What is reinsurance and why do insurers use it?

• A. Insurance for policyholders only.
• B. Insurance for insurers to spread risk, increase capacity, stabilize results.
• C. A type of investment product.
• D. A regulatory requirement.

Answer: (B)

Reinsurance is a risk transfer arrangement where an insurer passes part of its risk to another insurer. This helps the primary insurer reduce exposure to large or unexpected losses and increases the amount of risk it can take on, i.e., its underwriting capacity. It also helps smooth financial results and protect solvency after big losses or catastrophes, by providing a cushion when claims spike.

Insurers use reinsurance to spread risk, expand capacity to write more policies or enter new lines of business, and stabilize profits and balance sheets over time. It’s not for policyholders, it’s not an investment product, and it isn’t a regulatory requirement—it's a risk-management tool used by insurers to manage exposure and maintain financial stability.