Whether or not you think that insurance is the devil’s work, it’s a fundamental component of business in the real world. Without it we’d be lost, and some of us would find ourselves in financial turmoil. Insurance provides us with an added layer of security for situations in which we risk liability, such as owning a car or a home, by transferring the greater share of responsibility to the company if something goes terribly wrong.
But what is reinsurance?
Well, it’s the same principle. That’s the short answer. When an insurance company decides to go through with an especially risky venture, it might want more protection for your policy.
The policyholder pays a premium in order to buy insurance, that premium usually representing either a small fraction of the risk, or something that will add up to a large portion of the risk when paid over years and years. Normally the insurer takes 100 percent of the risk outside of that premium. On occasion an insurer will not be comfortable with that level of risk.
It’s on these occasions that an insurance company will opt to “reinsure” the original policy through an outside reinsurer. The reinsurer will be given part of the premium paid by the policyholder in direct proportion to the amount of risk the insurer wants to take, whether it’s 30 percent, 50 percent, 70 percent, etc.
If the worst happens, and the claim costs must be paid to the policyholder, then the insurer pays 100 percent. After the claim is paid, the insurer can follow up by requesting reimbursement in the percentage agreed upon with the reinsurer. Reinsurance is just insurance for your insurer. It’s that simple.
One type of reinsurance is called facultative coverage. This policy is an added layer of protection when an insurance provider covers an individual for a single risk in a single contract. Additional risks require additional contracts.
Another common type is called a reinsurance treaty. This policy covers any number of risks based on a period of elapsed time. An example of this is when life insurance isn’t calculated when someone is estate planning.
An excess-of-loss reinsurance policy is considered non-proportional coverage, and this type of policy is put into place when the reinsurer agrees to cover costs only when they go beyond whatever the original insurance company’s retained limit was set at. This coverage mostly applies to acts of god during substantially costly events.