The insurance industry is focused on managing risk. Producers know that protecting clients from risk also means exposing the companies that provide the coverage to financial risk. While companies may employ strategies to reduce their exposure, such as underwriting guidelines for both health conditions and financial status, large consistent losses may undermine the stability of the company. This is where reinsurance comes into play.
Protecting the protectors
Just like individual consumers, insurance companies will purchase coverage to reduce their risk. This is known as reinsurance. Companies pay a premium for coverage to offset losses sustained on policy claims above a certain amount or of a designated type. This allows companies to provide maximum coverage while still ensuring a stable financial position.
The benefits offered by reinsurance go well beyond financial stability for insurance companies. Carriers invest large sums of money in financial markets, making insurance companies major contributors to the economy as a whole. Therefore, reinsurance also helps to prevent major market fluctuations from occurring should a company sustain considerable losses, thereby reducing widespread negative economic consequences.
Additionally, reinsurance allows companies to offer products and services at more affordable prices, helping clients obtain the coverage they need in a more cost-effective manner.
By acting as insurance for insurance companies, the reinsurance process is relatively straightforward. The key factor to keep in mind is sharing, or, more specifically, how different organizations pass risk to one another to reduce their own exposure.
How does reinsurance work?
Every carrier retains a set dollar amount of coverage for every policy issued. Thus, when a carrier issues a policy above its retention, a portion of the excess coverage will be ceded to one or more reinsurers until all of the excess risk is covered by reinsurance.
For example, if one carrier was faced with paying out all of every claim, there’s a good chance the carrier wouldn’t be able to stay in business for long. Therefore the company shifts a portion of its risk on the life insurance policies it has issued to a reinsurer. The reinsurer can then shift a portion of the risk it has undertaken to another reinsurer (retro) or into capital markets through securitization.
Types of reinsurance coverage
Reinsurance coverage typically falls into one of two camps: treaty or facultative.
Treaty insurance includes a specific pre-negotiated level of risk the reinsurer will cover without individual underwriting. Meanwhile, a facultative agreement involves the primary insurer specifying a certain single risk or package of risks the reinsurer will cover.
Facultative insurance is used less often and is typically only sought by companies for specific risks that treaty coverage does not include or if a case doesn’t qualify for treaty coverage.
The cost of reinsurance
While vital to many insurance companies, reinsurance requires the company to incur an additional cost for the reinsurance.
“Purchasing reinsurance reduces insurers’ insolvency risk by stabilizing loss experience, increasing capacity, limiting liability on specific risks, and/or protecting against catastrophes,” stated a report titled “The Costs and Benefits of Reinsurance” authored by various researchers from North America. “Consequently, reinsurance purchase should reduce capital costs. However, transferring risk to reinsurers is expensive. The cost of reinsurance for an insurer can be much larger than the actuarial price of the risk transferred.”
It’s important to keep in mind that insurance is ultimately a financial product, and insurers may be willing to pay additional costs in order to reduce their risk.
Submitting cases for reinsurance
As a producer working with high-net-worth individuals, you will eventually come across a case that requires reinsurance. In these scenarios, it is important to pre determine which carrier you should submit the case to in order to obtain the desired amount of coverage.
Two factors to keep in mind are jumbo and automatic binding limits. Jumbo limits are intended to safeguard reinsurers, acting as a ceiling for how much coverage may be in-force and applied for without sending the case for facultative reinsurance. The automatic binding limit is the maximum amount of coverage that a primary insurer can automatically bind a reinsurer for without consulting on a case by case basis. Facultative does require full underwriting by the reinsurance carrier.
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