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

Insurers utilize reinsurance as a method to protect themselves against catastrophic losses. Reinsurance involves transferring a portion of the risk associated with insurance policies to another insurance company, known as the reinsurer. This practice allows primary insurers to reduce the likelihood of significant financial strain that could result from large claims, such as those stemming from natural disasters or other catastrophic events.

Reinsurance functions as a safety net, enabling insurers to maintain stability in their operations by sharing the risk. Therefore, when an insurer underwrites a policy, it may not retain all the potential liabilities; instead, it can cede part of the risk to a reinsurer. This helps to ensure that even in the face of severe losses, the primary insurer’s financial health remains intact, allowing them to continue serving their policyholders effectively.

In contrast, deductibles, self-insurance, and reserve funds are methods related to managing risk at the policyholder or insurance company level rather than transferring it to another entity. While each of these methods plays a role in an insurer's overall risk management strategy, reinsurance specifically addresses the need for protection against large, unexpected losses.