In some instances, the insurer may provide for a clause in terms of the insurance contract. The policyholder (as a participant in the legal insurance relationship) will act as a co-insurer in terms of its retention (limited by the franchise).
The peculiarity of coinsurance is that each co-insurer compensates for the loss only within the limit of its share in the sum insured. It is determined by the percentage of the premium received by each co-insurer.
Compensation for losses under coinsurance may be separate and joint.
With separate insurance, separate policies are issued, i.e., each insurer gives its approach to the insured, indicating only its share of liability and premium, while becoming a co-insurer.
If the policyholder is issued a general (collective) policy, it is signed by all insurers participating in the agreement, becoming co-insurers. This policy provides for the joint and several liabilities of the insurers. The legislation of the Russian Federation declares solidarity in coinsurance.
In practice, the insurer with the largest coinsurance share becomes the informal leader, and co-insurers with smaller percentages of risk follow coinsurance conditions approved by the leader. By agreement with all the co-insurers participating in the collective agreement, the leader carries out all mutual settlements with the insured and other co-insurers.
The main benefits of coinsurance are as follows:
- • it is understandable for the insurers’ clients (insureds);
- • protects significant risks that are beyond the power of one insurance company.
The main disadvantages of coinsurance are:
- • in case of separate policies, there is no joint and several liabilities of insurers;
- • it may be difficult for the policyholder to deal with two or more insurance companies;
- • Not all insurance companies, fearing competition, enter into co-insurance contracts.
The idea of coinsurance is based on the combination of two or more insurance companies of their insurance reserves contributes to a more even distribution and equalization of substantial losses and, therefore, increases their reliability and stability.
Coinsurance, protecting and distributing responsibility for considerable risks, thus has a very narrow scope. On the other hand, reinsurance makes it possible to protect insurance companies from large and all other dangers that make up the insurer’s portfolio, which is subject to constant threats of extraordinary accidental excesses of unprofitability.
Basic concepts, goals, definitions
Reinsurance (eng, reinsurance ) is an operation under which the insurer ( reinsurer, or
the assignor ( cedent )), accepting risks for insurance, transfers part of the responsibility for them, taking into account his financial capabilities, on agreed terms to another insurer ( reinsurer, or assignee ).
The transfer of part of the risks from the direct insurer (assignor) to the reinsurer is called a session.
Insurance companies cannot create a balanced portfolio of risks in most cases since the number of insurance objects is small. The portfolio contains significant and dangerous threats that introduce unnecessary elements into the portfolio.
In addition, practice shows that any insurance company, even with careful selection of risks when accepting them for insurance, cannot create a portfolio of insurance objects that are entirely isolated from each other. The fact is that the insurance terms usually cover various dangers that the insured things can be exposed to simultaneously in disasters: floods, hurricanes, earthquakes, devastating fires, etc. However, because the financial resources and even all the assets of any insurer are only a small share of the total amount of its liability to policyholders, these catastrophes (insured events) can significantly undermine the insurance company’s financial base but also lead it to complete bankruptcy.
Three dangers in doing business constantly threaten insurance companies.
- 1. Risk of incidental losses:
- – fluctuations in insurance payments;
- – uneven receipt of applications for the occurrence of insured events;
- – natural disasters and disasters lead to the cumulation of losses (hail, hurricane, earthquake, etc.).
- 2. Risk of change (forecast):
- – fluctuations in the value of money inflation, which can lead to both changes in the costs of doing business and in payments for insured events;
- – Technological development may lead to a mismatch of insured risks with new dangers and premium rates.
- 3. Risk of errors (assessments):
- – incorrect assumptions when calculating the premium rate (inaccurate insurance statistics, etc.);
- – the inevitable discrepancy between statistical sample estimates and actual losses.
To equalize the sums insured of the risks accepted for insurance and thereby create a balanced insurance portfolio, bring the potential liability for the total sum insured in line with the financial capabilities of the insurer, and therefore, to ensure the financial stability of insurance operations and their profitability, to obtain mutual participation in the risks taken for insurance by other insurers, there is an institution of reinsurance.
