What Is Catastrophe Excess Reinsurance?
Catastrophe excess reinsurance protects catastrophe insurers from financial ruin in the event of a large-scale natural disaster.
For instance, if a regional insurer covers 60% of the properties along a coastline affected by a storm surge, it can be suddenly hit with multiple claims that must be paid out in unison, which could otherwise bankrupt an insurer.
Key Takeaways
- Catastrophe excess reinsurance is a type of reinsurance in which the reinsurer indemnifies–or compensates–the ceding company for losses stemming from multiple claims occurring simultaneously.
- Natural disasters, for instance, may cause damage to a large number of insured properties in an insurer's portfolio of policies all at once.
- Insurers buy catastrophe excess reinsurance to allow them to pay out all claims owed and to continue operations in such an event.
Understanding Catastrophe Excess Reinsurance
Catastrophe excess reinsurance protects insurance companies from the financial risks involved in large-scale catastrophic events. The size and unpredictability of catastrophes force insurers to take on a tremendous amount of risk. Although catastrophic events infrequently happen, when they do happen, they tend to cover wide geographic areas and cause large amounts of damage. When an insurer encounters a large number of claims all at once, the losses potentially could cause it to restrict new business or cause it to refuse to renew existing policies, limiting its ability to recover.
Insurance companies use reinsurance to transfer some of their risk to a third party in exchange for a portion of the premiums the insurer receives. Reinsurance policies come in a number of forms. Excess-of-loss reinsurance, for instance, establishes a limit to the amount the insurer will pay following a catastrophe, somewhat similar to a deductible in a regular insurance policy. Provided no catastrophes take place that cause an insurer to exceed their limit over the duration of a contract, the reinsurer simply pockets the premiums.
To the extent reinsurance provides a financial backstop for an insurer's potential losses, its presence allows insurers themselves to underwrite more policies, making the coverage more widely and affordably available.
Example of Catastrophe Excess Reinsurance
Companiesthat purchasereinsurance policiescede theirpremiums to the reinsurer. In the case of catastrophe excess reinsurance, the insurer exchanges premiums for coverage of some percentage of claims above a defined threshold. For example, an insurance company might set a threshold of $1 million for a natural disaster such as a hurricane or earthquake. Suppose a disaster incurred $2 million in claims. A reinsurance contract covering all claims over the threshold would pay out $1 million. A reinsurance contract for 50 percent of claims above the threshold would pay $1.5 million. While reinsurance can cover a percentage of claims above a threshold, it does not constitute proportional coverage, which requires reinsurers to pay a percentage of claims in exchange for the proportion of premiums ceded to them. Returning to our example, adisaster that incurred $800,000 worth of claim would cost the reinsurer nothing.
Note that, unlike other types of reinsurance, catastrophe excess reinsurance policies may not have a hard cap on the amount the reinsurance company must pay out in excess claims, and therefore may offer more downside risk to a reinsurance company than other types of arrangements.
FAQs
For example, an insurance company might set a threshold of $1 million for a natural disaster such as a hurricane or earthquake. Suppose a disaster incurred $2 million in claims. A reinsurance contract covering all claims over the threshold would pay out $1 million.
What is an example of excess loss of reinsurance? ›
Excess loss of reinsurance provides protection to the insurance company by paying claims in excess of a predetermined amount. For example, an insurance company may purchase excess loss reinsurance coverage with a limit of $10 million. If a claim exceeds this limit, the reinsurer pays the excess amount.
What is an example of a catastrophic risk? ›
Some of the most devastating global catastrophic risks resulting in loss of more than 10 million lives include the Taiping Rebellion (1851-1864), and the famine of the Great Leap Forward in China, the Black Death in Europe, the Spanish flu pandemic, the two World Wars, the Nazi genocides, the famines in British India, ...
What is a simple example for reinsurance? ›
For example, if there were a flood of claims due to a recent hurricane, the reinsurer would be responsible for some of the liabilities incurred. This way, the primary insurance company is able to handle more clients who are located in these hurricane-prone areas, since it essentially has the backup to cover claims.
What is a catastrophe example? ›
A hurricane destroying hundreds of homes is certainly a catastrophe; baking a birthday cake without following a recipe might also result in catastrophe, if you don't know anything about cooking. Definitions of catastrophe. a sudden violent change in the earth's surface. synonyms: cataclysm. types: nuclear winter.
How does catastrophe reinsurance work? ›
Catastrophe reinsurance is purchased by an insurance company to reduce its exposure to the financial risks of a catastrophic event occurring. It allows insurance companies to shift some or all the risk associated with policies that it underwrites in exchange for a portion of the premiums it charges policyholders.
What is catastrophe excess of loss reinsurance? ›
Catastrophe excess of loss is a form of excess of loss reinsurance where the reinsurer agrees to reimburse the amount of a very large loss in excess of a particular sum.
What is catastrophe excess of loss? ›
It sounds self-explanatory. By just looking at the name, we can simply tell that a catastrophe excess of loss cover is for protection from catastrophes. A Catastrophe is an event (an occurrence) happening at a particular time and in a particular place on a large scale.
What is an example of an excess policy? ›
For example, an umbrella policy can also cover family members and those living in a household. Umbrella policies are considered excess policies since they're considered extra coverage for claims that exceed the payouts and coverage limits of the primary or underlying policy.
What are two examples of catastrophic events? ›
Any event or force of nature that has catastrophic consequences, such as avalanche, earthquake, flood, forest fire, hurricane, lightning, tornado, tsunami and volcanic eruption.
In the insurance industry, a catastrophe hazard is a type of risk that could cause a large number of policyholders to file claims at the same time. Common examples of catastrophe hazards include earthquakes, tornadoes, or acts of terrorism. Catastrophe hazards can be particularly costly for insurance companies.
How do insurers deal with catastrophic loss? ›
The period between the catastrophic event and the completion of repairs allows insurers time to fund the loss through underwriting cash flow, normal cash flow from investments, asset liquidation, debt financing, or advance funding from reinsurers.
What is an example of reinsurance in real life? ›
An example would be where an insurer provides policies to multiple homeowners within a city. The insurer, who is the ceding party, cedes some of the risk involved with underwriting the numerous policies to the reinsurer across a period of, say, 15 years.
How do you make money in reinsurance? ›
From an investment perspective, reinsurance serves primarily as an income-producing asset. Investors pool money in a reinsurance fund that, in turn, provides coverage to back the risk carried by other insurers. Those insurers pay premiums for the coverage, generating an income stream for investors.
What is the difference between excess insurance and reinsurance? ›
Reinsurance of a captive sits above and behind the captive's layer, and can in many circ*mstances be called upon in the event that the captive does not or cannot respond to a claim. Excess insurance, in general, does not always respond to a claim below its attachment point, regardless of other issues.
What is considered a catastrophe for insurance? ›
U.S. Natural Catastrophe Losses 2023: Aon defines a catastrophe as a natural event that causes $25 million or more in insured property losses, or 10 deaths; or 50 people injured; or 2,000 filed claims or homes and structures damaged.
What is a catastrophic event in insurance? ›
In the insurance industry, a catastrophe hazard is a type of risk that could cause a large number of policyholders to file claims at the same time. Common examples of catastrophe hazards include earthquakes, tornadoes, or acts of terrorism. Catastrophe hazards can be particularly costly for insurance companies.
What is catastrophic loss in reinsurance? ›
(Insurance: Reinsurance) Catastrophe excess of loss is a form of excess of loss reinsurance where the reinsurer agrees to reimburse the amount of a very large loss in excess of a particular sum.
