Insurance Broker Certification Practice Exam

What is the primary purpose of reinsurance?

1. To reduce policyholder premiums

2. To pool risks among multiple insurers

3. To protect insurers against catastrophic losses

4. To increase competition among insurers

The correct answer is: To protect insurers against catastrophic losses

Reinsurance primarily serves the purpose of protecting insurers against catastrophic losses. In the insurance industry, insurers assume risk when they underwrite policies. However, large or unexpected losses can threaten an insurer's financial stability. Reinsurance allows insurers to transfer a portion of their risk to another entity, known as a reinsurer. This mechanism helps maintain the insurer's solvency by mitigating the financial impact of significant claims. Reinsurers provide additional capacity for insurers to underwrite more policies and larger risks, knowing they have a safety net in place. This support is crucial during events such as natural disasters, where the volume and magnitude of claims could exceed an insurer's resources. While options related to reducing premiums or increasing competition may occur as a side effect of effective reinsurance strategies, the central and most critical role of reinsurance remains to equip insurers with protection against large-scale losses.