Most countries have minimum financial reserves that insurers must have on hand (so that they are financially prepared for the small probability of large claims), but this ties up enough of their capital to prevent them from investing in their own or other enterprises.

If insurers purchase reinsurance, however, some of their capital can be freed up, as the premiums involved are lower that the financial reserves that the insurers would otherwise have to maintain.

Since the bulk of the insurer’s risks of very large losses have been shifted to the reinsurer, the insurer can sell more policies because the capital reserves are now enhanced by the purchase of reinsurance and can be used to cover more individuals.

By providing protection to insurers for the risk of extraordinarily high costs incurred by any individual, reinsurance companies are in effect establishing a back up reservoir of funds to help pay for catastrophic cases. In this insurers do not have to build up such reserves into their premiums, which can thus be lower.

Small firms with reinsurance can then underwrite risks that they would not otherwise take on their own.

Solvency protection

Reinsurance also plays an important role in protecting the financial solvency of insurance entities. Insurers generally can use bona fide reinsurance to reduce their minimum capital requirements. This can be particularly important for smaller and start-up entities.

Market Entry protection
Reinsurance can also provide a cover for entry for new firms and cover into new unfamiliar risks for old firms. For example if an old firm wants to provide pharmacy benefits to it’s existing members and would like to be reinsured in case of  catastrophic medical/pharmacy claims.

Technical Expertise
Primary insurers reinsure so as to obtain specialized expertise or services from reinsures, such as advice on rate setting and management of risk.  Reinsurers also supply networks of vendors already certified and available at pre negotiated, favourable rates such as specialty pharmacies.

Market stability
Small employers and the insurers that serve them have problems in the small group market. Premiums are higher than for the large group coverage and quite variable over time. Risks are hard to predict because group size is small and insurers fear adverse selection. Groups often face sudden rate changes in the wake of bad claims experience. Insurers see much churning of enrollment as groups often change carriers in search of better terms.

Administrative costs are high because of individual underwriting and other factors. Reinsurance of very high cost cases will help stabilize the market by reducing the need for sudden price increases and shifting among carriers. Some saving from reduction of risk premiums can be anticipated. Good risk management can cover against average losses but it cannot cover against “shock” losses (large; unusual, non-recurring expenses, as from a severe accident or a neonatal intensive care case).

Pricing of reinsurance
Reinsurers charge premiums to primary insurers to pay for such coverage. The reinsurance premiums vary according to who buys the coverage and are set to include expected claim costs, administrative expenses plus a risk premium to compensate the reinsurer for taking the risk of capital loss if premiums prove insufficient.

Information required to get a quotation

To enable a reinsurance company to provide you with a quote the health care insurer will need to provide the following information:-

• Demographic data of scheme members
• Range of expenses to be covered (what is known as a “layer” of reinsurance)
• Where the layer fall in the distribution of expenses that might be covered by the policy i.e. top, middle or bottom
• The fraction of the expenses in that layer for which the purchaser will retain responsibility
• Data on claim experience in the past years