What does reinsurance specifically protect against?

Reinsurance specifically protects against catastrophic losses, which are large-scale losses that can significantly impact an insurance company’s financial stability. This mechanism involves one insurance company purchasing insurance from another to mitigate exposure to risk. By transferring a portion of their risk to a reinsurer, primary insurers can manage the financial implications of potential large claims, maintaining their solvency and protecting their policyholders.

Catastrophic losses can arise from events such as natural disasters (hurricanes, earthquakes, floods) or large-scale liability claims. Since these events can create extraordinary financial burdens, reinsurance permits insurers to spread the risk across the wider insurance market, thus reducing the likelihood of severe financial strain in the wake of such events.

Regular business expenses, small claims, and fraudulent claims are not the primary focus of reinsurance. Regular business expenses relate more to operational costs that are not directly connected to the insurance risk itself, while small claims are typically handled within the regular underwriting capacity of an insurer. Fraudulent claims, though serious, are addressed through different loss prevention and investigation strategies rather than through reinsurance.