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It is an independent contract between the reinsurer and the primary insurer, and the original insured (A) is not a part of the contract. If the claimant is an individual or even a group of individuals, an insurance company will find it relatively easy to
cover the claims. But if there are a huge number of claims at the same time and the loss is massive and widespread, this may not be possible.
A reinsurer enters into a reinsurance agreement for a very specific reason - either the nature of risk insured, or the business strategies of the insurers, or other possible reasons. Reinsurance is an important criterion to determine the success of insurance business. Reinsurance mainly covers catastrophic risks that are not predictable and cause the greatest exposure for the insurance companies. The September 11 attack was a similar situation. A single insurer will not be able to bear such damaging financial impact so the unbearable loss is broken down into bearable units by risk transfer. The amount of risk a company limits depends upon the contract terms as well as factors like worth of assets, trends of inflation in the economy, the price of the insurance products, and the type of risk.
Principles of Reinsurance
Reinsurance contract basically depends upon three principles: -
Principle of Utmost Good Faith - Reinsurers maintain utmost faith in underwriters of their company. These underwriters, in turn, maintain utmost good faith in the underwriters of the primary insurance company.
Principle of Indemnity - The principle of indemnity of the insured risk applies automatically on reinsurance. A reinsurer automatically follows the legal and technical features of the reinsured in writing and underwriting a risk.
The Insurer Must Retain a Part of the Risk Before Reinsuring. Though there cannot be the reinsurance of the complete risk, there can be a complete retention of risk. Those risks that are within the retention capacity of an insurer must be retained completely.
How Reinsurance Creates Value to Primary Insurers?
Reinsurance benefits primary insurers in following ways: -
Reduced volatility of underwriting results
Capital relief and flexible financing
Excess to reinsurer's expertise and services, especially in the fields of product development, pricing and underwriting and claim management.
The above benefits vary in focus for Life and Non-Life Insurance.
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* Contributed by: -
Jaya Nema,
Faculty - MBA (Finance & Marketing),
Laxmi Narain College of Technology, Indore.
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