JULY 2013

Reinsurance is insurance for insurance companies. It’s a way of transferring or “ceding” some of the financial risk insurance companies assume in insuring cars, homes and businesses to another insurance company, the reinsurer. Reinsurance, a highly complex global business. U.S. professional reinsurers (companies that are formed specifically to provide reinsurance) accounted for about 7 percent of total U.S. property/casualty insurance industry premiums written in 2010, according to the Reinsurance Association of America.

The reinsurance business is evolving. Traditionally, reinsurance transactions were between two insurance entities: the primary insurer that sold the original insurance policies and the reinsurer. Most still are. Primary insurers and reinsurers can share both the premiums and losses or reinsurers may assume the primary company’s losses above a certain dollar limit in return for a fee. However, risks of various kinds, particularly of natural disasters, are now being sold by insurers and reinsurers to institutional investors in the form of catastrophe bonds and other alternative risk-spreading mechanisms. Increasingly, new products reflect a gradual blending of reinsurance and investment banking, see also Background section.


  • Regulation: In July 21, 2010, President Obama signed into law a sweeping overhaul of how financial services are regulated in the United States. The legislation, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, included a section that had previously been a separate bill to streamline the regulation of reinsurance and surplus lines insurance. (The Nonadmitted and Reinsurance Reform Act had been passed by the House in 2009 but not voted on by the Senate.) The measure makes regulation of a reinsurance transaction the responsibility of the reinsurer’s home state and promotes greater uniformity in procedures and other rules among states.
  • Ending a long-standing debate on the issue of posting 100 percent collateral on reinsurance transactions with non-U.S. reinsurers, the NAIC voted at their November 2011 meeting to adopt an amended version of the Credit For Reinsurance Model Law, which will allow financially sound non-U.S. reinsurers to post less than 100 percent collateral. The current rule is designed to protect U.S-companies from reinsurers with a history of slow payment who are outside the reach of U.S. regulators. The new model law allows the NAIC to decide which foreign jurisdictions have sufficiently rigorous regulations for their reinsurers to be considered “qualified” and therefore permitted to post a lower collateral amount. The law also requires insurers to notify state commissioners when the amount that they expect to recover under their reinsurance contracts exceeds 50 percent of their policyholders’ surplus, the financial cushion that allows insurers to pay unexpectedly high claims. It also requires insurers to diversify their reinsurance programs to lower the risk of not being able to collect on their reinsurance contracts.
  • For some time the United States has been under pressure from international reinsurers and regulators, who see the 100 percent collateral law as protectionist, to modify these requirements. A number of states have already reduced collateral for the highest rated reinsurance companies, a move which some fear will lead to a patchwork of different rules and regulations.. Some regulators, including former Federal Deposit Insurance Corporation Chairwoman Sheila Bair, have warned against the risks of lowering collateral requirements.
  • The Dodd-Frank act also established the Federal Insurance Office (FIO), an entity that will report to the President and Congress on the insurance industry. Insurance will continue to be regulated by the states, but the act includes a narrow preemption of state insurance laws in areas where the FIO determines that the state law is inconsistent with a negotiated international agreement and treats a non-U.S. insurer less favorably than a U.S. insurer. The FIO has the authority to monitor the insurance industry, identify regulatory gaps or systemic risk, deal with international insurance matters and monitor the extent to which underserved communities have access to affordable insurance products. The FIO covers insurers, including reinsurers, but not health insurance.
  • Among other things, the FIO must submit an annual report to Congress on the insurance industry. In gathering information, the FIO may require insurers, with the exception of small insurers, which are exempt, to submit data. The FIO is empowered to issue subpoenas but it must obtain data from state and federal regulatory agencies, where possible, before requiring insurers to submit them. The new agency must also report on the modernization of insurance regulation within 18 months of enactment of the Dodd-Frank Act and report on the U.S. and global reinsurance market. The FIO oversees the federal terrorism insurance program.
