What is Underlying Retention
Let me explain underlying retention directly: it's the net amount of risk or liability from an insurance policy or policies that you, as a ceding company, retain after reinsuring the balance. The level of this retention varies based on your assessment of the risks in keeping part of the policy liability and the overall profitability of the insurance policy.
Understanding Underlying Retention
You should know that underlying retention lets an insurer like you avoid paying reinsurance premiums. Typically, you'll retain the most profitable policies or their lowest-risk parts, while reinsuring the less profitable, higher-risk ones.
Reinsurance, which I often call insurance for insurers or stop-loss insurance, involves insurers transferring portions of their risk portfolios to other parties through agreements. This reduces the chance of having to pay out large obligations from claims.
Through reinsurance, you can stay solvent by recovering some or all of the amounts paid to claimants. It cuts down your net liability on individual risks and provides protection against catastrophes from large or multiple losses. Plus, it gives ceding companies like yours the ability to expand underwriting in terms of the number and size of risks.
Key Takeaways
Here's what you need to grasp: underlying retention enables you to skip reinsurance premiums by holding onto lower-risk components. As the ceding company, you assess the risks of retaining policy liabilities to pick which ones stay in your portfolio. This approach is particularly used in non-proportional reinsurance.
Reinsurance covers you against accumulated commitments, offering more security for your equity and solvency, and stabilizing results during unusual or major events. You can underwrite more policies or larger risks without spiking administrative costs for solvency margins. It also frees up substantial liquid assets for exceptional losses.
Underlying Retention in Reinsurance
In proportional reinsurance, the reinsurer gets a prorated share of all your policy premiums. When claims come in, they bear a portion of the losses based on a pre-negotiated percentage, and they reimburse you for processing, acquisition, and writing costs.
With non-proportional reinsurance, the reinsurer steps in if your losses exceed a specified amount, called the priority or retention limit. This means they don't share proportionally in your premiums and losses. The limit could apply to one risk type or an entire category.
Excess-of-loss reinsurance is a form of non-proportional coverage where the reinsurer handles losses over your retained limit. It's usually for catastrophic events, covering you per occurrence or for cumulative losses in a set period.
Under risk-attaching reinsurance, all claims established during the effective period are covered, no matter if the losses happened outside that period. But there's no coverage for claims starting outside the period, even if losses occurred while the contract was active.
Example of Underlying Retention
Consider this example to see it in action: suppose your insurance company has a reinsurance treaty limit of $500,000. You decide to retain $200,000 of insurance risk as underlying retention. That retained part mostly includes policies worth much less and with significantly lower risk. For instance, you might keep claims under $100,000, which are low-risk, in your portfolio. Meanwhile, policies with larger payouts, averaging $100,000, get reinsured. This way, you save on premium payments for those low-risk policies.
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