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Chapter 10 Nature of the Insurance Industry
Reinsurance
Even insurance companies need insurance. What might happen if an
insurer wrote too many policies at too low of a premium? Or, if many of its
clients experienced catastrophic loss at the same time? The company may
not be able to pay its clients’ claims. This is where reinsurance comes in.
With reinsurance, an insurance company transfers some of its risk
to another insurance company. For example, an insurer writes a $20
million property policy to cover a commercial building. It can work
with another insurance company to share the risk. The first insurer
could agree to pay damages up to $10 million. The reinsurer would be
responsible for any losses above that, up to $20 million.
Reinsurance is a global business. This helps spread risk across
markets worldwide. Reinsurance proved to be enormously important
in 2011. In just the first six months of the year, policyholders around
the world suffered $67 billion in insured losses. This was more than
double the losses in the first half of 2010. From January through
June, the world witnessed earthquakes, a tsunami and the threat of
a nuclear accident in Japan, a massive earthquake in New Zealand,
landslides in Brazil, and deadly storms and tornadoes in the US.
Overall losses, not just insured losses, were estimated at $278 billion.
Checkpoint 10.2
1. What principle is based on the idea that the greater the pool of
policyholders, the lower the risk is to the insurance company?
2. What essential process determines the risk an applicant poses to an
insurance carrier?
3. From what source do insurance companies receive information
regarding industry-wide claims and losses?
4. What insurance professional uses statistics, math, computer science,
and finance to determine the probability of claims being made?
5. How do insurance companies transfer their risk?
Build Your Vocabulary
As you progress through this course, develop a personal glossary of
insurance terms. This will help you build your vocabulary and prepare you
for a career in insurance. Write out a definition for each of the following
terms, and add it to your personal insurance glossary.
law of large numbers
underwriting
adverse selection
smart systems
inspection report
Medical Information Bureau
credit score
insurance score
actuary
ratings bureau
reinsurance