Reviewed by Oct 05, 2020| Updated on
Cession is a term used in insurance, where a portion of insurance obligations is transferred by an insurance company to a reinsurer. It is the ceding of a certain amount of risk between two parties, both of whom are insurers.
An agreement is drafted between both parties, which specify the terms and conditions under which the cession will take place, and under what conditions the reinsurer will pay the claims.
The two types of reinsurance are facultative and treaty. Under facultative, an insurer transfers one type of risk, policy, or location to the reinsurer. Each type of risk passed on will have to be negotiated separately. Facultative reinsurance is used for high-valued risks, and extra hazardous or unusual risks, which fall beyond the capacity of the primary insurer.
Under treaty reinsurance, a set of insurance transactions under a certain category will be covered under the reinsurance agreement. No specific policy will be mentioned; instead, all policies which meet the criteria of the reinsurance agreement automatically become reinsured.
Treaty reinsurance is used to cover broader ranges of policies, such as all automobile policies, all fire policies, all homeowner policies, etc.
Reinsurance can be structured as proportional and non-proportional treaties. Under a proportional treaty, the insurer and the reinsured share a specific percentage of the premiums and losses. Under non-proportional reinsurance, the reinsurer takes on a claim only when the loss exceeds a certain amount that has already been agreed upon.
An insurance company is able to manage its risk exposure better by ceding a portion of its risk to a reinsurer. The other advantages of reinsurance include the expertise of the reinsurer, the opportunity for arbitrage, and the ability to offer higher protection limits, as well as absorb larger losses.