-Writing by Sang Hee Yu
11:04 a.m. PDT. July 6, 2013
A massive shadow of grief was cast upon the faces of people as news of the plane crash at San Francisco International Airport restlessly poured presumed specifics. Asiana Airlines Flight 214 from Incheon International Airport, Korea crashed on its final approach into San Francisco International Airport, United States, taking with it three beautiful lives and causing a lot of injuries. The tragedy is still in the process of a thorough and many-sided examination.
In the midst of the news about the crash on the internet, I found some writings concerning the insurance companies involved with this tragic event. An approximate figure is almost $2.5 billion for the crashed aircraft and compensation for the victims of the event. Will the Korean insurance companies that Asiana Airlines had policies with survive after this tragic event?
The FSC immediately embarked on observing and estimating the size of the impact that the involving insurers ought to take on due to the event. It’s anticipated that there will be no problem in compensating since the crashed aircraft was insured jointly by 9 insurance companies; one such as LIG insurance co., ltd. Also, the domestic insurance companies (the ceding companies) responsible for the event have purchased insurance from foreign insurance companies (the reinsurers) for most of the outgoings stemming from the event (97.45%). Therefore, the burden that the domestic insurance companies have to bear won’t be significant. In an attempt to make sure that every involved insurance company has a rapid response time in compensating all victims of the event, the FSC directed the corresponding companies closely to prevent any inconvenience.
At this point, you may be curious as to why or how one insurance company buys insurance from another. This practice is called ‘Reinsurance.’ The primary reason and purpose of reinsurance is to efficiently manage risk exposure. With reinsurance, the insurer is able to write policies with a better capacity of handling bigger risks. This is made possible because the entirety or a portion of the risk is transferred to the reinsurer. Since reinsurers are to take bigger chunk of risk aggregated from other ceding companies, they are usually global insurance companies with highly advanced techniques and knowledge to efficiently manage risk on a strong monetary basis. In addition to risk transfer, ceding companies can take more advantages: income smoothing by making potential revenue more predictable and forming a manageable and profitable portfolio through making available more heterogeneous sources of sale.
Now, let’s look into how it works in practice. A reinsurer and a ceding company enter into a reinsurance agreement which shows various conditions upon which the reinsurer has to pay a stipulated proportion of the claims incurred. In return for the coverage, the reinsurance is paid a reinsurance premium depending on the contents of policies. There are two big categories for reinsurance: Facultative reinsurance and Treaty reinsurance.
Facultative reinsurance is purchased by ceding companies for each reinsured insurance contract. So, the price and conditions for each contract is determined differently in accordance with the contents and the amount of risk transferred to the reinsurer.
Treaty reinsurance refers to a reinsurance established after a negotiation between a ceding company and a reinsurer upon the scope of the contract, liability limit for each company, and methodologies of execution for the contract.
It may seem like a perfect tactic for ceding companies to operate their business on a risk-free basis. However, if the impact is too huge for the reinsurer to survive and go bankrupt, the sheer risk comes back on the shoulder of the ceding companies. Hence, choosing the right reinsurer that is able to make it through perilous situations with sufficient resiliency is important for ceding companies.
Today, we took a look at what reinsurance is and how it works. As an influx of new types of uncertainties pour down across the world like a waterfall, the importance of the functions of insurance has been soaring up to the peak. With an understanding of insurance, I hope our readers now have more interest and profound insight into the market.
Sang Hee Yu