The World Bank Primer on Reinsurance

September 1995 A primer on reinsurance terms and concepts, covering the purposes of reinsurance, the nature of reinsurance contracts, the economics of risk transfer, the characteristics of reinsurance risk, and the market for, and regulation of, reinsurance. Reinsurance is a mechanism the insurance industry uses to spread the risks it assumes from policyholders. Through reinsurance, the industry's losses are absorbed and distributed among a group of companies so that no single company is overburdened with the financial responsibility of offering coverage to its policyholders. Catastrophes, unexpected liabilities, and a series of large losses that might be too great for an individual insurer to absorb can be handled through reinsurance. Without it, most insurers would be able to cover only the safest of ventures, leaving many risky but worthwhile ventures without coverage. McIsaac and Babbel present a primer of reinsurance concepts, explaining such terms as ceding company, primary carrier, direct underwriter, cession, retrocessions, ceding commission, and surplus relief reinsurance. There are separate sections on: ° The purposes of reinsurance (for example, underwriting capacity, earnings stability, reserve requirement reduction, and mechanism for exiting business). ° Methods of cession for reinsurance contracts (treaty, facultative, and automatic facultative). ° Types of reinsurance contracts (proportional, nonproportional, hybrid, and retrocessions). ° Prices and usage of reinsurance contracts. ° The economics of risk transfer. ° The characteristics of reinsurance risk. ° The reinsurance market. ° Reinsurance regulation. This paper --- a product of the Financial Sector Development Department --- is part of a larger effort in the department to study pension funds and insurance companies.