For retail agents, reinsurance may feel like someone else’s concern. And in many ways, it is – reinsurance is a risk-balancing tool carriers use in the regular course of doing business.
But in a hard market cycle, reinsurance rates have a compounding effect on carrier profitability and can ultimately increase the end customer’s premiums. Understanding the dynamics of reinsurance and how it drives insurance pricing is an important part of an agent’s toolbox, especially for those serving commercial clients with larger risks.
The basics of reinsurance
Insurance companies use the reinsurance market to balance their risk and mitigate the potential impact of unusually large claims or spikes in claims activity arising from catastrophic events. Reinsurers receive a premium for assuming these risks on behalf of primary insurers.
Though often referred to as “insurance for insurers,” reinsurance does not resemble a retail insurance product. Insurance companies secure the coverage through third-party brokers or direct negotiations with reinsurers to secure contracts addressing their specific needs – meaning negotiation influences reinsurance pricing as much as the actual underlying risk.
Regulatory oversight for reinsurance differs from oversight for retail insurance. While some states consider reinsurance a regulated product, they do not regulate it directly. Reinsurers do have to meet certain financial requirements and capital standards to conduct business in the United States, but they do not have to obtain regulatory approval for rates or products like the primary insurers that sell directly to consumers do.
The stakes of reinsurance
Reinsurance supports the stability and growth of insurance companies in various ways. By transferring financial liability for substantial risks to other parties, carriers are able to issue policies with higher limits and avoid the risk of insolvency following catastrophic events.
At the same time, limiting liability reduces the amount of capital carriers must keep on hand to comply with regulatory requirements, which gives insurance companies the freedom to write more policies or invest capital elsewhere. If a carrier finds a reinsurer that will rate a certain risk for a lower premium, it can transfer that risk to the reinsurer and realize a profit.
Reinsurers benefit from the arrangement by underwriting risks more effectively, whether through more precise risk modeling or by managing risk at a global scale, which helps insulate them from events primarily affecting national markets. Many large insurance companies, including Liberty Mutual, also sell reinsurance – which makes sense, as they often see opportunities to price certain risks more competitively than other carriers.
