Simply put, reinsurance is insurance for the insurance companies to lower their risk and reduce their exposure to a catastrophic event. If an insurer has too much exposure to a potentially costly event, then that event could cause the company to go bankrupt or even shut down if it’s unable to cover the loss. For example, when Hurricane Andrew caused $15.5 billion in damage in Florida in 1992, seven U.S. insurance companies became insolvent because they were unable to pay the claims resulting from the disaster. Insurers are legally required to have sufficient capital in reserves to pay all potential claims related to their issued policies. Thanks to this regulation, consumers’ losses will be covered even if their insurance company goes under.
Here in Texas, an insurance company might have a threshold of say $10,000,000 in claim payouts PER EVENT before reinsurance kicks in to pay the remainder. So, when a hurricane smashes Houston, an insurance company may actually pay out less in total than it would for three or four small hailstorms around the state. That’s because these hailstorms usually don’t exceed the threshold and the insurance company gets no help from the reinsurance.
So how does all this affect me?
Here’s your answer: Reinsurance costs quite a bit of money for your insurance company and that cost is embedded into what you directly pay for a policy.
Along with severe weather events in the form of wind and hail, there have been historical wildfires, multiple hurricanes, tsunamis, earthquakes, and more, making for quite a tumultuous insurance market. Even before Covid-19, the reinsurance market had hardened, rates were on the rise, and capacity was being restricted but the pandemic has now resulted in reinsurance companies’ loss of investment income worldwide. Subsequently, the cost of reinsurance has increased, and parameters are tighter on the total value of risks that can be placed by an insurance carrier.
So, when your rates go up this year on your home insurance, you can impress your spouse by telling them it’s partially due to reinsurance costs.
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