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how does reinsurance work

This is a transcript from PM. The program is broadcast around Australia at 5:10pm on Radio National and 6:10pm on ABC Local Radio.

How does reinsurance work?

PM Archive - Thursday, 24 May. 2001 00:00:00

Reporter: Emma Simkin

MARK COLVIN: As we know the chase is well and truly on for the money and for those accountable for the collapse of HIH. There are many creditors spread across the world all wanting to see their money again.

Fortunately for some, many of HIH's policies had been reinsured, which means that some funds should be forthcoming. But how exactly does re-insurance work?

Emma Simkin explains.

EMMA SIMKIN: Why do we, as individuals, take out insurance - whether it be for a house, car, or even medical insurance? Because we want someone else to cover the risks that are too big to cover ourselves.

In the same way an insurance company which could be taking on a big gamble may want to pass on some of that risk to another party and then, in turn, reinsurance companies will also pass on very big risks to other reinsurance companies.

So essentially each group is trying to control the risk that they individually are exposed to. Many of HIH's policies were reinsured and that means the liquidators should be able to recover some money.

John Pollard, Professor of Actuarial Studies at Macquarie University in Sydney, says there's no limit on how many times a company can reinsure.

JOHN POLLARD: In most cases reinsurance companies want to make sure that they're not getting back some of the same risk via a very long loop, so that they would want to keep a track on it and so it wouldn't go through to many reinsurance companies.

EMMA SIMKIN: With a company collapsing such as HIH, are the reinsurers legally obliged to pay up?

JOHN POLLARD: They're legally obliged to meet any contract that they have with HIH, yes.

There are many different types of scenarios. In most cases HIH will be owing money to the reinsurer and the reinsurer will be owing money to HIH. And so in a sense there's a net amount owed by the re-insurance company.

EMMA SIMKIN: So the reinsurance companies themselves could become creditors of HIH?

JOHN POLLARD: Indeed, yes.

EMMA SIMKIN: So, how does it all work? What exactly happens, for example, if you take out an insurance policy of $100,000 on your house?

JOHN POLLARD: The insurance company takes the premium and agrees to pay their claims up to $100,000 from the person concerned. Now, depending on the size of the company the insurance company might decide to reinsure part of that or if it's below what's called its retention, it'll keep the whole risk itself. So it will depend on the size of the company, what its retention is. But then it probably has a separate arrangement with one or other reinsurance companies to arrange catastrophe cover so if there's a big hailstorm for example in Sydney where many houses are damaged, then it can get reinsurance - or at least payments - for say any cost that it has between $10 million and $20 million dollars. Some sort of cover like this.

EMMA SIMKIN: A natural disaster highlights how far and wide insurance premiums can be spread. Professor Pollard explains what happened, for example, in the aftermath of Cyclone Tracey.

JOHN POLLARD: All the insurers that were involved with houses and cars and so forth in Darwin would have catastrophe cover with a reinsurance company, and because of the size of this the reinsurance company would have treaties with other reinsurance companies and so on and in that particular case the number of reinsurers involved was, from memory, somewhere in excess of 60 and they were spread across 51 different countries.

MARK COLVIN: John Pollard, Professor of Actuarial Studies at Macquarie University, with Emma Simkin.

Category: Insurance

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