Finite reinsurance is coverage that only transfers a portion of the total risk to the reinsurer. The remainder of the risk remains with the insured party. This approach allows the client to receive enough coverage to make the overall risk factor manageable, but without the need to pay the higher cost associated with other reinsurance strategies.
Understanding the nature of reinsurance makes it much easier to see the value of a finite reinsurance approach. Reinsurance is essentially insurance coverage for businesses that offer different types of insurance to companies and individuals. Obtaining this type of coverage helps to protect the insurance provider in the event that a huge number of claims are filed by clients, and the provider does not have cash assets on hand to settle all the claims. By obtaining reinsurance on the insurance claims written by the provider, the two companies essentially share the risk of having to pay out enough in claims to undermine the provider’s operations.
With finite reinsurance, the provider chooses to obtain enough coverage to keep the risk within a range that is considered reasonable. What cash and cash equivalents the provider can use if claims on a large amount of the policies are filed within a short period of time usually defines that range. By taking out finite reinsurance to manage whatever amount the provider’s cash would not cover, the business is able to continue operations without creating any real financial hardship.
For example, if an insurance provider has written policies that are valued at $1 billion in US dollars (USD), and has assets on hand that could be used to easily retire $750 million USD without causing hardship for the business, the provider would cover the remainder with a reinsurance policy. This would entail securing a finite reinsurance policy that would cover at least $250 million USD. Should the worst case scenario occur, and every client of the provider filed a claim at the same time, all claims would be honored and the provider could continue operations.
Since finite reinsurance is designed to offer protection for a portion of the provider’s risk, the cost is lower than securing what is known as complete or full reinsurance. As with most insurance policies, this type of reinsurance may be structured to allow monthly premiums paid directly to the reinsurance company, or managed with semi-annual or annual payments. Either party may terminate the coverage at any time, as long as the reasons behind that termination are in compliance with laws and regulations that govern the sale of insurance products within a given legal jurisdiction.
