Reinsurance is a transaction where the insurance company, the reinsurer, agrees to indemnify another insurance company, the reinsured or cedent or primary company, against all or part of the loss that the latter sustains under a policy or policies that it has issued. For this service, the ceding company pays the reinsurer a premium. The purpose of reinsurance is the same as that of insurance: to spread risk. The reinsurance receivables are receivable recognized by an insurer or a captive insurance entity for amounts recoverable under a reinsurance agreement.
As per the FASB guidelines, the allowance for credit loss is must be computed for the reinsurance contracts held by the insurance company. The following formula is used in the computation of allowance for credit loss for reinsurance contracts held:
ECL = Reinsurance Claim Outstanding Amount * PD * Loss Given Default