A type of reinsurance that transfers over only a finite or
limited amount of risk. Risk is reduced through accounting or
financial methods, along with the actual transfer of economic
risk. By transferring less risk to the reinsurer, the insurer
receives coverage on its potential claims at a lower cost than
traditional reinsurance.
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For example, an insurer will set aside an amount to cover a
percentage of the payouts that would be required if the particular
risk is realized. Only when the amount does not cover the payouts
will the reinsurer cover the risk. This limits the potential risk
that the reinsurer faces and leads to lower costs for the
insurer. The amount set aside is usually invested in government
bonds and provides income that is put against potential claims.
Due to the highly complex structure of these risk instruments,
there can be abuses where no risk is transferred and the insurer's
income is improved.
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