What Is Reinsurance? An Explanation For Those Who Don’t Work In Insurance
Your insurance company has a large pool of resources to pay for claims. Some of that money is from premiums paid by policyholders. Some of that money is from investments. The insurance company is divided up into smaller “writing companies,” which each have a portion of the pool of money to pay claims. Each of those writing companies also has a certain amount of risk.
Risk: the possibility that a company will have lower than expected profits or experience a loss instead of making a profit.
This is a great system, so long as claims are fairly evenly spread both geographically and between companies. There are certain types of events, though, that lead to an inordinate number of claims. Superstorm Sandy is an example of an event like that. A few states took a significant hit on claims, and if those claim reserve accounts were all that the insurance companies had at their disposal, it would have been a problem. Luckily, a little thing called reinsurance exists.
Reinsurance: Insurance that is purchased by an insurance company
Large-scale losses like these are why reinsurance exists. When you buy an insurance policy, you’re essentially betting that a catastrophic event (like Sandy) that will happen and the insurance company is betting that it won’t, or at least not within a given timeframe. But in case two of those only-every-hundred-year storms happen in a row, your insurance company can buy insurance for that event. More accurately, they can buy reinsurance.
The insurance company that buys reinsurance is ceding (or transferring) some of the risk to the company selling the reinsurance. This allows them to charge premiums that the market will bear, while still maintaining the capacity to pay claims in a large-scale loss. Multiple insurance companies can band together to buy reinsurance, and there can be tax benefits to the company, but those arrangements are a bit outside the scope of this article. We’ll address more complex scenarios in a separate post in the future.
What Is A Reinsurance Facility?
Ah, the real reason that some of you are here. If you have insurance in North Carolina, you’re probably here looking for the definition of a reinsurance facility, not of reinsurance in general. You’re in luck because we’ve got an answer for you there, as well.
A little background, first. The state of North Carolina caps property and casualty insurance rates. Other types of insurance have similar restrictions, but we’re focusing on policies that individuals would commonly buy, such as auto insurance in North Carolina.
Consent to Rate Form: Signing this form means you consent to your insurance company charging you up to 250% more than the rate set by the North Carolina Rate Bureau.
Even if you’ve signed a consent to rate form, the rates are still capped – you can waive some of those protections in order to get coverage that might not otherwise be available, but the carriers are still limited to a multiplier of the rate approved by the North Carolina Rate Bureau (or NCRB) for your policy even with that consent to rate form on file.
So what happens if a particular risk that you’d like to insure against doesn’t fit into the pricing model offered by the NCRB? The insurer that quoted the risk won’t be interested in writing it, under normal circumstances. Since all carriers are subject to substantially similar caps in North Carolina, you’ll find that if one carrier doesn’t want to write it, then most carriers won’t want to write it.
The solution to this is something called the reinsurance facility. In some ways, it’s similar to assigned-risk pools in other states, and in some ways it’s not. If, because of a characteristic of the risk, a carrier is unwilling to offer coverage for that risk, they’ll pass it off to the facility. This reinsurance facility is a way for carriers to share the risk of those policies where the risk is unacceptable to the company or the pricing of the risk would be inadequate.
The Insurance and Risk Management Institute notes that only two states use this mechanism, and defines a reinsurance facility as;
an unincorporated, nonprofit entity through which auto insurers provide coverage and service claims. After issuing a policy, an insurer may… transfer or cede to the pool a percentage of its policies. Premiums for this portion of business are sent to the pool, and these insurance companies then bill the pool for claims payments and expenses. Profits or losses are shared by all auto insurers licensed in the state.
There are a variety of reasons why your policy may have been ceded to the reinsurance facility. While the actual setup is more complicated, it’s nothing but a mechanism for sharing risk to ensure that everyone is able to get the coverage they need and are required to have. If your policy is ceded to the facility, it will generally be transparent to you, though some carriers avoid offering certain types of coverage.
If you still have questions on what a reinsurance facility is, call Effective Coverage and get the facts on North Carolina auto insurance and renters insurance. If you’ve signed a consent to rate form and your NC renters insurance premiums are too high, Effective Coverage has solutions for you, as well.
Reinsurance and the reinsurance facility are two separate topics, but they go hand in hand.
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