What is the primary purpose of reinsurance?

The primary purpose of reinsurance is to mitigate risk by protecting against significant losses. Reinsurance serves as a financial safety net for insurance companies, allowing them to transfer portions of their risk to other insurers. This process helps primary insurers manage their exposure to large claims that could potentially threaten their financial stability. By sharing the risk, insurers can stabilize their loss ratios and ensure they have enough reserves to cover potential payouts, particularly from catastrophic events.

This risk management tool not only allows insurers to write more policies without overextending their liability, but it also enables them to offer coverage for higher limits than they could otherwise support on their own. Consequently, reinsurance plays a crucial role in maintaining the overall health of the insurance market, as it promotes financial resilience among insurers.

Other options, while they may reflect certain aspects of the insurance industry, do not encapsulate the fundamental purpose of reinsurance as effectively. For instance, while promoting competition might be a consequence of reinsurance in some contexts, it is not the primary function. Similarly, increasing profit margins or ensuring all claims are fully paid does not align with the essential role of reinsurance, which is fundamentally about risk management.