Four Reasons for Reinsurance

Risk Transfer – you only have to look at the amount of money an insurance company would have to pay out if your house was damaged in a natural disaster to realise how there is the potential for them to have huge costs. By reinsuring themselves with other insurers they are able to spread the risk so that no matter how many of their policy are claimed upon they have the ability to pay out.

Income Balancing – for any large company its important they can predict their income for cash flow and often shareholder benefits. As you can imagine this would be difficult for insurance companies if they weren’t reinsuring. A number of big payouts if they weren’t reinsured could have a very significant effect on their bottom line. By reinsuring they are able to manage this risk more effectively.

mproved Surplus – on the balance sheet of a company it’s good to have a surplus. This is the sum of assets minus liabilities. Successful reinsurance can reduce the liability pushing up the surplus level upwards. It is desirable as it makes the company more financial stable and more attractive to potential investors.

Arbitrage – another reason reinsurance is often popular is due to arbitrage. If you are not familiar with arbitrage in simple terms it is where you sell something at a high cost which you then buy at a low cost. In reinsurance this would be where a company sells you insurance at one price yet is able to insure that same risk at a lower cost from another supplier. This is of course hugely appealing to insurance companies and fuels some of reinsurance popularity.