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Reinsurance and the Surplus Lines Market

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Key Takeaways
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Insurers themselves need a way to manage risk that is too large or too unusual to hold entirely on their own books. Reinsurance and the surplus lines market both exist to solve that problem.

Reinsurance: Insurance for Insurance Companies

Reinsurance is an arrangement in which one insurance company transfers part of a risk it has already assumed to another insurer. Insurers use reinsurance to limit the loss they would face from a single catastrophic claim, and to help manage their overall underwriting and mortality results.

  • The insurer that originally wrote the policy and transfers part of its risk is the primary insurer, or ceding company.
  • The insurer that accepts that transferred risk is the reinsurer, or assuming company.
  • The portion of the risk the ceding company keeps for itself is called its net retention, or net line.

In short, reinsurance is simply one insurance company buying insurance from another insurance company.

Treaty vs. Facultative Reinsurance

  • Treaty reinsurance is an ongoing agreement between two insurers under which risks meeting agreed-upon criteria are automatically shared, without needing a separate negotiation for each policy.
  • Facultative reinsurance is negotiated case by case, to cover one specific risk or exposure, when no standing treaty applies.
Important

Reinsurance is strictly an arrangement between insurers. The original policyholder's contract stays with the ceding (primary) insurer, which remains fully responsible to that policyholder regardless of any reinsurance in place.

The Surplus Lines Market

Surplus lines insurance serves risks that licensed, "admitted" insurers in a given state are unwilling or unable to cover — unusually large, hazardous, or one-of-a-kind exposures. Because surplus lines carriers operate outside the normal admitted market, they are not regulated the same way as standard insurers, and consumers who buy surplus lines coverage generally do not receive the same legal protections as those buying from an admitted carrier.

Producers who place this business must typically hold a separate excess and surplus lines license, and most states require proof that the applicant made a genuine, unsuccessful effort to find coverage in the admitted market first — wanting a lower price alone is not a sufficient reason to turn to the surplus lines market.

Lloyd's of London

Lloyd's of London is often mistaken for an insurance company, but it is not one. It is a marketplace — a syndicate of individual and corporate underwriters who each independently accept risk, much the way the New York Stock Exchange provides a venue for trading stock without itself owning any of it. Lloyd's facilitates the exchange of underwriting information, helps its member underwriters resolve claims and disputes, and, through those members, can provide coverage for risks that might otherwise be unavailable.

Key Takeaways
  • In reinsurance, the ceding (primary) insurer transfers risk to a reinsurer (assuming company), while keeping a net retention for itself.
  • Treaty reinsurance is an automatic, ongoing agreement; facultative reinsurance is negotiated for one risk at a time.
  • The ceding insurer always remains responsible to the original policyholder, regardless of any reinsurance arrangement.
  • Surplus lines insurance covers unusual or high risks the admitted market won't write, with fewer consumer protections and a requirement to first attempt the admitted market.
  • Lloyd's of London is a marketplace of independent underwriters, not an insurance company itself.