Insurance, Excess Insurance, Reinsurance: An Overview
There are many types of insurance policies, and each has its own rules and requirements. A typical insurance policy is usually a primary insurance policy, which covers the financial cost of an insurance claim up to a certain limit. Excess insurance covers specific amounts beyond the limits in the primary policy. Reinsurance is when insurers pass a portion of their policies onto other insurers to reduce the financial cost in the event a claim is paid out.
- Primary insurance is the policy that covers a financial liability for the policyholder as a result of a triggering event.
- Primary insurance kicks in first with its coverage even if there are other insurance policies.
- Excess insurance covers a claim after the primary insurance limit has been exhausted or used up.
- Reinsurance is a way of an insurer passing policies to another insurance company to reduce the risk of claims being paid out.
An insurance policy is a contract in which the policyholder receives financial reparations or protection from an adverse event that's covered under the policy. In return for this protection, the policyholder pays the insurance company in the form of premiums. There are various types of insurance policies that protect policyholders or those named in the policy from financial harm or liability, which is the risk of being sued.
Most insurance policies that individuals or companies buy are called primary insurance. Primary insurance is the policy that covers a financial liability for the policyholder as a result of a triggering event. Primary insurance kicks in first with its coverage even if there are other insurance policies. Only when the predetermined coverage limit has been exceeded would any other policies issue a payout. Primary insurance is the policy that covers the claim first before any other policies that are in place.
For example, the primary coverage of a fire insurance policy on a home or business would kick in if the insured property had suffered fire damage and a claim had been filed by the policyholder.
Primary Insurance Requirements
There may be some stipulations about timing and circumstance, such as promptness to report the claim, but generally, the insurer's obligations follow a similar pattern in each case. Each primary policy has a limit imposed on the amount of coverage available and normally sets deductible limits for the customer. Primary policies pay out against claims regardless of whether there are additional outstanding policies covering the same risk.
Primary Insurance and Medicare
Primary insurance in medicine typically refers to the first payer of a claim, up to a certain limit of coverage, beyond which a secondary payer is obligated to cover additional amounts.
For example, those with private insurance policies, who also have coverage under Medicare as a secondary policy, would have their primary insurance pay for claims up to the limit. Beyond that limit, Medicare would kick in and cover claims (assuming it was the secondary policy). In other words, Medicare would only cover costs if there were costs that the primary insurer didn't cover.
Excess insurance covers a claim after the primary insurance limit has been exhausted or used up. For example, if the primary insurance coverage limit was $50,000 and the excess policy covered another $25,000, a claim of $60,000 would result in a $50,000 payout from the primary insurance and $10,000 from the excess policy.
Excess policies, also called secondary policies, extend the limit of insurance coverage of the primary policy or the underlying liability policy. In other words, the underlying policy is responsible for paying any portion of a claim first before the excess policy is used. However, the underlying policy might not be a primary insurance policy but instead, could be another excess policy. Regardless of the type of insurance policy, the underlying policy pays before the excess policy.
Umbrella insurance policies are written to cover several different primary liability policies. For example, a family might purchase a personal umbrella insurance policy from an insurance company to extend excess coverage over both their automobile and homeowners policy. An umbrella policy is not limited to providing coverage to only the policyholder. For example, an umbrella policy can also cover family members and those living in a household.
Umbrella policies are considered excess policies since they're considered extra coverage for claims that exceed the payouts and coverage limits of the primary or underlying policy. Although umbrella policies are excess policies, not all excess policies are umbrella policies. If an excess policy only applies to a single underlying policy, it is not considered to be an umbrella insurance policy.
Umbrella Policy Benefits
Umbrella policies can be less expensive, meaning lower premiums for the insured, versus buying a few primary insurance policies. If the umbrella policy is purchased through the existing insurer that covers the primary policies, the overall cost is usually lower and the insured gets comprehensive coverage. Umbrella policies can also provide additional coverage not offered in the primary policy, such as protection against slander and libel.
Insurance companies are always at risk for claims being filed due to an event. If the event is widespread and there are many claims filed all at once, the premiums received from those policies might not be enough to cover the total amount of the claims. Insurance companies are only profitable if the premiums received for policies are more than enough to cover claims over the lifetime of those policies.
As a result, insurance companies can find themselves in financial hardship if they don't manage the risks of claims being filed based on the types of insurance coverages they have in their portfolio. Reinsurance is a way of an insurer passing or selling policies to other insurance companies to reduce the exposure or risk of claims being paid out. The insurance company taking the policies is called the reinsurance company while the insurer passing the policy is called the ceding insurance company since they're ceding the risk of claims being filed on the ceded policies.
In return, the reinsurer receives the premiums from the policies ceded to them minus a fee (called a ceding commission), which is paid to the initial insurer (the ceding insurer). In other words, reinsurance is insurance for insurance companies to help insurers remain profitable and stay in business. Unless you own or work for an insurance company, you are unlikely to encounter reinsurance on the market.
Claims with Reinsurance
The fundamental operating characteristics of reinsurance are similar to primary insurance. The ceding insurance company pays the premium to the reinsurer and creates a potential claim against undesirable future risks. Were it not for the added protection of reinsurance companies, most primary insurers would either exit riskier markets or charge higher premiums on their policies.
However, sometimes the reinsurer defaults on a ceded policy, meaning they can't cover the claim due to financial distress. As a result, the ceding company may still have a liability and may need to pay for the claims, despite ceding the policy to the reinsurer.
One common example of reinsurance is known as a "cat policy," short for catastrophic excess reinsurance policy. This policy covers a specific limit of loss due to catastrophic circumstances, such as a hurricane, that would force the primary insurer to pay out significant sums of claims simultaneously. Unless there are other specific cash-call provisions, which require cash payments from the reinsurer, the reinsurer is not obligated to pay until after the original insurer pays claims on its own policies.
Although catastrophes are rare, the amount of money paid out by an insurer could be enough to bankrupt the company. For example, Hurricane Andrew in 1992 cost $15.5 billion in damages to the state of Florida, which forced several insurance companies into financial insolvency according to the Insurance Information Institute. Catastrophe reinsurance helps spread out the risk and some of the costs of a catastrophic event.