Risk Management in Banking and Insurance · Structure and Type of Re-insurance

Concept and Need for Reinsurance: Meaning, Functions and Benefits

Updated 11 October 2026 · Fact-checked

Reinsurance is insurance for insurers. An insurer (the cedant) passes part of the risk it has written, and part of the premium, to another insurer (the reinsurer). It is needed to limit losses, stabilise results, write larger risks, and support solvency and capital. To answer a question, define it, name the parties, then link each need to a benefit.

Understand Concept and Need for Reinsurance

Reinsurance is a contract in which one insurer, the cedant (or ceding insurer), transfers part of the risk it has accepted to another insurer, the reinsurer. The cedant pays a reinsurance premium and, when a covered loss occurs, recovers its agreed share from the reinsurer.

The policyholder still deals only with the original insurer. The reinsurance contract is between the two insurers. The original insurer stays liable to the policyholder even if the reinsurer is slow to pay. This is a key difference from insurance, where the contract is between an insurer and the insured who faces the loss.

Why do insurers cede risk? Think of an insurer that has written a large factory fire policy. One big claim could wipe out a year of profit. By ceding part of it, the insurer:

Limits its exposure to a single large loss or to a catastrophe such as a flood hitting many policies together.
Gains underwriting capacity. It can accept a sum insured larger than its own capital would normally allow.
Stabilises results, because claims in any year become less volatile.
Supports solvency and capital adequacy. Ceding risk lowers the risk the insurer must back with its own funds.
Gets expertise and spread. Reinsurers see many markets and can advise on pricing and new classes.

Solvency matters because an insurer must be able to meet its liabilities. Under the Insurance Act, 1938, section 53A, when the solvency of an insurer is ascertained, no account is taken of assets consisting of unpaid-up share capital. So solvency rests on real assets, not promised capital. Reinsurance helps because it moves part of the liabilities off the insurer's own balance. Under the IRDA Act, 1999, section 14(2)(l), the Authority regulates the maintenance of margin of solvency. Section 14(2)(k) covers regulation of investment of funds by insurers.

The law also requires some reinsurance. Under section 101A of the Insurance Act, every insurer must re-insure with Indian re-insurers a percentage of the sum assured on each policy, as specified by the Authority with the previous approval of the Central Government. The percentage specified cannot exceed thirty per cent of the sum assured. This applies to general insurance policies issued or renewed on or after 1 April 1961, and does not include a re-insurance policy. Section 101A(7) clarifies that an insurer may still reinsure the whole sum assured, or any portion above the specified percentage, with any Indian re-insurer or other insurer.

Key rules to remember

Net retention: Net retention = Sum insured − Amount ceded to reinsurer; The part of the risk the cedant keeps for its own account.
Reinsurer's share in a proportional cession: Ceded amount = Sum insured × Cession percentage; Premium and claims are normally shared in the same proportion in proportional arrangements.
Statutory cap on compulsory cession (s.101A): Specified percentage of sum assured ≤ 30%; The Authority specifies the percentage, with Central Government's previous approval. Applies to general insurance policies, not to re-insurance policies.
Solvency rule (s.53A): Assets counted for solvency exclude unpaid-up share capital; Only real assets count when solvency of an insurer is ascertained.

How to solve Concept and Need for Reinsurance questions

Use this method for theory questions (define, explain need, distinguish) and for short case questions on why an insurer should reinsure.

1Define reinsurance in one line and name the parties: cedant, reinsurer, original policyholder.
2State the key feature: the cedant remains liable to the policyholder; the reinsurance contract is separate.
3Read the case. Identify the problem: a large single risk, a catastrophe, thin capital, a new class, or volatile results.
4Match each problem to a need: exposure limit, capacity, stability, solvency support, expertise.
5Add the legal link where relevant: section 53A (solvency), section 101A (compulsory cession, 30% cap), IRDA Act section 14(2)(l) (margin of solvency).
6If numbers are given, compute the ceded amount and the net retention.
7Close with a clear conclusion or recommendation for the insurer.

Quickest way: Need-to-Benefit chain

When to use it: Use it for 2-mark MCQs and short notes when time is tight.

Write: Cedant → cedes risk → reinsurer.
List five needs: limit loss, capacity, stability, solvency support, expertise.
Add one legal anchor: section 101A, 30% cap, Indian re-insurers.
For any numbers: retention = sum insured minus ceded amount.

