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Understanding Reinsurance: Four Pros and One Con

This week we covered the story of the Vermont Leagues of Cities and Towns (VLCT), a municipal insurance company that was faced with an estimated $14 million in property damage claims following the devastation of Hurricane Irene in 2011. Despite the large number of claims from towns and cities across the state, the VLCT was able to pay out all claims without issue and without facing insolvency. How is this the case? The insurance company had reinsurance—insurance for itself.

What are the four major benefits of carrying reinsurance?

  • Decreases risk. Insuring large numbers of homes and businesses against damage is a risky business. Especially if the area is prone to natural phenomena like severe storms. It can be extremely risky to run a business that could go under after just one weather event. Reinsurance spreads that risk out over several companies.
  • Increases capacity. When the risk of insolvency is decreased through the use of reinsurance, it allows the insurance company to take on more policyholders. It eliminates the fear that the company would not be able to pay out all claims in the event of a disaster.
  • Protects against large catastrophes. Insurance companies mostly need reinsurance in a situation where hundreds or even thousands of claims pour in at once. This almost always happens after a natural disaster such as a hurricane, tornado, or flood. When large percentages of policyholders suddenly need to repair damage, reinsurance companies are key.
  • Stabilizes loss. Even if an insurance company can pay for a large number of claims made in a short period of time, paying out all of those claims may leave it in a dire financial situation and extremely unstable. Reinsurance helps keep insurance companies stable even during tough times.

Are there any disadvantages to reinsurance? Sure. The main disadvantage for insurance companies is that buying reinsurance is costly. In fact, insurance companies face the same dilemma as home and business owners: is purchasing an expensive insurance policy worth it even though the risk is small? The answer for insurance companies is usually yes. They don’t want to take a chance and have the entire company go under if there is a damaging weather event that results in too many claims to pay.

Do you have a question about your insurance claim, or do you suspect that your insurance company is acting in bad faith? Contact a commercial insurance claim attorney today at the Voss Law Firm: 888-614-7730.

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The Voss Law Firm, P.C. represents clients on a local, national and international basis. We proudly serve companies and individuals along the Gulf Coast and around the globe on a contingency fee basis. Our law firm collects nothing unless we recover on our client's behalf.

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