Reinsurance tutorials #38
What is retrocession?
Retrocession is a transaction by which a reinsurer transfers risks it has reinsured to another reinsurer.
This following exchange often comes up during dinners, where one of the participants starts being asked questions about his profession as a reinsurer:
- I work in the reinsurance industry.
- Oh, what is that?
The reinsurer tries to explain his job in the best, simplest manner.
- So, all insurance companies have reinsurance?
Then the other replies, with a smile:
- Do you have reinsurance yourself?
- Well, yes.
They either look up to the sky,whistle and say:
- So it’s never-ending; your reinsurer is also reinsured by another reinsurer.
- Well, yes.
And the reinsurer elaborates, but not too much because everyone else is yawning…
Or they simply freeze and ask the reinsurer if he thinks they are paying too much for their motor insurance policy.
A retrocession is placed to afford additional capacity or reinsurance companies cede risks under retrocession agreements to other reinsurers, for reasons similar to those that cause primary insurers to buy reinsurance.
To get additional capacity, to optimize capital allocation, to spread risk across space and time, to be financially sound and be able to face major upsets, reinsurers need to be careful when reinsuring the retrocession treaties of other reinsurance companies.
Indeed, there is a danger called the ‘spiral effect’.
It became famous in the eighties when a big loss triggered claims in many reinsurance unions which were reinsuring themselves. The loss kept increasing, with one union claiming against different reinsurers B, C and D who, in turn, would claim part of it back against union A – a vicious circle would thus take place, referred to as a spiral.
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