Reviewed by Sep 30, 2020| Updated on
Reinsurance is a type of insurance that is purchased by insurance companies to reduce risk. Essentially, reinsurance may restrict the cost of damages that the insurer can theoretically experience. In other words, it saves insurance providers from financial distress, thus shielding their clients from undisclosed risks.
In simple words, reinsurance is nothing but insurance for companies which provide insurance. Reinsurance is a tool used by insurance firms to minimize their liability or to mitigate their exposure to a single catastrophic incident.
By distributing the risk, an insurance firm can take those clients on board whose coverage might be too burdensome for a single insurance company to deal with on its own. The premium paid by the insured is usually distributed among all the insurance companies concerned when reinsurance occurs.
In case a single company takes the liability on its own, the cost of covering the expenses could eventually end up with the insurance firm being financially ruined or even bankrupt in the worst-case scenario. This may also result in the firm not being able to compensate for the losses that the original company had paid for the insurance premium.
The risk associated with substantial coverage can be spread systematically among other companies.
Reinsurance allows companies to limit their losses by distributing specific risks with other companies. This can help in freeing up additional capital for the companies.
Reinsurance gives companies the provision to accept new clients with the purchase of additional relief insurance.