Do Insurance Companies Buy Insurance

JurisdictionUtah,United States
CitationVol. 22 No. 3 Pg. 22
Publication year2009
Utah Bar Journal
Volume 22.

Vol. 22, No. 3, 22. Do Insurance Companies Buy Insurance

Utah Bar Journal
Vol. 22, No. 3
May/June 2009

Do Insurance Companies Buy Insurance

by Mark Dykes

Yes. "Reinsurance" is "an insurance transaction where an insurer, for consideration, transfers any portion of the risk it has assumed to another insurer." Utah Code Ann. § 31A-1-301(140) (2005).

The Basics: Some Nomenclature

The insurer "transferring the risk" is the "ceding insurer," id. § 31A-1-301(140)(a), or more commonly, the "cedent." The "insurer assuming the risk" is the "assuming insurer," id. § 31A-1-301(140)(b)(i), or "assuming reinsurer," id. § 31A-1-301(104)(b)(ii), more commonly, the "reinsurer." Reinsurers can in turn cede portions of their risks to yet another insurer by "retrocession." The "retrocedent" here cedes business to the "retrocessionaire." Id. § 31A-1-301(143). In very complex, large risk situations, this process can continue through multiple levels of reinsurers and retrocessionaires.

The reinsurer and cedent share risks in different ways. In "proportional" or "quota share" arrangements, the cedent obligates itself to cede and the reinsurer obligates itself to receive an agreed portion of the risk; for example, 25% of all losses attributable to the cedent's builder's risk policies. Under a "non-proportional" or "excess-of-loss" treaty, the reinsurer's obligation does not engage until a loss within the covered portfolio exceeds the agreed-upon threshold. For example, the treaty may provide that the reinsurer will share only in losses in excess of $300,000 on any particular builder's risk policy.

In return for its services, the reinsurer receives from the cedent a portion of the premiums obtained by the ceding insurer from the underlying insurance policies less a "ceding commission," which is the reinsurer's allowance for the cedent's marketing and administration costs which the cedent expended on the ceded business. Because "[r]einsurance is feasible only if it costs less than the underlying insurance[,]" Travelers Indem. Co. v. SCOR Reinsurance Co., 62 F.3d 74, 76 (2d Cir. 1995), the premiums received by the reinsurer from the cedent are less than those the cedent charges the policyholder.

Reinsurance permits the cedening insurer to spread its risk, to smooth results, and to assume larger limits or risks without simultaneously increasing its capital base. Reinsurance is used to cushion the blow of catastrophic losses ("cat cover"), or to assist paying claims for multiple insureds arising out of a single occurrence ("clash cover"). The cedent can use reinsurance to free up funds for other investments or to create underwriting capacity for new business.

Insurers licensed in a particular jurisdiction can also use reinsurance to "front" the policies of an unlicensed insurer. Thus, the licensed insurer issues the policy, but contracts with the unlicensed entity via a separate reinsurance agreement to reinsure any and all such policies and claims. Utah requires insurance commissioner approval for reinsurance of "all or substantially all" of the cedent's business. Utah Code Ann. § 31A-22-1204. And as will be discussed shortly, a cedent, if the process is done correctly, is also entitled to account for such transaction as reinsurance in its financials, an important issue in every state, including Utah.

When the insurance at issue is life insurance (where it is absolutely certain, if the policy remains in force, that the insured will die and produce a claim, the only issue being when and where, and policy values often increase over time), the arrangement is called "coinsurance."

Coinsurance presents interesting pricing issues. Unlike liability insurance, life insurance often carries an investment component. To attract new business, the cedent may wish to increase "growth rates" on its policies. Thus, the cedent and reinsurer must agree on pricing that will permit the cedent to do so, because the reinsurer will be responsible for its proportionate share. One solution is to choose a market-based index, and to require the reinsurer to share only in increases that are within upward swings of the index, with the cedent left to bear the cost if it decides to increase returns above market.

Finally, "the relationship created is strictly one of indemnification." Travelers Indem. Co. v. SCOR Reinsurance Co., 62 F.3d 74, 76 (2d Cir. 1995). Thus, no payments are due the cedent until the


cedent pays the underlying claim.

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