Tier One: How Life Insurance Reinsurance Works

Given the size of the policies our consulting clients purchase, the subject of reinsurance is always a part of the client educational process. This is because when an individual purchases a life insurance policy, the assumption is that the insurance company will be there to pay the claim, whether tomorrow or decades from now. Behind the scenes, however, the life insurer itself may not shoulder the entire risk of that policy. Instead, it often transfers a portion of the obligation to another insurer, known as a reinsurer. This practice, called reinsurance, is one of the most important, but least visible, pillars of financial strength in the global life insurance marketplace.

The Basics of Reinsurance

At its core, reinsurance is insurance for insurance companies. The primary insurer, often called the ceding insurer, sells policies to clients. To manage its risk exposure, it “cedes” some of those risks to another insurer, the reinsurer. In exchange for taking on part of the risk, the reinsurer receives a share of the premiums collected.

From the client’s perspective, nothing changes. The policyholder’s contract and relationship remain with the original insurer, which is legally obligated to pay claims. The reinsurer’s role is strictly behind the scenes: it reimburses the ceding insurer for its portion of claims when they occur. This backstop allows insurers to keep their promises to clients while managing their financial strength responsibly.

Why Life Insurers Rely on Reinsurance

Reinsurance has been aptly described as the “quiet enabler” of modern insurance. Without it, insurers could not responsibly take on the volume or variety of risks demanded by today’s consumers. In the life insurance market, reinsurance serves several important purposes:

1. Risk spreading. Reinsurance allows insurers to spread mortality, longevity, or morbidity risks across multiple companies. This ensures no single insurer is crippled by an unusually large claim or a cluster of claims.

   
   

2. Capital efficiency. New policies often require insurers to reserve more cash than the premiums collected upfront. By ceding some of the risk, insurers free up capital to underwrite more business or invest in new products.

   
   

3. Product development. Reinsurers often provide technical expertise and underwriting support, especially for emerging product lines. They may help insurers design new policies, test actuarial assumptions, and carry part of the risk while the insurer builds confidence in its pricing.

   
   

4. Catastrophe protection. Catastrophic events such as a natural disaster or pandemic could lead to multiple deaths in a concentrated area. Reinsurance allows insurers to guard against such correlated risks.

   
   

5. Business continuity. If an insurer wishes to exit a product line, it can transfer most of the associated risks to reinsurers, while still servicing the policies in force.

Common Structures in Life Reinsurance

Reinsurance agreements are highly flexible, but they generally fall into two categories: proportional and non-proportional.

• Proportional (or pro rata) reinsurance. The insurer and reinsurer share risk, premiums, and claims according to an agreed percentage or amount. Common types include:

  
  

  • Quota share: Both parties share a fixed percentage of every policy.

  • Excess of retention: The insurer keeps coverage up to its limit and passes the rest to the reinsurer.

  • Coinsurance: The reinsurer assumes a proportional share of all risks, premiums, and reserves, while the insurer continues administering the policies.

  • Modified coinsurance: The reinsurer assumes risk but returns reserves to the insurer, often allowing the insurer to retain investment control.

    
    

• Non-proportional (or excess of loss) reinsurance. Here, the reinsurer pays only if claims exceed a certain threshold. Examples include:

  
  

  • Stop-loss: The reinsurer covers aggregate claims above a set amount or percentage.

  • Excess of time: Common in disability or long-term care, reinsurers step in after claims continue beyond a time limit.

  • Catastrophe coverage: Used when multiple claims arise from a single event.

    
    

Each structure is designed to fit the insurer’s unique portfolio, balance sheet, and strategic goals.

Retrocession: Reinsurers Reinsuring

Just as insurers use reinsurers, reinsurers themselves often transfer some of their assumed risk to other reinsurers, called retrocessionaires. This additional layer spreads risks even further, making the system more resilient. By the time a client’s policy is in force, its risk may have been sliced and shared by several different entities across the globe.

Global Reach and Scale

Reinsurance is now a worldwide business. According to the American Council of Life Insurance (ACLI), in 2022, U.S. life insurers ceded $374 billion in total reinsurance premiums, with $153.3 billion (41%) going to reinsurers domiciled outside the United States. This international scope not only increases capacity but also diversifies risks across geographic regions, regulatory environments, and capital bases.

The Hidden Role in Client Protection

Most policyholders will never hear the word “reinsurance” when buying coverage, but it underpins the security they rely on. By spreading risk and stabilizing insurers’ financial results, reinsurance ensures that life insurers can pay claims even in the face of extraordinary events.

It also supports competitive pricing. Because insurers can rely on reinsurers to shoulder part of the burden, they can issue larger policies and offer broader coverage at more affordable rates than they otherwise could. For high-net-worth individuals who often require significant amounts of coverage, reinsurance makes those policies possible.

Regulatory and Policyholder Considerations

Reinsurance is also closely watched by regulators. Since ceding risk changes an insurer’s capital position, regulators require that reinsurance contracts be carefully structured to ensure policyholder interests are safeguarded. For example, supervisory bodies such as BaFin in Germany or state insurance departments in the U.S. evaluate whether reinsurance arrangements unfairly shift costs or reduce client profit participation inappropriately.

While the practice primarily benefits insurers, its ultimate purpose is to protect policyholders by making life insurance markets more stable, flexible, and innovative.

Sharing the Risk

Life insurance reinsurance may be invisible to policyholders, but it is indispensable to the functioning of the industry. By acting as a financial backstop, providing technical expertise, and spreading risks across a global network, reinsurers make it possible for insurers to issue the very policies families and businesses depend on.

For affluent individuals purchasing large policies, reinsurance ensures that those obligations can be honored - today, tomorrow, and decades into the future. It is, quite literally, the insurance behind your insurance.