Reinsurance tutorials #2 • The Basics
What is reinsurance?
To provide a cover to their insured customers, insurance companies try to mutualize their risks on a very large basis with mass products: motor, homeowners, L&H, and so on.
The worldwide turnover of insurance companies exceeds $5,000 Bn. They employ hundreds of thousands and insure millions of people. They are known to the people.
As for reinsurance companies, they generate a turnover of around $300 Bn, have several thousands of employees and clients, but are mostly unknown to the wider public. It may seem modest, but reinsurance is badly needed, notable for:
- Offering capacity: to be a reliable and attractive partners to the insurance companies and their brokers
- De-risking: insurance companies face high competition, and thus low margins, increased volatility of their book of business at a time of increased severity of individual claims for individuals and increased trend to go to court, increased frequency and severity of CAT (catastrophe) events be it floods, hurricanes or even wildfires increased uncertainties on the legal side, social behaviour, economic environment, emergency and development of new risks they never thought of, did not exclude from their cover and that could be life threatening.
Insurance companies need:
- to protect their Surplus Funds against:
- Highly dangerous risks (e.g. chemical plants...)
- High sums insured where there is hardly any mutualization possible (e.g. satellite...)
- New risks very difficult to assess (e.g. cyber, terror...)
- Big CAT (catastrophe) events involving a huge number of risks and their accumulations of money at stake
- to innovate and face competition, they need to improve their own efficiency, innovate in terms of products and services offered. In order to achieve this, they have to bear a cost and take up risk. Reinsurers are much needed to meet these requirements.
- to optimize their portfolio of risks and their balance sheet for the cheapest possible price.
- Take over the volatility, high sums insured and/or dangerous individual risks
- Take over the volatility of major deviations due to large NAT CAT (natural catastrophes) or man-made CAT (catastrophe) events
- Offer services such as risk surveys (Life, Non-Life), portfolio audits, claims handling and reserving
- Offer solutions about the best way to reinsure a book in view of its own characteristics
- Offer solutions and support on protection and innovation
- Offer an alternative to the need to go the capital market to hire funds
How do reinsurers proceed ?
They use diversification of risks and work on a worldwide basis to compensate deviations on one type of risk or one market. They control their own risks. Reinsurance comes at a price, and reinsurers protect themselves too!