Insurance and reinsurance provide financial protection to an individual or company to guard against risk. They both allow for the transfer of potential loss from one entity to another in exchange for a financial payment in the form of a premium. They each function to pool risk; however, risk is transferred in different ways.
Insurance is a tool used by individuals to manage risk. Insurance companies sell individuals insurance policies designed to guard against financial loss. In return, an individual pays the insurance company a fee (premium) for the policy. The policy serves as a promise that the insurance company agrees to reimburse a policyholder (insured) for his financial loss due to a disaster or some other circumstance that results in a loss of life or property that the policy covers. For example, when an auto insurance policyholder has an accident, the insurer (insurance company) reimburses him for injuries and damage to his vehicle.
Reinsurance is also a tool used to manage risk. Unlike insurance which protects individuals from financial loss, reinsurance protects the insurance company from financial loss. It offers an insurance company protection by spreading risk among several insurance companies in a pool that agrees to back the policies sold by the company. This enables an insurance company to cover more individuals without fear of incurring significant financial loss should a disaster occur, resulting in multiple policyholders filing claims at one time.
A number of insurance products exist to protect an individual's property from potential loss. For instance, an individual can purchase life, homeowner's or business liability insurance, to name just a few. Each product covers a different asset and offers the insured different benefits. Alternatively, reinsurance is a specific product purchased by an insurance company to guard against its financial loss by transferring risk to multiple companies.
The premium paid for insurance by an individual goes directly to the insurance company that provides the policy. The premium payment paid by an insurance company for reinsurance, on the other hand, is shared with all of the insurance companies in the risk pool.