What is the purpose of reinsurance?

The purpose of reinsurance is to share risk among insurance companies. This practice allows insurance companies to transfer a portion of their risk to other insurers, thereby protecting themselves from large financial losses that could occur due to unforeseen events, such as natural disasters, high claims, or significant liabilities. By spreading the risk, primary insurers can stabilize their finances and ensure they have sufficient capital to pay out claims while also maintaining their ability to underwrite new policies.

Reinsurance plays a critical role in the insurance industry; it allows smaller insurers to remain solvent and competitive by diversifying their risk exposure. This mechanism also supports the overall stability of the insurance market by helping companies manage their risk portfolios effectively.