Reinsurance is an arrangement through which one insurance company transfers part of the risk it has assumed to another insurance company. The original insurer is commonly called the ceding insurer, while the company accepting the transferred exposure is the reinsurer.

Reinsurance enables an insurer to control the amount of risk retained on individual policies or across a portfolio. It can increase underwriting capacity, stabilize financial results, protect against catastrophic or unusually large losses, and assist with capital and solvency management. Depending on the arrangement, reinsurance may be structured on a facultative or treaty basis and may use proportional or nonproportional methods.

Importantly, reinsurance does not ordinarily change the policyholder ' s contractual relationship with the original insurer. The policyholder continues to look to the issuing insurer for payment of covered claims. Thus, the risk is not transferred back to the policyholder.

Risk avoidance is also incorrect. Reinsurance does not eliminate the existence of the underlying risk; instead, it reallocates some of its financial consequences between insurers.

Therefore, the defining function of reinsurance is to transfer risk from one insurer to another insurer, making D correct.

Study Guide Reference: General Insurance Concepts — reinsurance; risk transfer; ceding insurer; reinsurer; insurer risk management.