When a large number of claims arises due to a catastrophe loss, insurers face a strain on capital. In such a scenario, reinsurers may bear a portion of the burden.
A reinsurer provides insurance to an insurer. In other words, a reinsurer shares a portion of an insurer’s risk against the payment of some premium and provides a part of the claims payout.
As we can see in the chart above, large catastrophes impacted reinsurance capital in 2011. The ~$130-billion loss resulted in a 3% drop in reinsurers’ capital that year. Since then, their capital has grown consistently due to underwriting performance, investment gains, and lower-than-average catastrophe losses.
Need for capital
The $17 billion in insured losses from Hurricane Andrew caused a shortage of capital in the insurance industry, resulting in bankruptcy for several insurers. In order to address the issue of constrained capital in the traditional insurance markets (capital of primary insurers and reinsurers), the players moved to alternative sources of capital that came from third-party investors. In the next article, we will focus on these alternative capital sources.
Those who want to gain exposure to the insurance sector can invest in funds like the iShares US Financial ETF (IYF).