  • At the beginning of July 2012, the FIO asked for comments in seven areas, including the scope of the reinsurance market, the role of that market in supporting insurance in the United States and the effect of domestic and global regulation on the U.S. reinsurance market. In addition, the FIO asked about the role and impact of government reinsurance programs and the coordination of reinsurance supervision in this country and internationally. Because the FIO and Treasury may negotiate agreements with foreign governments on reinsurance collateral requirements and preempt state laws that conflict with those agreements, the FIO may address this issue in its report, industry observers say. The FIO’s report was delayed but is now expected to be submitted to Congress by July 2013.
  • Financial and Market Conditions: According to the Reinsurance Association of America (RAA), a group of 19 reinsurers property casualty reinsurers wrote $9.1 billion of premiums in the first quarter of 2013, compared with $7.7 billion during the same three-month period in 2012. The combined ratio, a measure of profitability that shows what percentage of the premium dollar that was spent on claims and expenses, was 78.9 percent, an improvement over the 95.6 percent reported in the first quarter of 2012. Policyholder surplus, capital that represents a cushion against unexpectedly high losses, had risen to $128.5 billion at the end of the first quarter of 2013, up from $123.3 billion at the end of 2012. Net income for the period rose to $3.4 billion, from $1.5 billion for the same period in 2012. RAA members account for about two-thirds of reinsurance coverage provided by U.S. reinsurers and their affiliates.
  • Catastrophe Bonds: Catastrophe bonds issued in the first quarter of 2013 are on track to exceed last year’s record of $1.02 billion for the period. According to a report from the reinsurance broker Guy Carpenter, eight transactions during the three month period brought the total to $1.34 billion. Total risk outstanding rose by more than 5 percent from $12.14 billion in the first quarter of 2012 to $12.77 billion in the first quarter of 2013. The report says that the bonds sold this year were more diverse than before.
  • Catastrophe bonds are attractive in the current investment environment, with the U.S. hurricane bond index posting a 10.5 percent return in 2012, more than four percentage points higher than 2011’s 6.1 percent.
  • Increasingly, catastrophe bonds are being developed for residual market government entities and state-backed wind pools. Taking advantage of the growing popularity of catastrophe bonds as investments, Florida’s Citizens Property Insurance Corp. issued $750 million in bonds through the special purpose vehicle, Everglades Re, in the second quarter 2012. This is the largest single natural catastrophe bond transaction. Citizens said that 32 investors participated in the deal. As with other types of reinsurance, the bonds cover losses above a certain level, in this case between $6.35 billion and $7.35 billion.
  • Bonds were issued by the Massachusetts Property Insurance Underwriting Association, two North Carolina pools (the Fair Plan and Beach Plan) and the Alabama wind pool. The Alabama bond was designed with a parametric trigger to pay a certain sum for a defined event, such as a hurricane with a particular wind speed. The pay-out is based on calculations using models to determine in advance how much damage such a storm would cause. In this way, the Alabama pool receives the funds soon after the wind speed has been verified and can start paying the claims of its policyholders rather than having to wait for total insured losses to be adjusted.
  • In 2011 the California State Compensation Insurance Fund issued a $200 million bond to cover workers compensation losses in the event of a catastrophic earthquake. Other bonds have been created to cover extreme mortality and medical benefit claim levels. In an entirely new realm, a Bermuda-based insurance company, Hoplon Insurance Ltd, has issued a bond that covers “MyLotto24” against lottery winnings exceeding a preset amount over a three year period.
  • The catastrophe bond market, which was largely pioneered by reinsurers, has begun to change. In 2009, for the first time, primary insurance companies were sponsors of the majority of bond issues–about 60 percent. Industry observers say primary companies are increasingly integrating cat bonds into their core reinsurance programs as a way to diversify and increase flexibility. Whereas traditional reinsurance is mostly purchased on an annual basis, cat bonds generally provide multiyear coverage and may be structured in tranches that mature in successive years.

