Reinsurance has become a hot topic of discussion within the insurance industry over the past few years. Reinsurance is essentially insurance for an insurance company. It is an arrangement whereby a standard lines insurance company transfers all or part of a risk to another insurance company to provide protection for large losses or catastrophic events and create increased capacity for certain types of risks. With all of the natural disasters in the news this past year, it is relevant for everyone to understand what is reinsurance and understand how it works.
What is Reinsurance?
Reinsurance is insurance that a standard lines insurance company purchases from another insurance company to insulate itself (at least in part) from the risk of a major claims event or catastrophic losses. It also allows insurance companies to offer coverage to more risks of a particular type or in a specified territory. With reinsurance, the purchasing insurance company passes on (“cedes”) some part of its own insurance liabilities to the reinsurance company.
Who are the Largest Reinsurance Companies?
Some of the top reinsurance companies in the world are Munich Re (Germany), Swiss Re (Switzerland), Hannover Re (Germany), SCOR (France), Berkshire Hathaway (USA), and Lloyd’s (England).
How Reinsurance Works
In the simplest terms, reinsurance is insurance for insurance companies. The main purpose is to protect and provide aid to insurance companies when hit with very large, unexpected losses and catastrophic events and create increased capacity for certain types of risks. Through a contract, a reinsurer or reinsurance company covers a portion of the risk that the insurance company takes on, and the contract covers who pays what, what is covered, how and when the reinsurer will step in, and the overall timeframe for the coverage.
Types of Reinsurance
There are several types of reinsurance, each serving a different purpose based on the level of risk and how the reinsurance agreements are structured:
- Proportional Reinsurance: The reinsurance company and standard lines insurance company agree to share premiums and losses based on a fixed percentage.
- Non-Proportional Reinsurance: The reinsurer pays a specific amount when a claim or loss occurs.
- Facultative Reinsurance: This type of reinsurance is arranged on a case-by-case basis. When an insurance company issues a policy with a high risk, it can negotiate a facultative reinsurance agreement with a reinsurer which is a one-time agreement to cover that single risk or set of risks.
- Treaty Reinsurance: Treaty reinsurance is where an insurance company transfers a whole portfolio of risks within a specified class to the reinsurer. Under this type of agreement, the reinsurer automatically covers all risks that fall within the defined treaty terms.. This helps insurers manage risk more efficiently and predictably.
Benefits of Reinsurance
Reinsurance plays a crucial role in maintaining the stability of the insurance market and allowing insurers to continue providing necessary coverage, in high risk categories and even in the face of significant losses. By transferring a portion of their risk to a reinsurer, standard lines insurance companies can better manage financial strain from large claims, ensuring their long-term financial viability. This, in turn, increases their capacity to underwrite larger and more complex policies that might otherwise be too risky to handle alone, allowing businesses and individuals to secure the coverage they need at affordable costs. Additionally, reinsurance strengthens the financial stability of the insurance industry, reducing the risk of insolvency following catastrophic losses and ensuring that policyholders’ claims are paid when needed.
As the insurance industry faces increasing risks from natural disasters and other large-scale losses, reinsurance has never been more essential. By sharing risk with reinsurers, insurance companies are able to provide coverage while maintaining financial security. This benefits not only insurers but also policyholders, ensuring they have access to reliable insurance even in uncertain times. Understanding how reinsurance works can help consumers feel more confident in their coverage and the security of their insurance providers all together.