Reinsurance

Reinsurance is a practice in which an insurance company, called the ceding company, transfers a portion of its risk to another insurance company, known as the reinsurer. Like a traveler sharing the weight of their load with a fellow wanderer, reinsurance allows insurers to spread risk, reduce exposure to losses, and maintain financial stability in the face of unexpected or catastrophic events.

Example

An insurance company issues a policy to cover a large commercial building worth $100 million against fire damage. To limit its potential liability in the event of a catastrophic loss, the insurer may purchase reinsurance for a portion of the risk, say $50 million. If the building suffers fire damage resulting in a $75 million loss, the original insurance company would pay the first $50 million, and the reinsurer would cover the remaining $25 million. Reinsurance helps insurers manage their risk, maintain solvency, and offer coverage for high-value or high-risk policies that might otherwise be unaffordable or unavailable.