For all of you who are reinsurance experts, check back in a week. We are first going to have a little Reinsurance 101.

Why would an insurance company buy reinsurance? The short answer is that an insurance company would buy reinsurance for many of the same reasons that an individual or business would buy insurance. One reason would be that in the event that there is a single large loss or series of losses, the size of these losses is greater than the company is comfortable showing on its books. A easy example would a natural catastrophe.

An insurance company writing property business on the eastern or southern coasts of the United States has to be concerned about the impact of a tropical storm or hurricane not only on its operating results but potentially even on its solvency. These storms can result in damage to many structures producing large losses. In order to protect itself from the full financial impact of these losses, the insurance company will buy reinsurance that will reimburse them once an accumulation of these losses exceeds a certain fixed amount. This type of reinsurance is called catastrophe reinsurance. The amount of catastrophe reinsurance that an insurance company will buy depends on the size of the company, i.e. capital, the amount of property insured in the area that is catastrophe prone and the company’s risk appetite.