When you need to protect your business or assets, you buy insurance. However, how do insurance companies protect themselves? The answer is reinsurance. Reinsurance is a unique insurance arrangement in which multiple insurance companies share risk by purchasing insurance policies from other insurers. This is done to limit an insurance company’s total loss in the event of an unexpected disaster.
Known as “insurance for insurance companies,” the reinsurance program works by picking up a portion of the expense instead of having the insurer pay it. This can result in lower insurance premiums, meaning more people are able to afford insurance. Insurers face certain risks that could potentially cause a company to go bankrupt or shut down. It helps prevent financial devastation in the event of a catastrophe.
How Reinsurance Aids Captive Insurance
Captive insurers often use reinsurance as a form of protection. A captive is an insurance company that is set up to insure or reinsure the risks of the group in which it belongs. A reinsurance captive does not issue insurance policies to insureds and generally operates on a non-admitted basis. Reinsurance captives reinsure the risks insured by one or multiple fronting companies. These fronting companies are licensed, admitted insurers that issue policies to the captive’s parent company.
When there is a fronting arrangement, the captive acts more as a reinsurer instead of a direct insurer. However, the fronting company must be licensed in the state in which the captive is located. With fronting arrangements, captives can comply with laws that are imposed by many states that require insureds to provide evidence of coverage.
Additional Protection Lowers Risk
Insurance companies rely on reinsurance to protect them when disaster strikes. An insurance company can only sustain so many losses and reinsurance helps limit these losses to prevent a catastrophic loss that can occur after issuing numerous large payouts. While reinsurance can be a complex topic, its benefits remain clear. The primary function of reinsurance is to protect primary insurance companies against major events that could potentially deplete their finances.
Reinsurance policies are designed to reduce an insurance company’s risk. When a reinsurance agreement is made, the reinsurer accepts part of the risk that the primary insurance company has taken on through the policies it has written. When a home or auto insurer pays a reinsurer to take on a portion of their risk, the primary insurer then becomes what is known as a ceding company.
Decreases Potential Liability
By law, insurers must have adequate capital to ensure that they are able to pay for all potential future claims in relation to the policies they issue. Having this requirement in place helps to limit the amount of business that an insurer is able to take on without putting their business at risk. However, this does not always happen, and some insurance companies choose to take on more claims than they can handle. This can result in financial ruin and the closing of insurance companies.
With reinsurance, insurers are able to reduce their liability for claims by transferring a portion of their liability to another insurer. This can lower the amount of capital that the insurer must maintain to meet regulations and sustain good financial health. When more capital is freed up, it becomes available to cover larger insurance policies.
Types of Reinsurance
There are two main types of reinsurance. These include treaty reinsurance and facultative reinsurance.
- Treaty reinsurance: This is a type of insurance agreement that aims to cover all or a portion of an insurer’s risks. Once implemented, treaty reinsurance remains effective for a set period of time.
- Facultative reinsurance: This type of insurance insures against specific risk factors. When facultative reinsurance policies are written, the underwriter must carefully evaluate individual risk factors before making a decision.
Treaty or facultative reinsurance policies can either be proportional or nonproportional. Also referred to as “pro rata” reinsurance, proportional reinsurance agreements occur when the reinsurer agrees to take on a portion of the losses and receives a prorated share of the premiums from the insurer. Non-proportional reinsurance, also referred to as “excess of loss” reinsurance, occurs when the insurer’s losses exceed a certain amount.
Speak to a Professional Benefits Consultant
Reinsurance can provide a variety of benefits to insurance companies by enabling insurers to continue to accept insurance business. It also reduces risks by spreading them across a wider area, which essentially minimizes losses among individuals. Reinsurance can also help to stabilize premium rates, which are typically calculated on the basis of the loss that is experienced by the insurance company in the past. It can even help reduce competition between companies as insurers have the incentive to act in a cooperative manner. To learn more about reinsurance or to acquire a policy, speak to a professional benefits consultant at BenefitCorp.