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Banking and Insurance - Laws and Practice · Functions in Insurance and Compliance related thereto (Part V)

Reinsurance and Risk Transfer: Types, Functions and Compliance

Updated 11 October 2026 · Fact-checked

Reinsurance is insurance bought by an insurer. The insurer (cedant) passes part of its risk and premium to a reinsurer, so one large loss cannot damage it. Main forms are facultative (risk by risk) and treaty (automatic, for a whole portfolio), on proportional or non-proportional terms. The Authority can direct changes to unfavourable treaties under Section 34F.

Understand Reinsurance and Risk Transfer

Every insurer faces the chance of a loss larger than it can bear. Reinsurance solves this. The insurer that issued the policy, called the cedant or ceding insurer, transfers a part of the risk to another insurer, the reinsurer. In return it pays the reinsurer a share of the premium. The policyholder still deals only with the original insurer. The reinsurance contract is a separate contract between insurers.

Why do insurers do this? Reinsurance spreads risk, caps the loss on a single risk or event, stabilises results, and lets the insurer write larger risks than its own capital would allow. It also gives access to the reinsurer's technical expertise and helps with solvency.

There are two ways to place cover. Facultative reinsurance is negotiated for one specific risk. The reinsurer may accept or refuse each offer. It suits large or unusual risks. Treaty reinsurance is an advance arrangement covering a whole class or portfolio. The cedant must cede and the reinsurer must accept the business that falls within the treaty terms, so no case-by-case negotiation is needed.

Both can be proportional or non-proportional. In proportional reinsurance (quota share, surplus) the reinsurer takes an agreed share of premium and of every loss. In non-proportional reinsurance (excess of loss, stop loss) the reinsurer pays only when losses cross an agreed retention or limit.

Do not confuse this with coinsurance. In coinsurance, several insurers each issue a share of the same policy directly to the insured, and each is liable to the insured for its share. In reinsurance, only the original insurer is liable to the insured, and the reinsurer is liable to the insurer. Related ideas: retrocession is reinsurance of a reinsurer's risk, and retention is the part the insurer keeps.

On compliance, Section 34F of the Insurance Act, 1938 gives the Authority control over reinsurance terms. Other compliance points include filing returns and the asset and liability statement under Section 64V, and statements after a business transfer under Section 37. Detailed reinsurance programme norms come from IRDAI regulations; check the current text in your study material.

Key rules to remember

Quota share
Reinsurer's share of loss = Quota % × Loss
Premium is also shared in the same percentage, usually with a ceding commission.
Surplus treaty cession
Ceded % = (Sum insured − Retention) ÷ Sum insured
Applies when sum insured exceeds the retention, up to the treaty limit. Reinsurer pays that % of every loss on the risk.
Excess of loss recovery
Recovery = Loss − Retention, limited to the layer limit
If loss is at or below retention, recovery is nil.
Section 34F(1)
Authority may order modification or non-renewal at next renewal
Applies if terms are not favourable to the insurer or are detrimental to public interest. Non-compliance is deemed failure to comply with the Act.
Section 34F(2)
Authority may require advance copy and approval before a treaty is entered
Used when the Authority has reason to believe such treaties are or are likely to be entered into.

How to solve Reinsurance and Risk Transfer questions

Use this method for theory and case questions on reinsurance.

  1. 1Identify the parties: cedant, reinsurer, and whether the original policyholder is involved.
  2. 2Name the arrangement: facultative or treaty, then proportional or non-proportional.
  3. 3State the purpose served in the facts: capacity, spreading, stabilising results or solvency.
  4. 4For numbers, apply the formula for the stated type, using retention and limits exactly as given.
  5. 5Check the compliance angle: Section 34F powers, returns, and any IRDAI regulation relevant to the facts.
  6. 6Conclude clearly, for example who pays what, or whether the Authority can act.

Quickest way: Three-question check

When to use it: Short questions and distinctions under time pressure.

  1. Who is liable to the insured? Only the cedant means reinsurance; several insurers means coinsurance.
  2. Is cover automatic for a portfolio (treaty) or chosen per risk (facultative)?
  3. Does the reinsurer share every loss (proportional) or pay only above a retention (non-proportional)?

