded risk
Retrocessio
Reinsurance of reinsurance
n
Automatic reinsurance
Treaty
arrangement
Facultative Case-by-case reinsurance
Capacity Maximum risk insurer can accept
Amount insurer keeps on own
Retention
account
XL Cover Reinsurance above a deductible
XL protection for catastrophic
Cat XL
events
Term Meaning
Accumulatio
Many losses from one event
n
🎯 1.13 CHAPTER 1 — MCQs (Exam Quality)
1. Reinsurance primarily exists to:
A. Increase insurer profits
B. Reduce premium rates
C. Expand insurer capacity and protect solvency
D. Lower claim frequency
Answer: C
2. Facultative reinsurance is:
A. Mandatory
B. Automatic for all risks
C. Optional and risk-specific
D. Used only in life insurance
Answer: C
3. In treaty reinsurance:
A. Reinsurer may freely accept or reject risks
B. Cedant must cede and reinsurer must accept eligible risks
C. It applies only above cat retention
D. It is priced per policy
Answer: B
4. Catastrophe XL protects against:
A. A single large policy
B. Expected small claims
C. Many losses caused by one event
D. Claims below retention
Answer: C
5. “Follow the fortunes” means:
A. Reinsurer decides claims
B. Cedant must follow reinsurer
C. Reinsurer follows cedant’s reasonable claim settlements
D. Cedant must share profits
Answer: C