Reinsurance – When numerous insurance firms share risk by acquiring insurance policies from other insurers to reduce their overall loss in the event of a disaster, this is known as reinsurance.
The Reinsurance Association of America describes it as “insurance of insurance firms,” with the concept that no insurance company has too much exposure to a particularly significant catastrophe or disaster.
- Reinsurance occurs when multiple insurance companies share risk by purchasing insurance policies from other insurers to limit their own total loss in case of disaster.
- By spreading risk, an insurance company takes on clients whose coverage would be too great of a burden for the single insurance company to handle alone.
- Premiums paid by the insured are typically shared by all of the insurance companies involved.
- U.S. regulations require reinsurers to be financially solvent so they can meet their obligations to ceding insurers.
The Beginnings of Reinsurance
According to the Reinsurance Association of America, reinsurance dates back to the 14th century, when it was utilized for maritime and fire insurance. Since then, it has expanded to encompass all aspects of today’s insurance industry.
There are reinsurance firms that specialize in selling reinsurance in the United States, reinsurance divisions of U.S. primary insurance companies, and reinsurers that are not regulated in the United States. Reinsurance is purchased directly from a reinsurer or through a broker or reinsurance intermediary by a ceding.
How Reinsurance Works
An individual insurance business can take on clients whose coverage would be too much for a single insurance company to manage alone by distributing risk. When reinsurance is used, the insured’s premium is usually split among all of the insurance firms participating.
If one business takes on the risk on its own, the cost might bankrupt or financially ruin the insurance company, and the loss for the original company that paid the insurance premium could be insufficient to cover the damage.
Take, for example, a major storm that hits Florida and damages billions of dollars in damage.
It’s doubtful that one business would be able to cover all of the losses if it sold all of the homes insurance. Instead, the retail insurance firm reinsurances sections of the coverage to other insurance companies, spreading the risk cost over a large number of insurers.
Reinsurance is purchased by insurers for four reasons: to restrict responsibility on a specific risk, to stabilize loss experience, to protect themselves and their insureds against catastrophes, and to enhance capacity. Reinsurance, on the other hand, can benefit a firm by providing the following:
- Risk Transfer: Companies can share or transfer specific risks with other companies.
- Arbitrage: Additional profits can be garnered by purchasing insurance elsewhere for less than the premium the company collects from policyholders.
- Capital Management: Companies can avoid having to absorb large losses by passing risk; this frees up additional capital.
- Solvency Margins: The purchase of surplus relief insurance allows companies to accept new clients and avoid the need to raise additional capital.
- Expertise: The expertise of another insurer can help a company obtain a higher rating and premium.
When numerous insurance firms share risk by acquiring insurance policies from other insurers to reduce their overall loss in the event of a disaster, this is known as reinsurance. The Reinsurance Association of America describes it as “insurance of insurance firms,” with the concept that no insurance company has too much exposure to a particularly significant catastrophe or disaster.