What is Catastrophe Excess Reinsurance? – Catastrophe excess reinsurance safeguards catastrophe insurers from financial devastation in case of a massive natural calamity.
Learn more about Catastrophe Excess Reinsurance
Catastrophe excess reinsurance safeguards insurance companies against the financial risks associated with major catastrophic events. These events are often massive and unpredictable, which means insurers have to bear a significant amount of risk. While catastrophic events occur infrequently, they have the potential to affect vast geographical areas and result in substantial damage. When an insurer faces a sudden surge in claims, the resulting losses could lead to limitations on new business or the refusal to renew existing policies, hindering its ability to recover.
Insurance companies utilize reinsurance to shift a portion of their risk to a third party in return for a share of the premiums collected by the insurer. Reinsurance policies come in various types. For example, excess-of-loss reinsurance sets a cap on the amount the insurer will pay after a disaster, similar to a deductible in a standard insurance policy. As long as no catastrophes occur that surpass the insurer’s limit during the contract period, the reinsurer keeps the premiums.
Reinsurance acts as a financial safety net for insurers, enabling them to offer a greater number of policies at more affordable rates. This expands the availability and accessibility of insurance coverage.
Example
Companies that buy reinsurance policies give their premiums to the reinsurer. In the case of catastrophe excess reinsurance, the insurer trades premiums for coverage of a certain percentage of claims that exceed a specific limit. For instance, an insurance company might set a limit of $1 million for a natural disaster like a hurricane or earthquake. Let’s say there were $2 million in claims from a disaster. A reinsurance contract that covers all claims above the limit would pay out $1 million. A reinsurance contract for 50 percent of claims above the limit would pay $1.5 million. While reinsurance can cover a percentage of claims above a limit, it is not proportional coverage. Proportional coverage requires reinsurers to pay a percentage of claims in exchange for the proportion of premiums given to them. In our example, if the disaster only had $800,000 worth of claims, the reinsurer would not have to pay anything.
Unlike other forms of reinsurance, catastrophe excess reinsurance policies do not have a maximum limit on the amount that the reinsurance company is obligated to pay for claims that exceed the coverage limit. As a result, these policies may pose a greater risk to the reinsurance company compared to other types of agreements.