What does "reinsurance" mean?

Reinsurance is a crucial concept in the insurance industry, referring to a financial arrangement where an insurance company (the ceding company) transfers a portion of its risk to another insurance company, known as the reinsurer. This transfer helps the ceding company manage its risk exposure, ensuring it has sufficient capacity to cover potential claims. By doing so, insurers can maintain stability in their operations, protect themselves against large losses, and ultimately offer more coverage to their policyholders while mitigating financial liabilities.

In this context, reinsurance acts as a safety net for insurers. It allows them to underwrite policies confidently, knowing that they can share the risk associated with high-value or high-frequency claims with another party. This practice is essential for maintaining resilience within the insurance market, especially following catastrophic events that could lead to significant claims.

Other options describe scenarios that do not capture the essence of reinsurance. For instance, the idea that policyholders must pay additional premiums refers to a different aspect of insurance, while insurance policies covering only catastrophic events are more aligned with specialized insurance products rather than the risk-sharing mechanism of reinsurance. The notion of limiting claims payouts pertains to claims management practices that involve reserves or claims handling, rather than the financial strategy of risk transfer inherent in reinsurance