Reviewed by Sep 30, 2020| Updated on
Reinsurance credit refers to the accounting entry made when an insurance company cedes premiums to reinsurers and recovers losses from reinsurers. The procedure allows an insurer to treat the money owed by reinsurers for covered losses as assets.
When an insurance company and a reinsurance company enters into a contract, it means the former has agreed to shift some part of the risk that it has agreed on the policy papers to the latter. In exchange for agreeing to share the risk, the reinsurer will receive a part of the premium from the insurer.
The concept of reinsurance makes the insurer to take up more policies as the overall risk profile has reduced. Meanwhile, it also exposes the insurer to reinsurance credit risk. This risk is associated with the reinsurer becoming insolvent, resulting in being incapable of fulfilling the reinsurance agreement. In case the reinsurer is unable to stand up to the agreement, the insurer will be at a much higher liability.
Reinsurance credits are accounting entries that illustrate the potential exposure to loss, though the loss must be covered by reinsurance companies in the ideal case. Based on the reinsurer's creditworthiness, the credit risk of an insurance company dealing with a reinsurer may vary.
With this in consideration, insurance companies will set up internal controls to ensure that the reinsurers they are planning to deal with having enough capital so that they remain solvent when a claim is made.
An insurer may list a reinsurance credit either as an asset or as a reduction in liability based on whether the reinsurer meets a basic set of requirements.
A few such requirements include the reinsurer holding the necessary licensing to operate in the location of the insurer, the reinsurer filing the required regulatory documents, and the reinsurer performing financial reviews.