Reinsurance is insurance that is purchased by an insurance company from one or more other insurance companies. Transferring portions of risk portfolios to other parties (or ‘cedents’) by some form of agreement is designed to reduce the likelihood of having to pay large obligations resulting from an insurance claim. Reinsuring is sometimes known as ‘insurance for insurers’ or ‘stop loss insurance’ as it solely exists to preventing losses to primary insurers by spreading risks across alternative institutions. The extent to which insurance companies engage reinsurers is measured by what is called the retention ratio, which is the ratio of policies a company keeps on its books (rather than passing on to a reinsurance company). Reinsurance retention ratios differ greatly between countries, from almost no policies being passed on in Finland to almost one third in New Zealand.
Reinsurers play an important role in managing climate and natural disaster risk, as these events can trigger very large claim obligations for insurance companies. Over the last few years natural disasters cost the global insurance industry between 50 and 150 billion U.S. dollars each year. Hurricane Katrina, which hit in 2005, was one of the most expensive natural disasters for the insurance industry, as well as one of the deadliest hurricanes recorded in the United States. Insured losses resulting from Katrina amounted exceeded 60.5 billion U.S. dollars. The connection between natural disasters and reinsurance is likely one of the main reasons that New Zealand – with its high risk of earthquakes – has such a low reinsurance retention rate.
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