Methods of Risk Transfer

Abstract

The traditional way to transfer underwritten risk by primary insurers was to buy reinsurance and for reinsurers to buy retrocession. The insurance company transferring the risk is called cedent and the reinsurance company taking the risk is called cessionaire. If a reinsurer is transferring risk to another reinsurer, the risk transfer is called retrocession, while the reinsurer is the retrocedent and the risk-taking company the retrocessionaire (see figure 4.1). The outward risk transfer is called cession, and the taking up of insurance risk assumption. The main reason to transfer risk is the creation of additional capacity. This may be necessary to write large risks, e.g. in the insurance of natural catastrophes or to increase the premium capacity, e.g. the ability to write large volumes of policies in the same business line. Another reason for the cession of risk is diversification. If the diversification of risks in a portfolio is low, the influence of single large losses can be strong. This effect can be reduced through diversification. The volatility of earnings after the diversification of risk is lower.¹