What is Underlying Retention?
Underlying retention is the net amount of risk or liability arising from an insurance policy or policies retained by a ceding company after reinsuring the balance of the risk or liability. The degree of underlying retention depends on the ceding company’s assessment of the associated risks and the profitability of the insurance policy.
Benefits of Underlying Retention
Reducing Reinsurance Premiums
Underlying retention allows insurers to sidestep the payment of reinsurance premiums by keeping the most profitable or lowest-risk policies and reinsuring the high-risk ones.
Maintaining Liquidity and Solvency
Reinsurance helps insurers stay solvent by recovering some or all of the funds paid out to claimants. This reduces net liability and provides catastrophe protection from significant or multiple losses. It also affords ceding companies the capacity to expand their underwriting capabilities, both in number and size.
Key Takeaways
- Optimize Costs: Insurers avoid reinsurance premiums by keeping low-risk policy segments.
- Risks Assessment: The ceding company evaluates and decides on the retainable portion based on their risk appetite.
- Non-Proportional Reinsurance: Underlying retention particularly benefits non-proportional reinsurance arrangements.
By absorbing individual obligations in aggregated form, reinsurance provides insurers with greater security, stable results during major events, and support for larger policy volumes without steep adjustments in administrative costs. If exceptional losses occur, reinsurance ensures insurers have liquid assets on hand.
Underlying Retention in Reinsurance
Proportional Reinsurance
In proportional reinsurance, the reinsurer receives a share of all premiums collected by the insurer. When claims are made, they also share in the losses based on an agreed upon percentage. The reinsurer additionally reimburses the insurer for processing costs, business acquisition, and policy writing.
Non-Proportional Reinsurance
With non-proportional reinsurance, the reinsurer covers losses exceeding a specified amount, known as the priority or retention limit. Here, they do not share proportionally in premiums and losses. The limit can be assigned to specific risk types or to an entire risk category.
Excess-of-Loss Reinsurance
For excess-of-loss reinsurance, the reinsurer takes charge of losses that exceed the insurer’s predetermined limit. This coverage type is usually applied to catastrophic events, covering per-occurrence or cumulative losses within a set period.
Risk-Attaching Reinsurance
Under risk-attaching reinsurance, all claims within the effective period are covered regardless of when the loss occurred. Losses outside this period are not covered even if the claim was filed while the contract was active.
Example of Underlying Retention
Imagine an insurance company with a reinsurance treaty limit of $500,000 decides to retain $200,000 of risk as its underlying retention. The retained portfolio might consist of policies worth less, generally under $100,000, and thus carrying lower risks. For instance, keeping claims below $100,000 lets the company save on premium payments and minimizes risk exposure. Larger policies, averaging $100,000 in payouts, are then reinsured.
Related Terms: insurance retention, reinsurance treaty, liability, ceding company, solvency.