Developing Countries

  • Mexico and MultiCat: Mexico has renewed its catastrophe bond program for another three years. The program will now expire in 2015. In October 2009 the Mexican government became the first to use the World Bank’s new MultiCat bond program, when it sold $290 million in catastrophe bonds to cover potential damage from earthquakes and Pacific and Atlantic hurricanes. MultiCat provides a common documentation, legal and operational framework for issuing catastrophe bonds, the World Bank says, offering developing countries a cost-effective way to transfer disaster risk to the private sector and lessen the financial and economic impact of natural disasters. In 2006 the Mexican government issued an earthquake bond, the first time a sovereign state had issued such a bond.
  • Regional Catastrophe Pools: The Caribbean Catastrophe Risk Insurance Facility (CCRIF) has given Haiti about $8 million, the full policy limit under an earthquake policy issued by the facility. The payment, which is about 20 times the premium paid, will be made after a 14-day waiting period. Haiti was devastated by a 7.0 earthquake on January 12, 2010.
  • The CCRIF is an insurance pool that covers hurricanes and earthquakes for its 16 Caribbean member nations and their territories and purchases reinsurance. In 2009 the European Union made a donation to the CCRIF, joining the World Bank, the Caribbean Development Bank and a number of developed nations in contributing to the facility’s reserve pool. The reserves paid for start-up costs. Japan funded the initial feasibility study, see Background.
  • Beginning in early 2010, the CCRIF will offer member countries a new excess rainfall insurance policy, which will serve as a hedging option for the economic impact of extreme amounts of rain. It is based on work carried out with the Caribbean Institute of Meteorology and Hydrology. Rainfall totals will be measured across the entire region four times a day and combined with data from a 60-year historical rainfall database.
  • The Caribbean is not the only area to establish a public-private partnership to provide disaster protection. In 1999 the Turkish government, with the help of the World Bank, set up the Turkish Catastrophe Insurance Pool (TCIP). Turkey is in an active earthquake zone. Despite the high risk of damage, there was a low level of earthquake coverage among the country’s households. The TCIP works with some 30 insurers to distribute its low-cost policies, resulting in three times the amount of coverage, or more than 2 million households insured.


Reinsurance is insurance for insurance companies. Just as a homeowners or auto insurance policy reduces the amount of cash a person must have on hand to pay for a new car after an accident or to rebuild a home after a hurricane, a reinsurance contract can protect an insurance company against large catastrophic losses. Reinsurance also enables an insurer to underwrite more or larger insurance policies.

When an insurance company issues an insurance policy, an auto insurance policy, for example, it assumes responsibility for paying for the cost of any accidents that occur, within the parameters set out in the policy.

By law, an insurer must have sufficient capital to ensure it will be able to pay all potential future claims related to the policies it issues. This requirement protects consumers but limits the amount of business an insurer can take on. However, if the insurer can reduce its responsibility, or liability, for these claims by transferring a part of the liability to another insurer, it can lower the amount of capital it must maintain to satisfy regulators that it is in good financial health and will be able to pay the claims of its policyholders. Capital freed up in this way can support more or larger insurance policies. The company that issues the policy initially is known as the primary insurer. The company that assumes liability from the primary insurer is known as the reinsurer. Primary companies are said to “cede” business to a reinsurer.

Types of Reinsurance: Reinsurance can be divided into two basic categories: treaty and facultative. Treaties are agreements that cover broad groups of policies such as all of a primary insurer’s auto business. Facultative covers specific individual, generally high-value or hazardous risks such as a hospital, that would not be accepted under a treaty.

In most treaty agreements, once the terms of the contract, including the categories of risks covered, have been established, all policies that fall within those terms – in many cases both new and existing business—are covered, usually automatically, until the agreement is cancelled.

With facultative reinsurance, the reinsurer must underwrite the individual “risk,” say a hospital, just as a primary company would, looking at all aspects of the operation and the hospital’s attitude to and record on safety. In addition, the reinsurer would also consider the attitude and management of the primary insurer seeking reinsurance coverage. This type of reinsurance is called facultative because the reinsurer has the power or “faculty” to accept or reject all or a part of any policy offered to it in contrast to treaty reinsurance, under which it must accept all applicable policies once the agreement is signed.

Treaty and facultative reinsurance agreements can be structured on a “pro rata” (proportional) or “excess-of-loss” (non proportional) basis, depending on the arrangement by which losses are apportioned between the two insurers. 

