Insurance practice aids firms

Reinsurance gives providers a cushion in times of disaster
Sunday, October 2, 2005 | 12:00 a.m. CDT; updated 6:11 p.m. CDT, Saturday, July 19, 2008

Hurricanes Katrina and Rita hit insurance companies with a big blow, but Shelter and State Farm Insurance, two of Columbia’s biggest employers, both said they don’t have financial worries.

The latest estimates from Risk Management Solutions, a risk modeling firm based in Newark, Calif., put insured losses from both hurricanes between $44 billion and $67 billion.

If insurers will pay tens of billions of dollars, why do industry experts say firms such as State Farm won’t feel substantial financial pressures? The answer, in a word: reinsurance.

“It basically divides the amount of damage into layers, so we may handle the first layer, while the reinsurer takes the next one,” said Joe Moseley, vice president of public affairs for Shelter, which has its headquarters in Columbia.

Reinsurance, simply put, is insurance for insurance companies. When the average consumer has a high-value item such as a car or home, they can purchase insurance to lower their financial risk if the property is damaged. Insurance companies act like consumers toward the policies they sell by taking out insurance to help lower their risk.

“You can think of it like a series of cushions,” said Gary Thompson, an attorney with the Gilbert Heinz & Randolph law firm in Washington, D.C., who specializes in representing policyholders with insurance complaints.

Typically, an insurance company will insure only a portion of their liabilities. For example, if an insurance company has sold $10 million worth of policies, it might take out a reinsurance policy that covers 50 percent. That way, if a Katrina-like disaster occurs, the insurance company would only have to pay the first $5 million in claims, and the reinsurance company would handle any losses beyond that amount. In addition, one insurance company can buy reinsurance policies from multiple firms.

But the cushions don’t end there. Reinsurance companies often purchase their own reinsurance. And those third reinsurance companies? You guessed it, they’ll take out some insurance, too.

Where do this process stop?

“There’s no magic number for this. It depends on the perception of risk and other things,” said Bill Bailey, managing director for the Hurricane Insurance Information Center in Flowood, Miss.

Thompson said that some of these policies extend so far back that the last reinsurer in a line rarely pays anything in losses but continues to collect “very high premiums.”

“The fact is, though, without even that tenth reinsurer, 100 percent of losses will not be covered,” said Matt Barton, a spokesman for the Missouri Department of Insurance.

For Columbia’s two major insurance companies, the story becomes even more

complicated, because both Shelter and State Farm reinsure themselves to an extent.

Shelter reinsures the biggest chunk of its premiums itself, Barton said.

In 2004, Shelter’s reinsurance premiums totaled more than $27 million, according to the state insurance department, $7.4 million of which was with Shelter Reinsurance.

Bailey said a company that reinsures itself will use an entity that has its own corporate presence to reinsure another portion of the same company. For example, the State Farm Fire and Casualty Co. may reinsure the State Farm Mutual Automobile Insurance Co.

“They’re reinsured, but the money is just getting passed across the table,” Bailey said.

Barton said that when companies reinsure themselves, they aren’t accelerating their risk because the financial dealings for various branches of a single company can be different. For example, Shelter Insurance operates Shelter Reinsurance, and though the companies have the same name, their balance sheets are calculated separately.

Companies choose to reinsure themselves because it allows them to keep the money they would have paid on premiums to an outside reinsurer within the company, Barton said.

“They still want to transfer part of the risk,” Barton said, “but at the same time these companies, like any company, want to make a profit.”

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