Reinsurance occurs when multiple insurance companies share risk by purchasing insurance policies from other insurers to limit the total loss the original insurer would experience in case of disaster. In other words, it is a form of an insurance cover for insurance companies.
The important legal considerations are summarized below in stratum –
(a) As a general rule, reinsurance is a contract between the direct insurer and the reinsurer to which the original assured is not a party and which does not obligate the reinsurer to the assured. If the reinsurer fails to meet their liability, the direct insurer would still be liable for the whole, loss to the policyholder. Policy holder’s redress lies with the insurer and not reinsurer.
(b) Contracts of reinsurance require utmost good faith on the part of the insurer. Generally, the same rifles with reference to misrepresentation and non-disclosure, which apply in connection with ordinary insurance contracts, apply in cases of reinsurance contracts.
(c) The contract of reinsurance is equally subjected to the requirement of insurable interest. It is a legal financial interest which entitles the insured or the insurer to insure or reinsure.
(d) Reinsurance is an agreement to indemnify the direct insurer, partially or altogether against a risk assumed by him in a policy issued to a third party. Reinsurance is a contract which involves the principle of indemnification.
(e) The reinsurer is obligated to the ceding company. The direct company known as the reinsured, by its contract with the reinsurers obtains the power to collect from the reinsurers by reason of the loss suffered by the original insured.
(f) From the business relationship established between the reinsurer and the reinsured the may arise a contract of reinsurance. The risk assumed in reinsurance must be determined by examining the contract of reinsurance. It cannot be taken for granted that the risk covered by the reinsurance contract is the same as, that covered by the original policy written by the direct insurer.
(g) Reinsurance does not mean coinsurance for the same reason as explained under double insurance whereas in coinsurance the insured is contractually linked up with the various co-insurers directly to the extent of respective shares assumed by them, in reinsurance be (insured) is not a party at all.
(h) Usually, reinsurance is liable as per liability of the original insurer. Therefore when ex-gratia payments, are made by the original insurers on different considerations without admitting liability under the policy of insurance they cannot claim recovery from their reinsurers.
(i) When after making payment of a claim the insurers make any recovery from the liable third party as tier policy terms and conditions the reinsurers become entitled to such recovery proportionately. This means that the principle of subrogation applies. The insurer cannot make a profit by recovery from all the sources.
(j) As insurance contracts are contracts of indemnity, the principle of contribution also equally applies to reinsurance contracts, the ceding company cannot recover from each reinsurer full amount of loss independently.