Reinsurance is a means by which an insurance company can protect itself with other insurance companies against the risk of losses.
Individuals and corporations obtain insurance policies to provide protection for various risks (hurricanes, earthquakes, lawsuit, collision, sickness or death, etc).
Reinsurers, in turn, provide insurance to insurance companies. The company requesting the cover is called the cedant and the reinsurer can be called the ceded, although the latter term is not in common use.
There are many reasons why an insurance company would choose to reinsure as part of its responsibility to manage a portfolio of risks for the benefit of investors.
Risk transfer:
The main use of any insurer that might practice reinsurance is to allow the company to assume greater individual risks than its size would otherwise allow, and to protect a company against losses. Reinsurance allows an insurance company to offer higher limits of protection to a policyholder than its own assets would allow.
For example, if the principal insurance company can write only $100 million in limits on any given policy, it can reinsure (or cede) the amount of the limits in excess of $100 million.
Reinsurance’s highly refined uses in recent years include applications where reinsurance was used as part of a carefully planned hedge strategy.
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