Ceded Reinsurance Leverage

Reinsurance refers to the purchase of insurance by an insurance company from a different insurance company. The company who bought the insurance is called the insurer or the ceding company, while the company to which the insurance is bought is referred to as the reinsurer or the cedent. Reinsurance is done for the purpose of shifting insurance risks such as liability for losses. In this case, the ceding company is not obliged to pay losses obtained in the course of business since the cedent remains accountable to the insurance policy holder. Thus, all losses are still shouldered by the cedent or reinsurer. In return, the reinsurer shall receive reinsurance premiums from the ceding company for indemnification. The amount of insurance transmitted by the ceding company to the reinsurer is called the reinsurance ceded.

Given that certain risks are now assigned to reinsurers in reinsurance, ceding companies can distribute higher limit policies. Thus, ceding companies are allowed to assume higher risks. Conversely, the present reinsurance market has become stricter and more complex. This is due to the considerable losses and financial impairments suffered by several reinsurers. Hence, reinsurers have employed tedious reviewing, examining, and checking on the status of the companies they will reinsure since the year 2000.

In business, leverage generally refers to the extent on how companies utilize borrowed funds to generate gains or losses. It is also referred to as capitalization. Example, companies may borrow funds to make its equity in leverage; may purchase fixed assets to make its revenue in leverage; or make use of the so called derivatives to leverage. Leverage can result to higher investment returns to stockholders. However, high-leveraged companies are exposed to higher risks of losses such as bankruptcy if they cannot pay their liabilities even if they have high surplus. Financial leverage ratio, or debt/equity ratio, measures the company’s reliance on borrowed funds to finance the company’s assets. It is computed by dividing the company’s total liabilities by its total equity. A company that has a high debt/equity ratio may face problems in paying the principal amount and the interest while at the same time borrowing more funds.

In insurance, there is also the so called Ceded Reinsurance Leverage. It is a ratio that measures the ceding company’s reliance on the security products supplied by the reinsurer. It also indicates the ceding company’s subsequent exposure to possible losses in line with its relation to the reinsurer. This is computed by adding the recoverable portion of the reinsurance, written ceded premiums, and the payable ceded balances; minus funds held; and divided by surplus of the insurance policy holders. Reinsurance recoverable include sums equivalent to a portion received by the insurer from reinsurance premiums unearned and paid to him; related expenses for due claims incurred by the insurer; recoverable sums on estimates of incurred losses that have not been reported; and related expenses incurred by the insurer on recoverable sums of estimated losses reported and occurred but not yet paid. A high Ceded Reinsurance Leverage means more reliance to reinsurers.