You’ve heard of insurance, but what about reinsurance? The concept of reinsurance has actually been in existence for over 700 years, starting in Genoa. Its creation was to protect the assets of traders and merchants. Reinsurance has since evolved to be a global industry that stabilizes local insurance markets, and provide capital to the economy.
In a nutshell, reinsurance in its modern iteration serves as insurance for insurance companies. It offers extended coverage of key risks at affordable rates. Risks covered include those associated with natural disasters, unexpected high numbers of expensive claims, and industry liabilities. By transferring these risks, insurers are able to better protect their balance sheet, reduce earnings volatility, and make better use of their capital. It essentially puts companies on more solid ground, allowing them to offer services to a greater number of clients.
Who buys Reinsurance?
Reinsurance companies are quickly rising in worldwide popularity amongst companies of all sizes. There are currently over 200 specialized companies worldwide that offer reinsurance, not including the numerous insurtech companies that have launched in recent years in emerging markets.
Generally speaking, reinsurers work with professional counterparties, which include insurers, brokers, and other reinsurers. There are numerous use cases for businesses that are looking to make use of reinsurance, which according to the Swiss Reinsurance Company which include the following:
- Insurers whose portfolios are heavily exposed to catastrophic events – such as wind- storms, earthquakes or floods – have a strong need for reinsurance cover.
- Small local players need more reinsurance coverage than larger international insurers who can diversify their insurance risks over a bigger client base.
- Insurers writing many different lines of business have a relatively better-balanced portfolio than specialized insurers, which focus on a few business lines or on selling to specific customer groups. Multiline insurers therefore need relatively less reinsurance cover.
- Commercial lines portfolios with a small number of risks with large exposures (such as aviation or utility industries) need more reinsurance than personal lines portfolios with a large number of small and homogenous risks (such as motor insurance).
- Life insurers with a greater proportion of contracts containing a mortality or disability risk element tend to cede more than life insurers with a high level of savings premiums.
- Insurers expanding into new products or entering new geographical regions often use reinsurance to benefit from reinsurers’ expertise and financing. This is of particular importance in life reinsurance.
- Insurers exiting markets or lines of business often use run-off reinsurance to transfer to reinsurers closed books of business where liabilities continue to exist under the contracts.
- Regulatory and rating agency considerations also significantly influence the individual demand for reinsurance cover, as reinsurance is a means to provide capital relief and to improve balance sheet strength.
Reinsurance Stabilizes Premium Rates
The premium rates of insurance are stabilized by reinsurance. Premium rates are generally calculated on the basis of the loss experienced by the insurer in the past, due to the risk concerned. Reinsurance takes this data into account and fixes the premium rate according to various types of risks under mutual agreement. Reinsurance therefore stabilizes the fluctuations of the premium rates of various types of risks.
Reinsurance Helps Companies Expand
Each policy sold carries a certain amount of risk, as well as a certain amount of cost, from pay to administrative costs, and sales agents. This is why company growth is so important. Unearned payment reserve requirements can be a burden for most companies, and reinsurance can help lessen that burden. It allows the company to focus its attention on expansion and growing the number of clients nationwide.
Reinsurance Reduces Profit Fluctuations
The reinsurance plans reduce the fluctuations in the profits of companies. On the flip side, heavy risks are retained by the original insurer, and their profits are greatly upset due to a heavy single loss.
Reinsurance Encourages New Enterprises
It encourages the new underwriters, who in their early period of development, and have limited retentive capacity. In the absence of reinsurance facility, the tremendous growth of new enterprises is not certain.
Reinsurance Minimizes Dealings
In the absence of insurance facility, the insured will have to approach several insurers to enter into various individual insurance agreements on the same property. This involves considerable cost, loss of valuable time and slow down the pace of protection covered. However, due to the reinsurance process, the insurer is required to indulge in the minimum dealings with only one insurer.
Reinsurance is a Worthwhile Investment on the Cusp of Innovation
Insurance companies understand the value of taking out insurance. By extension, it is natural that every insurance company would see the importance of investing in insuring themselves and their reputation through reinsurance. This is being made easier now more than ever, thanks to reinsurers and their long tradition of enabling new technologies.
Insurtech is currently going the extra mile by using AI and Machine Learning to disrupt reinsurance portfolio optimization. Thanks to companies such as Lemonade, the concept of chatbots that streamline how insurance is sold directly to customers, complete with fully automated claims is not new. It is however, on the verge of getting better for reinsurance companies in additional ways that mimic science fiction.
Thanks to technological components that are already in existence, companies will soon be able to ask their reinsurance chatbots questions such as, “How can I increase profits by 15% by minimizing my .5% TVaR, while making sure than less than 25% of my hurricane risk is in South America?” The AI would quickly get to work, and produce results in no time.
It’s important that all startup founders recognize the fact that reinsurance companies are at the forefront of efforts to identify risks that are brought about by new technologies. This is crucial in safeguarding all parties over the long term against the financial consequences of detrimental events, while enabling companies to take risks that would allow them to move forward.