In a proportional agreement, most often applied to property coverages, the reinsurer and the primary company share both the premium from the policyholder and the potential losses.

In an excess of loss agreement, the primary company retains a certain amount of liability for losses (known as the ceding company’s retention) and pays a fee to the reinsurer for coverage above that amount, generally subject to a fixed upper limit. Excess of loss agreements may apply to individual policies, to an event such as a hurricane that affects many policyholders or to the primary insurer’s aggregate losses above a certain amount, per policy or per year.

A primary company’s reinsurance program can be very complex. Simply put, if it were diagrammed, it might look like a pyramid with ascending dollar levels of coverage for increasingly remote events, split among a number of reinsurance companies each assuming a portion. It would include layers of proportional and excess of loss treaties and possibly a facultative excess of loss layer at the top.

Regulation: As an industry, reinsurance is less highly regulated than insurance for individual consumers because the purchasers of reinsurance, mostly primary companies that sell car, home and commercial insurance, are considered sophisticated buyers. However, in the early 1980s, state insurance officials became increasingly concerned about the reliability of reinsurance contracts – the ability of the reinsurer to meet its contractual obligations — and a primary company's use of them. Following the June 1982 annual meeting of the National Association of Insurance Commissioners (NAIC) in Philadelphia, an advisory committee was formed to review the regulation of reinsurance transactions and parties to those transactions. A model Credit for Reinsurance Act was adopted in 1984.

All insurers submit financial statements to regulators who monitor their financial health. Financial health includes not assuming more risk or liability for future claims than is prudent, given the amount of capital available to support it, i.e., to pay claims. The principal value of reinsurance to a ceding company (the purchaser of reinsurance) for regulatory purposes is the recognition on the ceding company's financial statement of a reduction in its liabilities in terms of two accounts: its unearned premium reserve and its loss reserve. The unearned premium reserve is the amount of premiums equal to the unexpired portion of insurance policies, i.e., insurance protection that is still "owed" to the policyholder and for which funds would have to be returned to the policyholder should the policyholder cancel the policy before it expired. The loss reserve is made up of funds set aside to pay future claims. The transfer of part of the insurance company’s business to the reinsurer reduces its liability for future claims and for return of the unexpired portion of the policy. The reduction in these two accounts is commensurate with the payments that can be recovered from reinsurers, known as recoverables. The insurer’s financial statement recognizes as assets on the balance sheet any payments that are due from the reinsurer for coverage paid for by the ceding company.

By statute or administrative practice, all states (but with considerable variation) recognize and grant credit on the financial statement for the reduced financial responsibility that reinsurance transactions provide. When reinsurers are not licensed in the United States, (these are known as “alien” or offshore companies) they must post collateral (such as trust funds, letters of credit, funds withheld) to secure the transaction. An alien company can also participate in the U.S. marketplace by becoming licensed in the states in which it wishes to do business.

For many years, few people outside the insurance industry were aware that such a mechanism as reinsurance existed. The public was first introduced to reinsurance in the mid-1980s, during what has now become known as the liability crisis. A shortage of reinsurance was widely reported to be one of the factors contributing to the availability problems and high price of various kinds of liability insurance. A few years later, in 1989, the reinsurance business once again became a topic of interest outside the insurance industry as Congress investigated the insolvencies of several large property/casualty insurers.

These investigations culminated in a widely read report, "Failed Promises: Insurance Company Insolvencies," published in February 1990. The publicity surrounding the investigations and the poor financial condition of several major life insurance companies prompted proposals for some federal oversight of the insurance industry, particularly insurers and reinsurers based outside the United States. However, no federal law was enacted. While a large portion of the insurance industry opposes federal regulatory oversight, many U.S. reinsurers and large commercial insurers view compliance with a single federal law as preferable to compliance with the laws of 51 state jurisdictions.

A critical tool for evaluating solvency is the annual "convention" statement, the detailed financial statement submitted by all insurance companies to the NAIC. In 1984, for the first time, the annual statement required insurers ceding liability to unauthorized reinsurers (those not licensed or approved in a designated jurisdiction) to include the amount of incurred but not reported (IBNR) losses in addition to known and reported losses. (IBNR losses are losses associated with events that have already occurred where the full cost will not be known and reported to the insurer until some later date.) This requirement reflects regulators' concern that all liabilities are identified and determined actuarially, including IBNR losses, and that IBNR losses are secured by the reinsurer with additional funds or a larger letter of credit than otherwise would have been required.

