In which situation might reinsurance be utilized?

Reinsurance is a critical tool used by insurance companies to manage risk. In particular, it is employed to mitigate significant loss risks associated with large policies. By ceding part of the risk to a reinsurer, an insurer can protect itself from catastrophic losses that could arise from high-value claims or a clustering of claims (such as from a natural disaster). This allows the primary insurer to stabilize its loss experience, maintain adequate reserves, and ultimately improve its financial strength.

When an insurer takes on a significant policy, it must consider the implications of that risk on its overall portfolio. Reinsurance enables the insurer to spread the risk among several parties, ensuring that it is not overly exposed to any single loss. This practice fosters a more sustainable approach to underwriting and helps insurers remain solvent even in the face of adverse situations.

In contrast, options related to expanding market presence or collecting premiums from low-risk policies do not directly involve the principles of risk management associated with reinsurance. Compliance with state insurance regulations also typically pertains to licensing and operational requirements, rather than the financial strategies of risk mitigation that reinsurance offers. Therefore, the use of reinsurance specifically to manage the risk of large policies is a fundamental reason this choice is the most appropriate.