A simple guide to reinsurance

Ask the average person on the street what reinsurance is, and the likely response will be ‘when you renew your insurance policy’, or in the case of a rental property ‘when you re-insure your property by taking out insurance cover again’. But it means something a bit different for insurers.

In the insurance world, put in its most simple terms, reinsurance is insurance for insurance companies. But before diving deeper into what that really means, it helps to take a step back and first understand what insurance itself is. It is only by grasping the basics of insurance that you can truly make sense of reinsurance.

How does insurance work?

Insurance is where a group of people, we’ll call them policyholders, with similar risks want to be financially protected against those risks. The policyholders pay an insurer a premium in exchange for the insurer promising to compensate them if they suffer a loss due to an insured event. The premiums paid by the policyholders are pooled together creating a fund that can be used by the insurer to pay out any claims from policyholders with valid claims. If a policyholder experiences a covered loss, they can file a claim, and the insurer will draw from the pooled funds to compensate them. This is insurance in a nutshell!

What happens if there isn’t enough money to pay claims?

This is a valid question. Sometimes the insurer may face many or large payouts, such as when natural disasters strike. So, to make sure they have enough money available to pay out claims, they take out insurance themselves – this is reinsurance, where the insurer insures their own risk.

Reinsurance defined

Reinsurance is basically a way for insurance companies to protect themselves from big, unexpected losses. It works like this: one insurance company buys insurance from another company (called a reinsurer). This helps the first company share the risk, so if something major happens and they have to pay out a lot of money, the reinsurer helps cover the cost.

Why do insurers take out reinsurance?

It helps the insurance company stay financially stable. It also helps them to manage risk – they may be able to take on larger or more complex policies without fear of being overwhelmed by claims. By sharing the risk using reinsurance, insurers may also be able to underwrite more policies, offer higher coverage limits and set more accurate premiums than they could on their own. This is also particularly important for covering large-scale events like natural disasters.

Who pays for reinsurance?

Reinsurance is one of the costs insurers need to factor into the premiums they charge policyholders. Reinsurance, especially for natural catastrophe cover, has been getting more and more expensive as the frequency and severity of natural catastrophes has been increasing over the years – and not just locally but globally.

How do reinsurance pools fit in?

Another term you may have heard is: reinsurance pool. A reinsurance pool is where multiple insurance companies come together to share and manage risk – they ‘pool’ their resources and this allows them to underwrite larger or more complex risks than they would be able to individually. Multiple insurers contribute to a common pool, which is used to cover claims. This is especially useful in managing catastrophic risks and ensuring that insurance companies remain solvent even after significant claims events. In some cases, governments may back these reinsurance pools to ensure stability and confidence in the insurance market.

What about the Cyclone Reinsurance Pool? 

The Australian Cyclone Reinsurance Pool is probably one you have heard about lately. Northern Australia is prone to cyclones. Over the years, the losses insurers incurred from damage caused by cyclonic winds and subsequent flooding got to the point where it became unfeasible for many insurers to continue offering cover for property in northern Australia. This meant that there were very few insurers willing to insure homes and businesses in cyclone-prone areas, and for those that did offer cover, the premiums were often beyond reach. This all led to an insurance availability and affordability crisis in northern Australia. To address this, the Cyclone Reinsurance Pool (cyclone pool) was established by the Australian Government in 2022. The Government’s reinsurance pool means that the Government, via the Australian Reinsurance Pool Corporation (ARPC), is acting as a reinsurer – adding to the existing global market. The cyclone pool is designed to lower insurance premiums for households and small businesses with high cyclone and related flood damage risk by reducing the cost of reinsurance, which is a significant cost component of premiums for these policies. The ACCC notes that the cyclone pool has begun to deliver lower premiums for some clients, but any savings are being offset by economic and environmental factors beyond the cyclone pool including the broader hardening of global reinsurance markets, extreme global weather events, and price increases of building materials and labour.

A quick summary

Just as landlords and property managers take out insurance to cover themselves and their interests in the event of an incident, so too do insurers. Reinsurance – insurance for insurers – is common in the insurance industry and enables insurers to share their risk with others.

If you have questions about reinsurance or any EBM RentCover landlord insurance policies, reach out to a member of our Expert Care team for guidance.