Related to solvency is the issue of reinsurance "recoverables,” payments due from the reinsurer. In the mid-1980s, some reinsurance companies that had entered the reinsurance business during the period of high interest rates in the early 1980s left the market, due to insolvency or other problems. (When interest rates are high, some insurance/reinsurance companies seek to increase market share in order to have more premiums to invest. Those that fail to pay attention to the riskiness of the business they are underwriting may end up undercharging for coverage and going bankrupt as a result.) Consequently, some of the insurers that reinsured their business with these now-defunct companies were unable to recover monies due to them on their reinsurance contracts.

To enable regulators, policyholders and investors to assess a company's financial condition more accurately, the NAIC now requires insurance companies to deduct 20 percent of anticipated reinsurance recoverables from their policyholders’ surplus on their financial statements—surplus is roughly equivalent to capital—when amounts are overdue by more than 90 days. The rule helps regulators identify problem reinsurers for regulatory actions and encourages insurers to purchase reinsurance from companies that are willing and able to pay reinsured losses promptly.

Concern about reinsurance recoverables led to other changes in the annual financial statement filed with state regulators, including changes that improve the quality and quantity of reinsurance data available to enhance regulatory oversight of the reinsurance business.

After Hurricane Andrew hit Southern Florida in 1992, causing $15.5 billion in insured losses at the time, it became clear that U.S. insurers had seriously underestimated the extent of their liability for property losses in a megadisaster. Until Hurricane Andrew, the industry had thought $8 billion was the largest possible catastrophe loss. Reinsurers subsequently reassessed their position, which in turn caused primary companies to reconsider their catastrophe reinsurance needs.

When reinsurance prices were high and capacity scarce because of the high risk of natural disasters, some primary companies turned to the capital markets for innovative financing arrangements.


Catastrophe Bonds and Other Alternative Risk Financing Tools: The shortage and high cost of traditional catastrophe reinsurance precipitated by Hurricane Andrew and declining interest rates, which sent investors looking for higher yields, prompted interest in securitization of insurance risk. Among the precursors to so-called true securitization were contingency financing bonds such as those issued for the Florida Windstorm Association in 1996, which provided cash in the event of a catastrophe but had to be repaid after a loss, and contingent surplus notes — an agreement with a bank or other lender that in the event of a megadisaster that would significantly reduce policyholders’ surplus, funds would be made available at a predetermined price. Funds to pay for the transaction should money be needed, are held in U.S. Treasuries. Surplus notes are not considered debt, therefore do not hamper an insurer's ability to write additional insurance. In addition, there were equity puts, through which an insurer would receive a sum of money in the event of a catastrophic loss in exchange for stock or other options.

A catastrophe bond is a specialized security that increases insurers’ ability to provide insurance protection by transferring the risk to bond investors. Commercial banks and other lenders have been securitizing mortgages for years, freeing up capital to expand their mortgage business. Insurers and reinsurers issue catastrophe bonds to the securities market through an issuer known as a special purpose reinsurance vehicle (SPRV) set up specifically for this purpose. These bonds have complicated structures and are typically created offshore, where tax and regulatory treatment may be more favorable. SPRVs collect the premium from the insurance or reinsurance company and the principal from investors and hold them in a trust in the form of U.S. Treasuries or other highly rated assets, using the investment income to pay interest on the principal. Catastrophe bonds pay high interest rates but if the trigger event occurs, investors lose the interest and sometimes the principal, depending on the structure of the bond, both of which may be used to cover the insurer’s disaster losses. Bonds may be issued for a one-year term or multiple years, often three.

Of the many new ways of financing catastrophe risk that have been developed over the past decade or two, catastrophe bonds are best known outside the insurance industry. One lesser-known alternative is the industry loss warranty contract (ILW). Unlike traditional reinsurance, where the reinsurer pays a portion of the primary company’s losses according to an agreed upon formula, the ILW is triggered by an agreed-upon industry loss. The contract “warrants” that the reinsurer will pay up to $100 million toward the buyer’s losses if the industry suffers a predetermined loss amount, say $5 billion or more.

