What does reinsurance involve?

Reinsurance involves the transfer of risk from one insurer to another. This process is crucial in the insurance industry because it allows primary insurers to mitigate their risk exposure by sharing it with other insurance companies. When a primary insurer issues a policy and takes on risk, it may decide to purchase reinsurance to protect itself against potential large losses that could arise from claims.

For example, if an insurer underwrites a large number of homeowners' insurance policies in a flood-prone area, it may seek reinsurance to limit its liability in case of a catastrophic event like a hurricane. This practice helps stabilize the insurance market and allows insurers to maintain solvency, ensuring they can pay claims while continuing to operate effectively.

While the management of insurance claims, the sale of insurance to individuals, and the underwriting of new insurance policies are indeed important functions within insurance operations, they do not accurately describe the concept of reinsurance specifically focused on risk transfer.