Why do most insurers purchase reinsurance?

Insurers purchase reinsurance primarily to protect against catastrophic loss. This means that when an insurance company faces a risk that could incur significant financial loss, such as natural disasters or widespread claims from an epidemic, reinsurance serves as a safety net. By transferring a portion of their risk to a reinsurer, the primary insurer can limit the potential impact of large claims on their financial stability. This arrangement allows the primary insurer to maintain solvency, manage their capital effectively, and continue providing coverage to policyholders even in the face of substantial losses.

While increasing profits, managing claim settlements, or expanding coverage areas can be secondary benefits of reinsurance, they do not capture the essence of why reinsurance is fundamentally important. It primarily serves the critical function of risk management, particularly in safeguarding against extreme or unpredictable events that could threaten the insurer's viability.