Reinsurance: what is it and what is its importance
Insurance companies are not without risk and also have to figure out how to protect themselves by purchasing insurance for themselves; that is, reinsurance.
This is key to reducing the percentage of loss that they could suffer in the event of being the victim of a catastrophic event. Furthermore, this not only protects them but also their customers.
If you want to know in depth what reinsurance is, how it works, and why it is so important, here we are going to explain it to you in a simple way so that you can understand it well.
What is reinsurance?
Reinsurance is a mechanism available to insurance companies to reduce the risk of bankruptcy or financial ruin in the event of a catastrophe.
In summary, it is insurance made specifically for insurance agencies and its main objective is to ensure the survival of a company after being exposed to an unfortunate event or disaster.
For example, if a natural disaster, such as a hurricane, were to cause significant damage in an area where an insurance agency has multiple clients, the company would have little chance of covering all losses.
However, reinsurance makes it possible, as it works by distributing parts of the coverage to other insurance companies, not having to cover the entire cost of risk. Types Of Reinsurance And Why The Insurers Need It?
How did reinsurance come about?
According to information from the Reinsurance Association of America, reinsurance dates back to the 14th century, when it was used for marine insurance to protect against fire.
Subsequently, due to the commercial and industrial development that occurred in the 19th century, insurance boomed and it was necessary to seek new forms of more flexible reinsurance.
From that moment, its application was extended, now coming to cover everything related to the insurance market. There are even companies that are dedicated only to selling reinsurance, especially in the United States
How does reinsurance work?
Reinsurance consists of transferring to other insurers, it can be one or several, the risk that an insurance company has, which was transferred to it through various natural and legal persons.
This helps companies to respond and guarantee coverage for claims or complex cases that generate very high expenses.
This process does not involve sharing the premium of the insured, being one of the benefits that reinsurance brings.
The importance of reinsurance
Insurance agencies purchase reinsurance for four main reasons:
- Limit your financial responsibility for a specific risk.
- Decrease or stabilize the loss experience.
- Protect themselves and their clients against catastrophes or disasters.
- Increase your financial support capacity and have more clients.
Reinsurance provides multiple advantages for insurance companies, among which the following stand out:
Reinsurance helps companies reduce the impact that a catastrophic event can have on them, preventing them from going bankrupt and still having to respond to claims by the insured.
An insurance company assumes the risk of possible claims that each of its policyholders will present, so reinsurance is an excellent strategy to limit your financial responsibility, placing part of the burden on the other company or companies instead of assuming the responsibility. responsibility alone.
Access to companies with more experience
Policyholders go to insurance agencies when they need advice, but… where do insurance companies go when they need advice or help? to reinsurers.
Reinsurers are more experienced entities and fully trained to understand industry patterns and the risks clients face, so they can provide guidance to other companies, especially those that have only been in the market for a short time.
Stabilize financial losses
Despite the fact that insurance companies have, for the most part, the financial capacity to face claims and respond to coverage, reinsurance is the perfect ally.
This means that the insurance company does not have to face significant losses and reduces the stress and risks of having many clients.
Have more insured
Reinsurance helps protect companies against a lack of economic solvency and guarantees that companies can respond to the claims of more customers, being able to increase their portfolio of insured.
The acceptance of multiple clients is fine because they are economic income, but if you do not have reinsurance, the risk also increases and may pose a danger to face unfortunate events, from which you are never exempt.
Every policy carries a certain amount of risk and cost, from paying sales agents to administrative issues. For this reason, it is necessary to seek to reduce this burden and ensure that the company focuses on growth, leaving concerns about risks behind.
In the absence of reinsurance, companies would be forced to limit their acceptance of risk to only an amount that they could absorb without being compromised.
This means that they could not accept a risk that went beyond their resources or their financial strength and, therefore, their offer and services would be very limited, being unattractive to customers.
Reinsurance offers flexibility to insurers by providing a condition that allows them to take risks that are beyond their financial capacity or resources.
types of reinsurance
There are two main types of reinsurance, depending on how risk and liability sharing work.
Insurance companies sometimes share a portion of the premiums and risks. In other cases, a loss threshold must be reached before reinsurance kicks in. Likewise, they can cover an entire portfolio or just one risk.
Depending on the characteristics, reinsurance is classified into two: reinsurance by agreement or treaty and facultative reinsurance.
Reinsurance by agreement or treaty
A reinsurance treaty, also known as compulsory reinsurance, is an agreement between the main insurer and the reinsurance agency. There it is established that the primary insurer yields certain risks and that the reinsurer assumes them.
In this way, the reinsurer agrees to cover large groups of policies. Generally, these agreements are only valid for a specific time and then expire.
Facultative reinsurance, unlike reinsurance by treaty, assumes that each risk is underwritten individually, that is, that it is established on a case-by-case basis how responsibility is to be assumed.
Generally, this type of reinsurance is high risk and covers stronger events, such as hurricanes or other natural phenomena. Each agreement may or may not be proportional.
It is a modality of mixed reinsurance. In this type, the reinsurer has the obligation to accept the risks ceded by the insurer as long as the requirements established in the letter of guarantee are met, even though the latter is not obliged to transfer them.
proportional reinsurance vs. non-proportional reinsurance
Within reinsurance agreements, there are two options: proportional reinsurance and non-proportional reinsurance.
In proportional reinsurance, the insured and the reinsurer reach an agreement on the percentage of premium and risk that each one will take. They can be of three types.
- Surplus contract: the reinsurer assumes a certain percentage of claims if a set amount is exceeded.
- Fee contract apart from each one: the percentage of risks that the reinsured will assume is determined and the corresponding premium is defined; the percentage does not have to be even.
- Compulsory insurance: the reinsurer compulsorily accepts the risks ceded by the reinsured.
Regarding non-proportional reinsurance, in this, the reinsurer is responsible for a part of the compensation in the event of a claim or accident, but only if a certain figure in the policy is exceeded.
There are three types of non-proportional reinsurance:
- Contract for excess claims: the reinsurer assumes the commitment to take charge of the claim as soon as it exceeds a certain figure or a percentage of the premiums.
- Contract for excess risk loss: an amount is fixed in the event of a claim and when it is exceeded, the reinsurer takes over.
- Contract for excess of loss by event: it is given for risk accumulations with the same insurance company.
Reinsurance plays a very important role for insurance companies because it is what allows them to offer greater coverage to their clients and, therefore, have a larger portfolio and better income.
It is a very valuable tool in terms of risk management for companies when it comes to managing and forecasting exposure to catastrophes, and capital requirements, among other events so that companies can recover from them.