June 23, 2011
Do Natural Disasters Matter To Me As An Insurance Buyer?
Does the recent string of catastrophes from New Zealand to Mid America to Japan matter to me and my Insurance Program? Should I worry about the impact and record breaking cost of these events? Currently the cost estimate is over 60 Billion dollars and counting. As with so many things in a global environment, are all of these events related and will they have serious implications for insurance pricing in the future? The simple answer is Yes.
The simple answer? Yes, they do. Insurance at its core is the ability to collect premiums from many businesses such as your local operation and many thousands of other small to medium size businesses and use those premiums to pay losses for the group. The insurance carrier has to charge a premium that not only is sufficient to pay smaller routine losses, but to also bank premiums for the large multi-billion dollar losses that can occur on an infrequent basis. Every carrier has to predict the potential loss that they could be exposed to from any source and make sure they have the financial strength to pay those claims. No one carrier, no matter how large, is able to take 100% of any loss or losses that might happen without facing financial insolvency. The solution to that problem is to purchase what is called reinsurance. In essence, each carrier pays a premium to another carrier for protection against a truly devastating event such as happened in Japan.
A carrier might have multiple layers of reinsurance with each policy taking a defined portion of any loss such as 5 million of coverage after the paid loss totals 15 million, and these policies each have a defined portion of a loss for a defined premium. These reinsurance premiums are then included in the premium that each policy holder pays each year. Reinsurance premiums can average as much as 15 to 20% of the annual premium you pay as a business owner. If the reinsurance carriers have to participate in the cost of a catastrophe such as Japan or New Zealand for earthquakes or hurricanes or tornadoes, then the premium they charge will increase which will increase the premiums your carrier pays for the protection and thus your individual premiums can go up. It is this ability to spread high dollar losses to numerous carriers that makes insurance work in any situation.
The reinsurance industry is absorbing losses at a record pace over the last six months, but through careful management of assets and surplus has been able to remain solvent and financially able to continue to provide protection. We are starting to see an indication that rates are going to adjust upward to replenish surplus for reinsurance carriers. Increases will be variable based on location, line of business and carrier concentration. The industry is keeping a wary eye on the upcoming hurricane season. If a large event takes place in the United States in a heavily populated area, it could be the final event that generates a rapid increase in pricing at the individual policy level. Stay tuned for further developments.