Reinsurance is defined as insurance for insurers. It works by insurers transferring portions of their risk portfolios to other insurers in some form of agreement.
The insurer that “buys” risk, or that “reinsures” an insurance policy is known as the “ceding” party. The party that accepts that part of the risk is the reinsurer.
The Insitute of Insurance Information cites the Reinsurance Association of America in saying that “Reinsurance is a highly complex global business. U.S. professional reinsurers (companies that are formed specifically to provide reinsurance) accounted for about 7 percent of total U.S. property/casualty insurance industry premiums written in 2010”.
How Reinsurance Works
Reinsurance is a method insurance companies can use to remain solvent. This is because it allows them to recover some or all amounts paid in case, they must pay claims resolutions.
Reinsurance reduces the liability on individual risks and gives the insurer protection for multiple or large losses. This protection against risks also allows those that seek reinsurance the ability to have bigger underwriting capabilities in terms of number and size of risks.
It is important to note that Insurers are legally required to keep sufficient reserves to pay all potential claims from issued policies.
According to The Insitute of Insurance Information “as an industry, reinsurance is less highly regulated than insurance for individual consumers because the purchasers of reinsurance, mostly primary companies that sell car, home and commercial insurance, are considered sophisticated buyers.”
Imagine that John Doe’s home is covered against natural catastrophes by Insurance Company “InsureComp”. A hurricane hits the area where he lives. He and his family are ok, but their house was destroyed.
At the same time, InsureComp got 130 claims from the same hurricane, and has no money to pay for them because they themselves were hit hard. Are people going to go without a paid claim? The answer is no. Since InsureComp has a reinsurance policy, Insurecomp would cede the claims to a reinsurance company “Reinsure Inc”. Reinsure Inc which absorbs the risks and pay for the claims.
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Are There Different Types?
Yes. Reinsurance is usually divided into two categories:
- Treaty: Treaties cover broad groups of policies, for example all a primary insurer’s liability coverage.
- Facultative: is coverage bought by a primary insurer to cover a single risk held in the primary insurer’s book of business.
The Importance of Reinsurance
The most important fact is that it gives insurers protection against massive losses and therefore enables risk to be scattered rather than concentrated. It also helps:
- Risk Minimization.
- Risk Transfer.
- Flexibility for wider reach of claims.
Overall, reinsurance is more than a “legal requirement” it is a necessity for insurance professionals. It is all about taking care and protecting the assets and health of your insureds in case you cannot be there for them financially when they file a claim.
Imagine needing a medical treatment and being told “you have no money” after your insurer went broke in a matter of days. Reinsurance is a matter of courtesy and to have people who trust in you, protected.
“The most important fact about reinsurance is that it gives insurers protection against massive losses and therefore enables risk to be scattered rather than concentrated.”
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