Reinsurance: A Review

The article Reinsurance is about the process of reinsurance by insurance company owners, who buy insurance to pay for their insurances, in terms of insurance payment.

Primary insurers and reinsurers both share the premiums and losses, or reinsurers may bear the primary company’s losses above a certain dollar limit for a fee. 

Risks of various kinds of natural disasters, are being sold by insurers and reinsurers to institutional investors in the form of catastrophe bonds and other alternative risk-spreading mechanisms, which was not available earlier.

 

Important insights of Reinsurance:

One main insight into the insurance business that Reinsurance provides is to ensure it will be able to pay all potential future claims related to the policies it issues. 

Although By this requirement insurers protect consumers, it limits the amount of business an insurer can take on. Therefore, if the insurer can reduce its responsibility, or liability, for these claims by transferring a part of the liability to another insurer, it can lower the amount of capital it must maintain to satisfy regulators that it is in good financial health and will be able to pay the claims of its policyholders. 

The important thing is, capital freed up in this way can support more or larger insurance policies. 

The primary insurer, the company that issues insurance, is ceded by a secondary insurer, a company that assumes liability from the primary insurer, and is known as the reinsurer. Primary companies are said to “cede” business to a reinsurer.

The two insurance types, Treaty and Facultative are the main types of insurance. The treaty type of insurance is agreed upon by the two groups and the insurer covers pretty much all the aspects that ate stated in the treaty. 

Facultative insurance is issued by reinsurance company, and it can agree or reject different coverages the insurer initially offers. If the reinsurance company observes any attitudinal or methodical discrepancies in observing safety and precaution, it has liberty to reject if the company finds any objectionable or malpractices. 

Insurance coverage can be pro-rata or non-proportional. Pro-rata coverage usually is covered by both primary insurer and reinsurance company, by sharing both losses as well as premiums. 

Excess of loss or non- proportional insurance is covered to an extent by the primary insurer and above that, possible losses are covered by reinsurer, who is paid premiums by the primary insurance.  Example of such losses are are hurricane and other such disasters.

This aspect is very much similar to what we discussed in the class, about the coverage of insurance, even after the deductibles are paid by the person or company or property insured by the owner, the reinsurance company can reimburse the amount paid as deductibles. 

Reinsurance has come to be regularized since the mid to late 80s. Insurers submit financial statements to regulators who monitor their financial health. "Financial health includes assuming prudent risk or liability for future claims. The principal value of reinsurance to a ceding company (the purchaser of reinsurance) for regulatory purposes is the recognition on the ceding company's financial statement of a reduction in its liabilities in terms of two accounts: its unearned premium reserve and its loss reserve. 

The unearned premium reserve is the amount of premiums equal to the unexpired portion of insurance policies, i.e., insurance protection that is still "owed" to the policyholder and for which funds would have to be returned to the policyholder should the policyholder cancel the policy before it expired. 

The loss reserve is made up of funds set aside to pay future claims. The transfer of part of the insurance company’s business to the reinsurer reduces its liability for future claims and for return of the unexpired portion of the policy. 

The reduction in these two accounts is commensurate with the payments that can be recovered from reinsurers, known as recoverables. The insurer’s financial statement recognizes as assets on the balance sheet any payments that are due from the reinsurer for coverage paid for by the ceding company."

This is a very important element in understanding how reinsurance is regulated as well as executed. Losses are covered to the extent the primary insurance company agrees, and what the reinsurance company either follows by the treaty or deems it as necessary loss to be covered. The unearned premium of the insurance coverage will be returned to the policy holder, should they decide to close, while it is still unexpired. This and the loss reserve forms the recoverables from the reinsurers.

After observing complications that arose after the 80s and 90s, in order to enable regulators, policyholders and investors to assess a company's financial condition more accurately, the NAIC requires insurance companies to deduct 20 percent of anticipated reinsurance recoverables from their policyholders’ surplus on their financial statements—surplus is roughly equivalent to capital—when amounts are overdue by more than 90 days. The rule helps regulators identify problem reinsurers for regulatory actions and encourages insurers to purchase reinsurance from companies that are willing and able to pay reinsured losses promptly

Hurricane Andrew and Katrina and other catastrophes have generated development in the insurance industry, to rely on reinsurance and the industry is also regulated to avoid risks and irregularities and cover losses and minimize overpayment.

The article is identifying reinsurance, regulation, problems faced by studying over a period of more than twenty years. A catastrophe bond, resulting, "is a specialized security that increases insurers’ ability to provide insurance protection by transferring the risk to bond investors. Commercial banks and other lenders have been securitizing mortgages for years, freeing up capital to expand their mortgage business. Insurers and reinsurers issue catastrophe bonds to the securities market through an issuer known as a special purpose reinsurance vehicle (SPRV) set up specifically for this purpose. These bonds have complicated structures and are typically created offshore, where tax and regulatory treatment may be more favorable. SPRVs collect the premium from the insurance or reinsurance company and the principal from investors and hold them in a trust in the form of U.S. Treasuries or other highly rated assets, using the investment income to pay interest on the principal. Catastrophe bonds pay high interest rates but if the trigger event occurs, investors lose the interest and sometimes the principal, depending on the structure of the bond, both of which may be used to cover the insurer’s disaster losses. Bonds may be issued for a one-year term or multiple years, often three."

In addition to catastrophe bonds, other options were also introduced, but they could not take off. 

Natural disasters, wars, terroristic activities that were not available for insurance are now managed and risk spread out and reduced due to reinsurance coverage. 

Article also throws light on nine-eleven of September, 2001and later problems faced by large scale of people and companies. 

Globalization is spreading the geographic regions that needs to be covered by reinsurance, owing to the fact that, there are companies in more vulnerable parts of the world in different countries. 

Insurance to different items like what has happened in New Delhi in 2013, and other places, where women are raped, tortured and left to die, and honor deaths, should be available and also, precautionary measures available, where self-help trainings, awareness camps, overseeing authorities, should also be developed, in addition to offering of insurance by may be privatized companies or government bodies, in the global arena, and also provide security to women being trafficked to different countries and cultures. 

This is one dark side in the society, where no one is willing to act upon, as it is not conducted by one person but is an organized crime. Funds from States and Unions should be allocated to protect these as well as those people who are losing their people in wars, and calamities and due to starvation and negligence. This may outrightly seem out of the boundary of insurance, but I am foreseeing a future, where not only insurance companies, regulators but also law and order, non profit organizations may act in tandem. 

References:

"Reinsurance" from Insurance Information Institute, November, 2014.

The Essential Guide to Reinsurance: Solutions to 21st Century Challenges. Swiss Re, 2012. A guide to the concepts of reinsurance and its contributions to the economy and society.

"Reinsurance: Fundamentals and New Challenges," Insurance Information Institute, 2004.