Insurance was created on the idea that the premiums of the masses pay for the claims made by a few.
This is a powerful principle. But the challenge arises when the total premium pool does not cover the cost of claims. There are many factors that can cause rising costs for claims, including natural catastrophes, interest rates, urban sprawl, and claims inflation.
Every insurer has a limit on how much insurance they can offer – this is called their capacity. Insurers are becoming more cautious as they take on increased risks due to the dramatic rise in global claims. Insurers can increase their capacity by purchasing reinsurance.
What is reinsurance then?
Reinsurance is insurance for Insurers. Reinsurance is bought by insurers for the same reasons that businesses and individuals purchase insurance – to transfer risks.
The same way a homeowner would purchase insurance to cover the possibility of their home burning down, the insurance company will also offer reinsurance to help them manage the risk of exposure to a major flood or bushfire.
In Australia, there has been an increase in natural disasters like floods and bushfires. This has increased the amount of capital that insurers must keep on their balance sheets to ensure clients are protected against these perils. This can be managed by transferring some of the risk to reinsurers.
Here are some ways in which reinsurers can influence the insurance industry:
- Setting underwriting standards: Reinsurers can influence underwriting standards by providing guidance on the types of risks that they are willing to cover and the conditions under which they will offer reinsurance. This can influence the types of risks that primary insurers are willing to write, as they may adjust their underwriting standards to align with what reinsurers are willing to cover.
- Providing capacity: Reinsurers have a significant amount of capital that they can use to provide capacity to primary insurers. This can allow primary insurers to write more business and take on larger risks than they would be able to on their own.
- Risk management: Reinsurers have a deep understanding of risk and can provide guidance to primary insurers on how to manage and mitigate risk. This can help primary insurers avoid losses and maintain their financial stability.
- Market pricing: Reinsurers can influence market pricing by setting the rates that they charge for reinsurance. Primary insurers often use these rates as a benchmark when pricing their own insurance products.
- Innovation: Reinsurers are often at the forefront of developing new insurance products and coverage options. They can influence the insurance industry by introducing new products and services that can help meet the changing needs of policyholders.
- Overall, reinsurers play an important role in the insurance industry, providing crucial risk management support and enabling primary insurers to underwrite more business. As a result, reinsurers can have a significant influence on how insurance is priced, underwritten, and managed.
Why might the cost of reinsurance affect insurance pricing for clients across Australia?
Pricing for reinsurance will rise in response to losses. However, you may also find areas where there is a shortage, so it’s a supply-demand issue. If there is a shortage of supply in markets that insurers are not able to service, the price will rise.
So now when you are hearing the term ‘hard market’ and notice that your rates have risen by 10%, it’s because insurance companies must themselves pay 10% more to keep offering insurance.
Why do the reinsurance prices change so dramatically?
Reinsurance covers peak risks such as earthquakes and pandemics. It also frees up capital for insurers to expand their businesses.
Capital and claims. Reinsurance prices will fluctuate depending on the cost of claims and capital. Insurance costs are driven by events such as earthquakes, hurricanes, fires, and typhoons. These events aren’t just isolated ones like a fire in a factory; they’re huge environmental catastrophes that can cost insurance companies and reinsurance companies billions of dollars. It has been yet another chaotic natural disaster year, which means that there is little chance of reinsurance pricing reliefs landing in the next twelve months.
COVID-19 also hasn’t helped, and this industry is suffering huge losses. Insurance and reinsurance market losses cause insurers to increase their pricing and reduce the amount of capacity they have available for the insurance products they offer.
Will this mean the losses taking place around the world affect the price of insurance in Australia?
Yes. Most insurance companies will buy reinsurance globally for their business, also known as a “treaty”. So even though losses may primarily be happening in the US, they will have an impact on what insurance companies can do here, in Australia.
It’s a global business for insurers. Strategy and direction are dictated by a centralised Head office, which is often offshore. Insurance was originally designed to distribute losses among the many.
However, transferring risk leads to economic growth
Reinsurance is a way to unlock the potential of insurance as an economic growth catalyst. Strong and efficient insurance sectors encourage commerce and trade greatly. It allows entrepreneurs to take risks, which in turn fuels innovation. Many products and services wouldn’t be possible without insurance that covers liability risks. Investors often require that assets such as power stations, factories shops, or laboratories are insured before they will commit funds to a project. Primary insurance companies wouldn’t be able often to insure many of the risks without reinsurance.
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These market conditions change rapidly, so we will keep you informed and up to date with the latest information.