How does Insurance differ from Reinsurance? Also elaborate the statement that the financial condition of an insurance company cannot be adequately assessed without sound loss reserve estimates.

Insurance, is a protection for the individual, whereas reinsurance is the protection taken out by a large insurance firm to ensure that they survive large losses. The premium that is paid by an individual will be received by the company that provides the insurance whereas the insurance premium paid for reinsurance will be divided among all the insurance companies in the pool that bear the risk of loss. Insurance spreads the financial risk of a specific individual or entity among all policyholders, so that the burden of a potential loss is shared and manageable. Reinsurance helps insurers manage risk by transferring a portion of their liabilities to the reinsurer, especially in cases of large-scale losses (such as natural disasters). Reinsurance is a financial transaction where an insurance company transfers some of its risk to another insurance company, called the reinsurer, in exchange for a payment. The goal of reinsurance is to limit the losses of insurance companies in the event of a major disaster or claims event. Reinsurance helps insurance companies by: Risk Transfer: Sharing or transferring specific risks with other companies Arbitrage: Purchasing insurance elsewhere for less than the premium collected from policyholders Capital Management: Avoiding having to absorb large losses by passing risk. Reinsurance is less regulated than insurance for individual consumers because the purchasers of reinsurance are considered sophisticated buyers. The financial condition of an insurance company cannot be adequately assessed without sound loss reserve estimates sufficient to meet any outstanding liabilities at any point of time. The estimation process involves not only complex technical tasks but considerable judgment as well. It is important for the insurance company to understand the data before embarking on the task of estimating loss reserve which has a significant impact on the financial strength and stability of the company. Loss reserves constitute a significant portion of an insurer's liabilities. Accurate estimation ensures that the balance sheet reflects the true financial position of the company. If the company has inadequate funds that may lead to liquidity issues, as the company might not have sufficient funds to settle claims promptly. The general insurance companies apart from the general reserves maintain a number of technical reserves which can be divided into following six categories, namely, Unearned Premium Reserves (UPR), Unexpired Risk Reserve (URR), Outstanding Claims Reserve (OCR), Incurred but Not Reported Reserves (IBNR), catastrophe reserves, and claims equalization reserves. A brief explanation of each of these reserves along with its significance has been given as follows; Unearned Premium Reserves (UPR): Unearned premium reserves are the proportion of premiums received which relates to the future period. It is assumed that the risk is uniform over the duration of the policy and the liability arising out of the risk can be met by reserving a pro rata amount of the balance of the premium after deducting initial expenses. In the circumstances of high inflation, changes in expenses and widely fluctuating claims ratio; the expected claims liability under the unexpired risks can differ significantly from the UPR provision. If the UPR is regarded as inadequate, an additional reserve is necessary. The insurer therefore needs to create extra reserve to offset the shortfalls in the UPR by creating an additional unexpired risk reserve (or AURR). Unexpired Risk Reserve (URR): Unexpired risk reserve is created by the insurer to manage the risk arising out of the non-receipt of future premiums. It is estimated by multiplying with the unearned premiums the ratio of the claims incurred in the year to the premiums earned in the same year. The unearned premiums also allow for inflation and changes in experience in the various risk groups and their relative proportion of the total premium. Over and above, a prudent fluctuation margin may be added to the above to minimize the impact of errors associated with the estimation process. Outstanding Claims Reserve (OCR): OCR is maintained by the general insurance companies to meet the outstanding liability for claims which have already been reported and not settled. The commonly used method to estimate OCR is to obtain estimates in respect of all outstanding claims on an accounting date after taking into consideration the following: The certainty of the claim; The likely time needed to complete settlements; The rate of inflation on claims costs between the accounting date and the date of settlements; and The judicial trends in claims settlements. Incurred But not Reported Reserves (IBNR): The IBNR reserve is the estimated liabilities for the unknown claims arising out of incidents occurred prior to the year-end but have not been notified to the company during the accounting period. In practice, the provision for future development on known claims, which is called as incurred but not enough reserved (IBNER) is included in IBNR. The average cost of an IBNR claim often differs from that of currently reported claims. The insurance companies hence develop the ratio of average cost of an IBNR claim to average cost of reported claims, for different classes of business on the basis of historical data in order to measure the effectiveness of the IBNR reserves. Catastrophe Reserves: The catastrophe reserves are created to meet any unprecedented and/ or uncontrollable risk factor affecting the insurer. These reserves are created out of taxed income after taking into account the operating position and the effect of provision upon the presentation of its results. Catastrophe reserve in the long run equates the accumulated catastrophe loadings in premiums without impacting the financial stability of the insurer. Claims Equalization Reserves: Claims equalization reserves are made to smooth out the effects of year-to-year fluctuations in the incidence of larger claims such as the unusual floods in Mumbai in 2005 and in Surat in 2006. The provision is created based on past experience of the frequency of claims and the 'probability density function' of this risk. Claims equalization reserve is not created to meet an inevitable liability.