What does 'reinsurance' involve?

Reinsurance involves the practice of an insurance company sharing its risk exposure with another insurer, typically to reduce the potential financial impact of significant claims. This arrangement allows the primary insurer to manage its risk more effectively, as it can offload a portion of the losses it may face to the reinsurer. This is essential in protecting the company's financial stability, especially in cases of catastrophic events that could lead to large claims.

Through reinsurance, the primary insurer can also increase its capacity to underwrite more policies without excessively increasing its risk exposure. It usually operates on a risk-sharing basis, where the reinsurer assumes specified portions of the losses from a defined book of business, allowing for more effective capital management and risk distribution across the insurance market.

The alternative options do not accurately encapsulate the concept of reinsurance. For example, insurance purchased by clients refers to the coverage individuals or businesses acquire directly from an insurer, and a policy sold to third parties does not represent the reinsurance structure but rather direct insurance transactions. Elimination of all insurance risks is not feasible; rather, reinsurance mitigates risks rather than eradicating them entirely.