Each line of insurance coverage has a different risk profile

If an insurance company was to insure numerous homes or cars in an area, and that area was heavily damaged, the insurance company could be facing financial hardship. Usually these storms happen in concentrated areas with the possibility of near-universal destruction in that area. No area of the country is immune from some major weather exposure, whether it is hurricanes, tornadoes, hailstorms or something else.

One example of how an insurance company uses reinsurance to mitigate risk is to decrease exposure to major catastrophic events. Insurance written by one insurer that limits the exposure of another is known as reinsurance. Or you can pay someone else to assume the risk. Some can't be mitigated, and you have to decide to either suspend that line of business or to write an insurance contract that limits your exposure. We look at all of the trends and try to determine what the issues are, then build a specific action plan for mitigating the most significant risks. An industrywide practice, followed in our own organization, is to have a professional risk-management function that does an analysis called a total risk profile. To "discriminate" is to recognize differences, such as when an individual has a limited amount of money to spend, and they must choose (discriminate) between two investments.

Insurance companies make business choices in selecting individual risks and in selecting the overall amount of risk they're comfortable with. Well-run companies, regardless of the industry, have a similar process of identifying, evaluating and mitigating risks. Purchasing reinsurance is just one of many potential strategies companies can use to avoid or mitigate the risks confronting their businesses. In this example, buying reinsurance helps the insurance company mitigate its exposure to large catastrophic events and the resulting financial impact in the same fashion as buying insurance helps an individual protect him or herself from the economic consequences of damage to personal property. For a price, the company can transfer ("reinsure") a portion of that exposure to another company. Just as that person would review all of the objective merits that make one investment better than another, an insurance company, before choosing to invest (take a risk), makes choices in their underwriting selection process.