August 04, 2023
By Mr. Thandanani Mbhele – SAADP Alumnus and an Actuary: Financially Motivated Reinsurance at Munich Re (Group)
Reinsurance is a vital aspect of the insurance industry that plays a significant role in managing risk and ensuring the stability and sustainability of insurance companies. As an actuarial specialization area, reinsurance demand pulls upon a deep understanding of risk assessment, statistical analysis and financial modelling. In this article, we will touch on the basic principles of reinsurance and its functions, as well as its crucial role in society.
1. What is Reinsurance?
Reinsurance is a contractual arrangement between an insurance company (the ceding company) and another insurance entity (the reinsurer). Through reinsurance, the ceding company transfers a portion of its risks and liabilities to the reinsurer in exchange for a premium. In short, it is insurance for insurers.
2. Some principles of Reinsurance
This is not an exhaustive list but does highlight a few major principles.
- Risk Sharing: Reinsurance allows insurance companies to spread their risks across multiple parties, reducing the potential impact of a large loss on their financial stability.
- Capacity Expansion: By transferring some risk to reinsurers, insurance companies can increase their underwriting capacity and take on more significant risks than they could handle on their own.
- Risk Diversification: Reinsurance enables insurers to diversify their portfolios by covering risks from various geographic regions or lines of business.
- Financial Stability: Reinsurance helps insurance companies maintain financial stability during times of unexpected or catastrophic losses by sharing the burden of these losses with reinsurers.
- Regulatory Compliance: In some jurisdictions around the world, insurance companies are required by law to maintain a certain level of reinsurance coverage to ensure they can meet their financial obligations to policyholders.
Insurance companies can also use reinsurance as a way to acquire expertise from reinsurers; or as another form of funding where the reinsurer provides financing to insurance company for its business needs.
3. Most Common Types of Reinsurance
- Treaty Reinsurance: This type of reinsurance involves a pre-arranged agreement between the ceding company and reinsurer to cover a specific portfolio of risks over a defined period. It is more structured and provides ongoing coverage for a set portfolio of policies.
- Facultative Reinsurance: Facultative reinsurance is negotiated on a case-by-case basis, providing coverage for individual high-value or unique risks that fall outside the scope of treaty agreements.
- Proportional Reinsurance: Under this arrangement, both the ceding company and the reinsurer share the risk and premium in proportion to their agreed percentages. It is commonly used for stable and predictable risks.
- Non-Proportional Reinsurance: This type of reinsurance covers losses that exceed a specific amount or retention. Main forms of non-proportional reinsurance are as excess-of-loss or stop-loss coverage. The reinsurer therefore only pays when losses exceed the predefined amount.
4. Role of Reinsurance in Society
- Enhancing Insurance Availability: Reinsurance allows primary insurers to expand their capacity and offer coverage to a broader range of customers, contributing to increased insurance availability for businesses and individuals.
- Mitigating Catastrophic Risks: Natural disasters, large-scale accidents, and other catastrophic events can cause substantial financial losses. Reinsurance can spread these risks globally, making it possible for insurers to manage and absorb such losses more effectively.
- Encouraging Economic Growth: A well-functioning insurance market, backed by reinsurance, imparts confidence in businesses and investors, facilitating economic growth and development. Reinsurers can also assist with growth of insurance companies by providing capital directly to finance insurance companies’ new business ventures.
- Promoting Innovation: Reinsurance fosters innovation within the insurance industry by providing insurers with the confidence to explore new lines of business and unique risk solutions.
5. Summary
Reinsurance is a fundamental aspect of the insurance industry, and its significance cannot be understated. As an actuarial specialization area, reinsurance demands skilled professionals with the ability to analyse complex risks, design appropriate risk transfer mechanisms, and ensure the financial stability of insurers. By understanding the principles of reinsurance and its role in society, we can gain insight into the interconnectedness and resilience of the global insurance market.
