In the insurance field, we have insurance companies, which is where every individual or company goes to get insurance policies, and then there are reinsurance companies. Now, you might ask yourself what is a reinsurer as it probably isn’t a term that you encountered unless you work in an insurance company. Simply put, a reinsurer is a company that exists to give insurance companies financial protection. If an insurance company signs a policy that offers more coverage than they can cover, they turn to a reinsurance company. Like that, an insurance company has access to more business that would otherwise be too expensive or costly for them to cover.
As mentioned above, the sole purpose of a reinsurance company is to provide additional insurance options that a typical insurance company doesn't offer. Yes. I know … a lot of insurers here, but we’ll simplify. The only business for reinsurance companies is to reinsure insurance companies. No individual person or company can go directly to the reinsurance company for coverage. They are very rarely even aware that a reinsurance company is involved at all in the process.
The insurance company is the one that individuals and companies go to so that they can purchase insurance policies. They sign a contract, and the policy goes into effect. Those individuals and companies then became policyholders who pay premiums to the insurance company by paying, let’s say, $100 and get coverage in case of damage of $10,000. The insurance company will pay the coverage for possible damage and reimburse the policyholder.
However, when an individual has an asset that requires a much higher coverage than the insurance company can give, are they to turn them away? If that would have happened, then the Titanic wouldn’t have been insured by anyone. Yes, that Titanic. An insurance company did insure the Titanic, however, and did pay damages once the cruise ship sank. The damages were so astronomical that the insurance company, which was a big one (Commercial Union), nearly went bankrupt and needed years to recover.
That might be one of the reasons why reinsurance companies came to be. Because an insurance company won’t tell their customers that the asset can not be insured, they will find a way to ensure it for their customers. This is where the reinsurance company comes in. The insurance company transfers part of the risk and premium to the reinsurer through cession. Like that, if worst comes to happen, the reinsurer covers a large amount of the damages. Reinsurers also aid insurance companies in case of natural disasters when thousands of claims come at the same time, and the coverage is too much for insurers to cover.
There are only four types of reinsurance policies that are offered by reinsurance companies: