Reinsurance Explained: Definition, How it works, Examples

Reinsurance is when an insurance company insures part or all of the risks it needs to bear with a reinsurance company. The insurance company that directly faces the market and general policyholders is called the insurer, but each company has limited underwriting capacity, so it transfers the insurance liability to other insurance companies to reduce the risks it needs to bear, and the entity that accepts this business is called the ‘reinsurance company’.

Some insurance companies also have reinsurance operations, accepting policies from other insurance companies, while others specialize solely in reinsurance. Large reinsurance companies typically operate across regions to effectively spread out regional risks.

Since each insurance company’s clients and products differ, the potential underwriting risks vary too, leading to different demands for reinsurance. For example, if an insurance company covers a massive asset like a building owned by a real estate firm, a serious accident could result in compensation exceeding HK$100 million. If multiple severe cases occur, it might impact the company’s solvency, so transferring responsibility through reinsurance is essential.

Additionally, many specialized risks require reinsurance, such as insurance for nuclear power plants or disaster-related policies. After determining their retention limit (the amount of risk they can afford to bear), insurance companies often purchase reinsurance as the original insurer to transfer the risk liability.

It’s worth noting that, according to the Insurance Ordinance, insurance companies must have adequate reinsurance arrangements in place to share risks for the insurance categories they plan to operate. So, reinsurance is a must in Hong Kong’s insurance industry.

Reinsurance can be divided into proportional reinsurance and non-proportional reinsurance .

• Proportional reinsurance , where the original insurer and the reinsurance company share the insured amount based on a pre-agreed proportion. Correspondingly, the reinsurance premium and compensation are also shared in the same proportion.
• Non-proportional reinsurance , also known as excess of loss reinsurance, where the responsibility is allocated based on the agreed compensation limit or payout ratio. If the loss is within the compensation limit, it’s borne by the original insurer, while any amount exceeding the agreed limit is shared by the reinsurer according to the contract. Here, the sharing of insurance responsibility, reinsurance premium, and claims has no proportional relationship with the original insured amount—it’s all separately agreed upon.

As for the forms of reinsurance, they can be divided into facultative reinsurance and treaty reinsurance .

• Facultative reinsurance , which is negotiated between the original insurer and the reinsurance company based on business needs, covering the reinsurance terms and premiums. This is typically a temporary agreement for a specific risk or a series of risks.
• Treaty reinsurance , where the original insurer and the reinsurance company establish a fixed reinsurance relationship through a contract that specifies the reinsurance items for a certain period. Both parties fulfill their obligations under the contract, with risks automatically transferred for the relevant insurance products or clients.

The biggest use of reinsurance is to help insurance companies share risks, so they don’t face situations where they can’t pay claims if something goes wrong. Plus, by transferring and sharing high risks through reinsurance, companies get more room to take on new business—it’s like a safety net that keeps things running smoothly.

Insurance companies buying reinsurance is actually a win for you as a policyholder. The biggest plus is that if a rare but devastating event—like a black swan occurrence—hits, the insurer gets the support it needs. This means their ability to honor claims and fulfill contracts with you improves, giving you even greater peace of mind and protection.

Pretty much any type of insurance can involve reinsurance. However, when it comes to natural disasters that cause property damage—like real estate—or loss of life, the scale of impact and payouts can be massive. That’s why insurers often turn to reinsurance to offload some of that risk and responsibility.

In the general reinsurance world, it breaks down into various categories, such as accident and health, auto, aviation, marine cargo, property damage, and financial loss.

In Hong Kong, some insurance companies handle reinsurance business, and there are even a few smaller firms that specialize in it. Back in 2019, for general insurance, the total gross premiums in the reinsurance category reached HK$13.42 billion, with professional reinsurance companies underwriting HK$3.83 billion.

But when it comes to sheer size of the company, foreign and Chinese reinsurance companies are the real heavyweights.

Beyond reinsurance, some insurers use catastrophe bonds to manage risks. These are high-yield debt instruments, typically designed for natural disasters like typhoons or earthquakes, helping cover potential payout needs. If the issuer suffers losses from such events, they might delay repaying the principal and interest—or even get partial or full waivers.