Individuals and organisations can cover their risks by taking insurance policies. But what about the insurance companies themselves? How do they cover their risks? They also have to run their business, and like any other business, they also face many risk.
In order to minimize risk, insurance companies deploy various strategies. Reinsurance is one of those strategies, which are universally accepted by insurance companies across the world. The best thing is that the policy holders do not even come to know about reinsurance as it does not affect the features and benefits committed under their policy document.
Reinsurance is a contract between the primary insurer and the reinsurer. The reinsurer provides the benefit of insurance coverage in consideration of a certain amount of premium from the primary insurer. In this case, the primary insurer has to follow a certain retention limit, as per the regulations set by the IRDA. This prevents over exposure of reinsurance companies to risks, and at the same time, primary insurers cannot offload all the risks on reinsurers.
Reinsurance is also used to cover risks related to natural disasters such as floods, hurricanes, earthquakes, etc.
But what about the risk faced by reinsurers? Well, reinsurers can also insure themselves further. This type of insurance is called retrocession and the company which provides this kind of risk is called retrocessionaire.
At times, reinsurers come across circumstances which affect a very large number of policy holders and insurance companies in one go. These types of events are called industry loss events. For instance, if shipping and oil companies suffer losses due to a disaster at oil exploration sites, then insurance companies have to compensate a number of organisations. The impact gradually flows down to reinsurers as well.
The best part is that reinsurance allows i nsurance companies to manage their risks in an organised and calculated manner.
Benefits of reinsurance
As discussed above, reinsurance provides several benefits to insurance companies. In a nutshell, these benefits include the following:
> Through reinsurance, an insurance company is able to enhance its underwriting capacity
> It helps in ensuring stability and managing unpredictable risks that may impact a company's profitability in a major way
> Re-insurance can also provide an exit path to an insurance company, whic
h can transfer policies to reinsurer
Apart from tangible benefits, reinsurance also provides intangible benefits to both primary insurers and reinsurers. It impacts the risk taking capacities of primary insurer and reinsurer as they are able to expand their product lines more aggressively.
Insurance companies can face market challenges with more confidence and vigour when they have reinsurance support at the backend. Of course, there are regulations on how much an insurance company can reinsure. Compliance with statutory regulations also prevents losses which may be caused due to over-exposure to risks.
How reinsurance affects unearned premium reserve?
The premium amount paid by a policy holder remains unearned for an insurance company until certain conditions with regard to coverage and lapse of time are fulfilled. As per regulations, the amount of premium paid by people goes into an unearned premium reserve. Insurance companies can take a fraction of amount from this reserve towards their administrative expens es. This is why, you will find some charges which insurance companies book under the heads of administrative expenses, in your premium receipts or statements.
By transferring a portion of risk element on a policy to a reinsurance company, a primary insurer can reduce the volume of unearned premium reserve, thereby helping it in optimising its funds and the overall liquidity scenario.
Re-insurance in India
Re-insurance services are largely provided by foreign companies. Until the last year, Indian insurance companies were taking these services from companies in other parts of the world, especially the United Kingdom (UK).
However, after the approval of the new Insurance Act, re-insurance services will be provided right from within India. Foreign companies are allowed to launch their Indian subsidiaries and start operating in the country. Thanks to the new Foreign Direct Investment (FDI) norms under which a foreign company can hold as much as 49% in an Indian company, from the earlier limits of 26%.
Overall, the re-insurance industry will have a direct impact on the insurance services and consumers can expect better services at a lesser costs. After all, insurance companies will be in a better position to cover their risks and get localised services in much efficient manner. The benefits will ultimately be passed on to the common man in some way or the other.