Government bailouts and limit-bearers have made the reinsurance industry something of a financial black hole for risk managers. Many companies face hundreds of millions of dollars in losses. The reasons for the failure to insure a risk, says Larry Glasscock, CEO of First Re, a contractor for reinsurance, are relatively complex.
The modern-day reinsurance industry is divided into four basic categories: primary, financial, secondary and excess.
A primary reinsurer is a company that will take any and all risks that primary carriers assume. This is the easiest class of reinsurer to understand. Primary reinsurers insure any given geographical, industry or business line for primary companies, but they have no claim to the insurance policy themselves. They are more interested in maintaining the commercial property and casualty industry. As such, they typically provide additional collateral to the insurance companies they insure as well as a non-tolling credit facility.
Primary and secondary reinsurers become involved as a means of capitalizing underwriters who may not have the financial capability to insure a risk. This step occurs when a company’s balance sheet is devastated by loss to one of its business lines. Reinsurance can help to realize the value of their business by providing cover in the event of a loss. However, they are not captive reinsurers but get paid to insure. This middle class insures not only insurance companies but also mortgage and pension firms, asset managers and other financial institutions.
Primary and secondary reinsurers are regarded as the pioneers of coverage.
Financial (as shown below) accounts for nearly 80 percent of the $83 billion worth of property-casualty reinsurance in the United States last year. In comparison, 10 years ago, the financial sector only accounted for 28 percent of the reinsurance market, according to Mr. Glasscock.
A major factor in the increase in written reinsurance business has been the increasing financial firms. Financial services companies now account for 50 percent of the total insurance lines in the industry.
It is interesting to note that companies that are not necessarily financial companies are now using reinsurance to enhance their balance sheets. Companies such as Allied World and Chubb are using reinsurance to double their scale.
In the past, if companies were unable to have multiple lines of insurance on their balance sheet, it would be difficult to service them or get business back when claims came into play.
Of the four major classes of reinsurance, only financials have experienced a meaningful drop. Though they may be down, financials have substantially increased in the last 10 years in contrast to the two primary categories, which have remained almost static.
Primary and secondary reinsurers are quite distinct. In reality, their customer relationships are somewhat similar, but with a primary reinsurer benefiting from being able to insuring a broader range of risks than a secondary one.
Primary insurers sell their insurance through agents and brokers who often offer reinsurance as a way to help purchase insurance, or assist in an orderly wind-down when a customer fails. On the secondary side, reinsurers are actually primary insurers themselves.
They simply provide reinsurance for a group of insurance companies on a wholesale basis. The marketplace consists of aggregators, which typically buy reinsurance from primary insurers and offer the products to the insurance companies.
Reinsurance risks are much more complex, compared to primary ones, that require the backing of pools of risk, as discussed above. Primary insurance risks (and (at least on the primary level) reinsurance claims) tend to be more short-term in nature. On the primary side, a break-up process is quicker to initiate and occur. On the reinsurance side, loss potential is determined by models and an average length of the insured could be much longer, taking many years. Primary insurers have shorter windows of opportunity.
Primary insurers have more flexibility in form and amount of collateral they set aside and where on the balance sheet they place the claims. Reinsurers, though they have more power when serving primary insurers, are required to maintain good-faith limits with market oversight.
These differences allow primary insurers to invest, offer guidance on business lines and provide insurance for general audiences. They also help protect reinsurers from the side effects of their own policies, which can result in unfavorable losses when the economic cycle turns.
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