With so many financial services like consumer credit and risks like bankruptcy, it can be hard to keep up with all the standards and trends. Most industries, including pharmaceuticals and automotive, need to know what can help them generate more profit while minimizing loss.
Financial reinsurance is just one of the many things you need to understand. With it, several insurance companies are sharing the risk. And to minimize their loss in the event of a disaster, they buy insurance policies from other insurers.
The Reinsurance Association of America calls it the insurance company’s own insurance because they also need protection from disaster risks.
Read on to understand more about financial reinsurance and how it can help you and your business.
What Is Financial Reinsurance?
Commonly known as finite reinsurance in the non-life insurance sector, this type does not focus on risk transfer. Instead, it puts an emphasis on capital management. One of the unique challenges of operating an insurance company is that its economic outcomes and profitability vary from year to year.
Insurance companies are typically drawn to stockpiling the current year’s earnings to cover potential losses for the following year. They do this due to their need to produce satisfactory results consistently. However, they are restricted by the standards applicable for financial reporting.
One way for companies in the insurance industry to achieve better results is through financial reinsurance (Fin Re). The main goal of reinsurance is to attain the desired business objective, such as:
- Increase the amount and timescale of profits
- Boost income stability
- Contribute to the financing of acquisitions or strategic partnerships
- Better tax administration
- Effective distribution of income or capital among organizations
How It Works
For a non-life insurer, a Fin Re contract typically spans several years. During this time, the reinsurer manages, keeps, and invests the premium. Once the term expires or the ceding company undergoes a deficit, the money – minus the reinsurer’s profit margin – is returned to it.
The advantage of Fin Re over traditional reinsurance is that regardless of a loss, the majority of the premium is given back to the company. Therefore, there is minimal to zero risk transfer involved.
Fin Re is more commonly used in the life insurance segment as a method for the reinsurer to give financial assistance to a life insurance company. It’s almost similar to a loan. The difference is that the reinsurer recognizes the risks involved in the business portfolio that is reinsured under the contract.
Paying off Fin Re is typically related to the earnings profile of the reinsured business, and this takes several years. Companies use Fin Re instead of a conventional loan since repayment is contingent and depends on the reinsured business’ performance and ability to make a profit. Therefore, it’s unnecessary to regard it as a financial obligation for published solvency reporting in some regimes.
By distributing the risks involved, a specific insurance provider can accept customers whose coverage would be too cumbersome for a single insurer to handle on its own. When reinsurance takes place, the insured’s premium is often split between all involved insurance providers.
What this prevents is the potential bankruptcy or financial ruin of the insurance company. Because if a single insurer takes on the risk, the loss may not be covered by the initial company that shouldered the premium.
Benefits of Fin Re
To better understand, take the following scenario as an example.
Let’s say a powerful earthquake strikes Southern California. It will most likely cause damages amounting to billions of dollars.
If a single company provides insurance to homeowners in the area, the chances of covering the losses are slim. The way to remove this risk is for the retail insurance company to distribute portions of the coverage to other insurers. Thus, the cost of risk is spread across a large number of insurance providers.
Some of the reasons why insurers buy reinsurance include the following:
- Limiting liability for a particular hazard
- For regulating and stabilizing the loss
- To protect both the insured and themselves from disasters
- To boost their capability
However, reinsurance can benefit a business by offering the following:
- Arbitrage for extra profits
- Capital management
- Risk transfer
- Solvency margins
Trust Only the Reinsurance Experts
To minimize the risks involved, make sure to rely only on the experts. Apart from being a certified arbitrator, Mary Lopatto is also an experienced insurance and reinsurance consultant. Make an appointment today and be financially savvy and capable of meeting obligations.