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Reinsurance: Who Insures the Insurance Companies?

When it comes to insurance, most people are familiar with homeowner’s, renter’s, automotive and life insurances. They are personal products people purchase to protect themselves from catastrophic financial consequences if the unthinkable happens. But do you know where the money comes from to pay out a claim if one of your customers has to file one, or if a tornado destroys the headquarters of an insurance company?

What is Reinsurance?

Most of the time, companies will either self-insure or purchase a policy from another company to provide financial protection if the headquarters is destroyed by fire or a natural disaster, or if the business suffers from a break-in or vandalism.

When it comes to protecting themselves from losses due to legitimately filed claims, insurance companies purchase policies on what is known as the reinsurance market. Reinsurers can be specialist reinsurance companies that only undertake reinsurance business, while other times they are traditional insurance companies. Because insurance companies have outstanding policies that can add up to millions or even billions of dollars worth of risk, they will often take out several reinsurance policies to protect themselves from having too much risk.

Top 5 Reinsurance Companies

Here are the top 5 reinsurance companies ranked by A.M. Best (gross premiums written related to unaffiliated assumed business | 2011 fiscal year (U.S. millions)):

  1. Munich Reinsurance Company—$33,719

  2. Swiss Reinsurance Company Limited—$28,664

  3. Hannover Rueckversicherung AG—$15,664

  4. Berkshire Hathaway Inc.$15,000

  5. Lloyd’s$13,621

Protecting themselves from risk isn’t the only reason insurance companies spend millions every year on this type of policy; reinsurance coverage also makes good business sense. By purchasing reinsurance coverage, insurance companies can reduce the amount of capital needed to underwrite policies while at the same time enabling them to absorb larger losses. Having reinsurance coverage can also help insurance companies grow. If an insurer can get coverage for less than it sells policies for, it will make a profit, even if it has to pay out claims. Not to mention, the coverage is legally required in most states. There are actually laws that prohibit insurance companies from writing policies worth more than 10 percent of the company’s net value unless they carry reinsurance coverage.

There are two basic types of reinsurance policies on the market: proportional and non-proportional.

  1. Proportional Reinsurance

    One or more re-insurers will take on a set percentage of the risks from policies written by insurers. The reinsurers’ profits and risks are divided according to this percentage. The original insurer will usually get a percentage of the policies as a commission to cover their expenses.

  2. Non-Proportional Reinsurance

    The reinsurance only comes into effect if the insurer’s losses are over a certain set amount. This is the equivalent of the insurance company having a deductible and basically caps the insurer’s exposure at the agreed-upon limit. Anything above that limit is paid for by the reinsurance company. In the past 30 years there has been a major shift from proportional to non-proportional reinsurance in the property and casualty fields.

Another way insurance companies can mitigate their risk is by actually investing in a re-insurance pool. Pooling arrangements permit participating companies to rely on the capacity of the entire pool's capital and surplus rather than just on its own capital and surplus. Under such arrangements, the members share all insurance business that is written and allocate the combined premiums, losses and expenses.

The Cost of Being a Re-Insurer

Here are the 10 most expensive insurance claims that have caused reinsurers to lean on one another to fulfill extreme financial obligations to policy holders.

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