An individual insurance company is usually not financially able to carry one huge risk on its own. As examples, think of the Boeing Aircraft Corporation in America, or here in South Africa, a firm like Anglo American. Reinsurance is a method used by insurance companies to spread the risk amongst insurers and thereby protect themselves against one huge loss that could cripple the company financially.

An insurer can enter into a reinsurance contract with another insurer in two ways: it can take place on a case-by-case negotiation or the insurance companies can come to an agreement before the contract is written. Proportional reinsurance refers to cases where

Reinsurers take a given proportion of the direct insurer’s premiums and losses. Basically reinsurance is an insurer taking out insurance.

The term direct insurer describes the company that originally enters into the insurance contract with the insured party. The re-insurer is a company who accepts reinsurance contracts and is also referred to as the reinsuring company. The direct company who now receives the reinsurance cover is called the ceding company and will refer to the reinsurance cover as reinsurance ceded. The direct insurer can also become a reinsurer by accepting risk from other insurance companies.

Insurance companies that only deal in reinsurance business are called professional reinsurers. These companies do not write any direct business themselves. The reinsurance premium is paid by the ceding company to the reinsurer for the risk the reinsurer is accepting. Reinsurance limits the exposure of a company to risk and also combines the expertise of the insurers. It increases the overall capacity to accept risk.