Reinsurance Fundamentals

🛡️ Reinsurance Fundamentals: The Insurance Safety Net

The Big Idea in One Sentence

Reinsurance is insurance for insurance companies — like having a bigger, stronger friend who promises to help you carry heavy bags when they get too heavy to lift alone!

🎪 The Story: The Circus Tent Helpers

Imagine you run a small circus. Every night, you set up a giant tent. Most nights, the wind is calm and your team handles it just fine.

But what if a HUGE storm comes? Your team can’t hold the tent alone — it might blow away!

So you make a deal with a bigger circus company:

“If the wind gets too strong for my team, YOUR team will come help us hold the tent.”

That’s exactly what reinsurance does!

• Your circus = an insurance company
• The tent = all the policies they’ve promised to cover
• The storm = a big disaster (hurricane, earthquake, massive claims)
• The bigger circus helping = the reinsurance company

📖 What is Reinsurance?

Definition

Reinsurance = When one insurance company buys insurance from ANOTHER insurance company.

Think of it this way:

You → Buy protection from → Insurance Company
Insurance Company → Buys protection from → Reinsurance Company

Simple Example

🏠 You buy home insurance from “SafeHome Insurance” for $200,000.

🏢 SafeHome Insurance thinks: “What if 100 houses burn down at once? That’s $20 million! I can’t pay all that alone!”

🏦 So SafeHome buys reinsurance from “BigShield Reinsurance”:

“If we owe more than $5 million in one disaster, you pay the rest.”

Now everyone sleeps better at night! 😴

🎯 Why Do Insurance Companies Need Reinsurance?

The 4 Big Reasons

graph TD
    A["WHY REINSURANCE?"] --> B["🛡️ Risk Protection"]
    A --> C["💰 Capital Relief"]
    A --> D["📊 Smooth Results"]
    A --> E["🌍 Grow Bigger"]

    B --> B1["Handle big disasters"]
    C --> C1["Free up money for new policies"]
    D --> D1["Avoid crazy profit swings"]
    E --> E1["Take on bigger risks safely"]

Let’s Break It Down

📝 Two Ways to Buy Reinsurance

Insurance companies can shop for reinsurance in two different ways. Think of it like buying clothes:

🧥 Treaty Reinsurance = Buying a Whole Wardrobe

Definition: An automatic, ongoing agreement covering MANY policies at once.

How it works:

• Sign ONE contract
• ALL qualifying policies are automatically covered
• No need to ask permission for each policy

Example:

“SafeHome Insurance signs a treaty: Every home policy between $100K-$500K is automatically 30% reinsured by BigShield.”

Like: Getting a store membership — everything you buy is automatically discounted!

👔 Facultative Reinsurance = Buying One Special Outfit

Definition: Individual, case-by-case reinsurance for ONE specific risk.

How it works:

• Insurance company asks: “Will you cover THIS specific risk?”
• Reinsurer reviews and decides: yes, no, or negotiate terms
• Custom negotiation for each policy

Example:

“SafeHome wants to insure a $50 million mansion. Too risky alone! They ask BigShield: ‘Will you take 60% of this ONE policy?’ BigShield reviews the mansion’s fire safety and says yes.”

Like: Hiring a tailor to make ONE custom suit, just for you!

Quick Comparison

⚖️ How Losses & Premiums Are Shared

Now let’s talk about HOW the insurance company and reinsurer split the money and the risk.

There are two main approaches:

🥧 Proportional Reinsurance = Sharing a Pizza

The Concept

In proportional reinsurance, the reinsurer takes a fixed percentage of:

• ✅ The premium (money coming in)
• ✅ The losses (money going out)

Everything is split by the same proportion!

Simple Example

The Deal: Reinsurer takes 40% of everything.

It’s fair — same percentage for the good stuff AND the bad stuff!

graph TD
    A["POLICY"] --> B["Premium: $1,000"]
    A --> C["Claim: $5,000"]

    B --> D["Insurer: $600"]
    B --> E["Reinsurer: $400"]

    C --> F["Insurer pays: $3,000"]
    C --> G["Reinsurer pays: $2,000"]

Two Types of Proportional

1. Quota Share — Fixed percentage (like 30% of EVERYTHING)
2. Surplus Share — Percentage only kicks in above a limit

🚨 Non-Proportional Reinsurance = The Emergency Rescue Team

The Concept

In non-proportional reinsurance, the reinsurer ONLY pays when losses go above a certain amount.

Think of it like:

“You handle the small fires. We’ll come running when the building is REALLY burning!”

Key Idea: The Threshold

The insurance company sets a retention (how much they’ll pay first). The reinsurer pays only the excess above that.

Simple Example

The Deal: Insurer keeps first $1 million. Reinsurer pays anything above that, up to $5 million.

graph TD
    A["CLAIM: $3 Million"] --> B{Above $1M?}
    B -->|First $1M| C["Insurer Pays: $1M"]
    B -->|Excess $2M| D["Reinsurer Pays: $2M"]

Two Types of Non-Proportional

1. Excess of Loss — “You pay first $X, we pay the rest up to $Y”
2. Stop Loss — “If your total yearly losses exceed X%, we help”

🎨 The Complete Picture

graph TD
    A["REINSURANCE"] --> B["HOW TO BUY?"]
    A --> C["HOW TO SHARE?"]

    B --> D["Treaty<br/>Many policies at once"]
    B --> E["Facultative<br/>One policy at a time"]

    C --> F["Proportional<br/>Split everything by %"]
    C --> G["Non-Proportional<br/>Reinsurer only pays excess"]

    F --> H["Quota Share"]
    F --> I["Surplus Share"]

    G --> J["Excess of Loss"]
    G --> K["Stop Loss"]

🌟 Real-World Example: Hurricane Season

Let’s see how all these pieces work together!

“CoastalGuard Insurance” sells home policies in Florida. Hurricane season is coming! 🌀

Their Reinsurance Strategy:

Result: CoastalGuard can confidently sell policies knowing they have backup! 💪

🔑 Key Takeaways

1. Reinsurance = Insurance for insurance companies (the safety net behind the safety net)

2. Two ways to buy:

   • Treaty = Bulk automatic coverage for many policies
   • Facultative = Custom one-at-a-time coverage

3. Two ways to share:

   • Proportional = Split premiums AND losses by percentage
   • Non-Proportional = Reinsurer only pays above a threshold

4. Why it matters: Without reinsurance, insurance companies couldn’t handle big disasters, and you might not be able to buy insurance at all!

💡 Remember This!

🎪 The Circus Tent Story:

• Small circus (insurance company) can’t handle big storms alone
• Big circus (reinsurer) promises to help when winds get wild
• Together, the tent stays up!

Insurance makes YOUR life safer. Reinsurance makes INSURANCE safer. Everyone wins! 🎉