Introduction to Reinsurance

We have already discussed How Insurance Companies Make Profit? But what if there is a situation where an insurance company fails to make profits or a natural disaster results in a large-scale loss that insurance company runs the risk of bankruptcy? That is where the concept of Reinsurance comes in.

Reinsurance simply means insurance for insurance companies. It is an agreement between the insurance and Reinsurance company that indemnifies the contract between both parties. It is used as cushion money against any sort of emergency, be it natural disaster resulting in a financial loss for the insurance company or a probability wherein the insurance company fails to make profits in a given year. It is one of the biggest capital consolidators and risk management tools available to insurance companies. Reinsurers help keep the industry sustainable with its larger capital pool by providing protection to various risks. They also contribute by providing research-based expertise and development skills to the insurance company.

How do Reinsurance companies benefit?

The same logic of playing on the probability that claims made will be lesser than the premium collected is how Reinsurance companies make a profit. However, this is easier said than done because there is a lot of research that goes into what premium they should set that is cost-effective. The processes include Risk Modelling, Reliable Legal Procedure, and Guaranteeing Capital Base. Apart from getting a small percentage of the premium collected by the insurance companies, Reinsurance companies also get a share from the underwriting margins.

Importance of Reinsurance:

• Risk Transfer
  Insurance companies can transfer the risk to Reinsurance companies in exchange for a small percentage of the premium acquired. In this way, insurance companies insure themselves against any unprecedented circumstances.
• Smooth Capital Flow
  By sharing the calculated risk, insurance companies ensure that the capital inflow is consistent and sustainable. Effectively, the insurance companies hardly run the risk of going capital deficit. This is very imperative as consumer trust increases with the increased capital of the insurance firm, thereby increasing its business.
• Arbitrage
  Given the amount of research and analysis that goes into building a Reinsurance firm, an insurance company finds it efficient and feasible to buy Reinsurance at a lower cost in exchange for any possible large claim made.
• Building Customer Trust
  Trust is integral in the insurance sector. The consumers find it comforting to know that their insurance policy is backed by a firm that has little chance of going bankrupt. In this way, Reinsurance companies act as a source of good faith and a seal of trust for the consumers.
• Facilitating Social and Economic Growth
  Owing to the security provided by the Reinsurance companies, insurance firms make available the policies at cost-effective prices. As a result, more people find it convenient to buy the policy at comparatively lower prices. Besides, the insurance industry employs a large chunk of the population apart from facilitating the growth of related sectors.
• Diversifying the portfolio
  Providing life insurance is a risky investment and insurance firms used to refrain from providing the same at feasible premium prices. However, with the cushion provided by the Reinsurance firms and analyzing the life insurance sector and making it profitable has helped that sector grow insurmountable.
• Fronting
  Nowadays, if any insurance company wants to extend the coverage that transcends geographical boundaries, they do by this process called Fronting. In this, a company may find the legal policies too complicated or it simply doesn’t possess the authority to extend the policy to an overseas client. In this situation, the company collaborates with a local insurance company and reinsures its policies under its own name. The claims are paid by the parent company and it gets the premiums too. In this way, Reinsurance also helps in spreading its wings to different places catering to different clients.

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