Essentially reinsurance is insurance for insurance companies. That may sound like a circular definition, but in fact insurance companies in the property/ casualty industry do purchase insurance from reinsurers to cover the risk associated with some of their clients.
Reinsurance is a way of transferring or “ceding” some of the financial risk insurance companies assume in insuring cars, homes and businesses to another insurance company, the reinsurer. As an example the Courant Insurance blog notes that insurance premiums rose 50% after the 2010 BP Deepwater Horizon Gulf explosion and oil spill.
"The insurance losses from the sinking of the Deepwater Horizon will be significant and one of the largest losses ever for global offshore energy insurance and reinsurance markets,” said Dr. Robert Hartwig, an economist and the president of the Insurance Information Institute.
British Petroleum (BP) owner of the Deepwater Horizon, and other offshore oil companies most likely purchased additional reinsurance as a result to cede some of the risk against catastrophic insurance losses should another oil rig disaster occur. Courant notes that, Premiums for shallow-water oil rigs rose 15-25 percent in the months after the BP Deepwater Horizon explosion, according to a Moody's report.
"We believe that this event will have a meaningful impact on the market for offshore energy-related insurance coverages," said James Eck, a senior credit officer at Moody's. "Pricing for offshore energy liability insurance will likely also trend higher as insurers and reinsurers take stock of their losses and reevaluate the complex risks associated with drilling in deep waters."
Reinsurance Overview
Reinsurance currently accounts for about 9 percent of the U.S. property/casualty insurance industry premiums in 2008, according to the Reinsurance Association of America website.
Most reinsurance transactions currently occur between two insurance entities: the primary insurer that sold the original insurance policies and the reinsurer. Primary insurers and reinsurers share the risk to avoid over-exposure to high claims outlays by sharing both the premiums and losses. Reinsurance effectively increases an insurer's capital and therefore its capacity to sell more coverage. The business is global and some of the largest reinsurers are based abroad. Reinsurers also have their own reinsurers, called retrocessionaires. Reinsurers don’t pay policyholder claims. Instead, they reimburse insurers for claims paid.
In some cases reinsurers may assume the primary company’s losses above a certain dollar limit in return for a fee. However, risks of various kinds, particularly of natural disasters, are now being sold according to the Insurance Information Institute by insurers and reinsurers to institutional investors in the form of catastrophe bonds and other alternative risk-spreading mechanisms. The III says that new products more and more reflect a gradual blending of reinsurance and investment banking.
Recent Reinsurance Changes
In 2010, the National Association of Insurance Commissioners proposed scrapping that current system with a different approach creating a regulatory framework for reinsurers closer to the model used in other countries, the NAIC says. It would have given the NAIC the power to determine which states could regulate reinsurance.
The current reinsurance practice for U.S companies purchasing reinsurance from foreign reinsurers is to include protection against nonpayment when a claim is made since all foreign reinsurers must post collateral in the U.S. of at least 100 percent of their liabilities to U.S. ceding companies. Without this protection, the ceding company cannot receive credit on its financial statement for having reduced its liabilities through the purchase of reinsurance.
According to the III, some U.S. insurers opposed the NAIC proposal, fearing that a lowering of collateral requirements would make them vulnerable to an option in some foreign countries under which a solvent reinsurer can limit i1ts potential losses for past events, such as workers’ exposure to asbestos, by entering into bankruptcy-like proceedings, known as “solvent schemes of arrangement."
The Dodd-Frank act (H.R. 2571) also established the Federal Insurance Office (FIO), an entity that will report to the President and Congress on the insurance industry. Going forward, insurance will continue to be regulated by the states, but the act includes a narrow preemption of state insurance laws in areas where the FIO determines that state law is inconsistent with a negotiated international agreement. Under the Act, the FIO has the authority to monitor the insurance industry, identify regulatory gaps or systemic risk, and deal with international insurance matters. The FIO covers insurers, including reinsurers, but not health insurance.
According to the Reinsurance Association of America (RAA), premiums for a group of 19 reinsurers for the first nine months of 2010 dropped to $18.3 billion from $18.7 billion for the same period in 2009. The combined ratio, a measure of profitability that shows what percentage of the premium dollar was spent on claims and expenses, deteriorated over the first nine months, rising to 96.6 from 95.1 over the same period in 2009.
