Insurance companies cede part of their risks to reinsurers; thus, a reinsurance company is an insurance company's insurance company. This situation enables insurers to underwrite a larger amount of business than would otherwise be possible, by protecting them both from a series of small losses and from a single big loss arising out of a major catastrophe.
Reinsurance is increasingly becoming the main sector of international insurance cooperation, and it is in this sector that most of the new problems may arise. The world reinsurance market is at present characterized by the existence of 'over-capacity', that is, by the eagerness with which a very large number of international reinsurers and brokers offer cover for all types of risks on very competitive terms and conditions. So far, this temporary 'over-capacity' - which is often of a cyclical nature - may have assisted the emerging insurance companies of the Third World, since these companies are generally highly dependent upon reinsurance protection, and since they have been able to buy such protection easily, on favourable terms. In the long run, however, such a situation tends to be harmful, for the following reasons: (a) reinsurance terms that are too profitable encourage local insurance companies to reinsure abroad much more than they would normally need to, thus depriving themselves and their national market of the bulk of their premiums; (b) easy placing of reinsurance prevents direct insurance companies from selecting their risks with adequate care, and from rating them correctly; (c) serious doubts must be expressed concerning the solvency of those who make these excessively favourable reinsurance offers, which might result in catastrophic bankruptcies, particularly detrimental to the weaker insurance markets of developing countries.
Dependence on foreign reinsurance is much more persistent than dependence on foreign insurance. With an increasing number of countries limiting or excluding direct foreign participation in national insurance markets and restricting the foreign ownership of insurance companies, international reinsurance is gaining in importance in the international arena. Even in countries where the insurance sector has been totally nationalized, dependence on foreign reinsurance cannot be eliminated altogether. This is particularly the case in developing countries, where the premium income is relatively small and where large risks cannot be covered by the premium receipts generated there. Developing countries are concerned about the cost of foreign reinsurance for two main reasons. The first is the cost in foreign currency and the second is the negative impact that excessive recourse to reinsurance has on the growth and development of the domestic insurance industry.