What is Reinsurance, And How Does It Affect Your Insurance Premium?
Millions of Americans carry some type of insurance coverage, from auto, homeowners, and umbrella, along with business and professional insurance too. Reinsurance coverage plays a critical role in varying scenarios, from devastating accidents resulting in fender benders to catastrophic natural disasters that decimate hundreds of homes.
Like their policyholders, most insurance companies buy reinsurance coverage. These policies are an essential piece of the insurance cost puzzle, offering much-needed protection for the insurer in many situations. But as insurance premiums rise in tandem with reinsurance costs, many policyholders question the correlation between the two.
This article dives into the specifics of reinsurance and how it impacts your insurance premium.
Reinsurance is essentially insurance for insurers. It’s a contract between your insurance provider and a reinsurer that helps balance risk. In these contracts, your insurance company becomes the ceding party or cedent and transfers a portion of its insured risk to its reinsurance company.
Reinsurance aims to mitigate risk by sharing it among multiple providers. By transferring risk to another company, the insurance company or ceding party limits the likelihood of paying out large amounts for a claim.
In this practice, ceding parties can remain solvent or pay their debts by recovering all or part of the sums paid out for claims. It acts as a safety net for the insurance company, reducing liability on individual risks and catastrophe protection due to substantial or numerous losses.
So, in essence, reinsurance for an insurance company serves much the same purpose as your policy through your insurance provider.
Reinsurance falls into several categories, including facultative, treaty, proportional, and non-proportional. The most often types of reinsurance used are Treaty and Facultative.
This type of coverage supplies a protective layer for the insurer regarding an individual or a specified risk or contract. The insurer must negotiate each risk or contract separately, and the reinsurer retains the right to accept or deny a facultative reinsurance proposal.
In some cases, the insurer and reinsurer may use a reinsurance treaty. Under this treaty, both parties agree to a set period instead of by risk or contract. In these cases, the reinsurer is responsible for all or part of the risk.
Treaty reinsurance is a type of reinsurance whereby the ceding company or insurance company agrees to cede a particular class of business to a reinsurer. The reinsurer agrees to accept all insurance risks qualifying within the agreement, which is now as a treaty. Under the treaty agreement, the insurance company knows that all of the risks qualifying within the terms of the treaty will be reinsured per the agreement.
The third type of reinsurance is proportional reinsurance. Under this type of reinsurance, the reinsurer receives a fixed amount, known as a prorated share, of each policy premium the insurer sells. Since they receive these shares, the reinsurer also holds some responsibility for losses associated with claims, which hinges on a pre-negotiated percentage.
On top of that, the reinsurer reimburses the insurer for various expenses, including processing, business acquisition, and writing costs.
In non-proportional reinsurance, reinsurers are liable for amounts exceeding the insurer’s specified loss ceiling. This is called a priority or retention limit. Unlike other types of reinsurance, the reinsurer has no share in premiums or losses.
Instead, the priority or retention limit hinges on an entire risk category or a single type of risk. Once the scales tip over the set ceiling, the reinsurer will step in and cover those losses.
Like nearly any business, insurance companies increase premiums based on overhead costs. Otherwise, the company wouldn’t make a profit, which isn’t feasible. So, to ensure the company turns a profit, the cost of reinsurance might be passed to the insurer’s policyholders.
You might notice increases in your insurance premiums after your insurer obtains a reinsurance policy. This is fairly standard and to be expected, especially when reinsurance becomes harder to get. Generally, the harder it is for an insurer to find and carry a reinsurance policy, the higher that insurer’s policyholder premiums will be.
In recent months, many policyholders have noticed increased insurance premiums. On the July 1st renewal date, property catastrophe reinsurance rates in the United States rose by as much as 50%, setting the stage for upcoming increases.
These skyrocketing reinsurance rates primarily affected states susceptible to natural disasters, including California and Florida, which are extremely vulnerable to wildfires and hurricanes. Of course, other states are experiencing similar upticks in reinsurance rates, but these two states are excellent examples of these exorbitant price increases.
Some insurance companies are pulling stakes in states with staggering reinsurance premiums and high chances of heavy losses. For example, a large insurance company declared in May that it would cease selling new homeowner insurance policies to California residents.
The increases in reinsurance premiums affect both the insurer and the policyholder. As reinsurers raise the costs that insurers have to pay before the reinsurance applies, policyholders under the ceding party also experience an increase.
To cover the difference in those costs before coverage, insurers are transferring higher rates to their consumers. So, if you notice higher rates trickling down to your insurance premiums, there’s a good chance reinsurance could have something to do with it.
The thought of paying more monthly or yearly for your insurance policy probably sounds unpleasant, and you’re not alone. However, the benefits of reinsurance affect you, too.
For example, suppose your insurance provider supplies homeowners insurance in an area decimated by an earthquake. However, since so many homeowners in the affected area file substantial insurance claims to cover the damage, your insurance provider can only pay some.
Here’s where reinsurance comes in. It serves as an extra layer of protection for both you and your insurer by keeping the insurer afloat in times like these. So, not only does your insurer receive assistance when it needs it the most, but it also ensures that you and other claimants receive the benefits and compensation you’re entitled to.
All in all, while reinsurance isn’t ideal for the raised rates it brings, it allows the insurer and policyholder to rest assured knowing there is an umbrella of protection from the reinsurer.
If you’re curious about the increases in your insurance bill and the reasoning behind them, reach out to us, and we will be glad to explain in more detail.