The possibility that either one of the parties to a contract will not be able
to satisfy its financial obligation under that contract. The classic example is
that of one commercial enterprise extending credit to another enterprise or
individual. Many insurance arrangements, especially finite risk programs, also
involve varying degrees of credit risk—on both sides of the
transaction—depending on the financial stability of the parties. Since
insurance and reinsurance companies are leveraged (i.e., their capital supports
many times its value in outstanding policy limits), an unforeseen number of
severe losses could impair such capital. While it is generally assumed that
credit risk is borne by the insured or ceding insurer (under a reinsurance
contract), insurance and reinsurance companies also bear credit risk.