Why do insurers purchase reinsurance?

Insurers purchase reinsurance largely to protect themselves from catastrophic loss. Reinsurance acts as a safety net, allowing primary insurers to transfer a portion of their risk to another insurance company. By doing this, they can manage the financial impact of large, unexpected claims that could otherwise threaten their solvency. When a catastrophic event occurs, such as a natural disaster, the costs can exceed the insurer's capacity to pay claims. Reinsurance provides a way to share these risks, thereby stabilizing the insurer's financial health and ensuring that they can meet their obligations to policyholders.

This practice allows insurers to write more policies and take on a greater amount of risk, knowing they have reinsurance coverage to back them up during particularly difficult times. Understanding this concept is crucial for managing risk effectively in the insurance industry.