Risk Management in Banking and Insurance · Managing Risk in Insurance Business

Reinsurance and Risk Transfer for Insurers

Updated 11 October 2026 · Fact-checked

Reinsurance is insurance bought by an insurer from another insurer (the reinsurer) to pass on part of its risk. The insurer keeps a retention limit and cedes the rest, under a treaty (automatic) or facultative (case by case) arrangement. To solve questions, find the retention, compute the ceded share, then compare the loss outcome.

Understand Reinsurance and Risk Transfer

An insurer collects premium and promises to pay claims. If one large loss or one bad year can wipe out its capital, it is exposed. Reinsurance is the tool that fixes this. The insurer, called the cedant or ceding company, passes part of its risk to a reinsurer and pays a share of the premium for it.

The insurer decides how much risk it will carry on its own account. This is the retention limit (also called the retention or net line). It depends on the insurer's capital, its claims history and how volatile the class of business is. Anything above retention is ceded. The reinsurer pays its share of claims, so the insurer's net loss is capped or smoothed.

There are two ways to arrange it. In treaty reinsurance, the insurer and reinsurer agree terms in advance for a whole class or portfolio. Every policy that fits the treaty is covered automatically. In facultative reinsurance, each risk is offered to the reinsurer individually, and the reinsurer can accept or reject it. Facultative suits large, unusual or hazardous risks that exceed treaty capacity.

Co-insurance is different. Here several insurers share one risk directly with the insured, each issuing its own policy or taking its own stated share, and each is liable to the insured for its share only. In reinsurance, the insured deals only with the original insurer, and the reinsurance contract is between the insurer and the reinsurer. The insured usually does not even know about it.

The law keeps an eye on these contracts. Under Section 34F of the Insurance Act, 1938, if the Authority is of the opinion that the terms of a reinsurance treaty or contract are not favourable to the insurer or are detrimental to the public interest, it can by order require modifications at the next renewal or require that the contract is not renewed. It can also direct an insurer not to enter into such contracts unless a copy has been furnished in advance and the terms approved.

Key rules to remember

Net retained loss (proportional, quota share): Retained loss = Loss × (1 − Cession %); The reinsurer pays Loss × Cession %. Premium is shared in the same proportion, less any ceding commission.
Surplus treaty cession ratio: Ceded % = (Sum insured − Retention) ÷ Sum insured; Applies when sum insured exceeds retention. The same % is applied to premium and to every claim on that risk.
Excess of loss recovery: Recovery = Minimum(Loss − Retention, Limit), if Loss > Retention; otherwise 0; Insurer bears the loss up to retention, plus anything above retention plus limit.
Co-insurance share: Insurer's claim payable = Loss × Insurer's share % (subject to its sum insured); Each co-insurer is liable to the insured for its own share only.
Section 34F (Insurance Act, 1938): Authority may order modification or non-renewal of unfavourable reinsurance contracts, or require advance approval; Non-compliance with the order is deemed failure to comply with the Act.

How to solve Reinsurance and Risk Transfer questions

Use this order for numerical and descriptive questions on reinsurance and risk transfer.

1Identify the arrangement: reinsurance or co-insurance, treaty or facultative, proportional or excess of loss.
2Write down the data: sum insured, retention, treaty limit, cession percentage, loss amount and premium.
3Find the retained share and the ceded share. For surplus, compute (sum insured − retention) ÷ sum insured.
4Apply the same ratio to premium and to the claim for proportional arrangements. For excess of loss, apply retention and limit to the loss.
5Compute the insurer's net loss and the reinsurer's payment. Check that they add up to the total loss, apart from any amount above the limit.
6For descriptive parts, state the purpose: capital protection, stability of results, capacity to write large risks.
7Add the regulatory point where relevant, such as Section 34F, and give a clear conclusion.

Quickest way: Split, then check the total

When to use it: Use it for MCQs and short numericals where you must find who pays what.

Decide the type first. Proportional means a fixed percentage split. Excess of loss means a retention and a limit.
Compute the reinsurer's share only. Net share is total less this.
Check: insurer share + reinsurer share + any uncovered excess = loss.
For theory MCQs, remember: the insured has a contract only with the original insurer in reinsurance, but with every co-insurer in co-insurance.

