As you pay your monthly or yearly premium to your home insurance company, it may surprise you to learn that that company too buys insurance. It’s called reinsurance and it’s what insurance companies do when they are anticipating the possibility of having large-scale claims to pay, and they want to protect themselves. Just like you seek protection against financial disaster in case your home is destroyed, the insurance companies seek protection against financial disaster in case hundreds of their customers homes are destroyed. The cost of buying reinsurance goes into the cost of your policy.

Reinsurance is especially relied on in states where natural disasters are common. Texas and Florida are two states frequently subject to disasters of various sorts. Homeowners in those states already pay higher rates to help balance the claims that are made throughout the state. What happens in a year where there are more disasters than usual, though? The insurance company’s usual funds may not be adequate to pay off such a high number of expensive claims. Some homeowners insurance companies have taken to investing in the stock market to try to earn money, but that too can sometimes have a catastrophic effect. When the stock market plunges, so does their capital.

One way that companies calculate the likelihood of a bad year is by hiring businesses who specialize in analyzing and predicting storm patterns. If these analyses show them that it’s likely to be a very costly year for the company, they buy more reinsurance to be sure they are covered. Of course, the reinsurance company has to watch its bottom line, so it raises its rates so that it also can afford the anticipated costs. This in turn causes a raise in homeowners premiums. It is certainly an imperfect system, but as long as natural disasters take place someone has to pay the cost of damages. For most people, paying high insurance rates is still a preferable option to risking complete loss and financial ruin if the worst does happen. For an increasingly high number of homeowners in vulnerable states, the worst has happened before and will likely happen again.

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