A ceding company is an insurance agency that passes some or all of the risks associated with the policies it offers to another company known as a reinsurance firm.

Definition of Ceding Company

Simply put, ceding companies are insurance companies that pass a portion or all of the risks associated with the policies it offers to a second entity that is commonly known as a reinsurance firm. By doing this, a ceding company can protect itself from potential exposure to financial losses. In addition, the ceding company can free up corporate finances for use in writing new policy contracts.

It is important to note that ceding companies are still held liable for their reinsured policies. This means, in the event that the reinsurance firm happens to default on reimbursements they are responsible for handling, the ceding company would have to make the payout on the reinsured policy in question. The insurance industry is under heavy regulation, and insurance companies are required to do a couple of things:

  • Write specific semi-standardized policies
  • Keep enough capital on hand to act as collateral and protect against potential losses

One way to counter this is for an insurance company to utilize reinsurance firms and, by doing so, providing themselves with greater freedom in terms of controlling the operation of the company. For example, cases in which an insurance company doesn't want to take on the risk associated with the losses for a standard policy can be reinsured as a means to help mitigate these risks for the ceding company. Reinsurance policies may also be used to provide greater control over the amount of money a ceding company is required to have on hand for collateral.

Why Ceding Companies Rely on Reinsurance

Ceding some or all of the risk associated with an insurance policy to a reinsurance firm provides ceding companies with an opportunity to manage their overall exposure to risks more efficiently and effectively. Reinsurance is a business arrangement that involves the ceding company and a reinsurance company. An agreement is reached that provides the ceding company with a measure of protection against some or all of the risks associated with the primary insurance policy that has been underwritten by the ceding company. This can happen under one insurance policy or many.

Reinsurance policies can be written by a number of entities, such as:

  • Specialized insurance firms
  • An outside insurance agency
  • A specialized, in-house department that focuses on reinsurance

In some industries, such as auto insurance, reinsurance can be handled on an internal basis by simply diversifying the kind of clients the company chooses to take on. In other scenarios, like in the case of providing liability insurance for large international companies, a specialized reinsurance company may be a better option because diversifying may not be a possibility.

Available Reinsurance for Potential Ceding Companies

There are many possible options available for insurance companies that are considering the ceding company route of business:

  • Facultative reinsurance
  • Reinsurance treaties
  • Proportional reinsurance
  • Nonproportional reinsurance
  • Excess-of-loss reinsurance
  • Risk-attaching reinsurance

The specific type of reinsurance that is chosen will depend largely on the potential ceding company's goals, what kind of insurance policies they plan to write, and the nature of the clients they intend to take on. All these factors will be used to determine the risks associated with each policy written by the ceding company and will ultimately determine what kind of reinsurance is right for the ceding company in question. It may be necessary to explore the possibility of utilizing more than one kind of reinsurance or none at all.

Definition of a Ceding Commission

Ceding commissions are fees that are paid by reinsurance companies to the ceding companies they are working with to cover the costs of things like:

  • Administrative costs
  • Acquisitions
  • Expenses

Ceding commissions are most common in pro rata and quota-share reinsurance treaties. These fees are normally calculated by figuring a certain percentage of the premium charged by the reinsurance company rather than charging on a flat-rate basis. An insurance company looking for a way to reduce its exposure to potential risk through reinsurance has several options and considerations to choose from.

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