Common mistakes in Concept and Need for Reinsurance

Saying reinsurance makes the policyholder deal with the reinsurer.
Students confuse transfer of risk with transfer of the contract.
Fix: State that the cedant remains liable to the policyholder. The reinsurer is liable only to the cedant.
Treating reinsurance as a way to avoid paying claims.
The idea of passing risk is read as passing responsibility.
Fix: Say it is a way to share the financial burden of claims, not to escape the claim to the insured.
Quoting the 30% limit in section 101A as the fixed cession percentage.
Students remember the number but not the wording.
Fix: Write that the Authority specifies the percentage, and that it cannot exceed thirty per cent of the sum assured on a policy.
Saying section 101A applies to life insurance and to re-insurance policies.
The word 'policy' is read loosely.
Fix: The section defines policy as one in respect of general insurance business transacted in India, excluding a re-insurance policy.
Listing benefits without linking them to solvency.
Students memorise a list and skip the reasoning.
Fix: Explain that ceding risk lowers the liabilities the insurer must back, and that solvency counts real assets only, not unpaid-up capital (section 53A).

Worked examples

Example 1

Bharat General Insurance Ltd. insures a textile plant in Surat for ₹40,00,00,000. It cedes 30% of the sum insured to an Indian re-insurer. A fire causes a total loss of ₹40,00,00,000. Find the ceded amount, the net retention and the recovery from the re-insurer. Assume proportional sharing of claims.

Show the solution

Ceded amount = ₹40,00,00,000 × 30% = ₹12,00,00,000.
Net retention = ₹40,00,00,000 − ₹12,00,00,000 = ₹28,00,00,000.
With proportional sharing, the re-insurer pays 30% of the claim: ₹40,00,00,000 × 30% = ₹12,00,00,000.
Bharat General pays the policyholder in full, then recovers ₹12,00,00,000. Its net loss is ₹28,00,00,000.

Answer: Ceded ₹12,00,00,000; net retention ₹28,00,00,000; recovery from the re-insurer ₹12,00,00,000.

Example 2

A new general insurer has limited capital and wants to write large industrial risks. Explain, with reference to the Insurance Act, 1938, why reinsurance is needed and how it helps solvency.

Show the solution

Define reinsurance: the insurer cedes part of the risk and premium to a reinsurer, but stays liable to the policyholder.
Capacity: with limited capital, one large loss could threaten the insurer. Ceding a share lets it accept bigger sums insured.
Stability: ceding large exposures makes yearly claims less volatile.
Solvency: under section 53A, unpaid-up share capital is ignored when solvency is ascertained. So the insurer cannot rely on promised capital. Ceding risk reduces the liabilities it must meet from real assets. The Authority also regulates the margin of solvency under section 14(2)(l) of the IRDA Act, 1999.
Legal requirement: under section 101A, the insurer must reinsure with Indian re-insurers the percentage of sum assured the Authority specifies, capped at thirty per cent. It may reinsure more under section 101A(7).
Recommendation: use reinsurance for large risks, keep only what its capital supports.

Answer: Reinsurance gives the new insurer capacity, stable results and solvency support, and it is partly compulsory under section 101A. The insurer stays liable to policyholders, so it should choose strong re-insurers and cede beyond the statutory minimum for large risks.

Exam tips

Always state that the cedant remains liable to the policyholder. Examiners look for this line.
For MCQs on section 101A, remember: Authority specifies the percentage, 30% is the upper limit, applies to general insurance, excludes re-insurance policies.
In case questions, name the exact problem (capacity, catastrophe, solvency) and match the benefit to it. Generic lists score less.
Show the ceded amount and net retention separately in numerical answers.
For 'difference between insurance and reinsurance', use a short two-column style in bullets: parties, contract, insured interest, and who faces the policyholder.

Practice questions from Structure and Type of Re-insurance

Concept and Need for Reinsurance: frequently asked questions

What is reinsurance in simple words?

It is insurance taken by an insurer. The insurer passes part of the risk it has accepted, and a share of the premium, to a reinsurer. In return, the reinsurer pays its share of covered claims.

What is the difference between insurance and reinsurance?

In insurance, the contract is between an insurer and the insured who faces the loss. In reinsurance, the contract is between two insurers, the cedant and the reinsurer. The policyholder has no direct claim on the reinsurer.

How does reinsurance help solvency?

It reduces the liabilities the cedant must meet from its own assets after a large loss. Under section 53A of the Insurance Act, 1938, unpaid-up share capital is not counted when solvency is ascertained, so real assets and risk transfer matter. The Authority regulates the margin of solvency under section 14(2)(l) of the IRDA Act, 1999.

Is reinsurance compulsory in India?

Partly. Section 101A of the Insurance Act, 1938 requires every insurer to reinsure with Indian re-insurers a percentage of the sum assured on each general insurance policy, as specified by the Authority with the Central Government's previous approval. That percentage cannot exceed thirty per cent.