Reinsurance in its simplest sense is insurance for insurance companies, that is purchased by an insurance company (the “ceding company” or “cedent” or “cedant” under the arrangement) from one or more other insurance companies (the “reinsurer”) directly or through a broker as a means of risk management.
The need for reinsurance arises due to the fact that any insurance company can only accept risk to the extent that its balance sheet allows. Where a large project or assets needs to be insured, the risk of which is bigger than the insurer can take on, the excess risk will be passed on to a reinsurer via a risk sharing arrangement.
The reinsurer then carries this risk against its balance sheet. Where the risk is very large, more than one reinsurance companies might be needed to carry the full extent of the risk.
A healthy reinsurance marketplace helps ensure that insurance companies can remain solvent (financially viable), particularly after a major disaster such as an earthquake, hurricane, or tsunami; because the risks and costs associated with such a major event is spread over the combined assets of the insurer and reinsurer/s.