Reinsurance

Insurers face the risk that a single catastrophic event, such as a major hurricane or earthquake, or an unusually high number of claims, could produce losses large enough to threaten their financial stability. Reinsurance spreads these risks more widely.

There are two broad forms. In proportional reinsurance, the reinsurer takes a fixed share of the premiums and pays the same share of the claims. In non-proportional reinsurance, the reinsurer pays only when losses exceed a certain level. For example, an insurer might keep the first 10 million of losses from any single event, with a reinsurer covering losses between 10 million and 100 million.

Reinsurance allows insurers to write more policies than their capital alone would support, to reduce the volatility of their results and to protect against catastrophic events.

The largest reinsurers operate globally and spread their risks across many countries and types of insurance. Reinsurers sometimes buy reinsurance themselves, called retrocession. Some catastrophe risks are also transferred to investors through catastrophe bonds, which pay high interest but can lose their principal if a specified disaster occurs.