California Life and Health Insurance Practice Exam

An insurer enters into a contract with a third party to insure itself against losses from insurance policies it issues. What is this agreement called?

1. Underwriting

2. Reinsurance

3. Coinsurance

4. Self-insurance

The correct answer is: Reinsurance

The agreement referred to in the question is known as reinsurance. This is a practice where an insurance company, essentially the primary insurer, transfers a portion of its risk to another insurer, known as the reinsurer. This allows the original insurer to manage its exposure to potential losses and maintain stability in its financial performance. Reinsurance helps to mitigate the risks associated with underwriting policies by allowing the primary insurer to offload some of their liabilities. This is particularly beneficial in cases where the potential claims from policyholders might exceed the insurer’s capacity to pay. It acts like an insurance policy for insurers themselves, enabling them to underwrite larger policies and diversify their risk. Underwriting, on the other hand, refers to the process of evaluating and analyzing risk when an insurer assesses applicants for policies, setting the terms of coverage and pricing. Coinsurance involves sharing risk between multiple parties, often seen in property insurance where different insurers share in the coverage of the same risk. Self-insurance is a strategy where an individual or business sets aside funds to cover potential losses instead of purchasing an insurance policy, taking on the full risk themselves. Understanding reinsurance is important for grasping how insurers manage risk and maintain financial health in a competitive market.