Reinsurance is a process where the insurance companies protect themselves against major claims. This happens especially for Non-Life insurance when the claim can be of humongous amount or in case of any natural calamity when large number of claims happens together.
Insurance Companies are into the business of taking risks of individual policies. They take the risk on people’s lives, goods, cars, health, etc. They also have to pay claims as and when the demand arises. In case of Non Life Insurance Policies, the insurers cannot be sure when the claim will occur and how big the claim will be. It can however be predicted for Life Insurance policies as the claim will be equal to the Sum Assured or Fund value, as the case may be but the time of claim is uncertain. This uncertainty is caused by Risk, of a person’s life, etc. and the very nature of unforeseen events like fire, flood, earthquake, etc. called Perils.
Insurers are normally financially sound enough to pay claims. But there are limits. An event like the Tsunami or a hurricane may generate claims amounting to crores of rupees, which may put a heavy strain on the reserves of the insurers.
Thus, the insurers protect themselves from situations which are beyond their capacity, by re-insuring the risk with another insurer. If there is a claim, the burden will be shared by the primary insurer and the reinsurers. This process of again insuring the same risk with another insurer by the primary insurer is called ReInsurance and the companies which take the risk of Re-Insurance are called Re-Insurers.
So, if a claim of say Rs 7,00,00,00,000 arises, then the initial Rs 5,00,00,00,000 would be paid by the primary insurer and the remaining Rs 2,00,00,00,000 would be paid by the Reinsurer. However, Ravi would get the entire claim from his primary insurer and he would not even be aware of how much risk is being borne by his insurer and how much risk is being taken by the re-insurer. The split depends on the equation between the insurer and its re-insurer alone.
There are some companies which are exclusively in the business of Re-Insurance like Munich Re, Swiss Re, etc. In India, the General Insurance Corporation of India is the national reinsurer for General Insurance business. However, there are no companies in India which are reinsurer for Life Insurance.
The process of Reinsurance works like insurance itself. Insurers would have to pay ceding premium to reinsurers for covering their risk and in turn they would receive ceding bonus from them. Thus, the concept of Reinsurance had been incorporated only to protect the insurers against major claims.