THE CONSUMER AND REINSURANCE

How is it possible for an insurance company to insure a property valued at many times over the company’s net worth?

The magic and mysterious word is reinsurance. When an insurance company decides to accept a piece of business, it keeps, or as they say in the trade, it retains for its own account only a small portion of that business.

For instance, on a P2.0 million fire insurance policy, the insurer may decide to retain only 10%, or P200,000. If the building burns down, the most the insurer will pay out of its own pocket is P200,000.

The 80% balance is paid via reinsurance. Before issuing the policy, the company arranges with other companies take the balance.

These companies, called reinsurers, are usually specialists, doing reinsurance business only, and are called – what else? – reinsurance companies.

Or, the reinsurers can be other insurance companies. The company issuing the original policy becomes the reinsured.

The company resorts to reinsurance in order to expand its capacity to do business without unduly exposing its net worth. The maximum retention on any one risk allowed under the Insurance Code is twenty percent of net worth. Actually, companies operate way below this limit.

In the early days, reinsuring on a policy-to-policy basis was the only way to pass on whatever the company could not afford to carry on its own. This is called facultative or retail reinsurance.

As the business of insurance grew and spilled across national boundaries and spanned oceans, it was no longer enough to seek the help of friends down the street but, more important, also of the big fellows on the other side of the world – in London, Munich, Zurich, and other places.

This led to the invention of the reinsurance contract, or as they say in the trade, treaty.

For example, under a fire insurance treaty, the reinsurer or a panel of reinsurers, agrees to be bound automatically to a specified share of every fire policy the insurance company issues within the scope of the treaty.  If the P2.0 million policy mentioned above falls within the treaty, the reinsurers are bound up to 80% automatically.

With the invention of the treaty, which is really reinsurance on the wholesale basis, the need for facultative reinsurance was restricted to insurances outside and beyond treaty limits. Yet, facultative business, especially in the Philippines, remains a major activity.

Of course, for taking a share of the policy, the reinsurer is entitled to a proportionate share of the premium, less an allowance to the insurance company for overhead expenses.

So, what has all the reinsurance mystery got to do with the consumer? Plenty. When an insurance company in Binondo phones his friend in London for reinsurance support, and this chap says yes, the manager can be absolutely certain that if a loss occurs even before the papers can be drawn up, London will come across. London is equally certain that, in the fullness of time, they will get their share of the premium. All these because of three venerable principles: reinsurance is an utmost good faith relationship, it is an engagement entered into by people of honor, and the reinsurer always “follows the fortunes” of the reinsured.

When you accept an insurance policy, you also accept, albeit tacitly, that the company has arranged proper reinsurance backup. You just have to trust the insurance company, because you have no access whatsoever to the reinsurance contract, treaty or facultative. You are not a party to it. If a reinsurer fails to pay his share of your claim (this sometimes happens, very rarely, you can be sure, even among the most honorable of men) you cannot sue him.

If you feel you must ask about reinsurance arrangements of an insurance company, more out of suspicion than curiosity, do not buy from that company.

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