What Is Reinsurance

Reinsurance is insurance that is purchased by an insurance company (insurer) from another insurance company (reinsurer) as a means of risk management, to transfer risk from the insurer to thereinsurer. The reinsurer and the insurer enter into a reinsurance agreement which details the conditions upon which the reinsurer would pay the insurer's losses (in terms of excess of loss orproportional to loss). The reinsurer is paid a reinsurance premium by the insurer, and the insurer issues thousands of policies.
For example, assume an insurer sells one thousand policies, each with a $1 million policy limit. Theoretically, the insurer could lose $1 million on each policy  – totaling up to $1 billion. It may be better to pass some risk to a reinsurance company (reinsurer) as this will minimize the insurer's risk.