What is reinsurance and how does it work?

Even though it happened far from Canada, the recent collapse of the Francis Scott Key Bridge in Baltimore has got people talking about something called ‘reinsurance.’ It’s like insurance for insurance companies, especially for big disasters.  

What does reinsurance mean for you as someone who has an insurance policy for their home, car, etc.? Let’s look at how reinsurance can impact your coverage.  

Reinsurance is basically insurance for insurance companies. It allows insurance companies to remain “solvent” – meaning they are financially able to pay their debts – by recovering either some or all the amounts that they are required to pay out to policyholders. This is particularly critical for large or multiple losses, such as those that might occur during a natural disaster.  

For insurance companies, reinsurance is like having a backup plan that gives them extra security. It helps them feel more confident about taking on new customers and covering risks in places they might usually be hesitant about. It can also help them avoid raising administrative costs to mend solvency margins, which saves their policyholders money on their premiums. 

There are two main types of reinsurance, treaty and facultative. Treaties are more general and cover broader groups of policies, like an auto insurer may have. Facultative is designed to cover specific or high-value risks, like hospitals, which might not be insurable with treaty reinsurance. Which type of reinsurance an insurance company has usually boils down to what kinds of coverage that insurer provides, and if they have niche or unique products.  

Reinsurance might seem like insurance jargon that doesn’t have any relevancy for the average policyholder. But that couldn’t be further from the truth. 

While reinsurance mainly benefits insurers, it can still impact the rates policyholders pay for coverage from those companies – for better or for worse.  

In most cases, reinsurance helps keep rates for policyholders affordable. In its absence, companies might need to raise premiums to be better prepared for large losses, increasing their pool to account for “the absolute worst.” If you live in a higher-risk area you’re still likely to pay more for coverage, but this cost would be greater if there wasn’t a reinsurance provider around to soften the blow of large losses. 

A growing issue that’s causing insurance prices to go up is climate change and natural disasters. As weather events increase in frequency and severity, there’s more reinsurance claim payouts and consequently a rise in the cost of reinsurance for insurance companies. To offset this hike in prices, insurers pass down the cost to their policyholders through higher premiums. You might experience this even if you don’t live in a high-risk area. 

This is because insurance companies will want to even out prices amongst all their policyholders, even those in low or medium-risk areas. Lumping all the price increases into a high-risk area doesn’t make sense from a business perspective, so insurers spread out the costs to all geographic areas regardless of risk to increase their profit margins and continue attracting clients. This is unfortunate for people who feel like their rates have gone up for no reason, but it’s a widespread issue that’s affecting everyone. 

Insurers are not legally required to have reinsurance, however many choose it as a risk management tool to protect themselves and their assets against unexpected losses. When acquiring reinsurance, FRIs (federally regulated insurers) must observe government guidelines for effective reinsurance procedures and practices. The expectation is that insurance companies should have a comprehensive reinsurance risk management policy with a defined purpose and objective for seeking reinsurance.  

FRIs are meant to use reinsurance as a tool to manage catastrophic losses. Reinsurance is not, however, used to cede 100% of an insurance company’s risks.  

In short, insurance companies are not required to have reinsurance, so no – not all insurance companies have reinsurance. Those that do, however, are expected to follow strict guidelines to ensure they’re utilizing reinsurance for the right reasons, and not just to alleviate all the risks they take on as an insurer. Reinsurance benefits both the company and the policyholders. 

Reinsurance is just one of many external factors that can influence the cost of your insurance, and it can be frustrating for policyholders who have seen their rates increase for seemingly no reason. If your insurance premiums are rising, Mitch can help you find affordable coverage. We work with over 70 Canadian insurers and can help you find the best one for your unique needs, saving you money and time. Give us a call and speak with one of our insurance brokers today.