South Carolina Life Insurance Practice Exam

What method do insurers use to protect themselves against catastrophic losses?

1. Self-Insurance

2. Reinsurance

3. Safety Margins

4. Loss Retention

The correct answer is: Reinsurance

Insurers use reinsurance to protect themselves against catastrophic losses by transferring a portion of their risk to another insurance company. This process allows insurers to manage their overall exposure to large claims and helps maintain their financial stability in the face of unexpected, significant losses, such as those that may arise from natural disasters or other large-scale events. By utilizing reinsurance, an insurer can ensure that they have adequate capital to cover claims while mitigating the risk of over-exposure to any single event or policyholder. This practice not only protects the insurer's financial health but also contributes to the overall stability of the insurance market. In contrast, other methods such as self-insurance, safety margins, and loss retention do not provide the same level of shared risk management. Self-insurance involves a company retaining its own risk instead of purchasing full insurance coverage, which could lead to greater vulnerability during catastrophic events. Safety margins refer to financial reserves set aside to cover potential losses, but they don’t provide as robust a solution for large, unexpected claims. Loss retention means that an insurer decides to assume the responsibility of certain losses, which, while practical for minor losses, does not offer the same protective mechanism against catastrophic risks as reinsurance.