Most people have never given a thought to reinsurance. In fact, most people on this planet have never heard of it. Yet, reinsurance is the engine that keeps the massive $1.32 trillion dollar insurance industry running. It directly affects the price you pay for coverage, the stability of the insurance market, and even the pace of innovation in our industry.
We'll pull back the curtain and demystify reinsurance by looking at its roots, how it works, and where it’s headed. You might just walk away with a fact or two to share at your next extremely dry dinner party.
In the simplest terms, reinsurance is "insurance for insurers."
Think of it this way: when you buy a policy (home, auto, life), the insurance company is taking on a risk. They collect your premium, and in return, they agree to pay out on a claim if something goes wrong. But what happens if a major catastrophe (like a hurricane, a wildfire, or a global pandemic) triggers an enormous number of claims all at once? The insurance company might not have enough cash on hand to pay everyone.
Here's a quick and dirty explanation using a life insurance example:
You get a $100K term life insurance policy.
Your insurance company is legally required to hold around 12% of premiums in an account in the event of unexpectedly high claims over a shot period of time. So they'll hold $12K in an account as a reserve.
A reinsurance company agrees to take on that risk in exchange for a percentage of the premium.
Because the risk is transferred, your insurance company no longer has to hold the $12K in reserve and can invest that capital elsewhere.
This makes reinsurance a commodity where risk is bought and sold. It's the proverbial person behind the curtain, paying your obligation but never interacting with you directly.
The history of reinsurance got its start in a rocky, nautical way. The first recorded instance was in 1370, when a bank in Genoa transferred the risk for the second half of a merchant ship’s voyage from Cadiz to Sluis. The trip was deemed too dangerous to keep on the bank’s books. Later, the first instance of the Italian word for "to reinsure" appeared in Florence in 1457.
Despite these early examples, reinsurance was banned in Great Britain for over a century due to “pernicious practices.” This is a recurring theme in the history of reinsurance: its distance from the policyholder has often led to allegations of wrongdoing.
While many of these early ventures failed, a man named Carl Von Thieme saw a different path. In 1880, he created Munich Re, which would become one of the most important reinsurers in the world. He envisioned an organization that didn't just offload a single company's bad risk, but one that could purchase bundled risk from many different countries to create a globally diversified portfolio. He realized that a large, independent reinsurance company could underwrite massed risk with greater accuracy and less fear of competition. As the historian Kopfe noted, this idea was "the first step toward the atomization and the widespread distribution of risk."
Today, reinsurance is a global force. In 2007, the face amount of recurring life reinsurance in-force amounted to $6.3 trillion with new business of over $683 billion.
The true effect of reinsurance is best seen in a major global catastrophe. For instance, the COVID-19 pandemic caused billions in losses for reinsurers. Despite this, the price of many insurance premiums did not immediately skyrocket for policyholders. Why? Because the risk was so widely dispersed across the reinsurance market that the initial hit was absorbed. The effects are delayed, as reinsurers will eventually leverage these losses to increase their share of premiums and, in turn, affect consumer prices in the future. It's a testament to the stability of the global insurance market that they're not felt on the surface.
While insurance companies are often seen as stagnant, the largest changes to the industry are being spearheaded by reinsurers. They are investing heavily in developing digital underwriting platforms and AI “brains” that power many new insurtech organizations.
Many modern insurtechs, think the ones with the sleek apps and frictionless user experiences, are essentially just a new "face" on top of a powerful reinsurance engine. Just as Carl Von Thieme realized that large, pooled risk was essential to creating sustainable insurance, today’s reinsurers are focused on creating frictionless, transactional insurance that is easy to buy and manage.
Gerathewohl, Klaus. Reinsurance Principles and Practice. Translated by John Christopher La Bonté. Vol. II. Karlsruhe: Verlag Versicherungswirtschaft e. V., 1982.
Holland, David M. “A Brief History of Reinsurance.” Society of Actuaries, Feb. 2009.
Kopf, FCAS, Edwin W. “The Origin and Development of Reinsurance.” Proceedings of the Casualty Actuarial Society XVI (1929).
Ross, Sean. “The Business Model of Reinsurance Companies.” Investopedia, 1 June 2020.
Vries, J. de; Woude, A. van der. The First Modern Economy. Cambridge University Press, 1997.
Yoder, Claude. Reinsurers React to the Impact of the Pandemic. Lockton International, 9 Oct. 2020.
Keshner, Andrew. “Has COVID-19 Made Life Insurance More Expensive?” MarketWatch, 7 Dec. 2020.