Insurers buy insurance of their own. Reinsurance exists because the events most capable of destroying an insurer are precisely the ones its own pooling cannot absorb.
Correlated events defeat local diversification
An insurer's pool works because individual losses are independent. A windstorm or earthquake produces thousands of claims from one cause simultaneously.
A regional insurer holding many policies in the affected area faces its entire book claiming at once, which no premium calculated on normal frequency could fund.
Reinsurance transfers that concentration to a counterparty whose own book spans many regions and perils, restoring the independence the local pool lacked.
Proportional and excess of loss are the two shapes
Proportional treaties share premiums and claims in a fixed ratio, so the reinsurer takes an agreed slice of everything the insurer writes.
Excess of loss contracts respond only above a threshold, leaving the insurer to absorb routine claims and covering the tail beyond a stated point.
Catastrophe protection is usually written in the second form, since the purpose is capital protection against severity rather than sharing ordinary losses.
Layers divide the exposure among many participants
Cover is arranged in stacked layers, each attaching at a higher loss level, with different reinsurers taking shares of each.
No single participant carries the whole exposure, which is what allows very large potential losses to be covered without concentrating them again.
Reinsurers themselves buy protection, called retrocession, distributing the risk further still through the international market.
Capital markets now absorb part of the tail
Catastrophe bonds transfer risk to investors, who receive a coupon and forfeit principal if a defined event occurs.
Because the triggering events are largely unrelated to financial markets, the returns are attractive to investors seeking exposure that does not move with their other holdings.
This has expanded the capital available for catastrophe cover well beyond what traditional reinsurers alone could supply.
Reinsurance pricing shapes what consumers can buy
When large events deplete reinsurers' capital, the price of cover rises and terms tighten, and primary insurers pass that through in premiums and reduced availability.
Withdrawal of affordable catastrophe reinsurance is often the direct reason home insurance becomes scarce in exposed areas, rather than any decision by the local insurer.
The market is therefore cyclical, alternating between periods of abundant capacity with soft pricing and periods of constraint following major losses.