If an insurer does not wish to bear
the whole risk of policy written by him, he may re-insure a part of the
risk with some other insurer. In such a case the insurer is said to
have ceded a part of his business to other insurer. The reinsurance
transaction may thus be defined as an agreement between a ‘ceding
company’ and ‘reinsurer’ whereby the former agreed to ‘cede’ and the
latter agrees to accept a certain specified share of risk or liability
upon terms as set out in the agreement.
A ‘ceding company’ is the original insurance company which has accepted the risk and has agreed to ‘cede’ or pass on that risk to another insurance company or a reinsurance company. It may however be emphasised that the original insured does not acquire any right under a reinsurance contract against the reinsurer. In the event of loss, therefore, the insured’s claim for full amount is against the original insurer. The original insurer has to claim the proportionate amount from the re-insurer.
There are two types of reinsurance contracts, namely, facultative reinsurance and treaty reinsurance. Under facultative reinsurance each transaction has to be negotiated individually and each party to the transaction has a free choice, i.e., for the ceding company to offer and the reinsurer to accept. Under treaty reinsurance a treaty agreement is entered into between ceding company and the reinsurer whereby the volume of the reinsurance transactions remain within the limits of the treaty.