We're going to have to deep dive into the reinsurance business here, so make sure you have some coffee handy...
Insurance companies have insurance companies too. These firms are called reinsurers. You might think this results in the most boring sales meetings of all time (and we're not going to argue with you). But these reinsurance policies help insurance companies limit their exposure to risk.
Reinsurance policies come in a variety of flavors. One form depends on what's called "quotas." In a quota system, the original insurance company (called the "ceding company" in the industry jargon) and the reinsurer share any losses according to a fixed percentage. So the ceding company might ask the reinsurer to take on 20% of the risk. They will then pay out 20% of any losses incurred, and will likely receive 20% of all premiums received as compensation.
Another form of reinsurance involves protecting companies against losses above and beyond a certain point. In these cases, the ceding company receives all the premiums and pays out all claims up to a certain point. If losses mount above a certain threshold, the reinsurer steps in and covers any additional costs. For this, the ceding company pays a certain amount for the coverage. They are fundamentally buying an insurance policy the same way you might.
Combination plan reinsurance uses aspects of both these structures. The ceding companies pay all claims up to a certain point. Above that level, the reinsurance company steps in. However, instead of covering all the losses, the reinsurer covers a fixed percentage; a quota system is in place from there.
This is a riskier situation for the ceding company, because there's no total cap to the losses. But the coverage will likely be cheaper, because the reinsurer is taking on less risk themselves.
Related or Semi-related Video
Finance: What are Secured Bonds v Unsecu...54 Views
finance a la shmoop what are secured bonds versus unsecured bonds and
debentures okay so that's an insecure bond but we're talking about here is an [Insecure bond hiding under the sheets]
unsecured bond what is an unsecured bond well this is that was an unsecured bond
old school like 15 century old school it was just a handshake one guy promised to [People shake hands]
pay back another 400 pounds of barley in return for three sheep next year or
something like that and the sheep were the payment form not the guarantee and
the bond was loan emic bond ursins word in fact the promise to pay was secured
but by his word or commitment to repay the loans kind of old school debenture
unsecured bonds work similarly today corporations sell debentures to Wall [Corporations sending debentures to Wall St]
Street all the time debenture being a fancy word for an
unsecured bond it's just debt that the company promises [Definition of debenture]
to pay back well if they don't then oh well and yes the debenture holders could
in theory then take ownership of the equity of the company but in reality [Debenture holders take the majority of the company equity pie chart]
unsecured bonds when not paid back almost always mean the death of the CEOs
career and likely also of the careers of all the other members of the management [Gravestones for the management board]
team so while unsecured bonds are notionally more risky than secured bonds
well this issue hasn't been tested all that often in real life okay so if
that's an unsecured bond what's a secured bond well it's one that
is secured by a specific asset or value or other stores of wealth which get [Definition of secured bonds]
forfeited if the lendee doesn't pay back the lender on time and in accord with
the terms of the debt deal example the dung and the restless' is a company that [Sign for 'The Dung and the Restless']
makes fertilizer by collecting old political speeches and grinding them up [Speeches going into the grinding machine]
selling them to farmers in the Midwest you know for a coin but they also own a [Tractor spraying crops]
pork farm which is kind of separate from their main fertilizer biz they need [Hogs Gone Wild logo appears]
money to build a bigger grinder because politicians are giving more speeches
these days you the internet and all that and they [Politician being applauded]
pledged their pork farm as collateral behind that secured bond offering that [Collateral sign on the pork farm]
is if they don't pay back the bond interest and principle on time then they
lose the pork farm to the lenders yeah and that would be a pig mistake... [Guy snorts like a pig]
Up Next
What are Bonds? The simplest explanation is that a bond is essentially an I.O.U. that is issued by a corporate or government institution to borrow...
What are the Major Classes of Bonds? Insofar as US dollar denominated bonds go, the primary classes of bonds are: 1) US Treasury Bonds; 2) US Treas...
What are the different types of bonds? Well, a mortgage is the biggie. Then there are government bonds, which are at the bottom of the risk ladder....