A:

Reinsurance occurs when multiple insurance companies share risk by purchasing insurance policies from other insurers to limit the total loss the original insurer would experience in case of disaster. By spreading risk, an individual insurance company can take on clients whose coverage would be too great of a burden for the single insurance company to handle alone. When reinsurance occurs, the premium paid by the insured is typically shared by all of the insurance companies involved.

Reinsurance can help a company by providing:

  1. Risk Transfer - Companies can share or transfer of specific risks with other companies
  2. Arbitrage - Additional profits can be garnered by purchasing insurance elsewhere for less than the premium the company collects from policyholders.
  3. Capital Management - Companies can avoid having to absorb large losses by passing risk; this frees up additional capital.
  4. Solvency Margins - The purchase of surplus relief insurance allows companies to accept new clients and avoid the need to raise additional capital.
  5. Expertise - The expertise of another insurer can help a company obtain a proper rating and premium.

(For more on this topic, read When Things Go Awry, Insurers Get Reinsured.)

This question was answered by Steven Merkel.

RELATED FAQS
  1. Why do some companies in the insurance sector engage in reinsurance?

    Discover how some companies in the insurance sector engage in reinsurance. Reinsurance allows insurance companies to transfer ... Read Answer >>
  2. What is the average return on total revenue for the insurance sector?

    Learn about the three main segments of the insurance industry, and find out what the average return on revenues is for the ... Read Answer >>
  3. What caused the European / Eurozone debt crisis?

    Understand how insurance companies price insurance premiums, and learn the importance of data and statistics in the insurance ... Read Answer >>
  4. Can your insurance company cancel your policy without notice?

    Learn about your rights as an insured when it comes to your insurance policy being canceled, including how to access your ... Read Answer >>
  5. What risks do I face when investing in the insurance sector?

    Read about the unique challenges faced by insurers, and learn how those challenges manifest themselves as risks for equity ... Read Answer >>
  6. What are the main factors that impact share prices in the insurance sector?

    Learn about some of the main factors that impact share prices in the insurance sector. Insurance companies make money by ... Read Answer >>
Related Articles
  1. Investing

    The Industry Handbook: The Insurance Industry

    As a result of globalization, deregulation and terrorist attacks, the insurance industry has gone through a tremendous transformation over the past decade. In the simplest terms, insurance of ...
  2. Personal Finance

    Exploring Advanced Insurance Contract Fundamentals

    Understanding your contract can help you protect our family's financial security.
  3. Personal Finance

    Bundle Your Insurance For Big Savings

    Bundling your insurance can save you money and time. Read on to see how get the most out of multiline insurance discounts.
  4. Markets

    5 Reinsurance Stocks To Watch

    Due to the decline in the reinsurance sector, many stocks within the sector are now trading at historic lows relative to book value. For investors, the time may be right to pounce on the values.
  5. Personal Finance

    What Happens If Your Insurance Company Goes Bankrupt?

    When insurance companies go bankrupt or face financial difficulty, it's bad news for policy holders.
  6. Personal Finance

    The History Of Insurance In America

    Insurance was a latecomer to the American landscape, largely due to the country's unknown risks.
  7. Managing Wealth

    How Does Reinsurance Work?

    Reinsurance is a practice in which insurers transfer portions of portfolios to other parties in order to reduce their exposure to claims.
  8. Markets

    The 5 Biggest Canadian Insurance Companies

    Learn more about the insurance industry as a whole, how it functions in Canada, and the five largest Canada-based insurance companies.
  9. Personal Finance

    How Much Life Insurance Should You Carry?

    Learn how much - if any - insurance you really need.
  10. Personal Finance

    The Dangers Of Stranger-Owned Life Insurance

    Find out how these policies can be used to abuse the system that many people rely on for protection.
RELATED TERMS
  1. Reinsurance Recoverables

    The portion of an insurance company’s losses from claims that ...
  2. Portfolio Reinsurance

    A type of reinsurance contract in which an insurer has a large ...
  3. Reinsurer

    A company that provides financial protection to insurance companies. ...
  4. Reinsurance

    The practice of insurers transferring portions of risk portfolios ...
  5. Net Line

    The amount of risk that an insurance company retains after subtracting ...
  6. Prospective Reinsurance

    A reinsurance contract in which coverage is provided for future ...
Trading Center