How does reinsurance affect you as the policyholder?
It is important to understand that your insurance policy must be strong. It will pay your claims if your insurance carrier has a high A.M. Best rating, and also has a strong reinsurance company behind it. For example, the NASW Risk Retention Group has an A.M. Best “Excellent” rating, and the #1 reinsurance carrier in the world behind it: SwissRE. It is critically important that policyholders do not rely on state guaranty funds because they are totally insufficient to make whole the insurance policy’s insurable limits in the event that the insurance company fails. State guaranty fund limits vary by state but are capped at $300,000 to cover a policy claim, well below insurance policy limits, so you are unprotected if the insurance company is unable to pay your claim. Do not rely on state guaranty funds because, by definition, they are inadequate. When you buy any insurance policy, find out what the A.M. Best rating is, and if and who the reinsurance company is. A weak reinsurance company is a bad risk for you. Reinsurance is insurance purchased by an insurance company under a contract called a “Treaty” by paying reinsurance premium to the reinsurance company to spread its risk to one or more insurance companies. Reinsurance can be purchased for a group of policies (treaty reinsurance), or for a specific risk (facultative reinsurance). The company that buys reinsurance is called the ceding company. “Cede” means to give up control or responsibility for something. In short, some of the risks are given up to the reinsurance company in exchange for the premium paid by the purchasing company. Almost all insurance companies have a reinsurance program in place. The purpose is to reduce the insurance company’s risk exposure to claims losses by passing (ceding) part of the claims loss risk to one or more reinsurers. So why are reinsurers comfortable with selling reinsurance to insurance companies? There are many reasons such as:
- The reinsurer may have more risk appetite than the insurance company.
- The reinsurer may have a more diversified risk pool, such as reinsuring multiple industries and varied occupations.
- The reinsurer is larger, has more assets, more efficiency, and economies of scale.
- The reinsurer operates under more favorable tax laws and overseas domicile.
- The reinsurer operates in countries with more favorable regulation which enables lower capital requirements to cover risk and more liberal risk valuing assumptions in policy pricing models.
Reinsurance risk can be split between many reinsurers who take a percentage of the risk of a corresponding percentage with proportional premiums and claims sharing. This is called proportional reinsurance, or a “quota share” basis. Non-proportional reinsurance is when the reinsurer only pays claims losses that exceed a stated amount in the Treaty. For example, a simple granular example is that the insurance company may have an aggregate policy limit of $3,000,000, but only wants to accept $1,000,000 of the risk arising from a claim associated with that policy. A reinsurance company would assume the risk for the balance. Aggregate reinsurance provides frequency protection to the insurance company such as a number of actual claims and tempered by severity, aggregates, and deductibles paid by the insurance company to the reinsurer. Reinsurance programs are very flexible with numerous designs and combinations. However, they all have one thing in common, and that is to shift some claims loss risk from the insurance company to the reinsurance company in exchange for reinsurance premium paid to the reinsurance company. Make sure that your insurance policy is backed by a strong reinsurance company, and that your insurance company has an “Excellent” A.M. Best rating.