Cession (Insurance) Definition

Cite this article as:"Cession (Insurance) Definition," in The Business Professor, updated March 14, 2019, last accessed October 28, 2020, https://thebusinessprofessor.com/lesson/cession-insurance-definition/.

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Cession (Insurance) Definition

Cession (or to cede) applies to an insurance provider and the insurance company’s insurer (re-insurer). Cession places part of certain losses on the re-insurer.  An insurance risk can be transferred to the reinsurer using two methods: proportional and non-proportional reinsurance.

Proportional reinsurance refers to an insurance arrangement where the insurer and the reinsurer agree to share a proportion of both losses and premium. Non-proportional reinsurance refers to an arrangement where the reinsurer pays the insured value in the event a loss occurs.

A Little More on What is Cession

Currently, the insurance industry has become more complex due to high competition among the insurance companies. In this regard, reinsurance provides an opportunity for both the insurer and reinsurer to share benefits and losses based on the accurate actuarial calculations that determine the loss or risk incurred. For example, when the insurer proposed that a particular risk of loss is lower than the actual cost, the insurer will be able to determine the undercharging by the reinsurer. In this regard, the insurer will sell its policies to the customers at a higher rate and buy the policy from the reinsurer a lower rate thus creating an arbitrage profit.

One of the major reason why the insurance companies rely on ceding is that it allows the insurer to manage its overall risk exposure effectively and effectively. The insurer can make reinsurance agreement with specialist reinsurance company such as Lloyd’s of London or Swiss Re.  some of the reinsurance agreement can be handled internally through ways such as automobile insurance by diversifying the types of their insured. It can also be done externally in the cases such as insurance liability for the large business.

The insurance agreement between the ceding insurance company and the reinsurance company include broad terms under which cession is ceded. These terms precisely outline the conditions under which reinsurance company is obligated to pay claims. The reinsurance contracts occur in two ways which include facultative and treaty. Under facultative contract occurs when the insurer transfers one type of risk to the reinsurer. Therefore, it means that every type of risks the insurer transfers to the reinsurer call for individual negotiation on each risk.  Under treaty contract, the ceding insurance company and the reinsurance company agree on various types of insurance risks that will be covered by the reinsurance company. For example, the ceding insuring company may decide to transfer all the flood risks to the reinsurance company, and the reinsurance company may accept to cover all these risks.

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