Final answer:
In the context of a reinsurance transaction, the AAA insurance company is known as the ceding company, and the BBB insurance company is called the reinsurer. This process assists in managing risk exposure and maintaining financial stability for the ceding company.
Step-by-step explanation:
In a reinsurance transaction, the AAA insurance company is referred to as the ceding company or cedent when it transfers a portion of its loss exposure to the BBB insurance company, which in this context is known as the reinsurer.
This arrangement helps the ceding company mitigate the risk of potential large losses by sharing it with another insurance entity. It is not to be confused with coinsurance, which is a separate concept where an insurance policyholder pays a percentage of a loss, and the insurance company pays the remaining cost.
Reinsurance can enable insurance companies to write more policies and accept greater risks than they would be able to manage on their own. Without reinsurance, the ceding company might be exposed to the financial instability caused by significant losses.
In the event the ceding company tries to charge a group an actuarially fair premium, but the risk profile is not uniform across the group, it could lead to financial losses or customers being disincentivized to purchase insurance due to increased premiums, affecting both high and low-risk individuals.