8/18/2014

2014 Spring Issue

REINSURANCE DEMYSTIFIED
By Sam Doan
Natural catastrophes are an unavoidable element in the world. Reinsurer Swiss Re reported that in the year 2013,
insurers paid $45 billion in global catastrophe claims. While this figure was 44 percent less than the amount paid in
2012, it still has a significant impact on insurers. It is safe to say that insurers would have entered the realm of
bankruptcy when faced with the aftermath of catastrophes like Hurricane Sandy, if it wasnt for their best friend,
reinsurance. When the question What is reinsurance? is asked, the following answer comes to mind: Reinsurance
is insurance for insurance companies.
Dedicated reinsurers such as Swiss Re and Munich Re emerged in the 19th Century and it was evident that these
companies were essential for insurance operations and development. Since then, reinsurance has continued to play a
major role in transferring part of the hazards and risks that direct insurers face from their issued policies onto a
secondary party (the reinsurer). The importance of reinsurance to the insurance industry is undeniable. What is of great
interest is how much reinsurance is necessary for a company, the enhancements that reinsurers offer and the risks
that reinsurers must take on as a result.
While reinsurance is indeed a necessity, it is natural to think about just how much of it is necessary for a typical
insurance company. It should not be a surprise that the amount of reinsurance required is linked to the companys
characteristics. Factors such as readiness to face risk, financial strength and market practice all play a role. That being
said, reinsurance is not a shield against bankruptcy, but rather, an entity which is able to lower the chances of a
company ending up in shambles.
In many ways, reinsurers are able to enhance the value of services offered by the primary insurer to their clients. As
stated above, the reinsurer is able to reduce the probability of an insurers ruin by taking on their catastrophic risks. In
addition to this, reinsurers are able to assist in maintaining an insurers stability with respect to their balance sheets by
taking on part of the risks of fluctuation, change and error. Reinsurance companies are also able to provide balance in
an insurers portfolio by covering the parts of the portfolio that are highly exposed to risk. By doing this, the reinsurer
frees up some space in the insurers capital which allows them to use their resources in another area besides risk
management.
When evaluating the relationship between a reinsurer and insurer, it is clear that there are many consequences which
the reinsurer must face by entering into an agreement. As mentioned before, reinsurers are responsible for handling
their clients highly exposed risks, catastrophic risks and other types of scenarios with high severity. While meeting this
criteria, the reinsurer must maintain its own portfolio in order to make a profit and stay in business. Many reinsurers
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2014 Spring Issue

such as Swiss Re and Munich Re strive for balance in their portfolios by distributing their services all over the globe.
It is safe to say that as long as insurance exists, so will reinsurance. In a world where catastrophes are just around the
corner, insurance companies need security when performing their day to day business, and it is up to reinsurers to
answer the call.
Sam Doan is currently a fourth year student at the University of Toronto. Sam can b e reached at

doansam@gmail.com.

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