Another recent innovation is the side-car. These are relatively simple agreements that allow a reinsurer to transfer to another reinsurer or group of investors, such as hedge funds, a limited and specific risk, such as the risk of an earthquake or hurricane in a given geographic area over a specific period of time. Side-car deals are much smaller and less complex than catastrophe bonds and are usually privately placed rather than tradable securities. In side-cars, investors share in the profit or loss the business produces along with the reinsurer. While a catastrophe bond could be considered excess of loss reinsurance, assuming the higher layers of loss for an infrequent but potentially highly destructive event, side-cars are similar to reinsurance treaties where the reinsurer and primary insurer share in the results.

An insurance company’s willingness to offer disaster coverage is often determined by the availability of reinsurance. When catastrophe bonds were first issued after Hurricane Andrew, they were expected to gain industrywide acceptance as an alternative to traditional catastrophe reinsurance, which was then in short supply, but they still represent a small, albeit growing, portion of the worldwide catastrophe reinsurance market.

Initially, catastrophe bonds were designed to indemnify the insurer or reinsurer for the actual losses incurred—half of all hurricane losses up to a certain maximum, for example, similar to a traditional reinsurance agreement. Now they tend to be indexed products where the loss of principal is tied to formulas that take into account the severity of a catastrophe and its location, such as an earthquake of a certain intensity in California, instead of the actual losses suffered by the issuer. Other formulas are based on data generated by loss models or historical data.

Several of the first attempts at true securitization were withdrawn because of time constraints — the hurricane season had begun before work on the transaction could be completed, for example — and lack of sufficient interest on the part of investors. The first deals were consummated in December 1996, one by a U.S. reinsurer, St Paul Re, and the second by Winterthur, a Swiss insurer which issued convertible bonds to pay auto damage claims stemming from hailstorms. This was the first large transaction in which insurance risk was sold to the public markets. The company said that it did not need to finance hailstorm damage in this way but sold the bonds to test the market for securitizing insurance risks. Six months later there was strong investor interest in a bond offering that provided USAA with catastrophe reinsurance to pay homeowners losses arising from a single hurricane in eastern coastal states, proving for the first time that insurance risk could be sold to institutional investors on a large scale.

The field has gradually evolved to the point where some investors and insurance company issuers are beginning to feel comfortable with the concept, with some coming back to the capital markets each year. In addition to the high interest rates catastrophe bonds pay, their attraction to investors is that they diversify investment portfolio risk, thus reducing the volatility of returns. The returns on most other securities are tied to economic activity rather than natural disasters.

The National Association of Insurance Commissioners (NAIC), which oversees insurance company investments and sets the rules that influence insurers’ investment strategies, classifies these new types of catastrophe risk securities as bonds rather than equities. Equities are considered riskier under formulas that dictate how much capital must be set aside to support various liabilities. In addition, at its June 1999 meeting, the NAIC approved a so-called “protected cell” model act that makes it easier to transact deals in the United States. Up to then, most securitization deals had been conducted offshore through special entities created for this purpose. The protected cells, separate units within an insurance company, protect investors from losses incurred by the insurer.

In addition to catastrophe bonds, catastrophe options were developed but the market for these options never took off. Another alternative is the exchange of risk where individual companies in different parts of the world swap a certain amount of losses. Payment is triggered by the occurrence of an agreed upon event at a certain level of magnitude.

In response to the nation’s growing exposure to the cost of natural disasters due to population growth in hazard-prone areas, the General Accountability Office (GAO) was asked by the U.S. House Financial Services Committee to look into the adequacy of insurance capacity, including the market for catastrophe bonds. The GAO presented its findings on catastrophe bonds and barriers to their wider use in 2002.

