By Michael F. Rellosa
Insurance and reinsurance are two sides of the same coin. On the one hand, insurance is a means of protection from financial loss in which, in exchange for a fee called a premium, the insurer agrees to compensate the insured in the event of a certain loss, damage, or injury arising out of a particular event. It is a form of risk management primarily used to protect against the risk of a contingent or uncertain loss. On the other hand, reinsurance is an agreement designed to manage the probable risk of insurers or direct writers. Reinsurers are separate companies that insure or protect the direct writers, so you can call them the insurer's insurer and reinsurance the insurance of insurers.
There are basically two types of reinsurance. First is facultative reinsurance, where each risk is marketed separately, and prospective insurers underwrite it accordingly. One can liken this to retail reinsurance; in other words, there is an offer and an acceptance for each risk. In this regard, premiums are shared commensurate to the percentage of risk accepted by the reinsurer, and more importantly, the reinsurer is actively and collaboratively involved in the decision-making process, be it underwriting or claims.
The other type is what is known as treaty reinsurance. This is where insurers agree to a business relationship with the reinsurer, who evaluates the direct insurer's underwriting philosophy and risk appetite and, therefore, selects the ceding company to do business with. This is done not on a per-risk basis but rather on a portfolio or wholesale basis.
The whole purpose of reinsurance is to allow direct writers to maintain their solvency through risk sharing. Risk sharing, in the meantime, is one of the guiding principles of the industry. It is akin to not keeping the proverbial eggs in one basket. If, for example, a direct writer does not reinsure, theoretically, this direct writer would be writing risk only from the Philippines (as it is a Filipino company). With the Philippines now considered the most vulnerable country to natural catastrophes such as typhoons, earthquakes and floods, it would, in short, be writing risky businesses that are prone to losses. By reinsuring, it shares this risk internationally, where it gets diluted with risks from other "less vulnerable" countries, thereby evening out the risk. The direct writer, therefore, gains by managing his risk, evening out the loss experience, and thereby increasing his own capacity to write more risk. At the end of the day, reinsurance plays a primordial role in bringing stability to not only the insurance company or the direct writer but also to the entire insurance industry and, more importantly, to the insuring public itself. Owing to the diversification that reinsurance provides, it becomes the life-saving device or the shock absorber of the local insurance industry by keeping it from collapsing after a large-scale crisis such as the anticipated "Big One" (a cataclysmic earthquake arising out of the West Valley fault system), or a super typhoon that may hit the country (now a more common occurrence because of climate change).
There are also certain classes of business that the local insurance industry is reluctant to go into but are nevertheless needed by the insuring public. Examples of these would be agriculture, livestock, and insurance for fisheries or aquaculture. Currently, insurance cover is almost solely provided by the government's own Philippine Crop Insurance Corp. Cybercrime and insurance on electric vehicles are the other lines, just to name a few. This may be uncharted territory for local insurers, but for the international market, experience in these lines is already developed and far-reaching. Reinsurers who can provide capacity for these lines to local insurers then allow them to get their feet wet and learn until they gain the confidence and expertise to go into it big-time. By mitigating the potential losses that could arise from these relatively new lines of business, reinsurance fulfills its other role of being an enabler of innovation.
The local insurance industry relies heavily on reinsurers, and this reliance will remain until our industry matures, grows and becomes more stable and resilient.