What does reinsurance provide to insurance companies?

Reinsurance is a crucial mechanism for insurance companies, as it allows them to take on greater risks by providing a safety net against potential large losses. When an insurance company underwrites policies, it assumes the risk of paying out claims. However, if the total claims exceed the company's capacity to pay, it could face financial difficulties. By engaging in reinsurance, insurance companies can transfer a portion of their risk to other insurance firms (the reinsurers). This arrangement enables primary insurers to write more policies and take on larger risks than they would be able to do on their own, effectively stabilizing their financial position and allowing them to operate more confidently in the market.

This risk-sharing strategy can lead to greater underwriting capacity, allowing insurers to expand their coverage and product offerings. It ultimately leads to enhanced financial stability for the insurance company, which is critical in ensuring that they can meet their obligations to policyholders in the event of significant claims.