What is the function of reinsurance?

Reinsurance serves a critical function in the insurance industry by allowing one insurer to indemnify itself for a portion of its liabilities. Essentially, when an insurance company underwrites policies, it takes on a certain amount of risk. However, if the number or severity of claims exceeds expectations, this can threaten the financial stability of the insurer. By entering into a reinsurance agreement, a primary insurer transfers some of this risk to another insurance company, known as the reinsurer. This process helps to protect the insurer's financial health, allowing it to manage and mitigate the exposure it faces from high claims.

Through reinsurance, the primary insurer can maintain more stable premium rates, improve its capital management, and ensure that it can meet its obligations to policyholders even in adverse circumstances. This mechanism plays a vital role in the overall stability and sustainability of the insurance market by spreading risk across a larger pool.