Reinsurance tutorials #37
What is retention?
Retention is the amount of insurance liability (in pro rata, for participation with the reinsurer) or loss (in excess of loss, for indemnity of excess loss by the reinsurer) which an insurer assumes (or retains) for its own account.
In pro rata contracts, the retention will be a percentage of the policy limit for QS but the retention will be an amount – a Line – in respect of SURPLUS treaties.
In non-proportional treaties, the retention can be an amount – the PRIORITY – or it can be a percentage in case of a Stop Loss.
Here below is an example that can be used to determine the right level of retention, i.e. whether it should be HIGH or LOW.
In the case of a QS where the retention is 50% or more, the Ceding party wants to keep a large amount of this treaty from the reinsurer. The Company has skin in the game. It is important to know if this retention remains un-reinsured, since it is a net retention.
Because the company retains 50% or above, it could protect this large retention with an XL cover, and it will depend on the level of the priority or attachment point of this XL to determine if the company really does have some skin in the game.
On the opposite side, a company having a retention of only 5% would want to cede as much risk as possible to the reinsurer. And it could make sense if it is a new line of business where the company needs to learn its way and needs a big support from the reinsurer.
Fixing the retention of a pro rata treaty is a key element, taking into account:
- Capital management
- Volatility linked to Severity, Frequency and Accumulations
- Shareholder’s Appetite (above average ; below average)
- Sum Insured or PML-based
In case of a Surplus treaty, the retention is expressed as a line and the cession is expressed as a number of lines.
There may be a Table of Retentions where the company will allow more capacity to certain lines of business depending on their quality, the retention line remaining the same.
In some cases, the company could also use a variable retention (with a minimum and a maximum amount) depending on its strategy and on the degree of risk involved with each class of risks.
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