What is the primary purpose of excess of loss reinsurance?

Excess of loss reinsurance serves a crucial function in the risk management strategies of insurance companies. Its primary purpose is to protect insurers from severe claims that could significantly impact their financial stability. This type of reinsurance kicks in when the losses from a particular event exceed a predetermined threshold, allowing insurers to limit their potential losses on particularly large or catastrophic claims.

By utilizing excess of loss reinsurance, insurers can manage their risk exposure more effectively, ensuring that even in the event of high-value claims, their financial resources remain intact. This is particularly important for maintaining solvency and securing the ability to pay out claims to policyholders, thus supporting the overall health of the insurance market.

While other options may sound relevant to the insurance industry—such as routine losses, predictable premiums, or enhancing policyholder benefits—these aspects do not capture the essence of excess of loss reinsurance. This type of reinsurance specifically addresses the need for protection against extremes in claims frequency and severity, which is imperative for the sustainability of an insurer’s operations.