Reinsurance
Reinsurance is a contractual arrangement in which one insurance company — the ceding insurer or cedent — transfers a portion of the risk it has underwritten to another insurer — the reinsurer — in exchange for a share of the original premium, thereby reducing the cedent's net exposure to large individual losses or catastrophic aggregate claims.
At its core, reinsurance is insurance for insurance companies. Primary insurers accumulate large books of policies covering homes, autos, businesses, lives, and specialty risks. Without a mechanism to spread individual large losses across the global capital base, a single catastrophe could threaten the solvency of an otherwise healthy carrier. Reinsurance solves this problem by allowing cedents to offload portions of their underwriting portfolios to reinsurers who specialize in accepting diversified slices of global risk.
The reinsurance market operates primarily on a wholesale basis, with transactions structured between institutional counterparties rather than individual consumers. Major global reinsurers include Munich Re, Swiss Re, Hannover Re, Berkshire Hathaway Reinsurance, and Lloyd's of London syndicates. In the United States, the market is regulated at the state level, with ceding insurers entitled to take credit on their statutory balance sheets for reinsurance only if the reinsurer meets financial security requirements — either by being a licensed U.S. carrier, a certified or accredited reinsurer, or by posting collateral through trust accounts or letters of credit.
Reinsurance transactions fall into two broad structural categories: proportional and non-proportional. Under proportional arrangements — quota share and surplus share — the reinsurer accepts a defined percentage of every risk and receives the same percentage of premium. Under non-proportional arrangements — excess of loss and stop-loss — the reinsurer only pays when losses exceed a defined retention threshold, providing catastrophe protection rather than routine claims sharing.
For primary insurers, the financial benefits of reinsurance extend beyond simple risk transfer. Quota share treaties, for example, can generate ceding commissions from reinsurers that help offset acquisition costs, effectively providing financing for premium growth. Catastrophe excess-of-loss covers protect statutory surplus from erosion following major events, preserving the cedent's capacity to continue writing business.
From an investor's perspective, the reinsurance sector is characterized by its exposure to catastrophe risk, which introduces earnings volatility not seen in most industries. Analysts focus on the combined ratio — the sum of the loss ratio and expense ratio — as the primary measure of underwriting profitability, with values below 100 indicating an underwriting profit. The sector is also sensitive to interest rate levels, as investment income from the float generated by premium collection is a critical component of total return.