(a) What is reinsurance? (b) Explain four essential features of insurable interest.

Answer Details

(a) What reinsurance is

Reinsurance is the arrangement by which an insurer (the ceding company or direct insurer), having accepted a risk from its policyholder, transfers or passes on part of that risk to another insurer (the reinsurer) in return for a share of the premium. In effect it is the "insurance of the insurer": it enables the original insurer to spread very large or heavy risks, avoid a single catastrophic loss, increase its capacity to accept business, and protect its solvency and stability. The policyholder still deals only with the original insurer, who remains fully liable to him.

(b) Four essential features of insurable interest

Insurable interest is the legal right to insure arising from a financial relationship, recognised at law, between the insured and the subject matter of insurance. Its essential features are:

• There must be a subject matter of insurance: There must exist some property, life, right, interest or potential liability that is capable of being insured, for example a house, a life, a motor vehicle or a legal liability.
• The insured must have a legal relationship with the subject matter: The interest must be recognised and enforceable at law, arising through ownership, possession, a contract, a mortgage or another legal right, and not merely from sentiment or mere expectation.
• The insured must stand to benefit from its safety and to suffer from its loss: The insured must be so situated that the continued existence or safety of the subject matter brings him financial benefit, while its loss, damage or destruction causes him a financial loss.
• The interest must be capable of being valued in money (financial value): The loss that would follow from damage to the subject matter must be measurable in monetary terms, so that a definite pecuniary interest can be established and compensated.