Common mistakes in Reinsurance and Risk Transfer

Treating co-insurance and reinsurance as the same thing.
Both involve more than one insurer sharing a risk.
Fix: Ask who has a contract with the insured. In co-insurance, each insurer does. In reinsurance, only the original insurer does.
Applying the cession percentage to the claim but not to the premium (or the reverse).
Students focus on the loss because the question asks for the claim.
Fix: In proportional reinsurance, premium and claims are shared in the same ratio. Write both down.
Computing surplus cession on the loss instead of the sum insured.
Confusing the ratio with the loss amount.
Fix: Work out the ratio from the sum insured and retention first. Then apply it to the loss.
Ignoring the limit in excess of loss cover.
Students stop after Loss − Retention.
Fix: Cap the recovery at the limit. The insurer bears any loss above retention plus limit.
Saying treaty reinsurance is optional for the reinsurer on each risk.
Mixing it up with facultative.
Fix: Treaty is automatic for risks within its terms. Facultative lets the reinsurer accept or reject each risk.
Overstating Section 34F as a general ban on reinsurance.
Memorising the section only as 'control over reinsurance'.
Fix: State it exactly: the Authority may require changes at the next renewal, require non-renewal, or require advance approval, where terms are unfavourable to the insurer or detrimental to the public interest.

Worked examples

Example 1

A general insurer has a surplus treaty with a retention of ₹20,00,000. It writes a fire policy with sum insured ₹80,00,000 at a premium of ₹1,60,000. A loss of ₹30,00,000 occurs. Find the premium and claim shares of the insurer and the reinsurer.

Show the solution

Ceded sum insured = ₹80,00,000 − ₹20,00,000 = ₹60,00,000.
Ceded % = 60,00,000 ÷ 80,00,000 = 75%. Retained % = 25%.
Premium ceded = ₹1,60,000 × 75% = ₹1,20,000. Premium retained = ₹40,000.
Claim ceded = ₹30,00,000 × 75% = ₹22,50,000. Claim retained = ₹7,50,000.
Check: 22,50,000 + 7,50,000 = ₹30,00,000.

Answer: Insurer keeps premium ₹40,000 and bears claim ₹7,50,000. Reinsurer receives premium ₹1,20,000 (before any commission) and pays ₹22,50,000.

Example 2

An insurer has an excess of loss cover of ₹50,00,000 in excess of ₹10,00,000 for a single event. Find the insurer's net loss and the reinsurer's payment if the event loss is (a) ₹8,00,000, (b) ₹35,00,000, (c) ₹75,00,000.

Show the solution

Retention is ₹10,00,000 and limit is ₹50,00,000, so cover applies to losses from ₹10,00,000 to ₹60,00,000.
(a) Loss ₹8,00,000 is below retention. Reinsurer pays nil. Insurer bears ₹8,00,000.
(b) Excess = 35,00,000 − 10,00,000 = ₹25,00,000, within limit. Reinsurer pays ₹25,00,000. Insurer bears ₹10,00,000.
(c) Excess = 75,00,000 − 10,00,000 = ₹65,00,000, which is above the limit. Reinsurer pays ₹50,00,000. Insurer bears 10,00,000 + 15,00,000 = ₹25,00,000.
Check (c): 50,00,000 + 25,00,000 = ₹75,00,000.

Answer: (a) Insurer ₹8,00,000, reinsurer nil. (b) Insurer ₹10,00,000, reinsurer ₹25,00,000. (c) Insurer ₹25,00,000, reinsurer ₹50,00,000.

Exam tips

For MCQs, the favourite tests are: who is liable to the insured, and treaty versus facultative. Learn those two contrasts cold.
In numericals, always show the retained and ceded split and the final check that they add to the loss.
In case scenarios, link the retention limit to capital and volatility, and recommend facultative cover for a large single risk beyond treaty capacity.
When citing Section 34F, state it in plain words with its conditions: unfavourable to the insurer or detrimental to the public interest.
Write the recommendation: what the insurer should retain, what to cede and why.

Practice questions from Managing Risk in Insurance Business

Reinsurance and Risk Transfer in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ProfessionalReinsurance and Risk Transfer

Reinsurance and Risk Transfer: frequently asked questions

What is the difference between treaty and facultative reinsurance?

Treaty reinsurance is an advance agreement covering a class or portfolio, so all eligible policies are ceded automatically. Facultative reinsurance is arranged risk by risk, and the reinsurer may accept or reject each one. Facultative is used for large or unusual risks.

What is the difference between co-insurance and reinsurance?

In co-insurance, several insurers share one risk and each is directly liable to the insured for its share. In reinsurance, the original insurer passes part of its risk to a reinsurer under a separate contract. The insured deals only with the original insurer.

What is a retention limit in insurance?

It is the maximum amount of risk an insurer keeps on its own account for a risk or an event. Anything above it is ceded to reinsurers. It is set based on the insurer's capital, claims experience and the nature of the business.

Can the regulator control an insurer's reinsurance contracts?

Yes. Under Section 34F of the Insurance Act, 1938, the Authority can require changes at the next renewal or non-renewal if terms are unfavourable to the insurer or detrimental to the public interest. It can also require an insurer to furnish the contract in advance and get its terms approved.