Insurance for insurance companies. Primary insurance carriers “cede” some portion of the risks they agree to underwrite (based on the design of the reinsurance contract) to a reinsurance carrier (known as the “cedant”). Primary insurers and reinsurers negotiate and re-negotiate these contracts based on market conditions, trends and loss history.
Reinsurance contracts often influence (limit) the risks primary insurance carriers underwrite. An insurer’s capacity and “appetite” is proportional to the availability and use of reinsurance: the lower the reinsurer’s capacity, the lower the primary insurer’s capacity; and the narrower the reinsurer’s appetite, the narrower the appetite of the primary insurer.
Reinsurers can also “reinsure” their exposure through “retrocession;” reinsurance for the reinsurer.
Reinsurance is vital to the insurance mechanism, especially in light of the global insurance economy. Reinsurance accomplishes four functions/goals:
1. Stabilizes the earnings of the primary insurer (in the event of catastrophic losses);
2. Increases primary insurer capacity by limiting liability on individual risks;
3. Provides liquidity, protecting against swings in business cycles; and
4. Provides underwriting expertise to the primary insurer.