The GAO said there were several barriers to more widespread use of catastrophe bonds. The first has to do with transfer risk from the insurance company to the reinsurer. As mentioned earlier, insurers get credit on their balance sheet for indemnity-based reinsurance in the form of a reduction in the amount of risk-based capital they have to set aside since the reinsurer will pay for losses covered by reinsurance. Indemnity-based deals are based on the insurer’s own book of business. They are not subject to basis risk, which is the mismatch between the company’s business and the index to which the transaction is linked. It is difficult, the GAO said, to assess how much credit to give for reinsurance that is not indemnity-based and may not fully reflect the company’s actual losses. The GAO said that accounting for risk-linked securities that are not based on actual losses would be a challenge for regulators, but a necessary step.

Disaster Recovery Bonds and Regional Pools: Disaster recovery bonds serve much the same purpose as a business income insurance policy, helping the government entity/policyholder get back on track after a catastrophic event.

In developing countries insurance penetration is low, meaning that few individuals and businesses have insurance, so the burden of recovering from a disaster falls almost entirely on the government. Traditionally, developing countries have relied on post-disaster funding to finance recovery efforts, including donations from developed countries, international emergency aid and humanitarian relief organizations. A faster and more reliable way to fund the recovery is prefinancing in the form of reinsurance, catastrophe bonds or other alternative risk transfer mechanisms.

One example of prefunding is the Caribbean Catastrophe Risk Insurance Facility, the first regional insurance fund. CCRIF provides hurricane and earthquake catastrophe coverage to its member nations, so that in the aftermath of a disaster they can quickly fund immediate recovery needs and continue providing essential services.

In 2004 hurricanes severely damaged the economy of several small Caribbean islands, causing losses in excess of $4 billion. This prompted Caribbean governments to request the help of the World Bank in facilitating access to catastrophe insurance. The CCRIF started operations in June 2007, after two years of planning.

The CCRIF acts as a mutual insurance company, allowing member nations to combine their risks into a diversified portfolio and purchase reinsurance or other risk transfer products on the international financial markets at a saving of up to 50 percent over what it would cost each country if they purchased catastrophe protection individually. In addition, since a hurricane or earthquake only affects one to three countries in the Caribbean on average in any given year, each country contributes less to the reserve pool than would be required if each had its own reserves.

The CCRIF was initially capitalized by its members with help from donor partners — developed countries, the World Bank and the Caribbean Development Bank. Its members pay premiums based on their probable use of the pool’s funds. As countries raise building standards to provide better protection against disasters, premiums will decrease.

Because the CCRIF uses what has become known as parametric insurance to calculate claim payments, claims are paid quickly. Under a parametric system, claim payments are triggered by the occurrence of a specific event that can be objectively verified, such as a hurricane reaching a certain wind speed or an earthquake reaching a certain ground shaking threshold, rather than by actual losses measured by an adjuster, a process that can take months to complete.

Payout amounts are derived from models that estimate the financial impact of the disaster. As a form of deductible that encourages risk mitigation, participating governments are only allowed to purchase coverage for up to 20 percent of their estimated losses, an amount believed to be sufficient to cover initial needs.

Post-September 11: The terrorist attacks on the World Trade Center left their mark on the reinsurance business in many ways. First, the huge losses incurred accelerated rate hikes over a broad spectrum of coverages, unlike the aftermath of Hurricane Andrew, the most costly disaster prior to September 11, where only catastrophe insurance, a property coverage, was in short supply. Furthermore, the reinsurers that are now offering some terrorism coverage look at the business they are being offered from an accumulation-of-loss viewpoint in addition to traditional considerations, particularly in areas that may be terrorism targets. Computer programs are now being developed that not only estimate likely terrorism losses but also enable companies to determine more easily what other businesses they have reinsured in the same neighborhood.

Legislation known as the federal reinsurance backstop, the Terrorism Insurance Act of 2002, was passed in November 2002 and extended in 2005 to December 2007 and extended once again through December 2014. The act does not cover reinsurers, see report on terrorism insurance.


The Essential Guide to Reinsurance: Solutions to 21st Century Challenges. Swiss Re, 2012. A guide to the concepts of reinsurance and its contributions to the economy and society.

"Reinsurance: Fundamentals and New Challenges," Insurance Information Institute, 2004.

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