Different Types of Reinsurance in India Explained

Reinsurance policies are contracts issued by insurance companies to ensure their operational costs never run out. Such remarkable losses usually happen if many policyholders turn up to encash their claims simultaneously.

In times of catastrophe, these events can weaken an insurer's financial condition if they do not take prior measures beforehand. The insurers who opt for reinsurance facilities are referred to as ceding companies. This article will discuss the various types of reinsurance sought by ceding companies in India.

1. Facultative Reinsurance

When a single risk or a set of risks prevails in a primary insurer's book of business, they approach facultative reinsurers to cover it. It is a one-time agreement with an insurance company that often only covers a single transaction. 

Example: Consider an insurer issues policy on extremely expensive real estate assets, such as a corporate office complex. Given that a particular policy is signed for ₹70 Crores, the original insurer is accountable for ₹70 Crores if the building sustains significant damage. However, insurer initially realised it won't be able to pay out more than ₹ 45 Crores on a single instance.

To manage the remaining ₹25 Crores, this insurer must test the market and look for facultative reinsurance.

2. Treaty Reinsurance

Treaty reinsurance is a contract bringing multiple primary insurers under one umbrella. In any event of extraordinary or large occurrences, treaty reinsurance offers more stability and further protection for the equity of the ceding insurer. 

Example: Suppose the primary insurer assumes 10% of a projected risk of ₹10 Crores, and the rest 90% is distributed among all reinsurers. If this distribution was not done through treaty reinsurance, then the direct insurer had to shell out the entire ₹10 Crores in case of a loss, instead of paying only ₹1 Crore, which is its total liability amount after signing the treaty.

3. Risk Attaching Reinsurance

Reinsurance policies offered under risk attaching basis provide coverage for claims that started during the relevant period. Even if claims are not discovered or filed until much later, the insurer will give coverage for the whole policy period. 

Example: Suppose a loss happens on April 7, 2018, under reinsurance contract that runs on risk-attaching basis from January 1, 2017, to January 31, 2018. It will be covered because the policy would have been in force within that time. However, if the insurance was issued before January 1, 2017, the loss would not be covered.

4. Loss-Occurring Coverage

Reinsurance firms operate as per dates when the insurance company bore the losses. Thus, when the claims are lodged, they are not considered under this principle. Therefore, most reinsurance contracts impose the reinsurer to reimburse sum for all losses incurred during the reinsurance contract period.  

Example: Suppose an insurer issues a policy to a company on 1st May 2020, valid for one year till 30th April the following year. Against similar insurance policies, the ceding party had previously signed a reinsurance contract on a loss-occurring coverage basis on 1st February 2020, which is supposed to run till 31st January 2021. 

Now, if the insurance company makes a loss on 29th November 2020, then it can file a valid claim to the reinsurer.

5. Proportional Reinsurance

Companies offering these types of reinsurance in India will get a fractional part of the premiums for all the policies sold by the insurance firm enrolled under this form of coverage. As a result, the reinsurer will also be responsible for certain losses in the event of claims. 

A predetermined percentage will be used to gauge how much of the premiums and losses the reinsurer will share. The reinsurance firm will also compensate the insurance company for all processing, business acquisition, and writing expenses in a balanced coverage. 

Example: If a corporation seeks insurance coverage for ₹10 Crores, the reinsurer will only contribute a portion of the claim, say 70%. Therefore, it's feasible that a reinsurance company will only be required to pay a specific portion, or ₹70 Lakhs, when the insurance is claimed.

6. Non-Proportional Reinsurance

Non-proportional reinsurance contracts require a reinsurer to make payments only if the insurer's claims exceed a predetermined amount. This amount is referred to as a "retention" or "priority."

Example: When an insurer requests a reinsurance arrangement that ensures all-natural hazard damages above ₹1 Crore, it shall not apply for compensation against damages below the quoted amount.

Insurers reach out to reinsurance firms mainly to ensure the following:

• Steady Income: By assigning huge insurance-related risks to reinsurers, insurance companies can increase the predictability of their income.
• Smooth Operation With Minimal Liquidation: Insurance businesses do not need as much money to cover future losses since insurance liabilities mitigate the risk of loss. As a result, they can use the money to invest elsewhere and boost their earnings.
• Acceptance of More Insurance Seekers: Reinsurance allows insurance companies to write more policies since reinsurers take on some of the insurance companies' obligations. As a result, primary insurance companies can accept more risk.

Reinsurance treaties and facultative reinsurance are two types of reinsurance contracts. In case of facultative insurance, the primary insurer purchases reinsurance coverage for a specific condition from one or more reinsurers. On the other hand, treaty reinsurance is the type of coverage that multiple insurance companies chalk out and adhere to in the form of a treaty.

Using facultative reinsurance, the reinsurer can assess the risks contained in an insurance policy and decide whether to accept or reject them. On the other hand, with a treaty reinsurance policy, the reinsurer often assumes all of the risks related to certain policies.

After knowing various types of reinsurance with examples, it will be easier to assimilate how reinsurers function in India. Similar to how insurers charge a predetermined premium from the policyholders, reinsurance companies also charge primary insurance companies premiums to transfer insurance liabilities. If one insurance firm takes on the risk alone, the costs in the case of a catastrophe can cause the company to go bankrupt. Hence they buy reinsurance policies.

Apart from this primary factor, reinsurers hand out policies to insurance companies for the following reasons:

• Risk Sharing: Companies may share or transmit a portion of their risk to other businesses.
• Arbitrage: Insurers can increase their profits by purchasing insurance from other sources at a lower price than the premiums they receive from policyholders.
• Capital Management: Businesses can use reinsurance to lower their risk and free up more capital without having to raise significant amounts themselves.

Reinsurance is essentially an insurance policy designed for insurers. These are necessary for insurance companies to manage their enormous portfolios effectively. In addition, reinsurance agreements help insurance firms manage various types of reinsurance contracts and simultaneously expand their business.