Reinsurance

Last Updated: 5/9/2024
Issue: Reinsurance, often referred to as “insurance for insurance companies,” is a contract between a reinsurer and an insurer. In this contract, the insurance company—the cedent—transfers risk to the reinsurance company, and the latter assumes all or part of one or more insurance policies issued by the cedent. Reinsurance contracts may be negotiated with a reinsurer or arranged through a third party; i.e., a reinsurance broker or intermediary. Reinsurers may also buy reinsurance protection, which is called “retrocession.” This is done to reduce any further spread risk and the impact of catastrophic loss events.

Overview: Reinsurance is an essential tool insurance companies use to manage risks and the amount of capital they must hold to support those risks. Insurers may use reinsurance to achieve an optimal targeted risk profile. In the reinsurance agreement, the reinsurer's obligation arises only when the company's liability under its original insurance policy or reinsurance agreement has been incurred. The extent of that obligation is defined by the terms and conditions of the applicable reinsurance agreement.

Reinsurance transactions in the insurance industry can become complicated. Companies may employ numerous reinsurance transactions with a variety of details. Several common reasons for reinsurance include: 1) expanding the insurance company's capacity; 2) stabilizing underwriting results; 3) financing; 4) providing catastrophe protection; 5) withdrawing from a line or class of business; 6) spreading risk; and 7) acquiring expertise.

While the U.S. reinsurance sector continues to be an important source of capacity for domestic insurers, state insurance regulators have long recognized the need for both U.S. and non-U.S. reinsurance capacity to fulfill the needs of the U.S. marketplace. Consequently, the U.S. has developed a system of reinsurance regulation that has led to the development of an open, but secure, reinsurance market where most of the reinsurance premiums are reinsured outside the country.

The regulation of reinsurance in the U.S. takes into consideration the domicile of the reinsurer and whether the reinsurer is licensed in a U.S. jurisdiction. Licensed reinsurers are subject to the same state-based regulation as other licensed insurers. When an insurer gives up business to a licensed reinsurer, the cedent is permitted under regulatory accounting rules to recognize a reduction in its liabilities in the amount of ceded liabilities, without a regulatory requirement for the reinsurer to post any collateral to secure the reinsurer's payment of the reinsured liabilities. A reinsurer that is licensed to accept reinsurance in a state or territory is an Authorized Reinsurer.

Reinsurers that are not licensed in the U.S., often referred to as “alien” or offshore companies, must post 100% collateral to secure the transaction, unless they are a Certified Reinsurer or a Reciprocal Jurisdiction Reinsurer. An insurer that is not licensed or approved to accept reinsurance is an Unauthorized Reinsurer. Companies that are domiciled in Qualified Jurisdictions can become Certified Reinsurers after completing additional review by the states, and this status allows the reinsurers to reduce the collateral required. Additionally, companies that have a head office or are domiciled in Reciprocal Jurisdictions can become Reciprocal Jurisdiction Reinsurers if they meet the standards in the Credit for Reinsurance Model Law (#785) and Credit for Reinsurance Model Regulation (#786), and this status will allow these companies to not post collateral.

On June 25, 2019, the Executive (EX) Committee and Plenary adopted revisions to Model #785 and Model #786, which implement the reinsurance collateral provisions of the “Bilateral Agreement Between the United States of America and the European Union on Prudential Measures Regarding Insurance and Reinsurance” (EU Covered Agreement) and “Bilateral Agreement Between the United States of America and the United Kingdom on Prudential Measures Regarding Insurance and Reinsurance” (UK Covered Agreement) (Covered Agreements). These revisions create a new type of jurisdiction—a Reciprocal Jurisdiction—and eliminate reinsurance collateral and local presence requirements for European Union (EU) and United Kingdom (UK) reinsurers that maintain a minimum amount of own-funds equivalent to $250 million and a solvency capital requirement (SCR) of 100% under Solvency II. The revisions also provide Reciprocal Jurisdiction status for accredited U.S. jurisdictions and Qualified Jurisdictions if they meet certain requirements in Model #785 and Model #786. All 56 U.S. jurisdictions adopted these revisions by September 2022.