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