Reinsurance tutorials #16
What is cession?
This is when a company ceded part of a risk or part of a multitude of risks to a reinsurer.
In other words, cession refers to the portion of insurance policies or portfolio which are transferred to a reinsurer.
Risk can be transferred to the reinsurer in one of two ways: proportional or non-proportional.
Proportional reinsurance is an arrangement where the insurer and reinsurer share an agreed percentage of both premiums and losses.
Non-proportional reinsurance is a system by which the reinsurer pays only when losses exceed an agreed-upon amount.
How cession works
Ceding a portion of the risk to a reinsurer allows an insurance company to manage its overall risk exposure more effectively and efficiently.
Reinsurance has become more and more sophisticated thanks to actuarial studies and, admittedly, because of a strong sense of competition within the insurance and reinsurance industries.
The aforementioned expressions “a part of” and “a portion of” are key.
How much a company cedes and at what price
A big portion is often ceded for a high price, while smaller portions are sometimes ceded for a lower price.
As for arbitrage and risk appetite, the latter are all about risk and price, about how well instance companies evaluate their risk.
It’s all about risk and price, and about how well risk is evaluated.Although it may sound like an exaggeration, there is a battle between cession and retention driven by price and risk appetite. There are actuaries – or risk managers – who are adverse to risk on the one side, and more risk-friendly underwriters on the other. Cession evolves between these two philosophies, these two strategies.
Reinsurance creates an opportunity for insurers and reinsurers to exchange profit at each other’s expense, based on the accuracy of the actuarial calculations which determine the price of the risk.
It is a WIN or LOSE situation, if taken at a given moment.
The WIN-WIN model can always be achieved. It needs time through a long, trusting relationship over the course of several years.
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