Reinsurance: The Key to Disaster Insurance

(image via rt.com)

(image via rt.com)

In the aftermath of Hurricane Sandy, those affected may be wondering about flood insurance.  “Do I have it?,” “How can I file my claim?,” and, unfortunately for some, “Why didn’t I buy it when I had the chance?!”   These are all very important questions, and those who suffered damage due to Hurricane Sandy can find the answers to these and other flood insurance questions here.  This post is going to look at another aspect of disaster, including flood, insurance: reinsurance.  While this term may look made up at first glance, reinsurance is a real concept used by insurance companies and many large law firms to assess risks.

To understand reinsurance, one should first understand how insurance works.  In its simplest form, insurance plans involve an insured person paying monthly premiums to the insurance company.  When the insured person has a claim (i.e., something covered by their insurance policy occurs), the insurance company pays the insured person the value of that claim if it determines that the claim is in fact covered.  Since the payout, typically, will be significantly larger than the amount paid in premiums, insurance companies can only be successful if many people buy in to their policies, most of whom will not submit claims.  The theory is that the amount collected in premiums will be larger than the amount the insurance company pays out in claims, thus keeping the insurance company solvent.  To be successful, the insurance company correctly assumes that not everyone who they insure will submit claims all at once, because such a situation might bankrupt the insurance company.

This situation is reversed with disaster (e.g., flood, tornado, etc.) insurance.  Unlike the insurance model described above, disaster insurance claims, by their very nature, occur all at once after a disaster.  When a natural disaster hits, such as Hurricane Sandy, all of those who have flood insurance and live in the affected areas are going to be filing claims.  If the insurance company were required to pay all of these claims at once, they would likely have to take out loans, or, at the very least, shell out more money than they would like.  This is where reinsurance comes in.

Reinsurance helps allocate the risk that the insurance company faces across multiple companies.  The reinsurance process involves an insurance company “selling” portfolios of insurance plans to reinsurers, who take on the risks associated with these portfolios in exchange for a percentage of the premiums that the insurance company collects from the customers whose policies make up the portfolio.  These sales then protect insurance companies from the risk that they will have to pay out claims to all (or many) of their customers simultaneously.  Therefore, when a disaster such as Hurricane Sandy occurs, the insurance company will pay only a fraction of the estimated $20 billion in insurance claims that will be filed by those with flood insurance.

The devastation of Hurricane Sandy goes far beyond the cost of rebuilding homes and replacing damaged property.  Many of the affected areas remain underwater, and it may take weeks for everyone to get their power back.  Although it will not fix everything, insurance and reinsurance will aid many of those who suffered property damage due to Hurricane Sandy and can help jumpstart the long rebuilding process.

3 thoughts on “Reinsurance: The Key to Disaster Insurance

  1. I noticed that among the top reinsurers there are a lot of life insurance companies. Is there a reason for that? Does life insurance have a specific quality that allows life insurance companies to take on more disaster risk? My gut tells me that if there is a disaster, people die, and therefore these life insurance companies would be paying out life insurance claims as well as these resinsured disaster claims, which might in turn be worrisome for the life insurance company’s solvency.

  2. Alex, that’s a great question. I’m honestly not sure why life insurance companies are often involved in reinsurance. Your point makes sense, but maybe the life insurance companies are so diversified that short of a nationwide disaster, they can still remain solvent even if they have to pay out disaster and life insurance claims at the same time. This would only be my guess.

Leave a Reply

Your email address will not be published. Required fields are marked *

*

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>