Reinsurance is often described as insurance for insurers, but this is a pretty vague way of describing things. So what does it actually mean? Well, let's assume that an insurance company has agreed to provide an insurance policy to an aviation company for a plane.

The insurance company would receive an insurance premium in exchange for providing the policy. However, this policy creates a potential issue for the insurance company, because any future claim against it could be very large in value. Whilst the opportunity for spreading this risk across a portfolio is fairly limited, because to be honest, the volume of planes needing insurance is small relative to, say, cars or homes.

This makes it hard for the insurance company to manage its risk.

The insurance company would therefore likely obtain its own insurance policy from a reinsurance company for a proportion of the risk.

This is known as ceding reinsurance.

This can be done in one of two ways. Firstly, there's proportional reinsurance, which is also known as quota share, which allows an insurance company to pay a fixed proportion of the premium to a reinsurance company in exchange for the same fixed proportion of the claims.

There's also non-proportional reinsurance, which allows the insurance company to pay a specific premium in exchange for losses beyond a certain amount. This could either be individual claims beyond a certain threshold, which is referred to as excess of loss reinsurance, or could be where portfolio claims exceed a certain level, which is stop loss reinsurance. Whilst reinsurance is widely used across both life and P&C insurance, it is particularly important for insurance companies exposed to catastrophic events such as storms, earthquakes, and floods. This is because of the unpredictable size and timing of any potential claims. It is also more common for commercial insurance with a small number of very large exposures.

Examples of this would be insurance within the aviation or utility industries.