Understanding Underlying Retention
Underlying retention refers to the portion of risk that a ceding insurance company keeps for itself after it has transferred (ceded) a part of the risk to a reinsurer. The aim here is essentially to strike a balance between risk retention and risk transfer. This strategy enables the primary insurer to retain control over profitable or low-risk segments, leveraging them to offset the costs associated with high-risk policies by passing these risks on to the reinsurer.
Key Concepts of Underlying Retention
Underlying retention is not just a policy choice but a strategic maneuver, reflecting the insurer’s appetite for risk and its analysis of the profitability spectrum of policies under its belt. This retention boosts the insurer’s liquidity by saving on reinsurance premiums while maintaining a shield against potential high losses through reinsurance.
Application in Reinsurance Models
Proportional Reinsurance
In proportional reinsurance agreements, reinsurers share in the premiums and losses of the ceding insurer proportionally. This type of reinsurance often includes quota share and surplus share treaties, where the reinsurer’s participation may vary based on the agreement terms.
Non-Proportional Reinsurance
Contrary to the proportional model, non-proportional reinsurance comes into play when losses exceed a predetermined threshold. This model is favored in scenarios where high-severity losses are plausible but infrequent, such as natural disasters or catastrophic events. Examples include excess-of-loss and stop-loss coverages.
Example in Practice
Consider an insurance company that has set its reinsurance treaty limit at $500,000 and decides on an underlying retention of $200,000. This decision implies that the insurer retains the first $200,000 of risk itself, potentially opting to cover small, low-risk claims that cumulatively do not surpass this retention limit. Larger or higher-risk exposures exceeding this threshold are ceded to the reinsurer, thereby stabilizing the financial risk and aiding in capital management.
Explore More!
Want to dive deeper into reinsurance strategies? Check out these terms:
- Catastrophe bonds: A high-yield debt instrument intended to raise money for companies in the insurance industry to cover losses from specified disasters.
- Solvent schemes of arrangement: Legal tools used in some jurisdictions to allow a company facing potential insolvency to restructure debt and obligations.
- Risk management framework: A structured approach that identifies, assesses, and prioritizes risks followed by coordinated efforts to minimize, monitor, and control probabilities and/or impact of unfortunate events.
Further Reading
To enhance your understanding of reinsurance and risk management, consider these books:
- “Reinsurance Fundamentals” by Risk Management Experts, which offers a primer into various reinsurance contracts and their strategic applications.
- “Managing Insurance Risk” by John Boardman, a detailed exploration into sophisticated risk management techniques in the insurance industry.
Ready to navigate the complexities of underlying retention and reinsurance? Understanding these concepts is more than just crunching numbers—it’s about sculpting a shield crafted from savvy decisions and solid strategies.
