The volatility of asset markets and economic uncertainties have impacted insurers, driving up interest expenses, increasing earnings volatility, and reducing market value. Reinsurance can help manage these effects by reducing the risk of unexpected events. It seems counterintuitive that a policy that pays out when the insurer makes profits (reinsurance) could match or even surpass the performance of a policy that only pays out when the insurer incurs large losses (risk corridors). Yet this is what we have observed.
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Focus on Their Core Business
Reinsurance allows insurance companies to focus on their core business by reducing the risk associated with individual policies and large catastrophe events. It helps them avoid the financial strain caused by a single event that would otherwise threaten their solvency. Reinsurance also allows insurance companies to reduce the money they must set aside for unearned premium reserves. It frees up capital solutions and enables them to grow more quickly.
In addition to transferring risk, reinsurers are increasingly looking for ways to provide value-added services to their clients, such as consulting or giving tech solutions. These additional benefits help to make reinsurers more attractive to primary insurers.
Diversify Their Risk Portfolios
Insurance companies generate revenue by charging premiums in exchange for insurance coverage and reinvesting those premiums into interest-generating assets. Reinsurance allows these companies to diversify their risk portfolios by transferring complex risks, reducing capital requirements and volatility, facilitating growth with additional capacity, filling capability gaps, and smoothing earnings fluctuations. Reinsurance also plays a key role in the industry’s response to new risks, as illustrated by the NFIP’s success and the growing flood insurance market. As reinsurance companies expand their capacity and expertise in these areas, they can support primary insurers in navigating uncharted territories. In this way, reinsurance companies can provide the scale, speed, and agility needed to meet the demands of the evolving insurance landscape.
Protect Their Capital
Reinsurance reduces the amount of capital required to pay claims. It enables companies to meet their financial requirements and maintain their capital ratios, improving the ability to pay dividends or pursue strategic plans. For instance, reinsurance can cover the risk from high-cost individuals, driving a large portion of insurers’ nonsystematic risk. Because reinsurance only impacts power for these high-cost individuals, it can achieve dramatically greater risk reduction for the same price as a policy that pays out only when the insurer experiences extraordinary losses (risk corridors).
In addition, reinsurance can be used to protect against new business strain by providing upfront funding to help finance the acquisition costs and reserve impact of blocks of new business. It is known as surplus relief or further business strain relief. This market is growing, with new investors and a wider range of business models. In addition, the availability of insurance-linked securities (ILS) can provide alternative sources of capital at better terms than traditional reinsurance.
Manage Long-Tail Claims
Long-tail exposures are claims that arise from exposures that have been in place for a long period and often require significant reserve set-up. Reinsurers can help companies manage these exposures by taking a proportional share. The current operating environment presents a challenging combination of factors that may lead to earnings volatility and capital strain for many insurers. The combination of higher catastrophe losses, lower investment returns and new risk-based capital standards have reduced available capital for many insurers. The good news is that the availability of alternative capital has grown significantly in recent years. This capital has the potential to transform insurance and reinsurance in the future. However, it will be important for regulators and the industry to work together to develop market-based solutions that are more responsive to risks and improve transparency around the underlying risk in insurance offerings. It will allow insurers to attract diverse investors and increase their capital relief options.
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