The Difference Between Insurance and Reinsurance

Insurance is about protection. It allows individuals and businesses to transfer financial risk of unforeseen events to a third party, usually an insurance company. These events can include a wide range of perils such as accidents, illnesses, natural disasters or property damage. In exchange for regular premium payments, an insurer promises to cover losses according to the terms of a contract (the insurance policy).

However, there may come a time when an insurance company may wish to minimize their risk of a certain type policy or book of business. In these cases, an insurer can look to purchase reinsurance which is a specialized type of insurance available to insurance companies.

This article will explore the differences between insurance and reinsurance in more detail.

The emergence of reinsurance

The nature of insurance such as property is such that insurers can be vulnerable to widespread, catastrophic losses that could cripple or bankrupt their businesses. For example, a fire destroying an entire town, or a massive natural disaster could overwhelm even the largest insurers.

To help address this problem, companies began to share the risks they had assumed with other insurers. This concept evolved into what we now call reinsurance.

The first reinsurance contract on record appears to have been entered into in or around 1370, when an underwriter contracted with another to reinsure a ship on part of the voyage from Genoa to the harbor of Bruges. The first dedicated reinsurance company was established in Cologne, Germany, in 1846: Cologne Re (now part of General Re).

Today, reinsurance is a cornerstone of the global financial landscape, providing a crucial backstop for primary insurers and supporting stability across industries.

Insurance vs reinsurance: What is the difference?

While insurance and reinsurance operate on similar principles, they serve different participants and purposes.

Insurance is a contract between an individual or business (the insured) and an insurance company (the insurer). The insurer agrees to pay for certain defined losses in exchange for premiums.

Reinsurance is a contract between an insurance company (the cedent) and another insurance company (the reinsurer). The reinsurer agrees to accept some of the risk from the cedent, in exchange for part of the premium.

An insurance company can only write policies that they have sufficient capital to cover. If an insurance company wishes to expand their book of business, at some point they may not have enough capital to be able to continue writing policies. Reinsurance can be purchased to make up for the deficit in capital and manage their risk by transferring portions of their policies to another insurance company, insulating itself against the risk of a major claims event.

Partnering with an actuarial consultant can help insurers model these risks and choose the most appropriate insurance or reinsurance arrangements.

Reinsurance explained: treaty vs facultative reinsurance

Reinsurance can be structured in two main ways: treaty reinsurance and facultative reinsurance.

Both methods allow insurers to manage their risk exposure, but they work differently.

Treaty reinsurance

Treaty reinsurance is an agreement where a reinsurer agrees to cover a specified portion of certain policies written by the insurer. The reinsurance company is not involved in the underwriting of individual policies. Rather the ceding company does all of this under the agreement made with the reinsurance company. The name of this agreement is a ‘treaty’ which is where this type of reinsurance gets its name. The reinsurance company will typically have a close relationship to the ceding company because they will trust the company to issue policies and write business based on the terms of their agreement.

This agreement for future policies will be outlined between the two companies and will include what risk classes the ceding company can accept, as well as the capital the reinsurance company has agreed to provide/cover.

The arrangement applies to all policies that fit within the agreed-upon parameters. There is no need to negotiate each policy individually.

Facultative reinsurance

Facultative reinsurance can be thought of as a more specific type of reinsurance in that the company purchasing the reinsurance (the ceding company) purchases reinsurance only on certain specified assets. For example, the ceding company may be approached to insure a business centre for $10 million, but they may not have $10 million in capital available to write the policy. The company will then approach reinsurance companies, asking them to cover the portion of the business centre insurance that they cannot cover. If they have enough capital to cover $7 million, they would look for reinsurance for $3 million.

Facultative reinsurance is typically used for high value or high-risk policies. Especially high risk or high-value assets may ultimately require the ceding company to shop around a bit before they find a company willing to issue reinsurance.

During the underwriting process of a facultative policy, the reinsurance company may also specify under which conditions they will pay, leaving most of the risk with insuring the asset in the hands of the ceding company. Of course, this is not always the case and facultative insurance varies largely based on the company that issues it and the asset(s) which are covered. In many cases, insurance companies use a combination of treaty and facultative reinsurance to build a resilient risk management strategy.

Looking for the most appropriate insurance or reinsurance option for your organization?

Whether you’re a small business owner seeking protection against everyday liabilities or an insurance provider needing to manage your exposure to catastrophic risks, choosing the right insurance or reinsurance solution is critical.

When evaluating your options, you’ll need to consider the following:

Risk profile: What are the most significant risks your organization faces?
Coverage needs: Are you looking for broad, ongoing protection (treaty) or specific, one-off support (facultative)?
Your partners: Are your insurance partners financially secure and reputable?
Cost: Are premiums or reinsurance cessions priced competitively?

Working with experienced insurance brokers and risk consultants can help you navigate this complex landscape and build a protection strategy tailored to your needs.

Being properly insured, and knowing when to layer that protection with reinsurance, can be the difference between thriving through adversity and experiencing the worst.

At Axxima our experienced professionals are committed to providing tailored solutions with the highest level of care and expertise.

We invite you to contact us today to discuss how we can support your risk management needs with confidence and security.