Legal Definitions - treaty reinsurance

Definition: Treaty reinsurance is a type of reinsurance where one insurer transfers all or part of their risk to another insurer in exchange for a percentage of the original premium. The reinsurer accepts the risk and is solely liable to the reinsured, which is the ceding company. The ceding company retains all contact with the original insured and handles all matters prior to and subsequent to loss.

Examples: Treaty reinsurance serves three basic purposes. First, it can increase the capacity of the insurer to accept risk. Second, it can promote financial stability by ameliorating the adverse consequences of an unexpected accumulation of losses or of single catastrophic losses. Third, it can strengthen the solvency of an insurer from the point of view of any regulations under which the insurer must operate which provide for a minimum ‘solvency margin,’ generally expressed as a ratio of net premium income over capital and free reserves.

Explanation: An example of treaty reinsurance is when an insurance company insures a large number of small risks or a combination of both, and transfers all or part of the risk to another insurer in exchange for a percentage of the original premium. The reinsurer accepts the risk and is solely liable to the reinsured, which is the ceding company. This helps the insurer to increase its capacity to accept risk and promote financial stability. It also strengthens the solvency of an insurer from the point of view of any regulations under which the insurer must operate.