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Friday, August 21, 2015

Risk management and reinsurance

By Flaviu Mircia

What is reinsurance?

Just like you need insurance for your home in case of fire or flooding from an insurance company, the same goes for your insurer. Insurance companies need an insurer of their own. Reinsurance is insurance purchased by an insurance company from other, larger companies, known as reinsurers. The reinsurance details are regulated and conditioned by a reinsurance agreement between both parties.

A reinsurance company helps ensure that insurance companies remain financially viable (solvent) even in the case of major disasters or catastrophic scenarios. After disastrous calamities, such as hurricanes, flooding or earthquakes, financial security is the most important aspect, and this is guaranteed because the risks and costs are spread over multiple companies. Essentially, the whole concept of reinsurance works as a means of risk management, spreading the risks over more insurers. This often includes other related services, such as tax mitigation, business audits, evaluation and risk analysis.

The benefits of reinsurance

Reinsurance is very important for primary insurers and helps spread the risks through efficient risk management mechanisms. Some of the main benefits are:

Capital relief and flexible financing options

Access to funds and financing is easier for large reinsurers, which can help smaller primary insurers in case of calamities.

Reduced volatility of underwriting results

The risks are spread for each contract on certain terms as agreed by the two parts.
Access to the reinsurer's experience, know-how, and services

This is particularly important as it allows even small time players in the insurance business to offer complete insurance packages to their clients with minimal risks. Similarly, a large reinsurance company can offer assistance in the process of product development, underwriting, pricing and can help create business connections with other players in the industry.

These benefits are applicable for both life and non-life insurance policies but vary greatly depending on the type of insurance and its main focus.

So how do reinsurance companies manage risks?

Imagine risk as a steady flow that goes from the primary insurer (your insurer) to the reinsurer. This flow, the risk, gets nurtured and managed by the large reinsurance company through its multiple mechanisms. This allows small insurance companies to expand and take on more and more customers without any additional risk. Depending on the type of reinsurance agreement, the risk management process can have varying degrees of effectiveness.

When primary insurers cede a part of their business (insurance contracts) to their reinsurers, they reduce their risks - both the underwriting and the asset management risks. The risks (the flow) is then transferred to the reinsurer, which assists the primary insurer.

Reinsurance companies implement advanced risk management techniques and processes to ensure that they are financially capable of meeting their obligations. The goal of risk management is to guarantee that the reinsurance company remains economically viable and can honor its financial obligations. Risk management processes involve the monitoring and identifying the risks, creating adaptive models of the main risks and study the various interdependencies between certain risk factors. 

A successful risk management plan combines the management of underwriting units, capital and assets. These three concepts are crucial in all risk modelling processes and may refer to credit risk, market risk and operational risk. Based on the analysis of these main types of risks, the results are used to quantify the impact of the risk factors on the reinsurer's balance sheet. The result is a statistically correct model of risk management which can guarantee that both the insurer and the reinsurer remain economically viable even in catastrophic scenarios.

For any type of insurance provider, reinsurance is a good bet. This is especially true in the medical industry where one mistake in a hospital could result in catastrophy. As such, make sure you find a high-quality reinsurer such as Oros Risk to help manage the potential costs.

About the author: Flaviu Mircea is a small business owner in the medical industry who has worked with many insurers over the years and shares what he has learned online. If you wish to learn more about Flaviu you can visit his profile on Google+.
Images: 1. Ken Teegardin, CC BY-SA 2.0; 2. Paul Cross, CC BY 2.0