Common mistakes in Reinsurance and Risk Transfer

  • Treating reinsurance and coinsurance as the same

    Both involve more than one insurer sharing a risk.

    Fix: Ask who owes the insured. In reinsurance the insured has no claim against the reinsurer.

  • Saying the policyholder is a party to the reinsurance contract

    Students assume all contracts on the risk involve the insured.

    Fix: State that the reinsurance contract is between insurer and reinsurer only.

  • Calling treaty reinsurance optional for each risk

    Confusion with facultative cover.

    Fix: Treaty business within its terms is automatically ceded and accepted. Choice per risk is facultative.

  • Applying excess of loss as a share of every loss

    Mixing it with quota share.

    Fix: Subtract the retention first, then cap at the layer limit.

  • Overstating Section 34F as a power to cancel any treaty immediately

    Reading the section loosely.

    Fix: The order operates at the next renewal date, and sub-section (2) concerns advance approval of future treaties.

Worked examples

Example 1

A general insurer has a quota share treaty ceding 40% of all fire policies. A fire policy with sum insured ₹5,00,00,000 suffers a loss of ₹80,00,000. Find the reinsurer's share and the insurer's net loss. Who pays the insured?

Show the solution
  1. Reinsurer's share = 40% × ₹80,00,000 = ₹32,00,000.
  2. Net loss to insurer = ₹80,00,000 − ₹32,00,000 = ₹48,00,000.
  3. The insured claims from the insurer for the full ₹80,00,000, as the reinsurer owes the insurer only.

Answer: Reinsurer pays ₹32,00,000; insurer's net loss is ₹48,00,000; the insurer pays the insured in full.

Example 2

An insurer has an excess of loss treaty with retention of ₹25,00,000 and layer limit of ₹1,00,00,000. Find recovery for a loss of ₹70,00,000 and for a loss of ₹1,50,00,000. Can the Authority act if the treaty terms are detrimental to public interest?

Show the solution
  1. Loss ₹70,00,000: excess over retention = ₹45,00,000, within the limit, so recovery is ₹45,00,000.
  2. Loss ₹1,50,00,000: excess = ₹1,25,00,000, which exceeds the limit, so recovery is capped at ₹1,00,00,000.
  3. Insurer bears ₹25,00,000 in the first case and ₹50,00,000 in the second (retention plus the uncovered ₹25,00,000).
  4. Under Section 34F(1), if the Authority thinks terms are not favourable to the insurer or are detrimental to public interest, it may by order require modifications at the next renewal or require non-renewal. Failure to comply is deemed failure to comply with the Act.

Answer: Recoveries are ₹45,00,000 and ₹1,00,00,000. Yes, the Authority can issue an order under Section 34F(1), effective at the next renewal.

Exam tips

  • Write the distinction between reinsurance and coinsurance in two lines; it is a frequent short question.
  • In numerical parts, show retention, limit and recovery as separate lines to earn step marks.
  • Quote the conditions in Section 34F: unfavourable to the insurer or detrimental to public interest, and effect at next renewal.
  • For case questions, follow provision, analysis of facts, conclusion.
  • Mention that current IRDAI reinsurance regulations should be cited from your study material, not memory.

Practice questions from Functions in Insurance and Compliance related thereto (Part V)

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.

Reinsurance and Risk Transfer: frequently asked questions

What is the difference between reinsurance and coinsurance?

In reinsurance, an insurer passes part of its risk to another insurer and remains solely liable to the insured. In coinsurance, several insurers share one risk directly, each liable to the insured for its share.

What is the difference between treaty and facultative reinsurance?

Treaty reinsurance is an advance arrangement covering a portfolio, with automatic cession and acceptance. Facultative reinsurance is negotiated for each individual risk, and the reinsurer may decline it.

What power does Section 34F give the Authority?

It can order an insurer to modify the terms of a reinsurance treaty, or not renew it, at the next renewal if the terms are unfavourable to the insurer or detrimental to public interest. It can also require advance approval of future treaties.

Is the policyholder affected by reinsurance?

The policyholder deals only with the original insurer, who remains liable for the claim. The reinsurance contract is between the insurer and reinsurer.