Reinsurance Cession

A reinsurance cession is the part of an insurance risk that an insurer transfers to a reinsurer, together with the share of premium paid for taking it on. The insurer that passes the risk is called the cedent or ceding company, and the reinsurer that accepts it is the assuming company. Insurers cede risk to protect themselves against large or accumulated losses, to smooth their results from year to year and to write more business than their own capital would otherwise support.

A cession does not change the insurer's duty to its policyholders. The original policy stays in force between the insurer and the customer, and the insurer must pay valid claims in full even if the reinsurer is slow to pay or fails. The amount the insurer keeps for its own account is its retention, and a reinsurer may in turn pass on part of what it has accepted through retrocession.

The terms of a cession are set by the reinsurance contract. Under treaty reinsurance, the insurer agrees in advance to cede, and the reinsurer agrees to accept, all risks that fall within a defined class of business, so individual policies are ceded automatically. Under facultative reinsurance, each risk is offered and accepted one at a time, which suits unusually large or unusual exposures.

Once a policy falls within the contract, the insurer records the ceded share of premium and reports it to the reinsurer on a periodic account, often monthly or quarterly. When a claim arises, the insurer pays the policyholder and then recovers the reinsurer's share. In proportional contracts the reinsurer normally pays a ceding commission back to the insurer, which contributes to the cost of acquiring and administering the business.

Cessions are usually grouped by how premium and losses are shared:

• Quota share. Under quota share reinsurance a fixed percentage of every policy in the class is ceded, and the reinsurer takes the same percentage of premiums and claims.
• Surplus. The insurer keeps each risk up to a set retention, called a line, and cedes only the amount above it, so the ceded percentage varies from policy to policy.
• Excess of loss. Under excess of loss reinsurance the reinsurer pays only when a loss, or a group of losses from one event, exceeds an agreed amount, up to a limit.
• Stop loss. Stop-loss reinsurance protects the insurer's overall result for a period once total losses pass a set level.

In the first two types a true share of each policy is ceded. In the last two the insurer pays a separately priced premium for protection rather than handing over a share of the original premium, although the word cession is still used loosely for both.

Ceded premiums reduce an insurer's gross written premium to its net written premium, and expected recoveries from reinsurers are shown as an asset. Under IFRS 17, reinsurance contracts held are measured and presented separately from the insurance contracts they cover, so the insurer's liabilities to policyholders are not reduced by netting. The reinsurer's share of outstanding and unreported claims is estimated as part of claims reserving.

Because risk has been passed on, a cession generally lowers the capital an insurer must hold. Under Solvency II in the European Union, effective reinsurance reduces the Solvency Capital Requirement, but the insurer must then hold capital against the chance that the reinsurer defaults. Supervisors therefore look at whether the contract transfers real risk and at the financial strength of the reinsurers used.

The main risk in a cession is that the reinsurer cannot or will not pay. Insurers manage this by spreading cessions across several reinsurers, setting minimum credit rating standards, and in some cases asking for collateral or the right to withhold funds. A second risk is a mismatch between the original policy wording and the reinsurance wording, which can leave the insurer paying a claim it cannot recover.

Operational control also matters. Policies must be correctly identified and ceded, accounts must be prepared on time, and recoveries must be collected. Errors in this bordereau and accounts process are a common source of disputes. Reinsurance decisions are normally tied to the insurer's risk appetite and its insurance underwriting strategy, and are reviewed by the board at least once a year.

Insurers can also transfer risk to investors rather than to reinsurers. A catastrophe bond and other insurance-linked securities pay out when a defined event occurs, with the investors' money held as collateral. In Islamic insurance, the equivalent arrangement between takaful operators is known as retakaful.

• International Association of Insurance Supervisors
• European Insurance and Occupational Pensions Authority