Most people don’t realize the many different areas that impact their insurance policies. One such area is reinsurance. How does reinsurance affect the individual or the business that buys insurance? It impacts the amount of money you pay for your insurance policy. Let’s find out how.
Reinsurance
Reinsurers insure the insurance company. The term reinsurer came about from the concept of “re” being defined as “once again” as in to re-apply a coat of paint. Reinsurers pay for losses that occur under the specific contract that is signed between themselves and the insurance companies that they reinsure. Usually, these agreements provide reimbursement for catastrophic types of losses. Examples of catastrophes that may be reinsured range from wide-spread losses that occur over a large geographical territory (such as storm damages from hurricanes and tornadoes) to claims involving significant dollar amounts at a specific location (such as damages associated with the September 11, 2001 terrorist actions in New York.)
Reinsurance protects insurance companies from paying out a significant amount of their policyholder surplus (savings) in cases where the insurance company is obligated to pay out very large dollar amounts usually within a very short period of time. In these situations, reinsurers reimburse companies for amounts paid out. However, reinsurance is, in some ways, nothing more than a loan to the insurance company. When reinsurers make payments to insurance companies, they will often recoup their payout in the form of higher prices in future years for the reinsurance they provided to such insurance companies. This approach is similar to what happens with your policy when the primary insurance company increases its prices when you
make claims under the policy.
Insurance companies typically purchase reinsurance in one of the following methods: treaty, facultative or bordereau. Companies can use all of these methods at the same time. Treaty reinsurance is negotiated across the insurance company’s entire book of business according to agreed-upon criteria. For example, the criterion might be losses that fall within a dollar value range between $500,000 and $1,000,000. Treaties include many exclusions. One such exclusion may prohibit the insurance company from binding any business that fills propane tanks from the potential of a large loss due to explosion.
Treaty exclusions can be overcome when the reinsurer grants an “exception” or “accommodation.” Sometimes these terms are used interchangeably. Other times, “exception” refers to a “minor” allowance of something excluded by the reinsurer, while “accommodation” refers to a “major” allowance. Using my propane tank example, the reinsurer will ask several specific, detailed questions and may agree to make an accommodation based upon answers given pertaining to the specific risk characteristics. One of the most important things that a business can do if it fills propane tanks is to make certain that their refill tank is located a significant distance (i.e., 100 feet or more) from any other combustible materials—buildings, contents, vehicles, etc. If not, the reinsurer will not make an accommodation.
One ancillary benefit of working with reinsurance companies is the opportunity for insurance company underwriters to gain additional knowledge about the kinds of risks involved in their various policies offered. Reinsurance underwriters are experts in their given area and freely share their knowledge with the insurance company underwriters that they work with.
Facultative reinsurance is purchased on a case-by-case basis when a specific risk falls outside of values that are contained within the treaty reinsurance agreement. An example is insuring a building valued at
$1,500,000. Here, if treaty insurance allows values of up to $1,000,000 to be insured, facultative reinsurance would be purchased in the amount of
$500,000.
When facultative reinsurance is purchased, an additional premium must be paid to the reinsurer to cover the additional exposure they have agreed to reinsure. While the purchase of facultative reinsurance was cumbersome in the past, today it is an easy process. Underwriters simply click on an icon on
their computer, answer a few questions and a price for the cost of reinsurance comes back almost immediately. The reinsurance may be immediately bound and used to place the risk with the insurance company.
Bordereau reinsurance is purchased when an insurance company wishes to reinsure a specific set of risks. An example of this type of reinsurance is when a book of business is purchased from another insurance carrier and the purchasing company wishes to limit its loss exposures associated with the new book of business by purchasing reinsurance. A book of business refers to the purchase of several insurance policies from another insurance company. Book of business can be defined in a variety of ways, but examples could include one insurance company buying all personal automobile policies or all farm policies from another insurance company.
Make no mistake—you pay for reinsurance. With treaty reinsurance, it is a cost that is built into all insurance policies. With facultative reinsurance, an additional surcharge is added specifically to your insurance policy based upon your individual risk characteristics.
As reinsurance premiums to insurance companies increase, these costs are passed along to consumers in the way of policy premium increases. With the exception of the years 2001, 2002 and 2003, we have been in a “soft” underwriting cycle for the years 2000-2011. A soft cycle is defined as a time when consumer insurance premiums have remained mostly flat (unchanged), or may have even decreased somewhat. Part of the cause of this phenomenon has been due to reinsurance premiums staying relatively stable overall as the result of reinsurance company profitability.
In 2012 and 2013 the soft market began to “firm” (also referred to as a “hardening” of the insurance market) and the price that primary insurers began charging their policyholders began to rise, generally across all types of policies. The cost for many insurance policies rose by single digits, but it was not unusual to see price increases of 20% and higher.
The 2012-2013 market hardening also impacted the reinsurance companies. They began increasing their prices to insurance companies and this price was passed along by the primary insurers to their policyholders. If you go back to Inside the Insurance Industry– Second Edition, ©2011 you will find that I correctly predicted when the current hardening of the insurance market would takeplace.
insurers will not be reluctant to increase prices considerably for those accounts where loss experience has been poor. On the other hand, if you pay significant insurance premiums (the definition of significant varies from insurer to insurer) and have had good loss history (i.e., no losses for several years), you will be able to keep your pricing level or even reduce your cost of insurance in coming years. Although to reduce your pricing, you must obtain competitive quotes from insurance companies that do not currently provide your coverage.
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