Reinsurance offers primary insurers capital relief and flexible financing.
Have you ever wondered what happens when insurance companies need insurance? Enter reinsurance: coverage that is bought by an insurer with the expectation of passing on larger risks to the reinsurer.
What is Reinsurance?
According to Investopedia, reinsurance is “when multiple insurance companies share risk by purchasing insurance policies from other insurers to limit the total loss the original insurer would experience in case of disaster.” By spreading risk across multiple parties, an individual insurance company can take on clients whose coverage would be too great of a burden to handle alone. All companies involved in a particular instance of reinsurance share in the premiums and profits of the coverage in question, but they share the responsibility for any losses as well.
Reinsurance can help insurance companies in many ways. The first and most obvious way is through shared or transferred risk. If an insurance company sells a life insurance policy worth $8 million, they can insure that policy through another insurance entity for $4 million. When the time comes for the beneficiary to cash in, both insurers will be on the hook for $4 million, having both shared in the premiums and profits of the policy up until that point. In other words, when insurers cede part of their business to reinsurers, they reduce their overall underwriting risk.
Capital Management and Rate Stability
Risk transfer provides smaller insurance companies with the opportunity to free up capital by avoiding large losses. Strategic reinsurance programs are customized to help insurers optimize their capital structures in order to improve returns and minimize costs. For these reasons, reinsurance is increasingly integrated into the long-term strategy and growth plans of many insurers.
When small insurance companies purchase reinsurance, capital is freed up as premiums are lowered and the need for vast financial reserves is reduced. By providing protection to insurers from the risk of high costs incurred by any policyholder, reinsurance companies are in effect establishing a backup reservoir of funds to help pay for catastrophes. Since the bulk of risk for large losses is shifted to the reinsurer, small firms protected by reinsurance can then underwrite risks that they would not otherwise venture to take. Because this phenomenon drives premiums down, the smaller insurer is then able to sell more policies and increase its profit margins.
The Future of Reinsurance
Many insurance carriers and independent agents are anxious about the future of the insurance industry, struggling to keep premiums low and wondering whether they will lose business to financial and insurance tech startups. Reinsurance offers insurance professionals an avenue to stay competitive in a rapidly changing insurance marketplace.
The reinsurance industry will undoubtedly face challenges in the years ahead, as demands for increased transparency and tightening regulations have historically threatened the reinsurance process. Reinsurance will thrive if and when agencies, independent brokers, and government officials successfully design a regulatory framework. Ideally, that framework will preserve both the public’s confidence in the financial viability of reinsurance, as well as a stable supply of skilled, knowledgeable underwriters who truly understand the risks and rewards that reinsurance can offer.