Ceding Company: Meaning, Benefits, Types

A ceding company is an insurance company that passes a portion or all of the risk associated with an insurance policy to another insurer. Ceding is helpful to insurance companies since the ceding company that passes the risk can hedge against undesired exposure to losses. Ceding also helps the ceding company to free up capital to use in writing new insurance contracts.

Understanding a Ceding Company

Sometimes, an insurance company may want to reduce the risk of paying out an insurance claim for some of the policies in its portfolio. Insurers can cede or offer the policy to another insurance company that's willing to take on the risk of paying out a claim for that policy. The company receiving the policy is called the reinsurance company, while the insurer passing the policy to the reinsurer is called the ceding company. However, the ceding company loses out on most of the premiums paid by the policyholders for any of the policies ceded to the reinsurer. Instead, the reinsurer gets paid the premiums from the policyholders. However, the reinsurer typically pays a portion of the premiums back to the ceding company. These payments are called ceding commissions.

The ceding company retains liability for the reinsured policies, so although claims should be reimbursed by the reinsurance firm, if the reinsurance company defaults, the ceding company may still have to make a payout on reinsured policy risks. Insurance is a highly regulated industry, which requires insurance companies to write certain semi-standardized policies and maintain sufficient capital as collateral against losses.

Benefits to Ceding Companies

Insurance companies can use reinsurance to allow them more freedom in controlling their operations. For instance, in cases where the insurance company does not wish to carry the risk of certain losses in a standard policy, these risks can be reinsured away. An insurer can also use reinsurance to control the amount of capital it is required to hold as collateral.

Reinsurance can be written by a specialist reinsurance company, such as Lloyd’s of London or Swiss Re, by another insurance company, or by an in-house reinsurance department. Some reinsurance can be handled internally, such as with automobile insurance, by diversifying the types of clients that are taken on by the company. In other cases, such as liability insurance for a large international business, specialty reinsurers may be used because diversification is not possible. Ceding companies and reinsurance providers will use calculations like the burning-cost ratio to estimate the rates of excess loss coverage.

Types of Reinsurance Available to Ceding Companies

There are various types of reinsurance contracts used for reinsurance ceding. 

Facultative Reinsurance

Facultative reinsurance coverage protects a cedent insurance company for a certain individual or a specific risk or contract. The risks or contracts being considered for facultative reinsurance are negotiated separately. The reinsurer has the right to accept or deny all or a portion of a facultative reinsurance proposal.

Treaty Reinsurance

Treaty reinsurance is effective for a broad set of parameters on a per-risk or contract basis. In other words, the reinsurer accepts the risks of a preset class of policies over a period of time. The reinsurer covers all or a portion of the risks that a ceding insurance company may incur. For example, an insurance company might cede all of its policies that cover floods or might only cede those flood risks for a specific geographic area within a set time period.

Proportional Reinsurance

Under proportional reinsurance, the reinsurer receives a prorated share of all policy premiums sold by the cedent. When claims are made, the reinsurer covers a portion of the losses based on a pre-negotiated percentage. The reinsurer also reimburses the cedent for processing, business acquisition, and writing costs.

Non-proportional Reinsurance

With non-proportional reinsurance, the reinsurer is liable if the cedent's losses exceed a specified amount, known as the priority or retention limit. As a result, the reinsurer does not have a proportional share in the ceding insurer's premiums and losses. The priority or retention limit may be based on one type of risk or an entire risk category.

Excess-of-loss Reinsurance

Excess-of-loss reinsurance is a type of non-proportional coverage in which the reinsurer covers the losses exceeding the ceding insurer's retained limit. This contract is typically applied to catastrophic events, covering the cedent either on a per-occurrence basis or for the cumulative losses within a set time period. For example, a reinsurer might cover 100% of the losses for policies over a specific threshold, such as $500,000. The reinsurer could also have it written in the contract that they only cover a percentage of the excess amount beyond the threshold.

Risk-attaching Reinsurance

Under risk-attaching reinsurance, all claims established during the effective period are covered, regardless of whether the losses occurred outside the coverage period. No coverage is provided for claims originating outside the coverage period, even if the losses occurred while the contract was in effect.