What is Reinsurance?
You might have heard of reinsurance companies, often described as “the insurance company for insurance companies,” but have you ever wondered why these businesses take on the risks that primary insurance companies don’t want? What makes a reinsurance company agree to insure risks that seem too large or too complex for a regular insurer? If the primary insurance company doesn’t want to hold onto the risky policies, why would the reinsurance company want it?
Reinsurers Can Take It
Here’s where the genius of reinsurance companies comes in: diversifications. While a primary insurer might be heavily exposed to one country or one type of insurance (like home insurance in hurricane-prone regions), reinsurers operate on a global scale, spreading their risk across various geographic regions and types of insurance products.
For example, a reinsurer like Swiss Re or Munich Re may underwrite property insurance in the U.S., life insurance in Europe, and health insurance in Asia. Because of this wide-ranging exposure, they are less impacted by localized disasters. A hurricane in Florida might severely impact a U.S.-based insurer, but for a global reinsurer, the effects are balanced by income from other, unaffected regions.
Share the Wealth
Another thing to note is that reinsurance isn’t always about fully offloading risk. Often, primary insurers and reinsurers share the risk. This is known as proportional reinsurance, where the reinsurer takes on a percentage of both the premiums and the claims. For instance, if a reinsurer takes on 50% of a policy, they can get 50% of the premium but also pay out 50% of the claims.
This sharing mechanism is a true win-win, because it allows primary insurers to protect their financial stability, while reinsurers get access to a broader range of premiums across different sectors and markets. Additionally, the reinsurer benefits from their expertise in managing large, complex risks. The primary insurer company can be happy with reducing their exposure to significant losses.