Why a company in China might end up paying your claim

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Insurance companies don’t always have the money to fully pay each claim. Consumers might realize that regulations designed to protect them require insurers to have the liquid capital, but insurers can also get insurance — called reinsurance — to help cover those claims.

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Sound confusing? It can be, especially when trying to determine whether there’s a chance that reinsurers could lack the funds to pay those claims. Reinsurers aren’t held to the same capitalization standards as insurers, according to Christopher Pesce, president of the Maritime Program Group, a marine insurance underwriter.

“Regulators typically are concerned about protecting the consumer, not the businesses,” Pesce says. “Insurance companies are regulated because if they fail it’s the consumer that gets stuck holding the bag. If a reinsurer fails, the insurance company gets stuck, not the consumer. That’s why the reinsurers are not regulated the same as primary carriers.

“But you can take, for example, an event like Sept. 11th, [which] was so huge it did bankrupt some reinsurers, leaving the primary carriers without payment,” Pesce says. “For that reason, and since that time, carriers have tightened their requirements for acceptable reinsurers.”

There is also reinsurance for reinsurers, which is called retrocession reinsurance. “The public never understands because they don’t get involved with reinsurance,” says Andrew Barile, a California-based independent insurance and reinsurance consultant. “All the public worries about is, ‘Is the insurance company going to pay my loss?’ They don’t realize China Re [China Reinsurance Corp.] may be paying your claim on some marina damage.”

Worldwide there are roughly 2,000 insurance providers, about 150 reinsurance companies and 30 companies that are very active in retrocession reinsurance, Barile says. The figure experts usually say would trigger core losses to retrocession players is $20 billion, says U.K.-based Steve Evans, who owns Artemis.bm, a firm that analyzes alternative risk transfer and weather risk markets, among other industry trends.

The large risk of retrocession reinsurance can bring big rewards, something that caught the eye of hedge funds a few years before Hurricane Katrina struck in 2005. The industries are also seen as a good return on investment and help companies diversify from stocks and bonds, Evans says.

Big players have increasingly gotten involved in retrocession insurance and reinsurance in the past year because returns had been so poor across other asset classes, Evans says. “Reinsurance is currently seen as one of the better places to put a small portion of your capital for an uncorrelated return with wider financial markets,” Evans says.

When other asset classes become more profitable, some investors would look elsewhere and leave reinsurance and retrocession behind, Evans says. But several would stick it out since “riding the reinsurance cycle — riding the cycle of rates going up and down — is how companies maintain longevity in the space,” Evans says.

The area between reinsurance and retrocession is very gray, Evans says. “I believe who has what bit is impossible to know,” Evans says. “It can change hands again and again.

“There are more gray areas with the introduction of more hedge funds, but generally I don’t feel there’s any major issue,” Evans says. “These companies are very sophisticated. They’re very careful not to become overexposed to anything.”

Marine insurance tends to end up retro because very few want to keep the risk on their books, Evans says. When it winds up in a hedge fund portfolio, it gets converted from a pure risk transfer into a catastrophe bond. That doesn’t affect consumers directly, but taking a market loss on that catastrophe insurance after a storm could in terms of rates.

Property insurance might also rise more generally in the Northeast because Sandy came just a year after Irene, which also caused lots of property damage. “Actually, a quiet loss year isn’t good for the [insurance] industry because rates decline,” Evans says. Rate increases in Japan after the tsunami helped the industry pad coffers and protect against 2012 risk.

Allstate says it had $1.175 billion in claims from Sandy to address, which will harm profits but won’t be too much for the company to handle, Evans says. “There is absolutely no mention of them impacting shareholders because they have plenty of reinsurance,” he says. “The people who actually pay for losses are hugely rich people or corporations. The whole market is worth $240 billion in premiums a year, so if you lose $20 billion from Sandy it’s quite a lot, but insurers and reinsurers have capital buffers.”

This article originally appeared in the January 2013 issue.

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