What is Underlying Retention
The underlying retention is the net amount at risk Where responsibility resulting from one or more insurance policies retained by a ceding company after reinsurance of the balance of the risk or the liability. The degree of underlying retention will vary depending on the ceding company’s assessment of the risks of retaining some of the policy liabilities and the profitability of the insurance policy.
Understanding Underlying Retention
The underlying retention allows an insurer to avoid paying the reinsurance premium. The insurer will generally retain the most profitable policies or their least risky components while reinsuring the least profitable and riskiest policies.
Reinsurance, also called insurance of insurers or stop loss insuranceis the practice of insurers transferring parts of risk portfolios to other parties by some form of agreement to reduce the likelihood of paying a material obligation arising from a insurance claim.
Reinsurance allows insurers to remain solvent by recovering all or part of the sums paid to claimants. Reinsurance reduces the net liability on individual risks and catastrophe protection against large or multiple claims. It also provides ceding companies the ability to increase their subscription capabilities in terms of number and size of risks.
Key points to remember
- Underlying retention allows insurers to avoid the payment of reinsurance premiums by retaining their lower risk components.
- The ceding company assesses the risks associated with keeping part of the policy liabilities in order to select the policies that can be kept in its portfolio.
- The underlying retention is used in case of non-proportional reinsurance.
By covering the insurer against accumulated individual liabilities, reinsurance gives the insurer more security for its own funds and solvency and more stable results when unusual and major events occur. Insurers can subscribe policies covering a greater quantity or volume of risks without excessively increasing the administrative costs to cover their solvency margins. In addition, reinsurance provides insurers with substantial liquidity in the event of exceptional claims.
Reinsurance underlying retention
Under proportional reinsurance, the reinsurer receives a pro rata share of all policy premiums sold by the insurer. When claims are made, the reinsurer bears a portion of the losses based on a pre-negotiated percentage. The reinsurer also reimburses the insurer for processing, business acquisition and drafting costs.
With non-proportional reinsurance, the reinsurer is liable if the insurer’s losses exceed a specified amount, called a priority or retention limit. Therefore, the reinsurer does not have a proportional share in the insurer’s premiums and losses. The priority or retention limit can be based on a risk type or on an entire risk category.
Excess of loss reinsurance is a type of non-proportional cover in which the reinsurer covers losses exceeding the limit retained by the insurer. This contract is generally applied to catastrophic events, covering the insurer either on a per event basis or for losses accumulated over a defined period of time.
Under risk-based reinsurance, all claims recorded during the effective period are covered, whether or not the claims occurred outside the coverage period. No coverage is provided for claims arising outside of the coverage period, even if the losses occurred while the contract was in force.
Example of underlying retention
Suppose an insurance company has a reinsurance treaty limit of $500,000. He elects to retain $200,000 of insurance risk as the underlying retention. This retained portfolio consists mostly of policies that are worth much less and carry much lower risk. For example, the company may choose to keep receivables under $100,000, which carry much less risk, in its portfolio. On the other hand, policies that for higher amounts, averaging $100,000 in payments, are reinsured. Thus, the reinsurer saves money on premium payments for low-risk policies.