Most governments limit the size and number of policies an insurance company may sell, based upon that company’s capital assets. This is to make certain they will be able to pay any claims their clients file. If an insurance company reaches the limit it must either stop selling policies, or it must sell a part of its risk to a reinsurance company. A reinsurance treaty is an agreement between an insurer and reinsurer in which the reinsurer agrees to take all or part of the risk on a certain type or size of insurance policy.
In 1842, a major fire in Hamburg, Germany devastated the local insurance industry. It became very apparent that traditional insurance companies were unable to handle major, catastrophic events, and the first reinsurance company was started. Reinsurance companies now operate world-wide. Two of the largest are Munich RE based in Munich, Germany; and Swiss RE in Zurich, Switzerland.
Reinsurance is insurance for insurers. It is also referred to as stop-loss insurance. The original insurance company may be referred to by many names: the ceding party, original or primary insurer, or the direct writing company.
A reinsurance treaty can take different forms. In some instances, a company will contract to take over the risk of any insurance policy that exceeds the limit which would have been set for the original insurer. For example, a particular company may only be allowed to underwrite a maximum business insurance policy of $1 million US Dollars (USD), yet their customer requires a $3 million USD policy. The policy can be written in the reinsurance company underwrites the additional $2 million USD.
In other cases, a reinsurance treaty can be written as a proportional policy. Under this plan, the reinsurance company agrees to take a certain percent of the direct company’s risk on all policies or on a particular kind of policy. In return, the reinsurer receives that percent of the premiums paid for those policies, less the cost for obtaining the business. The writing costs include commissions paid to the agent and the overhead cost of creating the policy.
The agreement may also be written in such a way that the reinsurance company only steps in when risk exceeds a predetermined amount. Such an arraignment is called a non-proportional reinsurance treaty. The type of reinsurance treaty a company chooses to engage in is determined by the kind of policies that are being written, and the size and assets of the primary insurer.
The Reinsurance Treaty is also the name of a secret agreement between Russia and Germany brokered by Bismarck in 1887. Bismarck’s primary aim was to protect German security against an attack by the French. In this three year treaty, Germany and Russia agreed to remain neutral toward each other in the event either party became involved in war with any third nation, with the exception of France and Austria-Hungary. In exchange, Germany recognized Russia’s claims in the Balkans and agreed to support its control over the Black Sea. The treaty was allowed to expire after Bismarck was removed from office.