Purpose of reinsurance:
- • creation of a balanced insurance portfolio;
- • expanding the financial capacity of the direct insurer, the possibility of taking on new and costly risks;
- • ensuring financial stability and profitability of insurance operations.
Both companies are dealing exclusively with reinsurance (professional reinsurers – they usually have an additive Re at the end of the name) and combining conventional types of insurance with reinsurance (universal insurance companies). There are associations of companies – pools, whose participants, according to specific rules, transfer parts of their risk to the entire collection, and it redistributes the resulting total risk between all participants.
Reinsurance of risks is achieved by:
- • protection of the insurance portfolio from the impact on it of significant insured events, or even one catastrophic or abnormally large volume of small risks;
- • redistribution of insurance risks – payment of insurance compensation does not place a heavy burden on one insurer but is carried out collectively by all reinsurance participants;
- • the insurer can accept for insurance a larger volume of contracts within the existing requirements for limits on reserves and excess.
The primary function of reinsurance is the secondary distribution of risk, due to which the quantitative and qualitative alignment of the insurance portfolio takes place.
In addition, reinsurance also performs some auxiliary functions. It allows you to expand the list of risks accepted in insurance to get unique and expensive risks in insurance. Thanks to reinsurance, the insurer can take on more risks than without reinsurance. This allows the insurance company to apply the basic principle of insurance, according to which the many must cover the losses of the few.
Risk-taking reinsurers may transfer risks to other reinsurers. The subsequent placement of risk in reinsurance is called retrocession. The insurer who transfers the risk is called a retrocedent, and the insurer who takes the risk is called a retrocessionaire.
According to the law, the insurer that has entered into a reinsurance contract remains liable to the insured under the insurance contract.
Reinsurance contract – an agreement (bilateral transaction) between the cedant and the reinsurer, in which one party (the cedant) undertakes to transfer, and the other party (the reinsurer) undertake to accept the risks in reinsurance on certain conditions.
The reinsurance contract states:
- • method of reinsurance;
- • limits of liability of the reinsurer;
- • share of his participation in the contract;
- • forms of calculation for premiums and losses;
- • reinsurance commission;
- • bonus, etc.
Own retention ( retention ) is that part of the cost of risk, or the sum insured, which the insurer himself takes for insurance protection, i.e., is taken at the expense of its technical reserves to provide insurance coverage.
The deductible amount must be beneficial for the insurer and economically justified, i.e., able to recover losses.
Excess (excess ) – these are all shares of risks (their sums insured) in their retention, i.e., what the insurer can provide with its technical reserves, which it transfers to reinsurance.
Reinsurance commission – paid by the reinsurer to compensate for the costs of doing business, concluding contracts with policyholders by the direct insurer (assignor) if he receives part of the gross premium as a reinsurance premium. Usually, the reinsurance premium is paid out of the net dividends, in which case no commission is paid.
Bonus (commission from profit) – a form of remuneration of the assignor by the reinsurer, a commission for transferring a benign risk to reinsurance. It is contained in the reinsurance contract in the form of a bonus clause (for participation and prudent conduct of business). The assignor usually pays the bonus annually as a percentage of the reinsurer’s net profit.
Bordereau ( bordereau ) – a list of risks – a list of policies covered by a reinsurance contract, containing information about the insured, the nature of the risks, their location and share transferred to reinsurance, premiums received and terms of insurance, etc.
Reinsurance is necessary for ensuring the financial stability and regular operation of any insurer, regardless of the size of its capital and insurance reserves. Using various reinsurance contracts, the insurance company has the opportunity to optimize its insurance portfolio. The developed system of reinsurance in the world makes it possible to increase the reliability of insurance. To ensure such large amounts, it is precisely the world level required, which allows the maximum redistribution and smoothing out all fluctuations in the unprofitability of insurance companies around the world. In addition to the primary and foremost function of protecting the insurance market, the reinsurance market contributes to the development of the world economy by investing enormous sums in its development and is, therefore, an essential link in the world economy as a whole.