Definition:Indemnity-based reinsurance
🔗 Indemnity-based reinsurance is a form of reinsurance in which the reinsurer's obligation to pay is tied directly to the cedant's actual incurred losses on the underlying insurance policies, rather than to an external index, modeled loss, or parametric trigger. This structure ensures that the reinsurer's financial exposure tracks the cedant's real-world claims experience, maintaining a direct economic link between the original risk and its transfer.
⚙️ Under an indemnity-based arrangement — whether structured as quota share, excess of loss, or surplus share — the cedant reports its incurred losses to the reinsurer, typically through periodic bordereaux or individual large-loss notifications. The reinsurer then reimburses the cedant according to the treaty's terms, including any retention, attachment point, or cession percentage. Because payment depends on the cedant's actual claims outcomes, follow-the-fortunes and follow-the-settlements doctrines are central: the reinsurer generally accepts the cedant's good-faith claims handling and settlement decisions without requiring independent verification of every claim. Loss adjustment expenses may or may not be included in the recoverable amount, depending on how the treaty is structured.
📈 The primary advantage of indemnity-based reinsurance is the near-total elimination of basis risk for the cedant. Because recoveries are calibrated to actual losses, there is no gap between what the cedant pays out and what it receives from the reinsurer — a critical consideration for solvency management and regulatory capital calculations. Regulators and rating agencies generally grant full credit for indemnity-based reinsurance when assessing an insurer's balance sheet, whereas parametric or industry loss warranty structures may receive partial or no credit due to residual basis risk. The trade-off is operational complexity: the cedant must maintain robust loss reporting infrastructure, and settlement timelines can stretch when large or complex catastrophe events require extended adjustment periods.
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