Reinsurance is one of the most frequently used insurance terms. Before explaining what insurance is, the de facto dictionary meaning of reinsurance should be given. The dictionary meaning of Reinsurance is;
insurance bought by an insurance company to protect itself against large demands from its customers:
Insurance companies insure some highly valuable assets etc. In such a case, the companies may not be able to pay the whole loss and in order to decrease their risks, they want to split the total risk and give some part of it to another company. The company that takes a certain part of the insurance risk from an insurance company is called a Reinsurance company and the process is called reinsurance.
Think that an insurance company insured a very expensive building which is worth 1 billion dollars in total including the assets in the building. If this building collapses, an average-sized insurance company would probably not cover the whole worth of the building which is 1 billion dollars. In order not to face such a loss, the insurance company shares the risk with a Reinsurance company. In this case, it can be thought of as the Reinsurance company insures the insurance company. At the end, if a loss occurs, the insurance company and the Reinsurance company split the total loss between each other and pay for the loss together.